Q: Chip – Is the Federal Reserve’s bailout of the whole world basically flooding the market with cash? Is this going to set off a round of very high inflation? If so, do we blame this on Bernanke for pulling the trigger; Greenspan for loading the gun; or Bush just because he is a putz?
This stock market is making me nuts. I know it’s all about the long term, but I can’t help thinking that we might yet see a complete meltdown. Personally, I blame everything on the Bush Administration (Greenspan deserves a share of the blame, too). This might be irrational, but that’s just how I’m feeling these days.
A: It’s a heck of a way to run an economy, isn’t it?
All the bailout action is indeed flooding the market with cash and it is inflationary. That’s one of the main reasons commodities have been going up so much. I think people are increasingly reluctant to buy into the low inflation numbers generated by the government. Who are people going to believe, the government or their own pocketbooks?
There seems to be plenty of blame to go around. I wish someone would at least adhere to the old adage that if you find yourself stuck in a deep hole, it’s advisable to stop digging. The Fed’s easy money policy and lack of regulatory oversight of the past are primary causes of these problems. Making monetary policy even looser is equivalent to curing a hangover with more drinking.
Politicians are also to blame. The main problem there is pandering to the masses rather than implementing tough long-term solutions. The public seems to reward any type of political courage with a quick exit for the incumbent. This “live for today” attitude seems to have infiltrated all aspects of the economy from the politicians to the public to the markets. I have no reason to believe it will stop until there is no choice. Then, we may very well see that meltdown you mentioned.
About the best thing I can say about it is that these things didn’t catch us off guard:
- Since the beginning of this letter, in October 2004, we’ve had a heavy allocation to commodities. During this time, our commodity fund has been up 64.2%, or 15.2% per year.
- We’ve also advocated heavy allocations to gold and silver. Gold has been up 109.5%, or 23.5% per year. Silver has done even better. It’s been up 143.3%, or 28.9% per year.
- We went light on U.S. bond and stock markets. Since the inception of this letter, Vanguard’s Total Bond Market Fund (“VBMFX”) has been up 16.3%, or 4.4% per year. Based on our anticipation of inflationary monetary and fiscal policies, instead of buying standard U.S. bonds, we chose Treasury Inflation Protected Securities (“TIPS”) and they did better. TIPS were up 21.4%, or 5.7% per year. Our other U.S. bond fund (“VWAHX”) was tax-exempt, so its returns are not really comparable, but it was up 13.2%, or 3.6% per year.
- With respect to the U.S. stock market, Vanguard’s Total Stock Market Fund (“VTSMX”) has been up 35.4%, or 9.0% per year. Again, our U.S. stock fund selection did slightly better than this, rising 41.0%, or 10.3% per year.
- We have been consistently bearish on the U.S. dollar and positioned our portfolio accordingly by investing half of our stock and bond allocations in unhedged international funds. Since October 2004, the U.S. dollar has declined 15.4% (according to the Fed’s Trade Weighted Exchange Index: Broad). As a result, our international bond fund was up 27.2%, or 7.1% per year (versus 16.3%, or 4.4% per year for VBMFX). Our international stock fund also outperformed. It was up 86.0%, or 19.4% per year (versus 35.4%, or 9.0% per year for VTSMX and 78.1%, or 17.9% per year for Vanguard’s Total International Stock Market Fund).
- As discussed in this month’s editorial, we were also able to receive excellent returns from REITs when they were going up and we sidestepped the subsequent downturn by selling all of our REITs in November 2006.
- Probably the most important investing decisions for many readers revolve around residential real estate. For this reason, we have discussed the U.S. residential real estate market extensively, warning about the housing bubble starting in March 2005 (and, subsequently, in December 2005, March 2006 and March 2007). I plan to revisit the topic in my June issue. It’s been gratifying to hear from readers that these analyses were influential in their real estate decisions.
I definitely sympathize with your frustrations regarding the current handling of the economy. I fear it will not change. I just hope that we will continue to be able to navigate our portfolios through these hazardous waters. I am encouraged that, so far, our asset allocation and fund selection has enabled us to earn 74.6%, or 17.3% per year, without taking undue risk.
