In December stocks were discounted like they were on sale at Filene's basement. Everything not sold at 10% off in the first two weeks were marked down again in the last two.

Wow! What a December to remember. As we pointed out in our fall release the market seemed to be indicating long term minded stock market sailors should be steering for the port of "BUY!", and sure enough, we hauled into port and dropped anchor December 17th and did as much shopping for bargains as time and cash would allow through the week of Christmas. At times, our confidence was shaken as we listened to one market trading expert after another on CNBC readily admit that they had gone to cash. However, the fundamentals kept telling a different story. Tax loss selling was giving a false signal. It seems the Fed had just one more quarter point raise before it could put its finger in the air to feel which way the market winds were blowing. Accordingly, captain chair Powel declared "Argh... we'll make market winds be fair 'til March!", on January 4th. And so, I pulled up anchor and headed back out to the sea of "HOLD!" on January 8th as the S&P 500 market tide rose above 2560.

"Well here is another nice mess you got me into." A change from my nautical analogizing to one of a comedic pair during the black and white film era of the last century. I have in mind a cartoon of our president and the fed chairman. You guess who's who.

As I pointed out in my last missive when interest rates go up bonds prices go down, except when they don't! As we approached September the long bond had rolled over hard and a change in our shorter-term fixed income tactic appeared necessary. I indicated that cash and short-term securities like Treasury FRN's looked best. Surprise! Bonds rallied in December and the broad bond market finished nearly even for the year. What happened? By rights the U.S. ten-year treasury should be offering a yield closer to 3.5% by now not 2.75%! The answer to this conundrum seems to have been a rather odd and unexpected two-step process. If you follow the foreign exchange markets the dollars strong showing against going into the 4th quarter exposed a desire for the relatively higher yield offered by U.S. Treasuries by the rest of the world. It appears that as the Fed has run off its balance sheet it has also lessened the excess reserves which it held for foreign banks. Effectively it had been using these funds to buy Treasuries under the QE. This in turn forced the foreign banks to find other sources of income from their excess cash and the theory is that they started buying Treasuries in the open market. This demand for Treasuries held up the dollar and bond prices on what should have been a glide path lower. Traders who were short bonds, expecting lower bond prices as interest rates continued to rise got caught in what is called a "short- squeeze." They were forced to cut their losses and close positions, buying back the bonds they were short at higher prices. Fortunately, this market whipsaw action did not go unnoticed. Chairman Powel has waved the white flag on further action until March. This will give bond market heavies time to lick their wounds, get re-positioned, and foreign banks time to figure out what to do with their excess reserves. However, unless the government shut down goes on forever the U.S. Treasury will need to barrow a lot more this year, and there should be an ample supply of Treasuries to satiate their need. All things being equal we continue to expect rates to move higher and bond prices lower as we approach mid-2019. Treasury FRN's look like the best house in a bad neighborhood, the rest of the bond market does not seem to offer a fair inflation/risk adjust return. This will probably go on for some time.

Fears of a recession as measured by leading indicators appear, at least for now, to be misplaced. The name of the game is discipline. In a nutshell, when the market acts irrationally all you can do is stick to your long-term strategy and make a few tactical adjustments as necessary. Control the factors you can control. Keep your transaction costs low, your portfolio well diversified, and don't spend a lot of time guessing where the market will go. In the short run the market will do what it's going to do, position yourself for the long run. The number one factor in determining long run performance is price. You can control when you decide to buy, so be patient and buy low. A good place to start looking is when the S&P 500 is trading at or below a trailing 4 quarter average P/E of 16. If you must buy, and are unable to wait, at least dollar cost average into the market to improve your odds. In the long run, publicly traded stocks are the best and most liquid long-term investment available, use bonds and cash as a hedge against stock market volatility. Stocks are always volatile and offer better returns for that very reason. If bonds are volatile and don't offer enough income to compensate shorten duration and hold more cash but stick to your long-term strategy of buying stocks.

Stocks are priced using two primary measures of return: growth and yield. A company's stock price is primarily driven by the expectation of its future earning potential, and secondarily by the dividends it offers. An investors total return is comprised of a stock's price appreciation (driven by the growth of its earnings potential) and the dividends they receive. A stocks future earnings growth is difficult to forecast, so value investors forgo this difficulty by looking for companies that are cheaply priced relative to their peers expecting that over time their true value will shine through as a better management team or better economy cycles through. Another tactic is to invest using the bird in hand approach. That is to buy a basket of stocks in companies that pay higher than average dividends. With these stocks, at least you have something to tide you over while you wait for a company's value to be recognized. Both methods are tried and true. However, in periods of slow economic growth the high dividend method offers an investor greater flexibility. This year I am replacing the Vanguard large cap value index ETF (Ticker: VTV) in my stock model with the Vanguard high yield index ETF (ticker: VYM). Both offer a value-stock oriented investment strategy and have returned virtually the same amount over the last 10 years. However, the higher dividend portfolio offers a slightly better risk adjusted return and requires less transaction vigilance in a volatile market as the dividend more rapidly levels up a portfolios cash balance.