The stock market is now up over 20% from the lows last year, officially entering a bull market, though still down around 7% from the highs of early 2022. The market is being driven by mega-cap growth stocks, fueled by optimism surrounding a new tech bubble of artificial intelligence and a Federal Reserve pause in rapid rate increases. Inflation is subsiding but remains well above the 2% target. Bonds have barely moved upwards for the year.

Our Conservative portfolio gained 2.41%, and our Aggressive portfolio rose by 3.47%. Benchmark Vanguard funds for June 2023 were as follows: Vanguard 500 Index Fund (VFINX) was up 6.60%; Vanguard Total Bond Index (VBMFX) was down 0.38%; Vanguard Developed Mkts Index (VTMGX) was up 4.44%; Vanguard Emerging Mkts Index (VEIEX) was up 4.30%, and Vanguard Star Fund (VGSTX), a total global balanced portfolio, was up 3.80%.

Considering our heavy exposure to value stocks and bonds, we're surprised to be at least in the ballpark of the Vanguard benchmark total global portfolio fund. This is despite the tech and large-cap growth market quickly outpacing us.

Much of the optimism is centered on a new tech stock boom, driven by existing AI developments. It remains unclear how the rest of the economy will fare if AI dreams come true. Individual stock speculation is making a comeback, along with crypto speculation — the bubble that just won't burst. Fund investors have mostly been exiting stocks since last summer — a move which seemed to indicate that stocks were in a good place. However, we didn't take advantage because rates were high enough to be a good alternative to stocks. In June, fund investors started returning to stocks in the most significant numbers since the market peak in early 2022.

If the 2022 bear market was 'fixed' with 1% fed rates, we probably would have jumped into stocks as well. But the allure of a 5%+ risk-free rate was too compelling. This may prove too risk-averse, especially if inflation drops and the Fed lowers rates.

Stocks in the early 2000 internet bubble were at roughly the current high valuations and cash yields were about the same in the 5-6% range. From that point, stocks only returned just under 7% a year with dividends.

Will the AI boom make up for current high prices? Unlikely, as the 2000 bubble was essentially pre-internet and smartphone boom. Plus, we now have more government debt relative to GDP, limiting opportunities to boost the economy. We're sticking with cash and bonds for now.

Our only really successful recent buy was Vanguard Communication ETF (VOX) last year. Although it continued to fall until November, it's now up around 13% on fast-rising big-cap tech stocks that comprise part of the fund. The fund was up 4.75% for the month and 29.67% for the year. The S&P 500 outperformed around 90% of the 100+ fund categories once again, and beat all of our funds except Franklin FTSE Brazil (FLBR), which was up 15.01% for the month. Inflation-oriented and commodities investments are still lagging this year, but this region is doing well. Conversely, Franklin FTSE China (FLCH) is down almost 5% for the year, even after a positive 3.95% month.

There's no way to predict how far this new tech bubble will go. In theory, it's at the early stages, and there's much more money that could flow back into stocks. It seems the Fed would consider speculative mania too close to an inflation fight and, even if they don't raise rates, the Fed probably won't lower rates with rocketing crypto and tech. The future largely depends on the real estate sector, which has held up despite near 7% mortgages. The mini bank panic is now in the rear-view mirror, but questionable loans haven't really gone bad yet.

This effectively summarizes our current strategy: we're sticking with our holdings in what might be seen as unexciting value and bonds. We're considering a few minor adjustments, such as potentially reducing our stock holdings and increasing our cash reserves. The rising trend in tech and AI development is intriguing, but it could just be the precursor to a new bubble that might burst quickly, similar to the pre-2000 internet bubble — only now we're already in a valuation zone akin to late 1999. Even with rate increases stopping for good at around 5% and AI turning out to be far more than just cool chats, future returns likely won't beat those from 2000 to now.

This year has been marked by turbulence in the banking sector. The total assets of failed banks already exceed the inflation-adjusted assets of the banks that failed in 2008 during the financial crisis. The first failure occurred less than 60 days ago. Although there were 25 bank failures in 2008, the current situation involves larger regional banks dealing with significant depositors. So far, the list consists of just three banks: Silicon Valley Bank, Signature Bank, and more recently, First Republic. These stark figures suggest we are likely to surpass the total assets of all the banks that collapsed during the 2008 crisis, which saw elevated failures through 2012 due to massive losses from aggressive real estate lending during a substantial housing bubble.

Our Conservative portfolio gained 1.39%, and our Aggressive portfolio gained 1.16% in April. As for the benchmark Vanguard funds for April 2023: Vanguard 500 Index Fund Vanguard 500 Index Fund (VFINX) was up 1.56%, Vanguard Total Bond Index Vanguard Total Bond Index (VBMFX) was up 0.54%, Vanguard Developed Markets Index Vanguard Developed Mkts Index (VTMGX) was up 2.55%, Vanguard Emerging Markets Index Vanguard Emerging Mkts Index (VEIEX) was down 0.66%, and Vanguard Star Fund Vanguard Star Fund (VGSTX), a total global balanced portfolio, was up 0.58%.

The best performers in our portfolio were Vanguard FTSE Europe (VGK) up 4.13%, Franklin FTSE Germany (FLGR) up 3.69%, and Franklin FTSE Brazil (FLBR) up 3.42%. On the downside, Proshares Short Bitcoin (BITI) was down 3.18%, UltraShort Bloom. Crude Oil (SCO) was down 3.97%, and Franklin FTSE China (FLCH) fell 4.27%.

In the midst of this banking sector upheaval, the broader stock market (surprisingly) remains somewhat resilient. While tech and startup stocks are still down significantly even with the big rebound this year, the S&P 500 ended April only about 10% down from its peak at the end of 2021. This lag in the broader market's response to a banking crisis is not entirely unexpected, as investors often anticipate the containment of the crisis or even a potential boost to the economy and stocks via lower rates.

Bank stocks, on the other hand, tell a different story, down about 50% from their peak in early 2022. Warren Buffett, swimming in cash, has steered clear of buying hard-hit banks, signaling potential long-term concerns. These banks are burdened by massive unrealized losses from loans written just a few years ago when generous stimulus spending and loose monetary policy led to trillions in new bank deposits. As depositors now seek higher yields, banks may find themselves in a precarious position, having to offer 3-5% rates without earning much due to their preexisting condition of low-yield loans in their portfolio.

All the failed banks thus far have a few things in common – a significant presence in tech-heavy California, a focus on large super-prime customers with deposits well above FDIC limits, and some exposure to crypto deposits. It's worth noting that the involvement with crypto has played a role in triggering the bank run, further exacerbating the crisis. Despite the increasing mainstream acceptance of crypto, it remains a destabilizing force for traditional banking institutions.

Interestingly, mega banks, which have been under stricter regulations since the 2008 crisis, seem to be weathering the storm better and have the cash to buy collapsing mid-size banks which had a lighter touch from regulators in recent years. That went well…

The last bank crisis was supposedly all about subprime loans. Investors thought that problem wouldn’t spread to the rest of bank lending – an expensive miscalculation. This new crisis starts with super-prime loans which can be just as toxic – if not more so — in a rising rate environment.

For instance, a super-prime loan for a $10M house can pose more risk to a bank's balance sheet if rates on 30-year mortgages shift from 3% to 6%, compared to $10 million in smaller defaulting loans that go into foreclosure. The actual loss after the down payment is taken into consideration may only be 0-20% while a safe-from-default 30-year fixed loan at 2.5% will not get paid off early and leaves the bank with a loan down maybe 20-40% in price if a fire sale is required. Who wants to own a 2.5% loan when new ones are at 6%?

Higher-risk bonds haven't even performed worse than investment-grade bonds, another surprising twist given the growing banking crisis. This discrepancy underscores the peculiarities of the current financial landscape, where banks can fail without triggering an immediate increase in risky debt defaults.

The Federal Reserve's recent rate hike to 5.25% from near zero just over a year ago also highlights the dangers of relying solely on monetary policy to combat inflation, especially in such a leveraged economy. A combination of tax increases, spending cuts, and a more modest rate hike could have potentially mitigated the current situation.

Despite the unfolding banking crisis and the economic uncertainty it engenders, there’s an unwarranted level of optimism in the stock market. Bargain hunting in stocks is not a good plan from these levels. Instead, investors might consider enjoying the more than 5% yields in safe T-bills while they last. There will likely come a point when the Fed will have to lower rates to shore up the real estate market and the banking industry. If not, we may find ourselves with just a few giant banks standing.

In conclusion, April 2023 has been a month of mixed signals. Despite the turbulence in the banking sector, the rest of the market has shown a degree of resilience. However, the current landscape underscores the need for a more balanced approach in dealing with inflation and for caution in the face of a highly leveraged economy. As we navigate these uncertain times, our portfolios remain diversified and primed to adapt to changing market conditions.

The strong recovery in bonds and stocks from the lows of 2022 that continued into January came to an abrupt halt in February. Bonds are now essentially flat for the year while the stock market gains, which almost broke 10%, have been cut in half. The hardest-hit stocks of last year have rebounded far more than 10% from their lows (but are still down far more than the broader market). This reversal of stocks and bonds puts a balanced portfolio up around 2–3% for the year. International stocks are holding up a bit better, though emerging markets were hit hard in February. With rates going back up, the U.S. dollar is recovering losses from the past few months, also weighing on our international funds.

Our Conservative portfolio declined 3.74% while our Aggressive portfolio declined 4.13%. Benchmark Vanguard funds for February 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 2.44%; Vanguard Total Bond Index (VBMFX), down 2.55%; Vanguard Developed Mkts Index (VTMGX), down 3.40%; Vanguard Emerging Mkts Index (VEIEX), down 6.27%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.20%.

The weight of double-digit drops in Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) as well as 3–7% hits to our bond funds pulled our portfolios down more than the benchmarks in February, leaving us barely above water for the year, while the S&P 500 is up 3.56% in 2023.

Our only winners were short funds last month. Of the hundred-plus fund categories available to investors, only short-term bonds and bank loans were up at all—and both under 1%. Some of our losses were after big run-ups in January, notably Vanguard Communication ETF (VOX), which was down 4.07% yet still up over 10% for the year. Our recently added LeatherBack L/S Alt. Yld. (LBAY) dove 5.73% and is down about as much for the year. The fund is somewhat similar to a fund we use in our managed accounts, Vanguard Market Neutral, and owns stocks while having short positions in some of the market's formerly highest flyers—questionable recent IPOs and trendy innovation stocks. These formerly hot stocks were down sharply last year but rebounded into the deep double digits in January, leading this fund to fall. The king of all future stocks, Tesla, has almost doubled since the bottom last year.

Recently added NightShares 2000 (NIWM) was down 5.88% for the month and is slated for removal from our portfolios. Unfortunately, this historical anomaly-based ETF hasn't come close to living up to the promise of an interesting risk–reward tradeoff by avoiding stocks during the day (the fund owns stock futures overnight). Most historical patterns end after investors catch on—but this one was early enough to seem workable.

Rounding out our weakness was the Euro slipping back down, sending Invesco CurrencyShares Euro (FXE) down 2.64%. Meanwhile, cryptocurrencies are in their own half-baked resurgence after the crash last year, sending Proshares Short Bitcoin (BITI) down 1.14% after a brutal January for this inverse Bitcoin fund. Surprisingly, the trouble keeps coming to companies in the crypto or digital currency area, from regulatory to more recently a run on a crypto-friendly bank. The Crypto faithful—or rather deluded—seem happy just hoarding the digital tokens and don't care if an actual business other than gambling comes to fruition after around a decade. This is not how the Internet and smartphone went down, disproving the theory that crypto is the next major innovation to take off and change lives and make a fortune “for the brave,” to misquote a recent commercial for crypto gambling by a famous actor.

It looked like the worst was behind the bond market, but rates have gone back up to roughly 4% for 10-year government bonds, sending mortgages back up toward 7%. While inflation is slowing (so far), it is definitely not falling fast enough to encourage the Federal Reserve to stop raising rates, much less lower rates as was the expectation a few months ago, which can risk inflation rising anew. T bills now pay around 5%, which is looking more attractive by the day. The main downside is that rates will go back down during the next mini-crisis. This will leave you at near 0% for who knows how long while stocks take off, keeping investors in the same uncomfortable position of early 2022—earn low yields or buy pricy stocks.

The economy is still hot. More of a surprise, the housing market hasn’t adjusted to reflect the new reality of near 7% mortgages. More of a mystery is how the commercial office market is hanging in there with the twin problems of rising rates and low occupancy in our new work-from-home reality.

High-risk debt hasn't tanked any harder than investment-grade bonds since the expectation is that the economy will remain strong enough (and inflation high enough) to allow the issuers of all the questionable debt to remain solvent. While the actual path to rising defaults could be slow, the realization defaults that could be coming can hit prices fast.

Nobody knows where inflation is going here or abroad. There is a “good news is bad news” game going on: strong economic data can hurt the market as investors speculate that it will lead the Fed to send rates too high, causing a financial calamity. The worst fund category last month was precious metals, down over 12% after a strong start to the year. Typically this area does best during rising inflation fears and falls as these fears subside. The worst thing for gold is a hawkish Fed raising rates to 6%, while a gold bug that holds no-yield gold then is faced with deflation caused by the Fed's high rates.

We're eventually going to find out if this inflation boomlet is a blip just like the years after WW2, in which case raising rates high is a bad move, or if it is the beginning of a new era of '70s-style economic stagnation and stubbornly high inflation.

Raising rates is a dangerous game because it takes time for the economy to slow down, and—by then—asset prices may have crashed. The safer move would be to raise taxes and cut spending and run a budget surplus, similar to post-WW2, to get the excess money out of the system. Today is more like the early '80s—there is no political will to remove money from voters’ hands, so we have to see what Fed rate hikes do.

2022 was one of the worst calendar years for the stock market. The 18.15% drop in the S&P 500 (including dividends and index fund fees) was the seventh worst annual hit since the 1920s. This in itself is not that remarkable. The interesting part was that the bond market was also down 13.25% – essentially the worst year in history for the bond market.

For the month, our Conservative portfolio fell by 1.30%, while our Aggressive portfolio dropped by 1.21%. Benchmark Vanguard funds for December 2022 were as follows: Vanguard 500 Index Fund (VFINX) down 5.77%; Vanguard Total Bond Index (VBMFX) down 0.61%; Vanguard Developed Mkts Index (VTMGX) down 2.16%; Vanguard Emerging Mkts Index (VEIEX) down 2.10%; and Vanguard Star Fund (VGSTX), a complete global balanced portfolio, down 3.40%.

For the year, our Aggressive portfolio was down 11.36% or around 62% of the stock market’s downside, while our more bond-heavy Conservative portfolio slid a whopping 15.31%, representing almost 85% of the stock market decline. There was no help from abroad as Vanguard Developed Mkts Index (VTMGX) was down 15.32% and Vanguard Emerging Mkts Index (VEIEX) was down 17.90%.

Our favorite overall benchmark (because it is globally balanced at roughly 60% stocks 40% bonds, with low fees) is Vanguard Star Fund (VGSTX), and this moderate risk fund was down 17.99% in 2022. The only year previously that this fund had been down more than 10% since 1987 was in 2008, when it had a return of -25.1%. So, the only good thing we can say is that both our portfolios beat this fund by falling less, which is also what happened in 2008.

It is hard to find a balanced total portfolio fund that has fallen by less than 15% in 2022, highlighting what a tough year it has been for lower-risk investors. The best performing Vanguard total portfolio fund from 2022 was the low-risk and low-fee Vanguard Target Retirement Income fund (VTINX). This fund is for those in retirement looking for income and is comprised of 67% bonds, 3% cash and 30% stocks. It was down 12.74% in 2022. Factor in near 10% inflation and this was a bad year for those in retirement.

The Vanguard Balanced Index (VBINX) has been around since 1993. This year it was down 16.97%. The only other time this fund has been down by more than 10% was in 2008, when it fell by 22.21%. The key difference is that in 2008 the stock market was down just over 37% and it was the second-worst calendar year on record for stocks, after 1931. What makes this year unusually bad is not that stocks were down by around 18%, but that because of the poor performance of the bond market, balanced ‘safe’ portfolios were hit almost as hard as in 2008 when stocks were down almost 40% (and investment-grade bonds were up).

The Vanguard Total Bond Index (VBMFX) was launched in 1986. Until this year’s 13.25% drop, the worst year for that fund had been a -2.66% return in 1994. Vanguard Long-Term Investment-Grade Inv (VWESX) invests in longer-term, more rate-sensitive bonds. Launched in the 1970s, its previous worst year was 1999 when the Fed raised rates to sink the dotcom bubble, sending the fund down 6.23%. This year the fund was down 25.62% – and that is after a rebound late in the year as rates slipped on recession fears. In late October this fund was down 32.8%! Many bond funds now have near-zero 10-year total returns – also a first by a wide margin.

Fortunately, we have cut back somewhat on longer-term bond funds in recent years, but the lower-duration bond funds we had added were still down by double digits. We should have just kept the funds in cash and accepted the 0% returns (which are now over 4%), but the fear of earning nothing with near 10% inflation, and the ‘knowledge’ that these safer bond funds ‘never’ fall by more than 10% proved a disaster of sorts.

Speaking of disasters, the twin disasters for the bond market were the Fed raising rates much faster than in the past to stop the multi-decades-high inflation, partially if not largely, created by the loose monetary policy of low rates and new money creation, AND a low starting yield. In other words, if rates had been 4% and the Fed had raised them to 6% relatively quickly, the price hit would have been partially offset by the 3% and rising yields. However, the starting yield was 1.7% in January for 10-year government bonds so the move to 3.7% (and briefly over 4%) was all price pain and little yield gain.

Note that the broad ‘bond market’ in index funds is investment-grade (no junk bonds) debt and since most bonds have less than 10 years to maturity, the bond market index is low risk in terms of rising rates and default risk. The bond market has a duration of less than 7, meaning that with a 1% rise in rates you lose around 7% in price. The average credit rating is AA as half the bonds are government-backed.

Rising rates ultimately hit stocks (and eventually real estate) because a company that earns 5% a year (20 P/E ratio) and pays out a 2% dividend isn’t as valuable when you can buy a safe 5% bond with essentially no default risk. A rental property that yields 2%-3% after expenses isn’t a very compelling investment if you can get inflation plus 2% in a no-default-risk bond. Note that currently even with a price pull-back of about 25% in 2022, the Vanguard REIT Index fund (VGSLX) yields just 2.2%, not including capital gains from property sales and return of capital.

The scary part is no longer bonds (or at least investment grade bonds), but stocks (and real estate). The current dividend yield on stocks after a top-10 bad year is STILL just 1.7%. Considering that riskier stocks and recent IPOs and cryptocurrencies are down 40%-90%+ across the board, with the Nasdaq index down 33% in 2022, the fact that stocks are still this pricy is remarkable.

Meanwhile, no-risk T-bills pay 4.3%. Investors are basically betting that rates will go back down soon and stocks are reasonably priced for the near-future sub-2% rates. The same ‘logic’ is being applied in the property market, which hasn’t yet taken a big hit. Sellers and some buyers are assuming that sub-4% mortgages are just around the corner, so why mark down the price by 20% to adjust for high rates? In the few deals happening in an otherwise frozen market, buyers probably think, ‘No problem, we’ll just refinance in a few years at a lower rate’. It is possible, but such speculation is just the kind the Fed is trying to end in the economy to bring down inflation. More likely to support the property market than 3% mortgages being just around the corner, is inflation not dipping below 4% and rent increases supporting the currently high property prices. Another problem with the 'buy now, refi at 3% later' mentality is 3% mortgages will likely occur during the next mini financial crisis and your recently bought 7% mortgage property may be down 30% in price and ineligible for a refi without a 2009 grade Government program to allow underwater refis.

We’ve seen much harder hits to stocks over more than a calendar year. The 2000 bubble really broke down over three years, with the Nasdaq down over 20% each year for three years in a row, amounting to a total loss of almost 80%. Could it happen again? Probably not for the tech index as a whole, as many of these companies are now established and make money; it is unlikely a capitalization-weighted index of companies including Apple (AAPL) and Microsoft (MSFT) would fall by 80% again.

‘Junky’ growth and bubble stocks are already down by 80%. A more likely worst-case scenario is a 50% top-to-bottom Nasdaq slide and a 90%+ slide in formerly popular stocks of the future (with many worth zero). This relates to innovation stocks such as those in the still (remarkably) popular ARK Innovation ETF (ARKK), which was down 67% in 2022, after a 23% drop in 2021; a total drop from the 2021 peak to the end of 2022 of around 80%, just as happened with the Nasdaq in 2000–2003. In recent months even the mighty Tesla (TSLA) bubble has finally popped, sending its stock down 65% in 2022. We’ve been waiting for these bubbles to pop and are glad to see the froth leave the market. Unfortunately, investors’ enthusiasm for these busted boom stocks is still too high.

It is likely our focus on foreign stocks would have helped somewhat this year had it not been for the war in Ukraine and the ensuing troubles in European economies, which resulted in a fast-rising US dollar that has only recently cooled off. Even with the recent rebound, we took some bruising hits abroad, with a 28.06% drop in Franklin FTSE South Korea (FLKR) and 24.72% drop in Franklin FTSE Germany (FLGR). China was at one point down over 40%, but a year-end sharp rebound has left us with just a 22.78% drop in Franklin FTSE China (FLCH). The stock winners were short funds, led by a 66.3% gain in ProShares UltraShort QQQ (QID), a perennial loser except when tech stocks tank, which we’ve been waiting for since the Covid stock bubble. Value oriented stocks did fine, with Vanguard Value Index (VTV) down just 2.1% for the year. VanEck Vectors Pharma. (PPH) was up 2.61% and Franklin FTSE Brazil (FLBR) scored a 10.78% year, being a beneficiary of rising commodity prices. Homestead Value Fund (HOVLX) was down just 5.5% for the year. Value stocks are no longer such a good deal relative to growth stocks.

Our biggest hits were actually in bonds, with a near 40% drop in Vanguard Extended Duration Treasury (EDV) and a 26.93% hit to Vanguard Long-Term Bond Index ETF (BLV). More frustrating were our losses in recently exited mortgage bonds, which only fell slightly less in 2022 than the inflation-adjusted bond funds we dumped for being over-priced as inflation increased. Former holding, Vanguard Mortgage-Backed Secs ETF Vanguard Mortgage-Backed Securities (VMBS) was down 11.9% in 2022, only slightly better than the former holding (sold in early 2021) of Schwab US TIPS Schwab US TIPS (SCHP) which was down 12.02% in 2022. We should have just gone to 0% yield cash.

Surprisingly, riskier bonds didn’t perform much worse than investment-grade bonds – the whole crash was primarily a rate adjustment rather than a credit risk one; risky bonds did not fall hard while safe bonds did well, as is more typical of a weakening economy. Our best performing bond fund was iShares JP Morgan Em. Bond (LEMB), down just 10.73% in 2022, despite being significantly riskier than the intermediate-term top-rated government-backed mortgages, which fell more in 2022. Part of this was due to the high-dividend yield on the emerging-market bonds offered some counter to the decline in bond prices, unlike low-yield investment-grade bonds this year. The rising US dollar slipping near the end of the year helped this fund recover.

One thing investors should learn from 2022 is that more directly ‘inflation’-oriented investments can do well during rising inflation, but often become over-priced and tank when inflation fears subside. This is why we recommended the Series I bonds purchased direct from the US Government last year – they don’t trade at a premium during periods of inflationary fear. Incidentally, exchange-traded TIPS are now as good or even better priced, with a guaranteed return above inflation (not just matching) over 5-10 years, though there is still market price risk that could cause another 10%+ drop if rates go up more or inflation expectations drop which could happen in a sharp economic decline.

The only really hot area in 2022 was energy and other commodities (though not gold as precious metals category funds were down around 15% for the year). The fund we sold way too soon in late November 2021, Vanguard Energy (VDE), was up an astounding 62.86% in 2022 (after a 56.21% return in 2021). So much for fossil fuels dying out as an energy source. We could really have used that boost in 2022.

But enough about the past. The new investing game for stocks and bonds has become speculating on when the Fed will go back to the world we had all become too used to – 0% to 2% rates at or below inflation that made property and stocks the only game in town. The answer is probably quite a bit longer than anyone expects. The Fed isn’t going to cause a second boom in inflation by going back to the old game of low rates too soon, after being asleep at the wheel when inflation took off. That said, what could lead the Fed to reverse course is some sort of panic in the debt markets – stocks and property falling alone won’t do it. Such a panic would likely happen at significantly lower stock prices, so at that time, getting ahead of the next money-creation wave could be a possibility.

In the meantime, 4%+ safe yields are a good deal. The real question is how far out should these rates be locked in? T-bills at 4.3% are a welcome improvement after a decade plus of essentially no return on such investments, but they may only last two years (but not 6 months as some expect) before returning to sub-2%. The risk of buying 10-year or longer bonds (which have already come down in yield from the peaks of a few months ago) is that higher rates could mean another 10%-20% drop in bond prices.

At some point when a real recession hits, bond yields will fall, boosting bond prices and creating a good opportunity to shift to stocks that will likely be at lower prices than today.

On a positive note, the future for lower risk investors should be brighter. The trailing 10 year annualized return on a bond index fund is 0.9% — which is a little higher than money market funds and T-bills at roughly 0.6%. For most of this period inflation was low but we've still had 2.6% per year inflation largely thanks to recent trends. In other words, investors seeking safety and yield have lost 2% a year to inflation, or about 20% of their purchasing power.

The US stock market rebounded strongly in October, rising over 8%. It was an even better month for value-oriented stocks and energy stocks, which helped push the Dow up 14%, its best month since the 1970s. The Federal Reserve’s interest rate increase and press conference in early November stoked fears of even higher rates to fight inflation, and reversed some of the gains. Bonds continued to slide, and 2022 is becoming the worst year in history for the bond market. Most large foreign markets did well, but not as well as the US. Emerging market funds were down, largely because of continued troubles in China.

As a sign of how strange this year has been for investors, as of October 31 the Vanguard STAR fund was down 20.53% compared to the S&P 500’s 17.75% decline. As this globally balanced fund is only around 60% in stocks, this is a remarkable development. Bonds have declined as much as stocks have in 2022. Foreign stocks are down more than US stocks, largely because of a sharply rising US dollar. The cumulative drag of bonds, China, and shorting weighed on our returns in October. Our Aggressive portfolio has fallen slightly less than the S&P 500 this year, with a negative 16.16% return. Our Conservative portfolio is more in line with the Vanguard STAR fund and is down 20.78%.

In October our Conservative portfolio gained 2.04% and our Aggressive portfolio gained 1.02%. The performances of benchmark Vanguard funds were as follows: Vanguard 500 Index Fund (VFINX), up 8.09%; Vanguard Total Bond Index (VBMFX), down 1.38%; Vanguard Developed Mkts Index (VTMGX), up 5.91%; Vanguard Emerging Mkts Index (VEIEX), down 3.45%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.66%.

Value stocks did well, lifting Vanguard Value Index (VTV) by 11.73% and Homestead Value Fund (HOVLX) by 11.45%. But that, and the handful of our other funds that beat the S&P 500 last month, didn’t make up for heavy losses in longer term bonds. Our move to increase long-term bonds in June was premature. Vangaurd L/T Treasury (VGLT) was down 5.2% for the month, while Vanguard Extended Duration Treasury (EDV) fell a whopping 9.08%. Long-term bond funds in general are now down over 30% for the year – far more than the S&P 500 and more akin to technology shares.

The only really hot area was energy, up 22% for the month as oil prices headed up again. This was an area we moved into during COVID-19, when the oil price collapsed and was sold way too early. Our Franklin FTSE Brazil (FLBR) fund was up 9.89% for the month and 20.97% for the year as the country is something of a natural resource play, but we’d prefer this year’s roughly 50% gains in energy funds. Energy, commodities, and Latin America are the only fund categories up this year. Most are down by double-digit percentages.

Except for so-called digital asset funds, which own crypto-related ‘investments’ and are down 58% in 2022, the worst category of funds this year (and last month) is funds investing in China. Our own Franklin FTSE China (FLCH) was down 15.83% for the month and 42.33% for 2022 as a grab bag of political and economic issues hit the already weak market.

Long-term interest rates at over 4% for government bonds and 6% for corporate investment grade bonds will be hard for stocks to beat over the next few years, unless the Fed is unable to get inflation under 3% and the economy and earnings keep inflating at the expense of bond holders, but with no recession. More likely we’ll eventually have a fairly deep recession, falling inflation, and a return to low interest rates. This will reward locking in some longer term high yields, and give some potential upside that can be shifted into stocks at even lower prices than are on offer today.