Ray Dalio on Bonds

[ahhrunforthehills]

They just didn’t respond much as one would expect with the sell off in equities ....

More fed action buying bonds to lower rates and create liquidity in the market is quite inflationary in the longer term and is being looked at as such.

You have a guaranteed loss with a 1.40% yield and the fed saying they will let inflation exceed 2%..return free risk as James grant calls it

But rates can still go down, driving the value up. And who knows what will actually happen to inflation?

It is a risk-adjusted bet. The odds of rates going up SIGNIFICANTLY outweigh the odds of them going down over the long-term. Would you pay the same amount of money for hurricane insurance in Florida as you would in Michigan?

[mathjak107]

Especially because the fed did everything but drop leaflets from helicopters saying if you buy our bonds you are guaranteed to loose money since those bonds are paying half of how much we will allow inflation to rise.

[Kevin K.]

It really has been ugly in the markets this week, with all the PP assets except cash tanking in unison.

Long term bonds have notably NOT tanked this week.

Yeah I misspoke. LTT's haven't tanked they've been flat rather than responding to the equity and gold sell-offs (as mathjak107 pointed out).

Since I still have a chunk of TLT that's in the red I'm hoping for one last flight-to-safety myself so I can get out. "Return-free risk" is indeed the perfect description of the PP's 25% in LTT's at this point, IMHO.

[Tyler]

"Return-free risk" is indeed the perfect description of the PP's 25% in LTT's at this point, IMHO.

Only if one ignores the 22% return YTD.

I hear what you're saying, though. Personally I think reading too much doom porn about individual assets tends to lead people astray way more often than choosing a consistent portfolio and letting it do its thing. So I'd recommend doing whatever helps you invest with confidence, but only after tuning out for a while and sleeping on it.

In any case, if I had one critique of the All Seasons Portfolio even before the events of the last few years, it's that I think Dalio/Robbins over-weighted long-term treasuries based on a not-so-arbitrary decision to only look at portfolio performance after rates severely spiked in the 1970s. I touch on that here. So it doesn't surprise me that he might want to back off now, although I disagree with the reflex to bail on them altogether. Investing in a measured percentage where you can afford to occasionally expect losses is part of how good asset allocation works.

[Kevin K.]

Thanks Tyler! I was just reading another critique of the All Seasons that pointed out that without inflation protection it isn't truly All Seasons/All Weather.

And of course you're right about the YTD return of LTT's But I don't see how 20-25% in LTT's makes sense going forward given both the current interest rate situation and the Fed's explicit statements about both its inflation targets and intentions of keeping interest rates at or near zero for at least three more years. I can see keeping maybe 10% as deflation insurance.

I'd also be curious to hear what you and anyone else here knowledgeable about bonds thinks of this bond duration glide path approach:

https://www.bogleheads.org/forum/viewtopic.php?t=318412

I'm especially intrigued with the 3-pronged approach shown towards the end of the first page in which a LTT, a STT and an inflation-protected fund are all used but with percentages changing over the investor's life expectancy.

[ahhrunforthehills]

Since I still have a chunk of TLT that's in the red I'm hoping for one last flight-to-safety myself so I can get out.

I’m on the other side... I have a chuck of TLT in a taxable account that I hate to pay the built up gains unless I am 1000% sure. Rates could go up, they could go down, but that check to the IRS is DEFINITELY going to be cashed.

Luckily, I think time is on our side here. I really can’t imagine rates going up anytime soon. Banks are simply not lending and there are a ton of delinquencies on the horizon that will play out in 2021.

My remaining 12.5% LTTs I plan on reducing by 25% each time the 30 year yield goes down by 0.25. I plan on dumping whatever is left after Dec 31, 2021.

[mathjak107]

"Return-free risk" is indeed the perfect description of the PP's 25% in LTT's at this point, IMHO.

Only if one ignores the 22% return YTD.

I hear what you're saying, though. Personally I think reading too much doom porn about individual assets tends to lead people astray way more often than choosing a consistent portfolio and letting it do its thing. So I'd recommend doing whatever helps you invest with confidence, but only after tuning out for a while and sleeping on it.

In any case, if I had one critique of the All Seasons Portfolio even before the events of the last few years, it's that I think Dalio/Robbins over-weighted long-term treasuries based on a not-so-arbitrary decision to only look at portfolio performance after rates severely spiked in the 1970s. I touch on that here. So it doesn't surprise me that he might want to back off now, although I disagree with the reflex to bail on them altogether. Investing in a measured percentage where you can afford to occasionally expect losses is part of how good asset allocation works.

i think you said it best when you said while we cant predict going forward not all portfolios are equally unpredictable .

i think in this case we are seeing the fact long term treasuries may be more predictable then not predictable as to the outcome .

for 40 years the saying dont fight the fed held true
.
that is why one could hold treasuries as rates slid down and inflation fell ...now the fed is saying they want inflation to rise higher.

we are looking at the opposite of the feds mandate the last 40 years ....

at some point history tells us inflation and bond yields in real return have to get back to about zero , that does not sit well with a bond that pays 1.40% and a target for inflation of 2-3%.

that i believe is why with gold and stocks falling daily , tlt responds with a whimper or falls too as investors don't want to be compensated any less on long term bonds for taking the risk on inflation .

[Kevin K.]

Everything you're saying makes sense to me. What I'm having trouble figuring out is what to replace the PP/GB bond barbell with.

[Kbg]

I think the answer to your question depends on what your objectives are and if you plan on adhering to the PP framework.

If safety is your concern, then I think it is what it is and you dial down on LTTs and reallocate to cash primarily and then stocks/gold.

If return is your concern, then I think you dial down on LTTs and reallocate to stocks and gold primarily and then cash.

Unless one believes they can predict the future then decisions on bonds should be beyond easy.

Look at the interest rate...that will be your return if held to maturity.

Look at the duration rate...that will be your loss/gain based on 1% interest rate moves...run some scenarios, what can you live with? Chose and be happy you made an informed decision based on your own risk preferences.

[Kevin K.]

Thanks Kbg - I needed that!

I guess many if not most who post here would say if you're not all-in on the 4 x 25% PP you're not "adhering to the PP framework" but I'm trying to respect Browne's insights while dealing (as we all are) with an interest rate environment he probably couldn't have imagined.

I'm in a situation where I have to put safety first while also still caring about return. I've pretty much done what you suggest, but piecemeal. The biggest part of my cash/bond pile is in short-term Treasury funds, along with CDs paying .80% at a local credit union, 20K in iBonds and a chunk of LTT's. Otherwise I'm pretty much in the GB camp. Guess it comes down to learning to live with something a bit messier than the "authorized" Treasury barbell or going all ITT's.

[mathjak107]

I still own lots of diversified bond funds instead. They are all less interest rates sensitive though

[ahhrunforthehills]

I think the answer to your question depends on what your objectives are and if you plan on adhering to the PP framework.

If safety is your concern, then I think it is what it is and you dial down on LTTs and reallocate to cash primarily and then stocks/gold.

If return is your concern, then I think you dial down on LTTs and reallocate to C.

Unless one believes they can predict the future then decisions on bonds should be beyond easy.

Look at the interest rate...that will be your return if held to maturity.

Look at the duration rate...that will be your loss/gain based on 1% interest rate moves...run some scenarios, what can you live with? Chose and be happy you made an informed decision based on your own risk preferences.

+1

If your plan is to adhere to the PP framework, you will also want a mechanism to readjust back into a 4x25 allocation.

I think a systematic approach is key to this. I view the PP as a safe harbor. I view near zero interest rates as a series of earthquakes. Is a tsunami coming? I don't know... but earthquakes cause tsunamis. Being in a harbor during a tsunami is usually bad. So, to balance this new risk, it might be a good idea to take your boat out to sea so you are closer to deep ocean where your boat will be safer. How far out you would want to drive should probably be based on how big the tsunami risk is (the current rate). As that tsunami risk starts going down (rates go up), you would want to start driving back into the harbor.

Reallocating to cash primarily and then stocks/gold is great advice for safety.

Obviously, if the tsunami never comes everybody that stayed in the harbor gets to say "I told you so". Heck, some tsunamis are only a foot high.
All those people also didn't waste money on gas and have some sleepless nights. That's life I also just paid my medical insurance that I never use.

What I am getting at is have a documented mechanism in place to allocate out of LTT as yields decline, and back in as LTT yields go up... otherwise your emotions can easily get you lost at sea going forward.

The PP can handle really $hi**y weather. In fact, it can probably handle a tsunami with minimal damage. Getting back into the harbor as soon as possible is probably a really good idea. To Tyler's point, it is also prudent to not go ALL THE WAY out to deep ocean.

After-all, the weather tomorrow is calling for fog

[mathjak107]

Everything boils done to risk vs reward. Different assets take on different risks at different times

we can debate lt all we like . only time will tell

[Kevin K.]

Thanks Mathjak107 and ahrunforthehills! Wise advice all around.

[Hal]

Everything you're saying makes sense to me. What I'm having trouble figuring out is what to replace the PP/GB bond barbell with.

I suppose you could consider this approach as a plan B...

https://www.youtube.com/watch?v=E0GQ1Gx8YCw

[Kbg]

Another way to consider LTTs

LTTs are good for deflation and hopefully are a counter when stocks tube...but ultimately a bond ride is as stated before. You can expect the i-rate of the bond.

So given that.

Steady - the interest rate

Deflation - Some cap gains

Inflation - Some cap losses

So an argument against LTTs could be an old Meat Loaf song...2 outta 3 aint bad.

[mathjak107]

given a choice between deflation and inflation , the fed would shift the odds greatly over to inflation . we are already on an inflationary path as far as the fed goes

that is really the crux of the quandary..

so much is going on that is inflationary .

remember that steady interest rate is already a loss in real return .so you really have 2 against and one for

[ahhrunforthehills]

given a choice between deflation and inflation , the fed would shift the odds greatly over to inflation . we are already on an inflationary path as far as the fed goes

that is really the crux of the quandary..

so much is going on that is inflationary .

remember that steady interest rate is already a loss in real return .so you really have 2 against and one for

If the fed doesn’t see inflation pickup in late 2020 or early 2021 they will almost certainly turn to another round of QE before anything else.

This should drop LTT yields (which is typically bullish for stocks). However, there is a strong possibility that yields rise quickly (as many remaining LTT bond holders will think that the long end of the yield curve has runout of gas.

That money will move into gold (which is essentially a 0% bond with no counter-party risk) and/or stocks.

LTT bonds do not correlate the same way at zero rates as they do at higher rates.

This is PRECISELY why they fed NEEDS inflation higher come hell or high-water. Another financial crisis at zero rates would be DEVASTATING. They need rates to get off the ropes to try and get an extra bullet or two into their gun. This is literally the purpose of the Federal Reserve.

There is a huge difference in effectiveness when you are running negative real yields vs negative nominal yields. Negative real yields (with non-negative nominal rate) supports the economy. Negative nominal yields would have very little stimulative effect.

So, I think that even if we could win with LTT going forward over the short-term, you would win with gold and/or stock as well. This makes LTT seem like an unnecessary risk all around.

Granted, bond convexity is powerful, however you would be taking a LOT of risk not only on the up/down bet of yields, but even if you win that bet you still need to hope that those gains don’t vanish quickly as the big-boys dump their positions on the market.

As I have said before, there are a lot of deflationary forces in the system. Banks are certainly not lending (and probably won’t be without a government guarantee for loans). As such, LTT looks pretty good in the short term. But make no mistake, you are betting against the fed big-time.

Does anyone here really think that the fed is incapable of inflation in a fiat monetary system?? Am I missing something here??

For argument sake, let’s pretend that the fed is completely helpless against deflation and you have slow growth. LTT does well, but so does gold (even more so when rates hit zero and below). What about deflation with fast growth? Stocks would outperform LTT.

Again, what am I missing besides a “you never know for sure what can happen” type of argument?? (which IMHO does deserve some allocation, but is not nearly strong enough of an argument to justify a 25% allocation in terms of risk).

[Kbg]

given a choice between deflation and inflation , the fed would shift the odds greatly over to inflation . we are already on an inflationary path as far as the fed goes

that is really the crux of the quandary..

so much is going on that is inflationary .

remember that steady interest rate is already a loss in real return .so you really have 2 against and one for

No, factually it is not...

https://fred.stlouisfed.org/series/M1

https://fred.stlouisfed.org/series/M1V

I'm not saying inflation won't happen down the line but I am saying it isn't happening now. Here are two graphs that, together, tell you if inflation is happening. Everyone knows about the top graph, but too few people understand both M1 and M1V have to be going up to have inflation. What you are seeing is just like what happened in 2008. The Fed is flooding the market with money and it isn't being used. Turns out the real economy actually matters and monetary theory only gets you so far.

So gentle readers, when both are going up, be worried. Until then, inflation isn't and won't be a thing.

For those interested in a deeper dive...https://open.lib.umn.edu/macroeconomics ... e%20period.

[ahhrunforthehills]

given a choice between deflation and inflation , the fed would shift the odds greatly over to inflation . we are already on an inflationary path as far as the fed goes

that is really the crux of the quandary..

so much is going on that is inflationary .

remember that steady interest rate is already a loss in real return .so you really have 2 against and one for

No, factually it is not...

https://fred.stlouisfed.org/series/M1

https://fred.stlouisfed.org/series/M1V

I'm not saying inflation won't happen down the line but I am saying it isn't happening now. Here are two graphs that, together, tell you if inflation is happening. Everyone knows about the top graph, but too few people understand both M1 and M1V have to be going up to have inflation. What you are seeing is just like what happened in 2008. The Fed is flooding the market with money and it isn't being used. Turns out the real economy actually matters and monetary theory only gets you so far.

So gentle readers, when both are going up, be worried. Until then, inflation isn't and won't be a thing.

For those interested in a deeper dive...https://open.lib.umn.edu/macroeconomics ... e%20period.

This is correct. As I mentioned before, there are a lot of deflationary forces in the system and I expect that LTT yields will drop further as the fed tries to get control of the deflation. Again, banks are not lending. I heard that they have a 0.1% cost to carry a loan... but they still refuse to lend.

The lower rates are AND the higher the risk of deflation, the more likely it is they will not recoup their investment if they have to foreclose a property. That is why I said that many of these deflationary forces are hard to fix without a government guarantee on the loans.

This is all great for LTT. As I said before, LTT looks pretty good in the short-term.

The problem is that betting on LTT is essentially a short-term bet. As a long-term bet, the upside/downside are too uneven. Timing your sale of LTT as you transition from the short-term bet to a long-term bet could be problematic for a typical retail investor.

[mathjak107]

inflation is NOT only about money supply . in fact most inflation in our lives is not monetary inflation . it is supply ,demand and shortage price inflation .

things like lumber quietly shot up 80% . all the rebuilding from hurricanes , rioting and the wild fires has thrown lots of pressure on many commodities ...


workers getting sick or companies in the supply chain not able to function at 100% , shortages in lots of consumer goods all are creating inflationary pressures .

groceries have been way higher too. what has shown slow rises in inflation is energy falling .


Among the items that have seen the biggest price hikes in grocery stores are:

Beef and veal, up 25.1 percent
Eggs, up 12.1 percent
Pork, up 11.8 percent
Poultry, up 8.7 percent

all this has nothing to do with the money supply ....if we can stop the over use prices will fall . the problem is we cant stop over using things .

the cpi and our personal cost of living are very very different .... a cpi index has no regard for how many times i buy an item vs you . or the fact i may buy a higher priced item with bigger price increases but lasts 2x as long . it also does not consider what we are willing to sub out of class in our lives .

so a price change index is only comparing prices around the 1500 mini economies we have . it has nothing to do with your cost of living personally

[ahhrunforthehills]

Mathjak makes a really good point. People like to say “inflation” and “deflation” as an all-or-nothing proposition. Different sectors have different rates across the board. Each person is impacted by those factors differently.

Not to mention how hedonics and geometric weighting skew it further. Afterall, self-driving car technology would technically be a deflationary force against the cost of everyday consumables (since you are getting more car for the same amount of money).

I suppose this is why the fed doesn’t come in with guns blazing too hard and takes a more measured approach. Inflation is a slippery slope.

Great posts guys.

[Kbg]

Don't disagree at all on a personal expenditures level. However, when we are talking about bonds and associated interest rates no one gives a crap about your personal economy, completely irrelevant. If I wanted to spend the time looking I'm sure I could find 4 things that price wise went the other direction and macro sets macro rates not micro.

But let's go with one price that impacts millions of people and is likely one of their largest if not largest expenditures consistently...https://www.macrotrends.net/2604/30-yea ... rate-chart

BAM...down 21% YoY.

[mathjak107]

bottom line is still going to be how tlt does going forward vs more conservative diversified bonds from short to intermediate

[Kbg]

Completely agree...and I do very much like a basic tenet of the PP and HB...we can’t predict the future. All we can do is evaluate risk vs. reward which is easy to do with bonds and cash, factor in our personal circumstances and make a choice. As an older guy I think dialing down duration makes the most sense, but if I was 25 it probably doesn’t matter as you simply want max return and can ride the cycle and invest new savings at higher interest rates which will work out fine over the long haul.