Realistic Expectations for Long Bonds

Discussion of the Bond portion of the Permanent Portfolio

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barrett
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Realistic Expectations for Long Bonds

Post by barrett » Mon Mar 12, 2018 5:47 pm

Harry Browne used to talk about why owning four asset classes that perform well in different environments did not ultimately provide a return of zero. His reasoning was that a winner could increase several fold while a loser was unlikely to go to zero. Even if we just look at the last two decades, we can see that this thinking is clearly true for both gold in the 2000s and stocks so far in this decade.

Given a high enough starting point (in terms of yield) and a long enough time frame, 30-year treasuries could theoretically do the same thing (I believe that Craig and Medium Tex wrote in their book that long bonds actually outperformed stocks from 1981 to 2011).

My basic question here is, "What are realistic expectations for long-duration treasuries when starting from a yield of 3%?" I've seen a few posters on here write some version of, "I held my nose and bought some more bonds." I'm clearly not the only one who has issues with this quadrant of the PP.

While stocks can keep going up provided that earnings are increasing (and investors are willing to pay a certain P/E multiple), and gold will do very well in times of lack of faith in the USD, high inflation, etc., where are the extended gains in bonds currently supposed to come from?

We all know that long-duration treasuries saved the PP in 2008, BUT while their run up was quite dramatic at the very end of that year, it was not sustained. In fact, it really can't be beyond a certain point. There was actually a very short window to sell treasuries and buy stocks at the end of 2008. One not only had to be paying attention to their investments, but also had to get pretty lucky with their timing to really capitalize on this "flight to quality."

I've posted on here a couple of times (with very little interest, I have to say!) that long bonds with low yields seem to only benefit a PP if one is fairly active in buying them when yields are up and selling them when yields are down. Of course it's virtually impossible to get the timing right with any consistency, and this strategy would really only be effective if one bought and sold a large percentage of their bonds.

So, what ARE realistic expectations for long bonds at the moment?

Thanks in advance for any thoughts.
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buddtholomew
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Mon Mar 12, 2018 7:35 pm

LTT’s + Cash are the easiest to manipulate for peace of mind. Just increase or decrease cash to manage duration without removing one of the legs.

I recently bought LTT’s along with the other assets and this was easier than buying LTT’s alone.

I’ve struggled with this for a while and that’s how I resolved. YMMV.
barrett
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Re: Realistic Expectations for Long Bonds

Post by barrett » Tue Mar 13, 2018 7:06 am

buddtholomew wrote:LTT’s + Cash are the easiest to manipulate for peace of mind. Just increase or decrease cash to manage duration without removing one of the legs.

I recently bought LTT’s along with the other assets and this was easier than buying LTT’s alone.

I’ve struggled with this for a while and that’s how I resolved. YMMV.
All understood, but my question remains... what do you expect long bonds to do for your portfolio in, let's say, a best case scenario? Both stocks and gold can lift a PP for years, and have both had their day in the sun since 2000. I'm 59.5 and expect to live a long time. If gold has just one or two more good runs while I'm still on this planet, I'll feel that holding it during its long periods of underperformance will have been justified.

I started my PP at the beginning of 2014 with the long bond yield at about 3.75%, and the Fidelity website tells me that I am up 12.86% after yesterday. For whatever reason, Fidelity does not add in the coupon payments, but I've made probably another 15% on those. So I have a total nominal gain of around 28%. Not bad at all, but also not anything where I can take action and buy low or sell high unless I get lucky on the timing. I'm certainly not being forced to take action by a rebalancing band breach.

The standard response of "we hold long bonds for their volatility" just seems questionable to me given the unlikeliness that yields are going to plunge into negative territory for whatever reason. With yields hovering around 3%, I feel as if I am holding long bonds primarily for their yield, so the potential risk/reward doesn't seem worth it with rates on the short end of the curve being steadily pushed up by the Fed.

Why not just buy short duration issues?
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buddtholomew
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Tue Mar 13, 2018 8:39 am

We're in the same boat barrett, although my LTT gains were closer to 40%, now 15%.
As long as the portfolio is growing as a whole I am less inclined to remove one of the assets.
True that we may not re-balance out of treasuries anytime soon, but that isn't a reason to exclude them altogether.
Rates will rise and fall (not a straight line up) and with a 17+ year duration could outpace other assets in the years to come.
They're a better buy today than they were at 2.x%
No easy answers barrett other than to stick with the plan.
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Xan
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Re: Realistic Expectations for Long Bonds

Post by Xan » Tue Mar 13, 2018 9:30 am

It does seem like bonds have a severely limited upside. But if we end up in a deflationary environment (see Japan) they could still be THE asset to own. Maybe they don't win nominally, but they sure can win in real terms.
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Re: Realistic Expectations for Long Bonds

Post by barrett » Tue Mar 13, 2018 10:09 am

Xan wrote:It does seem like bonds have a severely limited upside. But if we end up in a deflationary environment (see Japan) they could still be THE asset to own. Maybe they don't win nominally, but they sure can win in real terms.
Yeah, maybe you are right, Xan, but I guess I don't see the big opportunities in Japanese 30-year bonds either. This chart can be set to show the last 19-20 years of data (I wish it went back further but it's best one I found with a quick search):

https://tradingeconomics.com/japan/30-year-bond-yield

I guess if an investor bought at the absolute best times (the peaks) on that chart, and then held on to the bonds just for the interest payments and a bit of potential upside return from falling yields, the bonds would beat inflation most years... but only by a bit.

I'm just not seeing long bonds in the same league with stocks and gold in terms of upside potential. But they are clearly not cash, so what are they really? A second type of ballast?

I do hold them, but, after selling a property recently, I have what may be my last major chunk of cash to deploy (retirement looms). Just doing my due diligence/tire kicking.

Thanks so far for your replies.
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Re: Realistic Expectations for Long Bonds

Post by Hal » Wed Mar 14, 2018 5:26 am

barrett wrote:
Xan wrote:It does seem like bonds have a severely limited upside. But if we end up in a deflationary environment (see Japan) they could still be THE asset to own. Maybe they don't win nominally, but they sure can win in real terms.
. ................

I'm just not seeing long bonds in the same league with stocks and gold in terms of upside potential. But they are clearly not cash, so what are they really? A second type of ballast?

.
I must admit I have struggled with this as well......

So, here are my thoughts

Practice: Yes, in a Depression, the money supply shrinks. The base money stays the same but the "credit money" decreases. The value of the bond increases as does the value of the interest payments. Assuming the Government doesn't default, and they don't print money.
* Cough, except Australia defaulted, Cough... https://cuffelinks.com.au/australias-de ... ds-crisis/

Theory: Under our fiat currency system, cash is a debt instrument. ie. the Assets the Central Bank holds (eg. Gold, other Currencies etc) are offset by the Debt (currency) they issue. So a Government Bond is an IOU in which a debt instrument is lent to the Government. * My head hurts! *

I can follow it under a gold standard. I lend you a ton of gold, you give me an IOU (Bond) and pay me interest (extra gold) as payment for loaning it to you. After the bond matures I have more gold than before.

Anyway, back tp practicalities...

Classical Gold Standard. I cannot create more gold to increase the base money supply. Hence I cannot to counteract the decrease in "credit money"

Fiat Money System. I can increase the base money supply !

Here is the conundrum as I see it.

If the central bank does not create massive amounts of base money in a Depression, the HBPP works -> Bonds are good.
But if they do, both the bonds (which are like leveraged cash) and actual cash are destroyed. Cash ->Bad, Bonds -> Worse

And as a parting gift, listen to this talk on what Roosevelt did during the Depression (personally, I listen only to the presenters facts, NOT necessarily to all his conclusions). Think the Central Banks / Government would not print money if people were going hungry now ?

https://www.youtube.com/watch?v=jZVzA_ino7Q

And putting my money where my mouth is.....

I run a pure HBPP in my retirement fund, however I run a "Bondless" variant of the PP in my taxable account (and sleep better now ! )

Hal
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Re: Realistic Expectations for Long Bonds

Post by barrett » Wed Mar 14, 2018 2:16 pm

The more I rail against long bonds, the better they perform!
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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Wed Mar 14, 2018 4:09 pm

That's why I like the PP setup. It is forcing me to watch things like gold (never going up, until it did), bonds (down down down, until they didn't) and stocks (never a down day, until lately) and NOT DO ANYTHING STUPID! :D
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Re: Realistic Expectations for Long Bonds

Post by glennds » Wed Mar 14, 2018 6:08 pm

Let me get this straight... the discussion is among a group of believers in a defensive portfolio strategy built around the premise that nobody can predict the future.
And we are questioning one of the four components of that same portfolio because of our prognosis of the future?
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ochotona
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Re: Realistic Expectations for Long Bonds

Post by ochotona » Wed Mar 14, 2018 7:56 pm

glennds wrote:Let me get this straight... the discussion is among a group of believers in a defensive portfolio strategy built around the premise that nobody can predict the future.
And we are questioning one of the four components of that same portfolio because of our prognosis of the future?
Group of Believers? That sounds scary!
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Re: Realistic Expectations for Long Bonds

Post by stuper1 » Wed Mar 14, 2018 8:10 pm

I think the problem is that the PP hasn't really been tested in a situation where bond yields are on a long-term upward trend. The period prior to 1981 doesn't really count in my eyes because the U.S. was just coming off the gold standard, and the skyrocketing gold price helped the PP immensely. Nobody really knows whether the PP will be able to keep up satisfactorily against a long-term bond price-decline headwind.
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