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March 2019 Performance Update

April 5, 2019

With the Federal Reserve now more worried about the global economy than inflation, investors continued to jump back into stocks — causing U.S. markets to almost completely erase the sharp slide late last year.

With our long-term bond funds performing well, many of our stock funds beating the S&P 500, and even most of our shorts doing well (except for oil), we actually outpaced the S&P 500 in both portfolios and beat our balanced fund benchmark by a fairly wide margin in March — all at a lower risk profile.

Our Conservative portfolio gained 2.41%. Our Aggressive portfolio gained 1.97%. Benchmark Vanguard funds for March 2019 were as follows: Vanguard 500 Index Fund (VFINX) up 1.94%; Vanguard Total Bond Market Index Fund (VBMFX) up 1.96%; Vanguard Developed Markets Index Fund (VTMGX) up 0.42%; Vanguard Emerging Markets Stock Index (VEIEX) up 1.90%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.17%.

Long-term interest rates have plunged, as the Federal Reserve said they will dial back the money furnace that was essentially removing about $50 billion a month from the economy — a very slow rate of burn to the near $4 trillion in quantitative easing or "QE" money minted during the financial crisis. The recent action means more of the interest payments coming into the Fed on the bonds they bought with fabricated money will get recycled back into new bonds — essentially creating demand in the bond market and pushing down rates. This means mortgages get cheaper and we've seen a 30-year mortgage rate go from around 5% to around 4% in the last few months. Just the talk of this balance sheet reduction slowdown led investors to pile into long-term bonds.

But unless the Fed is now totally wrong about the economy and the economy is hotter than it looks globally, being more "accommodative" isn't going to kick off new boom times. At best, we may just avoid a recession. Bottom line, it's great that the Fed didn't cause a recession by fighting inflation too aggressively, but that won't create a boom either. It might create inflation (unlikely), but even that can be good for stocks and real estate. This is why investors like a Fed that errs on the side of too much inflation.

Normally, when the market is strong our shorts are weak, but last month, small cap, biotech, and gold were down while the market as a whole was up, boosting our shorts. Oil did continue this year's rally, hurting our oil short as the oil slide from last year reversed on optimism about lower interest rates and some oil production cuts.

The large cap growth vs small cap value performance gap was one of the worst over what has been a fairly wide performance gap over time, resulting from small cap value being overvalued about a decade ago relative to larger cap growth stocks. Large cap growth funds were up just over 2% for the month, while small cap value funds were down just over 3%.

Utilities were our strongest regular stock fund holding, with Vanguard Utilities (VPU) up 2.83% followed by some foreign markets that are rebounding well this year, driving iShares MSCI BRIC Index (BKF) up 2.72%, iShares Global Telecom ETF (IXP) up 2.51%, and iShares MSCI Italy Capped (EWI) up 2.36%. In general, higher yield stocks do well when rates go down, as the dividend yield becomes more attractive. As long-term bonds had a great month, we saw a 7.47% jump in Vanguard Extended Duration Treasury (EDV) and a 4.87% rise in Vanguard Long-Term Bond Index ETF (BLV). Our strong U.S. dollar limited the gains of SPDR Barclays Intl. Treasury (BWX) at 0.89% and Dodge & Cox Global Bond Fund (DODLX) at 1.23%.

Stocks in China seem to be benefiting from what looks like an improvement in the trade war, with funds in this area up almost 4% for the month (bested only by a near 10% rise in stocks in India). Latin American stocks were the only really weak area abroad, with a just over 3% slide for the month. Latin America has been the worst area over the last 5 years. Like small cap value, Latin American stocks got way too popular in the early 2000s. Financial sector funds were the worst sector, down 3.6%, as investors think the flat-to-negative yield curve is going to be bad for earnings.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)3.85%
Gold Short (DZZ)3.75%
Vanguard Utilities (VPU)2.83%
iShares MSCI BRIC Index (BKF)2.72%
iShares Global Telecom ETF (IXP)2.51%
iShares MSCI Italy Capped (EWI)2.36%
[Benchmark] Vanguard 500 Index (VFINX)1.94%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.90%
Vanguard Telecom Services ETF (VOX)1.80%
Homestead Value (HOVLX)0.91%
Vanguard European ETF (VGK)0.76%
Proshares Ultrashort NASDAQ Biotech (BIS)0.73%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)0.42%
Vanguard Europe Pacific ETF (VEA)0.17%
Vanguard Value (VTV)-0.12%
PowerShares DB Crude Oil Dble Short (DTO)-8.89%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)7.47%
Vanguard Long-Term Bond Index ETF (BLV)4.87%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.96%
Vanguard Mortgage-Backed Securities (VMBS)1.41%
Dodge & Cox Global Bond Fund (DODLX)1.23%
SPDR Barclays Intl. Treasury (BWX)0.89%

Febuary 2019 Performance Review

March 7, 2019

The market continued to recover quickly from the slide late last year. This year, the leaders are mostly the areas that fell the hardest during the mini-bear market of 2018. With foreign markets, value stocks, and lower credit risk bonds weak in February and our relatively low allocation to the hotter areas of the market (like tech and small cap), our model portfolios lagged the U.S. market.

Our Conservative portfolio gained 0.93%. Our Aggressive portfolio gained 0.73%. Benchmark Vanguard funds for February 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 3.20%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.06%; Vanguard Developed Markets Index Fund (VTMGX), up 2.18%; Vanguard Emerging Markets Stock Index (VEIEX), up 0.65%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.31%.

Our best performers were Homestead Value (HOVLX) and Vanguard Utilities (VPU), with 4.73% and 3.88% returns in February. This was a relatively weak month for value- and dividend-oriented stocks, so these were, to a certain extent, outliers. Telecom stocks were weak globally, with Vanguard Telecom Services ETF (VOX) and iShares Global Telecom ETF (IXP) barely up at all. Other than a 1.63% return shorting gold with Gold Short (DZZ), our weakest areas, as you would imagine, were short funds as global stocks and oil rose.

In bonds, all our funds fell except for a relatively new holding Dodge & Cox Global Bond Fund (DODLX), which is actively managed (not an index fund) and takes a little more credit risk than our other holdings that were held down by slightly rising interest rates.

The hottest areas last month included U.S. small-cap growth funds, up just over 6% in February, almost double the S&P 500. Stocks in China were hot, as their economy and stock market probably have more to gain if this trade war winds down because they have seen more of a drag to both.

Emerging markets in general performed about as well as the U.S. market last month. Investors were comfortable with risk again as higher credit risk bonds did well, even as safer, longer-term bonds were down. Technology stocks continued a sharp rebound, though energy stocks didn't rise with oil prices.

Much of this rebound is driven by relief that the Federal Reserve is no longer on inflation watch, risking causing our next recession to fight it. In addition to not raising shorter term rates more, the Federal Reserve is likely going to slow—if not stop—the already slow unwinding of the so-called "balance sheet".

In brief, this is the roughly $4 trillion in new money the Fed created during the financial meltdown and its aftermath to counter the money destruction and deflationary forces in a crashing economy. The Fed essentially created money out of thin air, bought bonds mostly from the U.S. Government, then sat on those bonds, collecting interest. This put new money into the system and lowered longer-term interest rates including, importantly, mortgage rates. They called this process "Quantitative Easing", or QE, rather than "New Money Maker" or something that might frighten investors.

The unwinding means the Fed essentially burns the interest payments they were receiving monthly—to the tune of around $55 billion a month—in a digital furnace. This is the opposite of what they were doing when they created money in the crash aftermath years. Investors started getting scared this printing press in reverse was going to cause a recession, so the Fed is now considering collecting the interest payments and just buying more debt with them (as opposed to destroying the payments and making the money pool shrink). This means in the next recession we'll probably just start creating even more money out of thin air to buy bonds again because, even in a good economy, we can barely destroy some of the new money created in the last recession without a mini-meltdown.

While this all seems quite scary, it is still one step away from actually creating money to buy government debt and then saying "Forget it. You don't owe us anything, U.S. Government. Keep the new money." That is called monetizing the debt and, officially, we are not there yet. Even monetizing the debt is still a step away from just printing money and paying bills, like they apparently have been doing in Venezuela.

The important distinction between us and Venezuela is we can still reverse engines if inflation picks up. In fact, we have more power to stop inflation than perhaps at any time in history because we can just sell our $4 trillion in bonds and destroy the proceeds. Imagine selling a bond you own, getting cash out from the bank, and burning it in the backyard—that money is gone from the system. You are shrinking the money supply and doing the opposite of leaving that money in the bank, where it would become available to make new loans.

But the danger here is not inflation, even though it seems the obvious risk attached to creating money to fix problems. The danger is deflation and recessions that can't be fixed, even by unorthodox monetary policy. Since our government is now growing the yearly deficit again significantly—just recently, we started moving close to a gap of $1 trillion a year between what we collect in tax revenues and what we spend—our ability to fight the next recession with more tax cuts and interest rate cuts is diminishing. Nobody wants to shore up the budget, and investors freak out when interest rates go up. We're trapped.

This situation could increase the severity of our next recession and the next bear market

Stock Funds1mo %
Homestead Value (HOVLX)4.73%
Vanguard Utilities (VPU)3.88%
iShares MSCI Italy Capped (EWI)3.74%
[Benchmark] Vanguard 500 Index (VFINX)3.20%
Vanguard European ETF (VGK)3.16%
Vanguard Value (VTV)2.86%
Vanguard Europe Pacific ETF (VEA)2.33%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.18%
Gold Short (DZZ)1.63%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.65%
Vanguard Telecom Services ETF (VOX)0.37%
iShares Global Telecom ETF (IXP)0.31%
iShares MSCI BRIC Index (BKF)0.26%
Proshares Ultrashort NASDAQ Biotech (BIS)-5.78%
Proshares Ultrashort Russel2000 (TWM)-9.50%
PowerShares DB Crude Oil Dble Short (DTO)-10.01%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)0.86%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.06%
Vanguard Mortgage-Backed Securities (VMBS)-0.07%
Vanguard Long-Term Bond Index ETF (BLV)-0.79%
SPDR Barclays Intl. Treasury (BWX)-1.08%
Vanguard Extended Duration Treasury (EDV)-1.77%

January 2019 Performance Review

February 6, 2019

What December took away January gave back. With the sharp rebound that started right after Christmas, the stock market has recovered a little over half the losses from the 20%+ drop that started in late September. The primary support has been low interest rates (which have also helped bond prices). Earnings have been good enough to beat reduced expectations. The fund categories that have lagged the most over the last 5+ years were leaders in January, the main exception being technology-oriented funds that have been top performers over the last five years and in January, bouncing back from a sharp decline in late 2018.

Our Conservative portfolio gained 3.34%. Our Aggressive portfolio gained 3.15%. Benchmark Vanguard funds for January 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 8.00%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.01%; Vanguard Developed Markets Index Fund (VTMGX), up 7.36%; Vanguard Emerging Markets Stock Index (VEIEX), up 8.52%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 5.90%.

These don't seem to be the most impressive figures for our model portfolios relative to the S&P 500 until you consider the recent downside as well. In December, the Vanguard 500 fund was down 9.04% and the Vanguard STAR fund was down 4.73%, as opposed to only a fractional decline in our Conservative portfolio and a 1.66% decline in our Aggressive portfolio. Our upside in January was significantly higher than the inverse of our downside, unlike these benchmarks. That said, much of this was the benefit of long-term interest rate exposure and, with rates now fairly low again, this upside potential and downside protection will diminish, which means we will have to take on more stock market risk to maintain significant upside which will increase downside as well.

It's looking like we missed a brief opportunity to increase our risk level and capture more upside, but the bottom in this 20% decline didn't last very long. Without a global recession, the stock market likely won't drop 20% to 50%. This is basically what happened in 2011 when problems in Europe led to a 20% slide in U.S. stocks, which then recovered— things just didn't get bad enough for it to drop more. There is just too much money piling in on dips (including companies buying back their own stock in big numbers), especially when the alternatives—bonds—are now yielding significantly less than in late 2018. That said, investors are on edge waiting for the bull market and economic expansion to end, so the selloff could be even more significant.

This recovery is also likely not the beginning of higher records for stocks. The rest of the world isn't doing that well, and the possibility of the U.S. having problems buying its way out of the next recession (as we already have tax cuts and increased spending) could start to be a concern. We need this economy to remain strong to get us financially stable for the next trouble zone.

Our top performer was iShares MSCI BRIC Index (BKF), up 11.6% as emerging markets rebounded and the U.S. dollar weakened slightly. Latin American stocks were the primary driver, up over 15% for the month. China has been a drag during the trade-war scuffle but recently turned around by having the second-best larger international market performance of the month.

Stocks from India were actually down but have been the hottest foreign market over the last five years.

Now that the index providers have turned telecom stocks into information-technology stocks, essentially by adding Facebook and the like, it is no surprise that Vanguard Telecom Services ETF (VOX) is now one of our most volatile holdings. This worked in our favor in January with a 10.56% return, followed by the recently added iShares Global Telecom ETF (IXP), up 9.07%.

Dodge & Cox Global Bond Fund (DODLX) was up 2.54% as this newish holding for us benefited from a slightly weak dollar and falling interest rates. We no longer own it, but higher-risk bonds did well in January, with high-yield (junk) bonds delivering about 4%, recovering much of their sharp losses of late 2018.

The last will be first as many of the worst places to be over the last 5+ years led the returns in January. Smaller cap value funds in general where tops—up over 11% after the worst five-year showing relative to other U.S.-style categories. The gap was significant even with this turn, as small cap value delivered annual returns of just under 5% over the last five years and larger cap growth gained just over 10%.

The hottest sector was energy-related funds, up around 14% for the month but also the worst- performing five-year sector.

Stock Funds1mo %
iShares MSCI BRIC Index (BKF)11.60%
Vanguard Telecom Services ETF (VOX)10.56%
iShares Global Telecom ETF (IXP)9.07%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)8.52%
iShares MSCI Italy Capped (EWI)8.10%
[Benchmark] Vanguard 500 Index (VFINX)8.00%
Vanguard Europe Pacific ETF (VEA)7.47%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)7.36%
Vanguard Value (VTV)6.95%
Vanguard European ETF (VGK)6.68%
Homestead Value (HOVLX)5.98%
Vanguard Utilities (VPU)3.72%
Gold Short (DZZ)-5.00%
Proshares Ultrashort Russel2000 (TWM)-19.60%
Proshares Ultrashort NASDAQ Biotech (BIS)-23.35%
PowerShares DB Crude Oil Dble Short (DTO)-34.61%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)2.54%
Vanguard Long-Term Bond Index ETF (BLV)1.86%
SPDR Barclays Intl. Treasury (BWX)1.41%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.01%
Vanguard Mortgage-Backed Securities (VMBS)0.83%
Vanguard Extended Duration Treasury (EDV)0.18%

December 2018 Performance Review

January 10, 2019

On Christmas Eve in this very rocky December, the stock market, as measured by the S&P 500, was down 20% from its October peak. Technically, this wasn't officially a bear market as the price slide from the peak closing value in the S&P 500 to the bottom in late December was just shy of 20%. Officially, the market needs to be down 20% from a market close to market close. Unofficially, this is a silly concept, and any 20% drop from a high in the market should qualify as something bigger than a "correction" (itself an overly positive term), which is a 10% drop. Whatever you want to call it, we haven't had many of these drops since the 2009 bottom, which is one reason investors are skittish—the good times have to end eventually, right?

Any way you slice it, December was the sort of month where the benefit of not taking on too much risk and avoiding popular strategies worked, basically the opposite tack from the previous months.

Our Conservative portfolio declined 0.35% in December. Our Aggressive portfolio fell 1.66%. Benchmark Vanguard funds for December 2018 were as follows: Vanguard 500 Index Fund (VFINX) down 9.04%; Vanguard Total Bond Market Index Fund (VBMFX) up 1.80%; Vanguard Developed Markets Index Fund (VTMGX) down 5.37%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.97%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 4.73%.

December was among our best performances relative to the S&P 500 since these model portfolios started in early 2002. It's way too early to brag, and we were lagging during the last months of this bull market such that our returns relative to the stock market are still so-so. Still, if you like sleep-at-night downside risk, it was a good near-bear market for us.

For 2018 as a whole, our performance was underwhelming but acceptable. Our Aggressive portfolio was down 5.24% compared to the negative 4.52% showing for the Vanguard 500 fund in 2018 (with dividends). Our Conservative portfolio dipped just 2.81%. The Vanguard Star fund, our globally balanced benchmark, was down 5.34% for the year. What was most interesting about 2018 was how lousy "diversified" portfolios did, even ones that are balanced with bonds and stocks. Vanguard Star Vanguard Star Fund (VGSTX) is 60% stocks and 40% bonds, and it fell more than the S&P 500 and our portfolios.

2018 was the worst year for a globally balanced portfolio since 2008. This was largely because bonds were down significantly in 2018, especially longer-term and higher-credit-risk bonds, and foreign markets were down sharply. Just looking at market gyrations up and down, we're taking less risk than the market and less even than most balanced funds. According to one hedge fund tracker, the average hedge fund fell over 4% in 2018 as the highest-paid experts in minimizing downside had trouble doing just that.

The few positive return areas in December (if not the year) included longer-term and investment-grade bond funds like those we own in the portfolios. All bond funds except short-term bond funds with limited interest rates and credit exposure (including our holdings) were actually down for the year. Still, the rebound in bond funds in December was a key reason our portfolios didn't fall much during this rough month.

Higher-yield, higher-credit-risk bonds performed poorly for the year and month as these areas tend to have near-stock-market downside during market corrections and less upside than stocks during rebounds. Selling our position in Artisan High Income Fund (ARTFX), a higher-credit-risk bond fund, in June proved timely as this fund, which was up solidly in 2016 and 2017 and early 2018, slid 5.27% in the last three months of 2018 year.

The only fund sector in positive territory in 2018 was utilities. Our own Vanguard Utilities (VPU) holding was down 4.12% in December but still delivered a positive 4.37% for the year. After technology, utilities have shown the highest returns over the last five years in sector mutual funds, sort of amazing in this growth-oriented market. Considering the lower down side, the risk/reward has been very good.

Unfortunately, our inverse MLP (Master Limited Partnerships) fund was shut down for lack of investor interest in 2018 right before shorting energy-related investments started working very well. This could have helped our Conservative portfolio score even better numbers in 2018. MLPs fell as much as 20% in the last three months of 2018 and were down double-digits for the year. Our oil short PowerShares DB Crude Oil Dble Short (DTO) was up 18.59% after a 45%+ gain the previous month, yet only delivered a 13.77% return for the year. The smart move would have been doubling up on this holding when the short MLP fund was closed.

Shorting in general obviously worked well in December, except for shorting gold. Proshares Ultrashort Russel2000 (TWM) was up 26.35% for the month for a 19.19% year, while Proshares Ultrashort NASDAQ Biotech (BIS) gained 24.40% but was only up 5.18% for the year.

Conceptually, our call to favor large cap and short small cap in recent years was right in the sense that large cap funds were up 6.6% on average per year over the last five years, while small cap funds were only up 3.2%. The gap was even bigger between large cap growth and small cap value—the latter up just 1.86% per year over the last five years. But, as we noted, there were no ETFs with which to do that other than shorting small cap value ETFs directly. Our short positions in inverse ETFs dwindled during the booming market (because they are flawed products) such that the offsetting gains where limited here.

So, is this a dip to buy or the start of a 50% slide?

When the market broke down in 2007 and 2008, we saw similar relative performance benefits in our portfolios compared to falling benchmarks. We also increased the risk level on the way down in that bear market by increasing our stock allocation. This worked when the eventual recovery hit. We have no way of knowing if this market slide will continue or rebound quickly (as it did after the 2011 slide and appears to be happening in January so far). Either way, a 20% decline is an opportunity for any portfolio that isn't on a fixed-risk level (say, 60% stocks, 40% bonds permanently) to start increasing risk. If the market goes down 50%, we aim to be as aggressive as we were in early 2009, meaning our downside risk can start increasing on the way down in order to boost our upside.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)26.35%
Proshares Ultrashort NASDAQ Biotech (BIS)23.40%
PowerShares DB Crude Oil Dble Short (DTO)18.59%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.97%
iShares MSCI Italy Capped (EWI)-3.36%
Vanguard Utilities (VPU)-4.12%
Vanguard European ETF (VGK)-4.86%
iShares MSCI BRIC Index (BKF)-5.18%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-5.37%
Vanguard Europe Pacific ETF (VEA)-5.70%
iShares Global Telecom ETF (IXP)-6.45%
Homestead Value (HOVLX)-7.94%
Vanguard Telecom Services ETF (VOX)-8.27%
[Benchmark] Vanguard 500 Index (VFINX)-9.04%
Gold Short (DZZ)-9.08%
Vanguard Value (VTV)-9.16%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)8.06%
Vanguard Long-Term Bond Index ETF (BLV)4.36%
SPDR Barclays Intl. Treasury (BWX)2.09%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.80%
Vanguard Mortgage-Backed Securities (VMBS)1.66%
Dodge & Cox Global Bond Fund (DODLX)0.89%

November 2018 Performance Review

December 6, 2018

November was a rocky month for stocks and bonds, but it ultimately ended on a positive note. Our portfolios did well compared to the Vanguard STAR fund, which has recently had more downside than our portfolios and potentially less upside as investors shift their portfolio strategies.

Our Conservative portfolio gained 1.04% in November, and our Aggressive portfolio gained 2.15%. Benchmark Vanguard funds for November 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 2.03%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.53%; Vanguard Developed Markets Index Fund (VTMGX) up 0.39%; Vanguard Emerging Markets Stock Index (VEIEX) up 4.45%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.30%.

Just a few weeks ago, fast-rising interest rates risked dragging the housing market (and possibly the entire economy) into a mild recession. Now falling interest rates are indicating a possible recession on the horizon. There seems to be a very small band of acceptable interest rates.

The initial take by professional investors when rates went up was that they were going up for the right reasons, which means the economy is booming, demand to borrow is high, and inflation is picking up. This narrative quickly changed when stocks started to drop, and a prevailing view emerged that significantly higher rates would cause a recession for a variety of reasons, including a too-strong dollar, real estate market issues, and the great unknown of trillions in corporate debt.

When interest rates drifted back down, things improved for stocks. In recent weeks, the benchmark 10-year government bond rate drifted up towards 3.25% on several days, which equates to roughly a 5% 30-year fixed rate mortgage; each time this happened, stocks slipped hard and then recovered as rates drifted back down.

Now we are facing a more disturbing situation since the benchmark rate has sunk below 3%: rates are going down for the wrong reasons, which means a recession could be coming, and low inflation and demand for safe investments will push rates right back down to the levels we saw a year or more ago.

This drop in rates has been good for bonds and yield-oriented investments and helped our portfolios—we are effectively recession-ready relative to other portfolios. Our top three stock funds were all value- and yield-oriented, and they beat the S&P 500: Homestead Value (HOVLX), Vanguard Utilities (VPU), and Vanguard Value (VTV) went up 4.42%, 3.92%, and 3.27%, respectively. These three were only bested by our short on oil PowerShares DB Crude Oil Dble Short (DTO) and iShares MSCI BRIC Index (BKF) riding a reversal in emerging markets in general and stocks in India in particular, for a 6.48% gain.

Larger-cap value funds were the best performers in U.S. stock funds last month. Emerging market stocks and bonds had a nice run after a terrible year. These areas could see a move up if investors start to look somewhere else for risk besides U.S. tech.

The rising economic fear has also been bad for oil, which slid more in recent weeks than even after the 2008 commodity bubble burst. The trigger may have been increased output by Saudi Arabia and Russia in anticipation of Iran sanctions that never came in earnest. Fears of a recession and leveraged gamblers in the oil market unwinding their positions didn't help either. We saw a 45% gain in November shorting oil with 2x leverage in PowerShares DB Crude Oil Dble Short (DTO) after an 18% gain in October. Don't be too excited since the fund is still down slightly for the year because oil rose substantially during the economic optimism of recent months, setting up shorting oil as a good hedge against a recession. Shorting small-cap stocks and biotech stocks lost money in November as riskier stocks recovered after the slide in October.

Stock Funds1mo %
PowerShares DB Crude Oil Dble Short (DTO)45.61%
iShares MSCI BRIC Index (BKF)6.48%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)4.45%
Homestead Value (HOVLX)4.42%
Vanguard Utilities (VPU)3.92%
Vanguard Value (VTV)3.27%
[Benchmark] Vanguard 500 Index (VFINX)2.03%
iShares MSCI Italy Capped (EWI)1.36%
iShares Global Telecom ETF (IXP)1.22%
Vanguard Europe Pacific ETF (VEA)0.51%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)0.39%
Gold Short (DZZ)-0.33%
Vanguard European ETF (VGK)-0.68%
Vanguard Telecom Services ETF (VOX)-0.74%
Proshares Ultrashort Russel2000 (TWM)-3.77%
Proshares Ultrashort NASDAQ Biotech (BIS)-10.13%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)2.18%
Vanguard Mortgage-Backed Securities (VMBS)0.90%
SPDR Barclays Intl. Treasury (BWX)0.85%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.53%
Vanguard Long-Term Bond Index ETF (BLV)0.40%
Dodge & Cox Global Bond Fund (DODLX)0.19%

October 2018 Performance Review

November 4, 2018

Ouch. The good times ended in October and rather suddenly at that. There are many straws out there, and it's impossible to know which one broke the market's back but break it did.

The best explanation, which is one part voodoo and one part real economics, was that the market has been up for so long that investors were looking for signs that the music was going to stop. The sign was rising interest rates leading to fears that the global economy and real estate market couldn't handle higher rates. This in turn led to worry that tech stocks have risen so far so fast that the downside is exceeding the upside.

In October, our Conservative portfolio declined 3.52%. Our Aggressive portfolio declined 3.11%. Benchmark Vanguard funds for October 2018 were as follows: Vanguard 500 Index Fund (VFINX) down 6.85%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.73%; Vanguard Developed Markets Index Fund (VTMGX) down 8.49%; Vanguard Emerging Markets Stock Index (VEIEX) down 7.58%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 5.71%.

Even with our interest-rate-sensitive portfolios with significant foreign exposure (a performance drag), we fell significantly less than the S&P 500. More notable is that the global total portfolio benchmark that we also aim to beat over time, the Vanguard STAR fund, was down 5.71%, almost as much as the S&P 500 and quite a bit for a diversified global portfolio that is only 60% stocks. We're trying to deliver a better risk/reward tradeoff than this balanced fund (not an easy task given this is a great low-fee total portfolio fund, but we aim high) but have been lagging it recently on the way up. As you can see, such upside performance often comes at a price—Vanguard STAR was taking quite a bit more downside risk than we were.

One reason balanced portfolios fell in October is that all categories fell. That has become the new problem with building portfolios: there is nowhere to hide when the drops come but low-return cash. Diversification doesn't really work anymore.

The best-performing fund categories in October were precious metals, utilities, and Latin America. Not coincidently, precious metals funds and Latin American funds have some of our highest category ratings on MAXfunds: 91 and 97, respectively. We're still short gold because we don't believe it has any long-term investment merit, and our limited stake in Latin American stocks in our iShares MSCI BRIC Index (BKF) fund was offset by losses in the RIC part—Russia, China, India—of BRIC (though the fund fell less than emerging markets in general).

Other areas of relative strength include value stocks in general, an area we are focusing more on after the big run in growth and tech this past decade or so. But our only traditional stock fund that posted a gain was Vanguard Utilities (VPU), up 1.17%—even Vanguard Value (VTV) was down 4.35%.

Homestead Value (HOVLX) dropped 9.03% despite being a value fund because it's somewhat of a tech value fund now. The fund's holdings are probably more economically sensitive than many other value funds, and the fears of rates hurting the economy hit this fund hard.

All our bond funds where down, but long-term bonds fell the hardest with Vanguard Extended Duration Treasury (EDV) down the most at 4.61%. Long-term rates shouldn't go up much from here (at least not quickly without risking much more downside to stocks). You'd rather be in long-term bonds with the moderate loss you will take than the stock alternatives if rates climb quickly.

The shining stars of October were our three short funds, all up high double digits: PowerShares DB Crude Oil Dble Short (DTO) up 18.6%, Proshares Ultrashort Russel2000 (TWM) up 24.56% and Proshares Ultrashort NASDAQ Biotech (BIS) up 33.42%. These funds, which can slowly go to nothing over time as markets long term go up, can be useful in a crash scenario. We should have rebalanced into a short tech fund because our short stake was so small after dwindling in value in the portfolio from losses in the bull market as to have minimal upside performance impact. That said, we did beat the balanced portfolios out there and these funds are a good part of the reason our "riskier' aggressive portfolio actually fell by less than our short-fund-free conservative portfolio.

Stock Funds1mo %
Proshares Ultrashort NASDAQ Biotech (BIS)33.42%
Proshares Ultrashort Russel2000 (TWM)24.56%
PowerShares DB Crude Oil Dble Short (DTO)18.60%
Vanguard Utilities (VPU)1.17%
Gold Short (DZZ)-3.47%
Vanguard Value (VTV)-4.35%
Vanguard Telecom Services ETF (VOX)-6.20%
iShares MSCI BRIC Index (BKF)-6.32%
iShares Global Telecom ETF (IXP)-6.79%
[Benchmark] Vanguard 500 Index (VFINX)-6.85%
Vanguard European ETF (VGK)-7.53%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-7.58%
Vanguard Europe Pacific ETF (VEA)-8.26%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-8.49%
Homestead Value (HOVLX)-9.03%
iShares MSCI Italy Capped (EWI)-9.44%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-0.57%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.73%
SPDR Barclays Intl. Treasury (BWX)-1.65%
Dodge & Cox Global Bond Fund (DODLX)-1.77%
Vanguard Long-Term Bond Index ETF (BLV)-3.22%
Vanguard Extended Duration Treasury (EDV)-4.61%

September 2018 Performance Review

October 7, 2018

In early October the unemployment rate dropped to its lowest level since 1969. This is sending interest rates back up to 'normal' levels. The difference this time is the stock market is now sinking along with bonds.

In September, larger market value stocks crept up slightly in the U.S. while smaller-cap stocks fell. Abroad was a similar story — big companies in major economies were up marginally while riskier emerging market stocks continued to sink.

Bonds where weak across the board with bigger drops in longer-term interest rate sensitive bonds as rates continued to move up on good economic news and general optimism. The backdrop of a strong economy helped junk bonds and higher risk debt score fractional gains as defaults seemed less likely. All in, our benchmark global balanced fund by Vanguard was down fractionally, as was our Aggressive model portfolio. The recent changes to our Conservative model portfolio helped it eke out a positive month.

Our Conservative portfolio gained 0.18% in September. Our Aggressive portfolio declined 0.37%. Benchmark Vanguard funds for September 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 0.55%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.54%; Vanguard Developed Markets Index Fund (VTMGX) up 0.73%; Vanguard Emerging Markets Stock Index (VEIEX) down 1.31%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.18%.

The strong economy is pushing interest rates up, which so far has been good for U.S. stocks and higher risk bonds. Foreign stocks and bonds have been weak as the brunt of the trade war seems to be hitting markets that export to us.

But there also could be another reason that rates are going up that is not just the backdrop of a growing economy with rising inflation. In fact, inflation isn't rising that fast — nor are wages, which would warrant higher interest rates across the board. No, what we may be seeing is just too much borrowing.

Our government is now increasing borrowing in a strong economy that normally would lead to a slowly shrinking yearly deficit (as was the case in recent years and is the case with most foreign governments). Corporations are borrowing more too. While a handful of tech companies are swimming in trillions in cash, most are still borrowing, and a good chunk have credit ratings that are either junk grade or just marginally investment grade — they're basically subprime borrowers. Lucky for them bond fund managers and increasingly index funds keep loading up on borderline junk debt just like investors did with low grade mortgage debt in the mid 2000s.

These companies seem to be using the increased cash flow from tax cuts to buy back more stock and not pay off debt, which is good for stock prices, but not bonds. In fact, the tax cuts make debt less valuable in financial engineering because the tax deduction of interest rates becomes less valuable. The problem is twofold — CEOs are compensated (highly) when stock prices rise. Paying off debt doesn't increase the value of their stock options like buying back stock does.

In the movie Scarface a young climber up the criminal ladder played by Al Pacino is given sage advice by a more conservative successful drug dealer: Don't get high of your own supply. Today many companies are high off of their own supplies of bonds. Buying other companies, buying back stock etc.

Low interest rates and debt-hungry investors make it all work, at least for now. But many of these marginal businesses are in no position to handle higher interest rates. They need to stop buying stock at high prices and start paying down debt because refinancing at 2-3 percentage points higher isn't going to work — companies that need to leverage are already having problems. GE's stock price is not far off from the 2009 levels when the world economy was in perhaps the worst debt crisis in history.

Stocks may look reasonably valued compared to past bubbles when you look at the dividend yield (1.96% on the S&P 500) but when you consider that some of these companies need to cut back on the dividend sooner rather than later and start paying off debt, and that payout ratios (how much of earnings are going out as dividends) are already higher than in 2000, and that earnings are somewhat juiced by low interest rate borrowing — a spread that can quickly decline with rising borrowing costs — the market is almost as expensive as the biggest valuation bubble in history, early 2000.

The days of rising rates hurting bonds while stocks go up with the economy and earnings likely ended in early October as the market blew through 3% on the 10-year government bond. Nobody knows how real estate is going to do with 6% or even 7% thirty-year mortgages, but we're already seeing indicators that the 5% level just hit this week is causing issues. Nobody knows what happens to Ford when customers can't finance a new truck at low rates. It is completely possible 1/3 of the S&P 500's earnings could away at a 5% 10-year bond rate a level.

More disturbing is how our government is going to finance the $20+ trillion in debt at 5% — or $1 trillion a year in interest costs alone. We currently shelling out $500 billion a year in interest costs. As recently as 2012 that number was $360 billion. We're now paying 2.5% on the debt pile, which (lucky for us) is barely above inflation. Yes, it takes quite some time to change this rate given the vast portfolio of maturities and debt type, but it is going up.

Best case: if interests keep rising (and they may not because the demand to borrow at higher rates could plunge) we'll have to raise taxes and cut spending rapidly (like Greece) and some leveraged companies (like GE) will go bankrupt. You don't want to know the worst case.

The longer corporations and our Government use excess debt to drive GDP growth and stock prices during these good times, the harder the next fall is going to be. The President — no stranger to debt problems — knows this which is why he, according to inside the White House stories, wanted to raise the top income bracket to help pay for the corporate tax cut. Republicans talked him down because Republicans don't do that. If interest rates continue to climb somebody is going to be paying more taxes soon. Maybe that's the real reason we're adding tariffs to imports.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)4.68%
iShares Global Telecom ETF (IXP)3.51%
iShares MSCI Italy Capped (EWI)2.07%
Gold Short (DZZ)1.69%
Homestead Value (HOVLX)1.14%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)0.73%
[Benchmark] Vanguard 500 Index (VFINX)0.55%
Vanguard Telecom Services ETF (VOX)0.52%
Vanguard Europe Pacific ETF (VEA)0.35%
Proshares Ultrashort NASDAQ Biotech (BIS)0.19%
Vanguard Value (VTV)-0.04%
Vanguard European ETF (VGK)-0.32%
Vanguard Utilities (VPU)-0.38%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.31%
iShares MSCI BRIC Index (BKF)-1.32%
PowerShares DB Crude Oil Dble Short (DTO)-8.31%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)0.75%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.54%
Vanguard Mortgage-Backed Securities (VMBS)-0.60%
SPDR Barclays Intl. Treasury (BWX)-0.74%
Vanguard Long-Term Bond Index ETF (BLV)-1.27%
Vanguard Extended Duration Treasury (EDV)-4.11%

August 2018 Performance Review

September 6, 2018

U.S. stocks were hot again in August while foreign stocks were very much not. At this stage it looks like the U.S. is winning the trade war, but some of this global stock divergence could be due to frightened international investors moving funds into the U.S. from suddenly scary looking emerging market stocks and bonds. There are now at least three economies in some form of economic chaos — Venezuela, Argentina, and Turkey.

Our Conservative portfolio fell 0.15% in August. Our Aggressive portfolio declined 0.77%. Benchmark Vanguard funds for August 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 3.25%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.52%; Vanguard Developed Markets Index Fund (VTMGX) down 1.91%; Vanguard Emerging Markets Stock Index (VEIEX) down 3.55%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.17%.

The small gains for our value/income focused U.S. stock funds (and even smaller gains from U.S. bond funds) were more than swallowed up by losses in anything foreign last month, stock or bond. The Vanguard STAR fund we aim to beat over time not only has more in stocks (60%) and less interest rate exposure but also has more of the stock allocation in U.S. stocks (40% U.S. / 20% non-U.S. Our net stock exposure in our Aggressive portfolio in real money now is about 28% US to 22% foreign In Conservative we are just under 20% US / 16% foreign).

Notably weak recently have been Italian stocks; sending our iShares MSCI Italy Capped (EWI) position down 9.27% for the month. Investors want to avoid being invested in the next crisis economy abroad. Politically questionable and leveraged Italy sitting on a rocky economic foundation seems a likely trouble spot.

The hottest areas in the U.S. were growth stocks, notably smaller cap growth stocks, up 7.65% for the month and capping a 32%+ twelve-month streak. The five-year leader remains larger-cap growth, the category where all the tech giants live.

The coldest August performers were foreign stocks with Latin American stocks sliding just shy of 10% — double the next worst performer China. This was not good for our iShares MSCI BRIC Index (BKF) position last month. Latin America is really the only stock fund category down over the last five years.

In sectors, technology was again the top gainer up 6.11% for the month and the one-year leader at 28%. Some famous managers that underperformed much of the last decade by being too heavy in foreign and value stocks are finding new focus in tech and healthcare This is likely a mistake. Such performance chasing will be a drag over the next ten years.

This recently intensifying performance gap in foreign vs domestic stocks really started around the last bear market in 2007. Some of the gap can be chalked up to currency changes as the dollar's long slide in the early 2000s reversed course over the last decade or so, but a lot more of it has to do with investors putting too much money abroad in the early to mid-2000s. They bid up international stock prices too high relative to U.S. stocks and we're still working it off. The gap is also widened by the sheer domination in technology companies in the United States and the relatively strong U.S. economy.

That said, China has big powerful tech companies and even more economic growth and the main China ETF (FXI) price is still down over 40% from the bubble peaks of 2007 (though with dividends an investor is only down about 25% over a decade later). The fund asset level is down around half from the near $10 billion peak and the fund is sitting on a couple of billion in realized losses because the average investor lost money in China and most other hot then not funds. Come back and look at U.S. biotech ETFs in ten year's you will see a similar pattern.

Looking just at ETF cash flows this year (where most of the hot money goes now) investors moved money out of U.S. stocks during the brief slide early this year and into foreign stocks — which turned out to be exactly the wrong move as U.S. stocks rebounded and foreign stocks dropped.

Even without a bear market the performance pendulum should swing back to foreign stocks as it did after the late 1990s performance run by U.S. growth stocks.

Looking back over the last 9+ years of this historic bull market with no drops over 20% (the definition of a bear market) along the way, our main performance problem was not sticking with our U.S. growth focus and a high stock allocation well after the last crash — these trends tend to last longer than you expect. There was too much money still going abroad over the last few years for foreign to be the bargain of the early 2000 era.

Ideally, we'd get another full-blown emerging market crash. This ultimately could lead to the sort of pricing where you can get back into the high-single low-double digit stock returns for taking on higher risk. Today there is plenty of downside risk in the U.S. market and just mid-single digit upside.

Stock Funds1mo %
Gold Short (DZZ)4.99%
[Benchmark] Vanguard 500 Index (VFINX)3.25%
Vanguard Telecom Services ETF (VOX)2.83%
Homestead Value (HOVLX)2.13%
Vanguard Value (VTV)1.90%
Vanguard Utilities (VPU)1.15%
iShares Global Telecom ETF (IXP)-0.10%
Vanguard Europe Pacific ETF (VEA)-1.73%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.91%
Vanguard European ETF (VGK)-2.83%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.55%
iShares MSCI BRIC Index (BKF)-4.77%
PowerShares DB Crude Oil Dble Short (DTO)-5.56%
Proshares Ultrashort Russel2000 (TWM)-8.11%
Proshares Ultrashort NASDAQ Biotech (BIS)-9.20%
iShares MSCI Italy Capped (EWI)-9.27%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)1.65%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.52%
Vanguard Mortgage-Backed Securities (VMBS)0.50%
Vanguard Long-Term Bond Index ETF (BLV)0.48%
SPDR Barclays Intl. Treasury (BWX)-0.62%
Dodge & Cox Global Bond Fund (DODLX)-1.20%

July 2018 Performance Review

August 5, 2018

The stock market continued its rebound in July. We're still underperforming for the year, with too much interest rate exposure and too little stock exposure, but for the month we were basically in line with the benchmark Vanguard total portfolio fund while still taking less risk in both our portfolios. Our recent changes to our Conservative portfolio seem to be helping.

Our Conservative portfolio gained 2.04%. Our Aggressive portfolio gained 1.87%. Benchmark Vanguard fund performances for July 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 3.71%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.03%; Vanguard Developed Markets Index Fund (VTMGX) up 2.32%; Vanguard Emerging Markets Stock Index (VEIEX) up 3.18%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.12%.

In general, larger value stocks did best in July and smaller growth stocks the worst — though all U.S. broad categories were in positive territory. The only real weakness was Chinese stocks, as the growing trade war seems to be impacting their stock and currency markets. (Commodities were also down.)

Value stocks took the lead after a long stretch of growth stock outperformance. This boosted Homestead Value (HOVLX) to our top performer's spot for the month, with a 6.84% rise. Shorting gold and oil through PowerShares DB Crude Oil Dble Short (DTO) and Gold Short (DZZ) delivered gains of 6.77% and 4.79% respectively. After a long run up, oil seemed to hit a ceiling, and commodities in general were weak. Our biggest loser was in shorting biotech stocks with leverage, which resulted in a double-digit loss for Proshares Ultrashort NASDAQ Biotech (BIS).

Stocks sensitive to interest rates did well in July, though bonds were mixed to down. Our new holding Dodge & Cox Global Bond Fund (DODLX) had a solid month — up 1.68% — but our high interest rate risk zero-coupon bond fund Vanguard Extended Duration Treasury (EDV) was down 2.21% as interest rates climbed.

iShares Global Telecom ETF (IXP), our new pick for our Conservative portfolio, had a good month. It was up 3.53%, in sharp contrast to our old telecom pick, Vanguard Telecom Services ETF (VOX).

Vanguard Telecom Services ETF (VOX) was up only 0.30% in July because the index makers decided telecom and communication indexes are too boring and needed some Facebook (FB) magic, because why own boring stocks like Verizon (VZ)?

Of course, the index experts didn't cook up this idea years ago when social media stocks were new to the market. No, they waited until Facebook was one of the most valuable stocks in history before adding the stock to the dull benchmark index, and just days before Facebook collapsed 20% in ONE DAY as various questionable behaviors began to scare investors.

You know what stocks don't fall 20% in one day? Verizon and other large telecom companies. This is a warning to anyone over-relying on index funds these days (ourselves included).

Not to belabor the point, but one of the long-term rationales for indexing or passive management over actively managed funds has been control over the holdings and no style drift, which means a fund going from, say, a value slant to a growth slant. I can't imagine a bigger drift in style than cutting back on old phone companies for Facebook stock. At the end of the day, these indexes are actively managed. They chase performance and trends just as much as actively managed funds.

Questions hanging over the market for the short and long term include: 1) rising tariffs with China, which has so far been almost a non-event for U.S. stocks ; 2) the continuing investigations into Trump and Russia; 3) rising interest rates and the impact we're starting to see in real estate, and; 4) increasing government debt without a recession, resulting from tax cuts and spending increases.

Lots escalating — including stocks, for now…

Stock Funds1mo %
Homestead Value (HOVLX)6.84%
PowerShares DB Crude Oil Dble Short (DTO)6.77%
Gold Short (DZZ)4.79%
Vanguard Value (VTV)4.65%
[Benchmark] Vanguard 500 Index (VFINX)3.71%
iShares Global Telecom ETF (IXP)3.53%
Vanguard European ETF (VGK)3.40%
iShares MSCI Italy Capped (EWI)3.39%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)3.18%
Vanguard Utilities (VPU)2.56%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.32%
Vanguard Europe Pacific ETF (VEA)2.28%
iShares MSCI BRIC Index (BKF)2.04%
Vanguard Telecom Services ETF (VOX)0.30%
Proshares Ultrashort Russel2000 (TWM)-3.27%
Proshares Ultrashort NASDAQ Biotech (BIS)-11.76%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)1.68%
Vanguard Long-Term Bond Index ETF (BLV)0.41%
SPDR Barclays Intl. Treasury (BWX)0.29%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.03%
Vanguard Mortgage-Backed Securities (VMBS)-0.05%
Vanguard Extended Duration Treasury (EDV)-2.21%

June 2018 Performance Review & Trade Announcement

July 3, 2018

June was a respectable month for U.S. stocks (though you wouldn't know it from our portfolios…) but a down month for bonds and foreign stocks. Emerging market stocks were the big loser among foreign stocks — down 4.44% — primarily on trade war fears .

Our Conservative portfolio declined 0.52% in June. Our Aggressive portfolio fell 0.84%. Benchmark Vanguard funds for June 2018 were a­s follows: Vanguard 500 Index Fund (VFINX) up 1.22%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.33%; Vanguard Developed Markets Index Fund (VTMGX) down 0.83%; Vanguard Emerging Markets Stock Index (VEIEX) down 4.44%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.12%.

U.S. growth stocks were hot while value-oriented stocks lagged again. In an odd turn interest rate sensitive funds with higher yields were top sectors even though value stocks in general lagged.

Real estate funds jumped 4.6% (though still down for the year) while utilities and communication funds were up 3.15% and 2.85% respectively. Other than our short on gold (which had a good month) only our holdings in these three areas beat the S&P 500 last month, with Vanguard Telecom Services ETF (VOX) and Vanguard Utilities (VPU) scoring 2.83% and 1.53% returns respectively.

These gains could be because recent weakness in these sectors created bargains, but could also be because interest rates stopped rising (by and large) with a strange 3% ceiling forming across the treasury yield curve at most maturities. This is relevant to our positions in telecom funds which we are in the process of changing to global telecom funds because U.S telecom indices are evolving to include tech stocks like Facebook and Google.

At the end of June we made some trades in the Conservative portfolio largely because one of our holdings, ETRACS 1xMonthly Short Alerian MLP (MLPS), was liquidated for lack of investor interest.

The trade brought two new holdings to the Conservative portfolio: iShares Global Telecom ETF (IXP) and Dodge & Cox Global Bond Fund (DODLX).

iShares Global Telecom ETF (IXP) is a new global telecom fund, an index fund based on a global telecom index. The yield is attractive if interest rates don't rise significantly and will offer extra benefits over a domestic telecom fund should our dollar fall.

Dodge & Cox Global Bond Fund (DODLX) was added because it's becoming a good time to consider low fee active management in general as indexing takes over the investing landscape. In addition, our previous no-transaction fee ETF in this area is no longer NTF at TD Ameritrade (the brokerage platform we use for our real money model portfolios and client accounts). This is a global fund so there is significant US exposure. We went with a larger allocation here (30%) but are getting some currency oomph from global telecom stocks as well.

The very low fee choice that is NTF iShares Core International Aggregate Bond ET (IAGG) for us at TD Ameritrade is hedged to the dollar which defeats the main purpose of owning non-US dollar denominated bonds which is diversification and protection from a slide in the U.S. dollar. Otherwise, unless you go with a higher risk emerging markets bond fund you wind up with 1% yielding government bonds. We can do better than that in yields from our own debtor nation which is paying near 3% as our deficit widens (while other major economies are seeing shrinking debt to GDP levels in this strong global economy).

With this trade we removed 4 holdings (not including the fund company liquidation and cash settlement in ETRACS 1xMonthly Short Alerian MLP (MLPS) which would make it 5):

It was time to cut back on junk bonds, which have been doing well, and our pick in this area, Artisan High Income Fund (ARTFX), was in the top 10% of this category for much of the fund's existence (including this year). At $3 billion in assets the top percentile returns and 5-star rating are no longer likely given the high 1% fees.

Artisan Global Equity Fund Investor Class (ARTHX) has been a solid performer and is still smallish but is too expensive at 1.40%

SPDR Barclays Intl. Treasury (BWX) is no longer transaction-fee free at TD (where we keep our real-money portfolios), and it's too expensive for a non-NTF fund. Recent weakness could get you a tax loss. In general active management with low fees should do slightly better than indexing in coming years.

We're trying to get away from higher credit risk yield though may come back to this on weakness. The iShares Mortgage Real Estate ETF (REM) mortgage REIT ETF, which owns mortgages purchased with borrowed money, has been a decent performer for us with a roughly 41% return (with dividends reinvested) since January 7th 2016.

We also rebalanced some holdings to slightly different allocations just to make the trade more cost efficient: Vanguard Mortgage-Backed Securities (VMBS) from 14% to 12%, Vanguard Long-Term Bond Index ETF (BLV) from 20% to 19% and Homestead Value (HOVLX) from 6% to 7%. These ETFs (but not HOVLX) also stopped being NTF for us at TD so small trades don't make sense at this time and we may eventually move out of some of these for this reason.

Alternates to consider here:

For iShares Global Telecom ETF (IXP): Because domestic telecom indexes are getting tech stock updates, this category is about to get noticeably higher risk and lower yield. You might try Fidelity Select Telecommunications Portfolio Fidelity Select Telecommunications Portfolio (FSTCX) and you can stick with Vanguard Telecom Services ETF (VOX) if need be but don't also own tech funds. The ETFs in this area are heading in the direction of T. Rowe Price Comm & Tech Investor (PRMTX) which already went tech years ago and has big stakes in Amazon (AMZN) so you won't be worse off than in Vanguard Telecom Services ETF (VOX) after the changes. In general we’re not in telecom to increase tech exposure – rather to avoid it - which you already get plenty of in regular stock indexes and just about everything these days.

For DODLX you can continue to use SPDR Barclays Intl. Treasury (BWX) or the cheaper iShares International Treasury Bond ETF (IGOV). Those who want more risk and higher yield could consider iShares J.P. Morgan EM Local Currency Bond ETF (LEMB) which is NTF at TD Ameritrade. In active management, if you can avoid the sales load one of the classes of Strategic Global Bond Fund (MAWIX) can work. AB FlexFee International Bond Advisor (FFIYX) is cheap and new and small and the flex fee is interesting (at 0.20% for now until the fund performs well against a benchmark) but the dollar hedging is unappealing right now PIMCO Foreign Bond (Unhedged) (PFUIX) if you can avoid the sales commission or load and get a cheaper class no more than 0.75% a year.

Stock Funds1mo %
Gold Short (DZZ)7.94%
Vanguard Telecom Services ETF (VOX)2.83%
Vanguard Utilities (VPU)1.53%
[Benchmark] Vanguard 500 Index (VFINX)1.22%
Vanguard Value (VTV)0.21%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-0.83%
Vanguard European ETF (VGK)-1.22%
Homestead Value (HOVLX)-1.34%
Proshares Ultrashort Russel2000 (TWM)-1.40%
Vanguard Europe Pacific ETF (VEA)-1.64%
iShares MSCI Italy Capped (EWI)-1.88%
Proshares Ultrashort NASDAQ Biotech (BIS)-2.99%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.44%
iShares MSCI BRIC Index (BKF)-4.91%
PowerShares DB Crude Oil Dble Short (DTO)-19.41%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)1.35%
Vanguard Mortgage-Backed Securities (VMBS)0.08%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.33%
Vanguard Long-Term Bond Index ETF (BLV)-0.58%
SPDR Barclays Intl. Treasury (BWX)-1.02%

May 2018 Performance Review

June 2, 2018

The market was rolling along just fine in May with the volatility from earlier in the year seemingly easing and good economic data slowly pushing up stocks and interest rates (and inflation).

Then, at the end of the month, Italy returned as a potentially destabilizing force to foreign investing, sending Italian stocks (which we own directly through iShares MSCI Italy Capped (EWI)) down sharply and taking the euro and most other foreign markets down with it.

Treasury bonds had one of their best days in years at the end of the month as money flowed into the U.S. (which, ironically, is following similar policies being discussed by rising political parties in Italy — raising spending and cutting taxes and backing away from global trade arrangements). With losses in our foreign currency dominated bonds in SPDR Barclays Intl. Treasury SPDR Barclays Intl. Treasury (BWX) and European stock ETFs, plus our shorts on suddenly hot small cap and biotech stocks, we couldn't come close to the U.S. stock and bond heavy benchmarks.

Our Conservative portfolio gained 0.01% in May. Our Aggressive portfolio fell 1.22%. Benchmark Vanguard funds for May 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 2.39%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.61%; Vanguard Developed Markets Index Fund (VTMGX) down 1.60%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.86%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.23%.

Investors have been favoring foreign markets up until recent weeks. This could have been a warning sign this slide was coming but is also largely the result of everybody benchmarking and indexing these days. In other words, unlike in 2000 investors aren't favoring foreign stocks so much as rebalancing. Foreign stocks have been underperforming for years, which is why investors still have 2.5x times more money in domestic stocks.

Even though interest rates slipped and our longer-term bond holdings like Vanguard Extended Duration Treasury (EDV) and Vanguard Long-Term Bond Index ETF (BLV) posted returns of 2.33% and 1.28% respectively in May, we had too many negatives in foreign funds and shorts — including a 2.03% drop in foreign bonds owned through SPDR Barclays Intl. Treasury SPDR Barclays Intl. Treasury (BWX) as the euro slid along with Italian bonds.

The hottest areas in the market last month were growth funds — notably small cap growth which was up 6.68% for the month.

Emerging markets were hit hard, especially Latin American funds which were down by double digits in May.

Technology funds were the strongest sector, up over 6% last month, and have the highest five year returns now of any fund category at just under 20% annualized returns.

Currently out-of-favor communication sector funds, which where the worst sector last month, should be considered for the next five years. The dividend yield will make a decent return compared to alternatives, in all likelihood.

We're sitting on a solid economy domestically and now globally. The trouble for investors going forward is two-fold. First, things looked great in 2000 as well. Second, people seem hell bent on messing up a good thing and pulling defeat from the jaws of victory.

We're risking our longer term financial solvency and increasing interest rates needlessly in the shorter run to increase spending and cut taxes into an already solid economy that doesn't need stimulus. Then we are pursuing risky and vaguely defined trade wars to fix wrongs in global trade. Abroad there seems to be rising nationalism with Brexit and now Italy to separate from global economic policy. Little was broke in post WWII global economics except a brief period of high inflation with low growth and a dangerous real estate bubble, but there seems to be a rising desire to fix it anyway.

Stock Funds1mo %
iShares Mortgage REIT (REM)2.89%
Gold Short (DZZ)2.81%
[Benchmark] Vanguard 500 Index (VFINX)2.39%
Homestead Value Fund (HOVLX)0.98%
Artisan Global Equity (ARTHX)0.93%
PowerShares DB Crude Oil Dble Short (DTO)0.74%
Vanguard Value ETF (VTV)0.61%
Vanguard Utilities (VPU)-0.31%
iShares MSCI BRIC Index (BKF)-1.09%
Vanguard Europe Pacific ETF (VEA)-1.43%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.60%
Vanguard European ETF (VGK)-2.42%
Vanguard Telecom Serv ETF (VOX)-2.63%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.86%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-4.57%
Proshares Ultrashort NASDAQ Biotech (BIS)-9.27%
iShares MSCI Italy Capped (EWI)-9.77%
Proshares Ultrashort Russel2000 (TWM)-11.09%
Vanguard Extended Duration Treasury (EDV)2.33%
Vanguard Long-Term Bond Index ETF (BLV)1.28%
Vanguard Mortgage-Backed Securities (VMBS)0.74%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.61%
Artisan High Income Fund (ARTFX)0.42%
SPDR Barclays Intl. Treasury (BWX)-2.03%

April 2018 Performance Review

May 5, 2018

April was not a particularly good month for stocks or bonds but once again the modest monthly change disguised the intramonth and often intraday volatility that is becoming more common in the stock market. Foreign non-emerging market stocks performed well. Riskier debt moved up slightly but longer-term, investment grade bonds and foreign bonds slid as the dollar reversed a steady decline. Our government debt now pays substantially higher interest rates than other major economies, and it's likely attracting inflows of cash which could push our currency back up in value.

Our slant towards longer-term bonds didn't help in April compared to benchmarks. Our Conservative portfolio declined 0.88%. Our Aggressive portfolio fell 0.56%. Benchmark Vanguard funds for April 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 0.37%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.83%; Vanguard Developed Markets Index Fund (VTMGX) up 1.55%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.03%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.07%.

Much of the volatility in stocks appears to be related to ten-year government bonds getting to around the 3% level. The worry is that rates will blow through that threshold and shoot up to 4% and beyond with rising inflation fears. The already strong economy is now getting fanned by increased spending and tax cuts. Effectively we've got a small stimulus package kicking in when unemployment is already below 4%. Nobody really knows what will happen to the economy if borrowing costs rise significantly but if interest rates rise in anticipation of higher inflation it could cause problems — particularly for the government than needs to rollover trillions in debt at higher interest rates.

This interest rate focus may be taking away from an issue which is more about growth stocks: are these earnings growth rates and rocketing stock prices sustainable? Or are we near the end of another boom cycle in tech with signs of over-indulgence everywhere?

A more value and yield-oriented portfolio could beat a more growth and risk-oriented portfolio in coming years, which would be a near-reversal of the last decade or so. We may still see gains in growth, but the risk-vs-return is becoming unfavorable in the types of stocks that rely more on earnings growth to rationalize higher prices.

We're getting close to year-2000 levels (when value was where you wanted to be, not growth) and farther away from 2008 (when growth, particularly U.S. growth stocks, was where your portfolio should have tilted). Growth index funds have now beat value index funds by just over 2% a year over the last decade — a sizable difference.

The most surprising action in April was the performance of yield oriented stocks like those in utility and telecom funds. These did well even as the stock market was barely up and while interest rates moved higher. Vanguard Utilities (VPU) climbed 2.47% and Vanguard Telecom Services ETF (VOX) rose 1.36%. This may because these areas have been so weak that they are attracting value investors. In general value stocks are getting attractively priced relative to growth stocks after about a decade of growth beating value by upwards of 2% a year.

Oil continued to move higher even as the U.S. dollar rose, which is typically bad for oil prices. Our oil short fund PowerShares DB Crude Oil Dble Short (DTO) fell 10.65% in April, and this time ETRACS 1xMonthly Short Alerian MLP (MLPS) fell 7.51%, reversing some of the recent gains. While this likely won't happen if the economy remains strong, oil is now priced for a near 50% hit if we get a global slowdown.

Stock Funds1mo %
Proshares Ultrashort NASDAQ Biotech (BIS)4.64%
iShares MSCI Italy Capped (EWI)4.42%
Vanguard European ETF (VGK)2.65%
Vanguard Utilities (VPU)2.47%
Gold Short (DZZ)2.30%
Vanguard Europe Pacific ETF (VEA)1.64%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.55%
Vanguard Telecom Serv ETF (VOX)1.36%
Artisan Global Equity (ARTHX)0.61%
Vanguard Value ETF (VTV)0.42%
[Benchmark] Vanguard 500 Index (VFINX)0.37%
iShares Mortgage REIT (REM)0.28%
Homestead Value Fund (HOVLX)-0.28%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.03%
Proshares Ultrashort Russel2000 (TWM)-2.39%
iShares MSCI BRIC Index (BKF)-2.66%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-7.51%
PowerShares DB Crude Oil Dble Short (DTO)-10.65%
Bond Funds1mo %
Artisan High Income Fund (ARTFX)0.38%
Vanguard Mortgage-Backed Securities (VMBS)-0.49%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.83%
Vanguard Long-Term Bond Index ETF (BLV)-2.04%
Vanguard Extended Duration Treasury (EDV)-2.77%
SPDR Barclays Intl. Treasury (BWX)-2.80%