Historical Portfolio Returns

December 25, 2016

Merry Christmas Everyone!

This week I will look at the historical performance of different portfolio allocations.  Also, a comparison of this year’s performance to long term averages.  There are a few surprises.

In the weeks since the election, there has been a strong demand for risk, lifting the broad SP500 index by 8%. So how goes it over on the safety side of the ledger? Holders of an index of the total bond market, VBMFX or BND, have seen a price drop of a bit more than 3% since the election, but a net gain of 2-1/4% in the past twelve months.  Almost all of that gain is the yield, or interest earned on the bonds.  Inflation eats up most of that net gain, leaving the bond investor with little net gain for the year, but no loss.

 Morningstar provides a comparison table of various investments.  The AGG broad bond index in their table has an average total return of 2.18% over the past five years.  Yes, this year’s rather low return of 2.25% is better than the five year average.

Vanguard provides a 90 year comparison of various portfolio allocations and it is the first one on the page that I’ll turn to.  Over 90 years, the average total return of interest and price appreciation on a 100% fixed income, i.e. bond, portfolio is 5-1/4%, or 3% more than this year’s total return.

In today’s low yield universe, there is little difference, or spread between today’s yield on a broad bond index and that on a broad stock index.  Over that 90 year period, stocks have averaged 10% per year total return.  The difference between the average total return on bonds and stocks is almost 5% and is called the risk premia.  It means that, on average, a bond investor sacrifices 5% annual return for the income and the relative price stability of bonds. That’s the 90 year average.  The 5 year average tells quite a different story: a 15% per year total return for the SP500 vs 2.18% for a broad bond index.  That risk premia is 2-1/2 times the 90 average.   Seniors and others needing safety have paid a high price.

OR…let’s look at this from a different perspective.  In the long run, the law of averages is like gravity. What price would the SP500 be if its total return were more in line with the 90 year average of 10%?  The answer is a price that we last saw during February of this year – about $1840.  That is an 18% drop from today’s current price of $2264.

As the generation of boomers continues to draw down savings to supplement their income, we can expect that price stability will become more valued.  That should balance some of the downside price risk of owning bonds in an environment of rising interest rates.  There are some countervailing forces.  Oil states may derive more than half of their revenue from profits based on the price of oil.  When oil prices were high, the sovereign funds of these states bought U.S. Treasuries and other assets with the excess profits.  As prices declined since mid-2014, the lower revenues have produced budget deficits in those countries dependent on oil.  They have already sold some assets and will continue to do so if prices remain below $60 a barrel.

Comfortability Ratio

The Vanguard table of returns for various allocations (see above) shows that a 60% stocks/ 40% bond portfolio allocation (60/40) produces the best total returns of the choices for a balanced portfolio.  Let’s look at a comfortability ratio – the average return divided by the percent of years with a loss, or %AR / %YL.  This can be an important psychological ratio for those approaching and in retirement.

As many studies have shown, we give more weight to losses than gains.  We are naturally risk averse, and especially so as we near the end of our working years.  Higher comfort ratios are safer.  A 40/60 and 50/50 allocation have comfort ratios of .44.  Their average return is 44% of the percent of years that an investor suffers a loss.

Ranked by this comfort ratio, the surprise is that a 60/40 allocation acts more like a growth, not a balanced, allocation.  70/30 and 80/20 growth allocations have the same .37 comfort ratios as the 60/40.  On a more surprising note, a strongly agressive 90/10 allocation with a .38 ratio  has a better comfort ratio than any of these growth allocations.  Here’s a table:

Allocation Avg % Years Comfort Ratio
                   Return    With Loss
40/60 7.8 17.7 .44
50/50 8.3 18.8 .44
60/40 8.7 23.3 .373
70/30 9.1 24.4 .373
80/20 9.5 25.5 .373
90/10 9.8 25.5 .384
100/0 10.1 27.8 .364

Allocation based on income needs

As an alternative to conventional allocation models using percentages, an investor might keep five years of income needs in bonds and cash and devote the rest to equities. An important caveat: income needs do not include emergency cash. Using this model, an investor who needed $20K from their portfolio each year, would keep $100K in bonds and cash, and put the rest in stocks.  A 35 year old with no income needs would have 100% in equities.  This model naturally becomes more conservative as the portfolio is drawn down.

For two years the stock and bond market have seen little net change.  Investors might have become complacent.  Since the election, the shift in sentiment has been strong and investors should check their year end statements and make adjustments based on their needs and targets.


In a country far, far away….

Cue the Star Wars theme. Dah, dummm, dah, dah, dah, dummmmm.  In 2008, China overtook Japan to become the country that holds the largest amount of U.S. Treasuries. Since this summer, China has been selling Treasury bonds to support its currency, the yuan, and is now again in 2nd place.  As long as the dollar continues to rise, China is likely to continue this practice which will maintain a slight downward pressure on bond prices.

The Role of Government

December 18, 2016

What role should government at many levels – Federal, state and local – play in our lives?  Some want a large role, some small.  Does the Constitution give the Federal government a diminished role in our lives? That is the viewpoint of those on the right side of the political divide in this country.  As Donald Trump gets ready to lead a Republican dominated Federal government, the debate burns white hot, as it did at the founding of this country.

Let’s turn the time dial back to 1936, the middle of the Great Depression, to appreciate just how much we depend on government today.  At that time, the unemployment rate had declined from a soul crushing 24%, but was still high at 17%.  The Roosevelt administration had ushered in many programs to alleviate joblessness.  In 1936, total government spending at all levels was $257 billion. (Dollar amounts don’t include what is called transfer payments like Social Security. and are in 2016 dollars.)

Eighty years later, it is $6 trillion, about 24 times the 1936 level.  Some might counter that the population has grown so, of course, government spending has grown.  The population has indeed increased, but only 2.7 times, far below the 24 times that government spending has multiplied.  In 1936, per person spending was $2,000.  Today it is $19,000.

During World War 2, government spending climbed six times to $1.6 trillion, about 25% of today’s level.  We are not currently engaged in a global war which occupies most of our economy as it did in the 1940s.  We do not have millions of young men in combat.  And remember, these figures don’t include Social Security, welfare and business subsidies.

Now let’s look at this from another viewpoint, one that might lead to a different conclusion.  Let’s look at government spending as it relates to family income.  According to the IRS and BLS, average family income was about $26,000 in 1936. (IRS and BLS See note below).  Remember, this was during the most severe Depression in our nation’s history.  So, per capita government spending was about 6% of this rather low family income.  Today, it is 33% of the $56,000 median family income.  So, we squint at these figures from two viewpoints and we are still left with the same conclusion.  As a percent of income and on a per capita basis, government spending has become a significant part of our lives.

When Republicans talk about smaller government, the “small” in that catch phrase should be kept in perspective.  At best, Republicans might want to lower spending growth to eight times, not ten times, the spending of 1936.  Those on the left might want to accelerate that growth to 12 times.  In either case, neither party advocates the frugal spending levels of 1936.  I should note that President Roosevelt himself was concerned that this low (to us) level of government spending – most of them his New Deal programs – was becoming too high.

The current fad is speaking in hyperbole.  Many daily experiences in our lives are awesome.  Our kids, our vacation, the latte we had yesterday – all awesome. It is no surprise, then, that we would  use hyperbole to describe those who don’t agree with our political views.  They are communists, or socialists, or capitalist anarchists, or [insert epithet here].  The voices of moderation are growing smaller by the year.

Half of the voters in this country want less government, half want more.  If each of us wants “our” views to prevail, we need to get up off our asses and pull on the rope in this political tug of war.  When “our” side gets into power, the other half has to suffer through it, and vice-versa.  This battle of ideas will continue throughout our lifetimes and – God Forbid! – we might even change sides.



According to the IRS, only 4.3% of tax returns reported positive taxable income in 1936.  One out of 20 families footed the entire bill for Federal government spending. 95% of families had no federal taxable income. 

Real wage growth in the U.K. has turned negative for the first time since the 1860s.

The most common job in a lot of states:  truck driver.  (NPR)

Optimism Reigns

Dec. 11, 2016

For the second week since the election the SP500 index rose more than 3%, reversing a slight loss the previous week.  The SP500 has added 160 points, or 7.6%, in total since the election.  Barring some surprise, the market looks like it will end the year with a 10+% annual gain, all of it in the 6 – 7 weeks after the election. Small cap stocks have risen 17% in the past five weeks.  Buoyed by hopes of looser domestic regulations, and that international capital requirements will be relaxed, financial stocks are up a whopping 20% in the same time.

Having held their Senate majority, Republicans now control both branches of Congress and the Presidency but lack a filibuster proof dominance in the Senate.  They are expected to pass many measures in the Senate using a budget reconciliation process that requires only a simple majority. The promise of tax cuts and fewer regulations has led investment giants Goldman Sachs and Morgan Stanley to increase their estimate of next year’s earnings by $8 – $10.  Multiply that increase in profits by 16x and voila!  – the 160 points that the SP500 has risen since the election.  The forward Price Earnings ratio is now 16-17x.

Speculation is about what will happen.   History is about what has happened. The Shiller CAPE10 PE ratio is calculated by pricing the past ten years of earnings in current year’s dollars, then dividing the average of those inflation adjusted earnings into today’s SP500 index.  The current ratio is 26x, a historically optimistic value.  The Federal Reserve is expected to raise interest rates at their December meeting this coming week.

As buyers have rotated from defensive stocks and bonds to growth equities, prices have declined.  A broad bond index ETF, BND, has lost 3% of its value since the election.  A composite of long term Treasury bonds, TLT, has lost 10% in 5 weeks.  For several years advisors have recommended that investors lighten up on longer dated bonds in anticipation of rising interest rates which cause the price of bond funds to decline.  For 6 years fiscal policy remedies have been thwarted by a lack of cooperation between a Democratic President and a Republican House that must answer to a Tea Party coalition that makes up about a third of Republican House members.  The Federal Reserve has had to carry the load with monetary policy alone.  Both former Chairman Bernanke and curent Chairwoman Yellen have expressed their frustration to Congress.  If Congress can enact some policy changes that stimulate the economy, the Federal Reserve will have room to raise interest rates to a more normal range.


Purchasing Manager’s Index

The latest Purchasing Manager’s Index (PMI) was very upbeat, particularly the service sectors, where employment expanded by 5 points, or 10%, in November.  There hasn’t been a large jump like this since July and February of 2015.  For several months, the combined index of the manufacturing and service sector surveys has languished, still growing but at a lackluster level.  For the first time this year, the Constant Weighted Purchasing Index of both surveys has broken above 60, indicating strong expansion.

The surge upward is welcome, especially after October’s survey of small businesses showed a historically high level of uncertainty among business owners.  This coming Tuesday the National Federation of Independent Businesses (NFIB) will release the results of November’s survey.  How much uncertainty was attributable to the coming (at the time of the October survey) election?  Small businesses account for the majority of new hiring in the U.S. so analysts will be watching the November survey for clues to small business owner sentiment.  Unless there is some improvement in small business sentiment in the coming months, employment gains will be under pressure.



Occasionally productivity growth, or the output per worker, falters and falls negative for a quarter.  Once every ten or twenty years, growth turns negative for two consecutive quarters as it has this year. Let’s look at the causes.  Productivity may fall briefly if businesses hire additional workers in anticipation of future growth.   Or employers may think that weak sales growth is a temporary situtation and keep employees on the payroll.  In either case, there is a mismatch between output and the number of workers.

During the Great Recession productivity growth did NOT turn negative for two quarters because employers quickly shed workers in response to falling sales.  The last time this double negative occurred was in 1994, when employment struggled to recover from a rather weak recession a few years earlier.  For most of 1994, the market remained flat.  In Congressional elections in November of that year, Republicans took control of the House after 40 years of Democratic majorities.  The market began to rise on the hopes of a Congress more friendly to business.  Previous occurrences were in the midst of the two severe recessions of 1974 and 1982.   As I said, these double negatives are infrequent.


The Next Crisis?

The economies of the United States and China are so large that each country naturally exports its problems to the rest of the world.  The causes of the 2008 Financial Crisis were many but one cause was the extremely high capital leverage used by U.S. Banks.  A prudent ratio of reserves to loans is 1-8 or about 12% reserves for the amount of outstanding loans.  Large banks that ran into trouble in 2008 had reserve ratios of 1-30, or about 3%.

Now it is China’s turn.  Many Chinese banks have reported far less loans outstanding to avoid capital reserve requirements.  How did they do this?  By calling loans “investment receivables.”  It sounds absurd, doesn’t it?  Like something that kids would do, as though calling something by another name changes the substance of the thing.  70 years ago George Orwell warned us of this “doublespeak,” as he called it.  Reluctant to toughen up banking standards for fear of creating an economic crisis, the Chinese central bank is planning a gradual move to more prudent standards that will take several years.  However, it is a crisis waiting for a spark.  Here’s a Wall St. Journal article on the topic for those who have access.


The Un-Recovery Machine

December 4, 2016

I’ve titled this week’s blog “The Un-Recovery Machine” for a reason I’ll explain toward the end of the blog as I look at the lack of growth in household income for the past 16 years.  Lastly, I will show how easy peasy it is to do a year end portfolio review. First, I’ll look at the latest job figures and a quick five year summary of a few key stats of stewardship under the Obama administration.

The economy added 180,000 jobs in November, close to estimates.  Obama will leave office with an average monthly gain of 206,000 jobs over the past five years, a strong track record. The president has a minor influence on the number of jobs created each month but each president is judged by job growth regardless.  We need to have a donkey to pin the tail on when something goes wrong.

The real surprise this month was the drop of .3% in the unemployment rate to 4.6%.  Some not so smart analysts attributed the drop to discouraged workers who dropped out of the labor force.  However, the number of dropouts in November was the same as October when the unemployment rate declined only .1%.  Seasonal factors, Christmas jobs and variations in survey data may have contributed to the discrepancy.  What is clear is that the greatest number of those who are dropping out of the labor force are the increasing numbers of boomers who are retiring every month. I’ll look further at this in a moment.

The number of involuntary part-timers has dropped from 2.5 million five years ago to 1.9 million, about 1.3% of workers. This is a lower percentage than the 1970s, the 1980s, and the first half of the 1990s.  It is only when the tech boom and housing bubble grew in the late 90s and 2000s that this percentage was lower.

Growth in the core work force is a strong 1.5%, a good sign.  These are the workers aged 25-54 who are building families, careers and businesses.  The change in the Labor Market Conditions Index (LMCI) turned positive again in October.  This is a composite labor index of twenty indicators that the Federal Reserve uses to judge the overall health of the labor market.  They have not released November’s LMCI yet.  This index showed negative growth for the first part of the year and was the chief reason why the Fed did not raise interest rates earlier this year.

The quit rate is back to pre-recession levels at a strong 2.1%.  This is the number of employees who have voluntarily quit their jobs in the past month and is used to gauge the confidence of workers in finding another job quickly. The highest this reading has ever been was 2.6% just as the dot com boom was ending in 2001.  Too much confidence. When the housing boom was frothing in the mid-2000s, the quit rate was typically 2.3%, a level of over-confidence. 2.1% seems strong without being too much.

Another unwelcome surprise this month was a .03 decline in the average hourly wage of private workers.  On the heels of a welcome .11 increase in October, this decline was disappointing. One month’s increase or decrease of a few cents is statistical noise.  The year-over-year increase gives the longer term trend.  For the past five years, the yearly increase in wages has been unable to get above 2.5%, which was the annual growth in November.

The greatest challenge that the incoming president will face is the ever growing ranks of Boomers who are retiring.  In 2007, the number of those Not in the Labor Force was 78 million.  These are adults who can legally work but are not looking for work, and includes retirees, discouraged job applicants, women staying home with the kids, and those going to college.  That number has now grown to 95 million, an increase of 2 million workers per year, and will only keep growing as the 80 million strong boomer generation continues to retire each month.   The millenials, those aged 16 to 34, are a larger generation than the boomers but will not fully offset the number of retirees till the first half of the 2020s.  If any president can explain this in very simple terms, it is Donald Trump, who has mastered the art of communicating a message in short bursts.


Construction and Local Employment

Construction employment matters.  When growth in this one relatively small sector drops below the growth of all employment, that signals a weakness in the overall economy that indicates a good probability of recession within the year.  It’s not an ironclad law like the 2nd law of thermodynamics but has proven to be a reliable rule of thumb for the past forty years.  Fortunately, the economy is still showing healthy growth in construction employment that has outpaced broader job gains for the past four years.

The puzzle is why construction spending is an economic weathervane.  It has fallen from 11% of GDP in the 1960s to slightly over 6% of GDP today. (Graph )   Yet when this  relatively small part of the economy stops singing, there’s something amiss.

Real construction spending (in 2016 dollars) is currently at a healthy level of $175K per employee, 16% above the low of $151K in the spring of 2011.  Although we have declined slightly in the past year, the average is about the same level as late 2006 – 2007 and is above the spending of the 1990s.  As a rule of thumb in the construction industry, an employee is going to average 33% in wages and salaries. That doesn’t include the cost of employee benefits, insurance and taxes which will bring the total cost of the employee above 40% of the total cost.   So, if spending is $175K, we can guesstimate that the average worker is making about $58K.  When I check with the BLS, the average weekly earnings in construction is $1120, or almost $58K.  As a side note: that 40% employee cost is used by some contractors as a rule of thumb for a bid total when estimating a job.

During the recession many workers dropped out of the trades.  Older workers with beat up bodies cut back on hours, went on disability or took early retirement.  Younger workers who saw the layoffs and lack of construction employment during the recession turned their sights to other fields.  Workers who do come into the trades find that the physical transition takes some getting used to.  Even workers in their twenties discover that muscles and joints working 8 – 10 hours a day need some time to adapt.

The average workweek hours for construction workers hit at a 70 year high in December 2015 and is still near those highs at 39.8 hrs a week.  In some areas the lack of applicants for construction jobs is constraining growth.  In Denver, construction jobs grew by almost 20% in the past year and that surge is helping to attract  workers from other states.  The unemployment rate in Denver is 2.9%, below the 3.5% in the entire state.  (BLS Denver  Colorado)  This pattern is not confined to Colorado. Very often economic growth may be strong in the cities but weak and faltering in rural communities throughout the state.  For decades this has caused some resentment in rural communities who feel that politicians in the cities dominate policy making in each state.

Local employment

The Civilian Labor Force, those working and actively wanting work, is growing in all states except Alaska, Louisiana, Minnesota, New Jersey, New York, Nebraska, Nevada, Oklahoma and Wyoming (BLS here if you want to look up your city or state stats).  Some of the changes may be demographic.  I suspect that is the case in New York and New Jersey. The decline in some states are those related to resource extraction.  Employment in states with coal mining and oil production has taken a hit in the past two years.  In Colorado, the 11% gain in construction jobs has offset a 12% decrease in mining jobs.


Household Income

On a more sobering note…In 1999 real median household income touched a high $58,000 annually.  Sixteen years later that median was $56,500, a decline of about 3%.  There’s a lot of pain out there.

For readers unfamiliar with the terminology, “real” means inflation adjusted.  “Median” is the halfway point.  Half of all incomes are above the median, half below.  Economists and market analysts prefer to use the median as a measure of both incomes and house prices to avoid having a small number of large incomes or expensive houses give an inaccurate picture of the data.

Both parties can take responsibility for this – two Republican administrations (Bush) and two Democratic (Obama) terms. There have been a number of different party configurations in the Presidency, House and Senate, so neither party can reasonably lay the blame at the other party’s feet.  The “new” more idealogically pure Republicans  in the House regard the “old” Republicans of the two Bush terms as traitors to conservative ideals.  Never mind that a lot of those “old” silly Republicans are still taking up room in the House.

Both parties have borrowed and spent a lot of money but little has flowed down to the American worker.  So much for the imaginativeness of trickle down economic theory.  When George Bush assumed office in January 2001, the Federal Public debt totalled $5.6 trillion.  When he left office in January 2009, the debt had almost doubled to $10.7 trillion.  Under Obama’s two terms, the debt nearly doubled again, crossing the $19.4 trillion mark in June 2016.  $14 trillion dollars of Federal borrowing and spending since early 2001 has not helped lift the incomes of American families.  It is a damning indictment of both major parties who have lost touch with the everyday concerns of many American families.

Can Donald Trump be the catalyst that miraculously turns the Washington whirlpool of money into an effective machine?  Doubtful, but let’s stay hopeful. 535 Congressmen and Senators, each with an outlook, a constituency, and an agenda funded by a coalition of lobbyists, are going to fight against giving up control.  Spend the money on my constituents. they will say.  Republicans throw out the phrase “limited government” to their base voters who whuff, whuff and chow down.  Once elected, many Republican politicians are as controlling as their Democratic counterparts, only in different areas of our lives. A Republican controlled government will push for more regulations on women’s health, regulations on people’s moral and social behaviors, a proposal to reinstitute the draft, and threats to private companies who move jobs out of the U.S.   Donald Trump recently enacted Bernie Sanders’ prescription for keeping jobs in America.  He no doubt threatened Carrier’s parent corporation, United Technologies, that they would lose defense contracts if Carrier moved all those 1000 jobs to Mexico.

So Donald Trump, the leader of the Republican Party, is following a socialist play book.  We are going to see more of this because Trump is the leader of the Trump party, not wedded to any particular ideology.  He is a transactional leader who plays any card in the deck to win, regardless of suit. Chaining oneself to ideals is a good way to drown in the political soup.

Republicans in Washington have consistently betrayed conservative ideals of financial responsibility and a smaller government imprint on the daily lives of the American people.  Democratic politicians cluck, cluck about progressive principles but Democratic voters find that their leaders have left them a pile of chicken poop. Unlike Republican voters, Democrats haven’t developed the organizational skills to make personnel changes in party primaries. Both parties are infected with old ideas, loyalties and prejudices.

Because of this, retail investors – plain old folks saving for their retirement – can expect increased volatility in the next two years.  We may look back with fondness at these last two years, a peaceful time of few accomplishments in Washington, and a sideways market in stocks and bonds.  A balanced portfolio will help weather the volatility.

Mutual fund companies and investment brokers track this information for us and we can access it fairly easily online at the company’s website.  Even if we have several places where we keep our funds, it is a relatively simple paper and pencil process to calculate our total allotment to various investments. We don’t need to be precise.  We are not launching a rocket to Mars.

If I have $198,192.15 at Merry Mutual and they say I have 70% stocks and 30% bonds, I can write down $140 in stocks, $60 in bonds.   Then over to my 401K at the Ready Retirement Company to find out that I have $201,323.39 balance, with 80% stocks and real estate funds and 20% bonds.  I write down $160 for stocks and $40 for bonds.  Then over to my savings account at Safety Savings where I have $39,178.64, which I include with my bonds.  I write down $40.  Finally, over to my CDs at the First Best Bank in my neighborhood where I have $32,378.14 in CDs of various maturities.  I include those with my bonds and write down $32. Maybe I have an insurance policy with some paid up value that I want to include in my bonds.

So, adding it all up, my stocks (more risk) are $140 + $160 = $300.  My bonds/cash (less risk) are $60 + $40 + $40 + $32 = $172.  $300 + $172 = $472 total portfolio value.  $300 stocks / $472 total = .635 which is about 64%.  So I have a 64% / 36% stock / bond split and I have figured this out without expensive software, or an investment advisor.

Depending on my comfort level, knowledge and expertise I may want some software or some advice from a professional but I know where my allocation lies.  I am on the risky side of a perfectly balanced (50% / 50%) portfolio and how do I feel about that?  If I do talk to an advisor or a friend I can tell them up front what my allocation is and we will have a much more informed conversation.