Advisor Perspective's Article on PP/PRPFX

[KevD]

http://advisorperspectives.com/newslett ... tfolio.php

We may not agree with it's conclusions, but it is a thoughtful article.  Better than the normal Marketwatch tripe.

[TBV]

Nice summary.  However, claiming that gold and LT bonds are going to have lower returns over the next ten years does not mean that stocks are preferable.  John Hussman's analysis (link below) indicates that the S&P 500 is poised to deliver average total returns of just 3.15% over the same period.

http://www.hussmanfunds.com/wmc/wmc110214.htm

[foglifter]

"I ran the three-fund version of the PP through Quantext Portfolio Planner, my forward-looking asset allocation tool. "

For those who don't know Geoff Considine: he's selling an Excel-based Monte Carlo tool. I tried it and it perfectly does what a usual MC tool does - uses past performance data to predict the future outcome for your portfolio. If I recall correctly a 36 months historical performance is recommended as a "seed" for the calculation. I don't want to repeat all the cons of the approach - almost every brokerage firm offers these tools as a way to calculate if one's portfolio would grow enough to provide retrenchment income. Many retirees learned the shortcomings of the MC method the hard way in 2008.

I noticed that Geoff usually uses every article he writes on the Web (he's also active on Seeking Alpha) to advertise his software. Nothing wrong with that - he has a business to run. But when it comes to PP performance analysis I prefer to read articles that are not biased by some crystal-ball method. Although I understand that in investing everybody is biased to some extent. 

[longeyes]

The author avers that the PP won't keep up with inflation.  Are not "cash" and gold responsive to inflation?  To a lesser degree, are not stocks?

I'm not sure what kind of portfolio the author prefers instead.

[moda0306]

Seems fair enough, but I have a few problems with it.

- His prediction that interest rates will rise (I think) is a bit unfounded (based on Japan discussion).  Not to sound disrespectful of those that think differently than me, but usually the "rates are bound to rise" argument wreaks of groupthink.

- He somehow thinks that because gold has risen during what he calls a deflationary period (I think there is room for debate on that) that it may not rise with inflation the way we need it to.  I share this fear, though only in the short-term prospects for performance of the portfolio.

- Gold and bonds did both rise, yes, but gold had fallen over an extremely long period of disinflationary prosparity.  Any kind of shocks to our economy and societal fabric were bound to see good gains by gold, whether overtly inflationary or not.  9/11, 2 wars, huge defecits, higher gas prices, the U.S. political discourse, (??talk radio ads??)... all this after a period of disinflationary prosperity that few could have dreamed.  That sure sounds like a recipe for gold to do well if you ask me.  Definitely playing the role of "canary in the coal mine."  

- He claims that the PP is much too conservative for a retired couple who may need "much more than 6.?? return to have enough income in retirement" (or something like that).  I'm sorry, but if 6.5% is wholly inadequate as ROI during retirement, then I don't know if one is ready to retire.  That statement just struck me as extremely odd, as I have little confidence that stocks will average much more than that over the next 5-10 years.

[clacy]

He lost all credibility when he said that it may not keep up with inflation for retirees.  If the PP doesn't the only thing that might would be 50%+ commodities.  Most retirees will tend to be bond heavy in their later years and surely the PP will do much better then their portfolios.

I could respect him if he made the argument that it wouldn't preform well enough to build wealth compared with a 80%+ equity portfolio, that is debatable.  But he's way off on the ability of the PP to protect wealth.

[moda0306]

Additionally,

To put much weight on his "crystal ball" seems a bit laughable... "Well my computer says that the PP is going to return 6.6% while a Coffeehouse portfolio will return 8.2%.  Since 6.6% would leave my retired clients eating catfood by age 75, I can't really recommend this overly conservative portfolio."



Anybody else a bit confused by that logic?

[moda0306]

There are periods where the PP has looked a little weak compared to a CH portfolio that doesn't stress safe assets... in a Coffehouse portfolio, the use of corporate bonds and absence of a precious metal can definitely make the PP look ultra conservative.

Problem is that eventually those periods hit an end and there's a rush to safety.  I could definitely see the PP having a couple malaise-like years as corporate/treasury yields tighten, precious metals fall back, unemployment drops and stocks do alright (just one scenario... not necessarily a prediction).  How much am I willing to bet on that scenario unfolding?  For the cost/benefit of choosing coffeehouse over the PP, not much!

[Lone Wolf]

Thoughtfully done, although I obviously reject the "I can predict the future" premise.

If you take it as a given that gold and LT bonds are going to do poorly in the coming years and that equities are going to do wonderfully, of course the Permanent Portfolio will lag behind the Coffee House types of portfolios.  That's a mathematical certainty.

The day will come when equities win big and put gold and Treasuries into a retreat.  Every PP user knows that's coming some day and that this is when the PP is going to lag the stock-heavy portfolios of their buddies.  We all should have internalized by now that market conditions like that will one day be here.  We'll likely be clanking along at our same old boring rate of return while equities are turning in double digits.  Some of us will even lose patience and find the temptation to jump back into equities to be irresistible.  Bernstein said this a while back and he was right.

In the meantime, though, the United States is fighting 3 hot wars, the printing presses are churning, and trouble with demographics and entitlements looms large on the horizon.  There's never been a time when I've felt less eager to bank on any one outcome playing out.

[moda0306]

There's never been a time when I've felt less eager to bank on any one outcome playing out.

Motion seconded.  Everything seems overpriced in some ways.

[MediumTex]

I didn't see him say a word about inflation-adjusted returns.  It's crazy to talk about an allocation during retirement years without talking about inflation.

He also said that gold was a speculative investment.  Really?  And stocks aren't?

More broadly, these johnny-come-lately types spend a couple of hours looking at past returns and maybe read an excerpt from HB's writings and then write these articles as if they were experts.  For example, although he listed them at the beginning of the article, he didn't provide any analysis of the different economic conditions on which the PP is based and the suitability of each PP asset to these different economic conditions, which is, IMHO, the key to really understanding the PP.  It's sad that articles like this are all most people will ever know of the Permanent Portfolio.

There is so much more to explore in the structure of the PP.  I wish that some of these carnival barkers would spend a little more time studying before they started talking about it as if they had a complete grasp of it.

The tipoff to me that someone doesn't know what they are talking about is when they start talking about the individual components and which ones they like and dislike and which ones are about to rise and which ones are about to fall.  For example, I am amazed at the number of people who are absolutely certain that interest rates are about to start rising dramatically.  They don't have any rationale for this belief other than what they heard on TV and read in the papers, but they treat it as gospel.  It's weird.

[Lone Wolf]

I didn't see him say a word about inflation-adjusted returns.  It's crazy to talk about an allocation during retirement years without talking about inflation.

He mentions inflation-adjusted returns only once, in the single weirdest part of the article (the conclusion.)

"Given today’s environment, characterized by historically low interest rates, the PP, with its interest rate exposure, will not be an attractive portfolio in the coming years, and it is ill suited for retirement-oriented investors who require the ability to keep pace with inflation."

Basically, the PP might be all right... if you don't care about inflation.  This is a strange statement because the PP shines most in terms of yielding a steady inflation-adjusted return!

Furthermore, Harry Browne himself achieved a much of his early notoriety by demonstrating that he knew exactly how to protect wealth from inflation.  "Profiting from the coming devaluation" was what it was all about.  In addition, his "99% of All You Need to Know About Money" is a wonderful, tidy summary of inflation's mechanisms, causes, history and economic implications.  (I believe the "99%" book is a distillation of the economics lessons from the earlier "Devaluation" book.)

It's such a weird little remark that I wish he'd fleshed it out more.  As best I could tell, he's calling gold overbought on equity fears and that when inflation comes it won't react in the normal way.  I think?  Hard to agree\disagree when it's just sort of hurriedly blurted out like that.  The conclusion didn't seem to show the same care that the rest of the article took.

[moda0306]

MT,

They don't dive into the 4 economic cycles because they're not interested in macroeconomics, often.  They'd rather talk about their crystal ball that has the PP narrowed down do a tenth of a percent in performance over the next 5 years.

This is what bothers me about these people.  Everything has to fit into their little wall-street world of interest and dividends, technical analyses and contracts.  "If we can't beat the returns of a yellow metal sitting in a safe, or treasuries paying pathetic interest for 30 years, then what good are we?" they must think to themselves.  So what do you do at that point?  Yield chase.  Get out your crystal ball and move into the best corporate bond risk-class based on technical analysis, hedge into some random commodity that charts indicate is hitting a floor.  DON'T GO LONG ON BONDS, though! Interest rates CAN'T drop.

LW,

I think his attitude was that with long-bonds losing to increasing rates and gold retracting since it seems overpriced, the PP will  significantly lag a coffeehouse portfolio over the next few years.  I can't say I disagree that that's a possibility, but the way he framed the whole thing was just full of holes.  If he's right, it's not because he knows markets, it's because he's lucky.

[moda0306]

Another thing... gold drives these guys nuts becuase it's so hard to price.  It has no industrial use, so its price is based on what could appear to be very difficult to track macroeconomic factors that don't make much sense, but when one looks at golds historical performance, it's nature as a monetary metal and its status as a "canary in a coal mine," its movements have made a lot of sense:  Huge gains during the 70's, retrenchment in 1981 due to contractionary monetary policy (that was a big surprise), and then a steady fall during a period of disinflationary prosperity that we couldn't have dreamed of.  The events of the past 10 years maybe have not been as overtly inflationary as one might expect given gold's jump, but remember where it was coming from (In 1999 things were amazing and looked like they could only get better), and also, it's the "canary."  We got ourselves involved in wars, are targets for terrorist attack, institutions that we used to take for granted (fed, fanny, freddy, DOD, the accounting and finance industries) have proven to not be nearly as trustworthy as we thought they'd be.  Gold, as it should, rose during that period.  That's its job.  Now if we can find ourselves with the low gas prices, mideast peace, low unemployment, safe financial institutions, etc that we thought we had in 1999, I'm sure gold will rightfully retreat, and I'll happily accept that.

Gold is not TIPS.  It won't "keep up" with inflation until you need it to, but then it won't just keep up, but explode... for the same fundamental macroeconomic reasons that may be making stocks and/or treasuries go down.

[MediumTex]

Another thing... gold drives these guys nuts because it's so hard to price.  It has no industrial use, so its price is based on what could appear to be very difficult to track macroeconomic factors that don't make much sense.

It's interesting that no one ever notes that a share of stock also has no industrial use.

I can't take a share of stock and make anything with it (it's not a tool or a natural resource).

In an aside in his 1967 audio program, Harry Browne talked about how stocks were widely misunderstood.  Since a share of stock represents no claim to any individual asset of a corporation, or to any share of a corporation's earnings (other than what may be paid out in the form of dividends), stocks are actually far more speculative than many people imagine.

It would be pretty funny to roll up to the gates of one of these big corporations with some stock certificates in hand and start unbolting fixtures from the buildings because you were ready to cash in your shares.  People would think you were crazy.  

[moda0306]

MT,

While I love the perspective on gold vs stocks, I think people are speaking in terms of "what am I going to hold in my basement as a hedge against inflation," or at the very least "what commodity ETF should I invest in (not that an ETF has intrinsic value)?"  I'd still say gold, but I used to think differently and I think many others still do.

"Joe Six-pack" might find there to be some "truth" in canned food in his basement and an industrial commodity ETF, because those are things he tends to understand.  Likewise, William Wall-Street may find there to be more of a chance that copper would keep up with inflation since he can visually see the ramping up of emerging market demand, and given how much gold has already done its "canary" work (if he even understands that).  The way he sees inflation is different than what it may mean at a more fundamental level...

Is it a) a general rise in prices that fits well within the world we live in (industrial commodities would rise), or b) a fundamental unraveling of the fabric of the society within which we live causing several negative side effects, including rising prices (gold would rise))?  This is where William Wall-Street will want to fall back on the rules of the world he knows (input/output, contracts, markets, profits, etc) and not at the world as it might be (broken promises, fear, currency problems, etc).

[moda0306]

To add to my thoughts on why I love gold.  Most commodoties were dropping 50%+ without flinching during the deflationary spiral we were entering in 2008/2009.

To get gold to drop 50%, you'd need to see a wholly different set of circumstances than we did in 2008, even if a rampant deflation had taken hold, IMO.

If gold drops 50% from its current level, here are my predictions as to what we may see:

- Gas below $1.50 per gallon
- Continued huge gains in computer technology making things work better and more convenient
- Huge gains in energy efficiency or some new energy technology cutting down our utility/gas expenses significantly
- Unemployment around 4%
- We are out of the middle east militarily (or significantly less so)
- Housing stable
- Middle East peace (relative to today)

When gold hits $700, somebody can flame me all they want if these things aren't how we'd describe the world.  I may have overdone it a bit, but I think these points are pretty spot on to what it would take to see gold collapse.  Funny how different gold looks from copper when you do a "what would make it drop 50%" test.

[MediumTex]

This is where William Wall-Street will want to fall back on the rules of the world he knows (input/output, contracts, markets, profits, etc) and not at the world as it might be (broken promises, fear, currency problems, etc).

For me, there is something incredibly liberating about embracing uncertainty rather than trying to constantly ignore it or make weak efforts to somehow neutralize it.

I like the uncertainty of the world.  I know things are in a constant state of change.  I also know that TPTB in all walks of life are troubled by change and will tell all sorts of dumb stories to either justify their existence or validate their claims on power and privilege.  Some of these dumb stories involve claims to know the future, claims that uncertainty has finally been mastered, and claims that the lessons of history are no longer relevant.  

It's all just noise really.  People have to decide on an individual basis what makes sense to them, and all of the talk, speculation and chatter that comes out of the media are rarely of any real help in this quest.  At best, the media tells stories that are loosely based on reality.  Saying that you have a strong understanding of what is really going on in the world based on media outlet reports is sort of like saying you have a strong understanding of Italy from eating at The Olive Garden.

The nice thing about the PP is that it has a "clock in a thunderstorm" quality and continues its steady upward march no matter what the world decides to throw at it (including things that no one saw coming or even thought were possible).

Let me try to capture the sentiment in a haiku:

Future is unknown
Wizards claim to have knowledge
PP keeps one safe

[TBV]

Just as we shouldn't look forward to a world where gold is commanding huge prices, we shouldn't be fearful of one where its price is substatially lower.  A scenario of low unemployment, a more peaceful world, and cheaper energy isn't half bad.

[moda0306]

(including things that no one saw coming or even thought were possible).

What are you referring to that nobody thought was possible?  Deflation? 

[MediumTex]

(including things that no one saw coming or even thought were possible).

What are you referring to that nobody thought was possible?  Deflation? 

In the last 10 years:

9/11
Enron, Worldcom, etc.
Afghanistan War
Iraq War
Housing bubble pops
Oil hits $150 per barrel
2008 financial panic
Bear Stearns, Lehman, AIG, GM, etc.
U.S. elects black President
Peaceful revolution in Egypt
Japan earthquake followed by Godzilla-style nuclear disaster
Libya War
Gold quintuples in value from 2000 low
Treasury yields fall through whole period, continuing 30 year trend

All kinds of crazy stuff that would have seemed unthinkable this time 10 years ago.

[TK3]

I have been a fan of Geoff's for some time, and indeed found the PP through the use of his tool, QPP.  I highly recommend it.  I took a number of the static or lazy portfolio's and put them though this tool and the PP was by far the most balanced relative to projected average annual return and beta.  Geoff's article reports this, it simply makes the point that most others don't understand about PP which is that it is not designed to meet or exceed the market, only to have minimal volatility, real return, and allow the holder to sleep at night.  I use QPP to assist with the selection of low beta, high dividend stocks in my VP which complement the PP very well.  I have targeted a 9% return with 7% beta with 80 percent of my portfolio in the PP.  Since we never know what the future will hold, all you can do is have a plan that allows you to hold on. 

[moda0306]

TK3,

While Geoff's article wasn't grossly unfair by any means, it did make some pretty odd assumptions and brought what I think is a flawed understanding of gold to the table.

[TK3]

I don't know, I think his article reflects what most of the world thinks about the PP.  If you have half of your money in SHY and TLT when interest rates rise  and GLD reverts to the mean, you have a very low probability of success.  When I tell most people how I invest my money, they think I have lost my mind.  Most of the people over at the Bogleheads forum seem to think the same thing.  Since my goal is not to beat the market, but to minimize SD, the PP works well for me.  My intestinal fortitude will be tested when my 40 percent gain in GLD starts retreating( whenever that may be).  I also agree with the previously posted comment that if I could get a 6 percent return with a 6 percent standard deviation, most retirees would go for that in a minute.  For comparative purposes, Geoff's tool QPP projects a go forward average annual return of the S&P of a little over 8 percent with a standard deviation of 15 percent  so the 6 percent doesn't seem bad to me.

[HB Reader]

Boy, this article sure stirred things up.  

I don't know anything about the author or his predictive model, but the firm with whom he is associated (Foliofn) is one of three brokerages that I use and would recommend to others.  While I agree with most of the comments above (and could add some), I do think the article is an interesting read.

I think the article's biggest problem, along with much of what is written about HB's investment strategy, is that it misses the broader point that the PP allocation is intended for money that you can't afford to lose.  It is supposed to protect you come what may, while likely offering a competitive return.  It is far and away the best asset allocation for that purpose that I've seen.  I think it makes sense for most people to have a substantial portion, or possibly all, of their money invested in a PP.  But I don't think HB intended it to be a singular "be all and end all" portfolio into which an investor has to pour all his money (unless he literally can't afford to take any risk whatsoever), regardless of any expectations he may have.  That is why HB wisely incorporated a VP into his strategy.

The article strikes me as something my business professors in graduate school would have loved.  I'm glad I studied history and read a few HB books before I went there.