Maximum Bond Upside

[vnatale]

Well yes I suppose there is a number for everyone. The bond number for me is 1% for sure. At that point I don't want them anymore. Under 2% I'm probably not buying them as a new investor, but if I already have them I'm not selling until 1% or so.

This is all highly subjective. But with bonds you kind of know what you're getting in terms of valuation. Stock P/E can change rapidly for a variety of reasons, but a long bond paying 0.50% is pretty much a known bad deal by most any measure I can come up with.

In terms of the Permanent Portfolio I know this would break the model, but sometimes dogma needs to step aside for reality. That reality for me is risk vs. reward for the bonds and the fact that at 1% it's just too rich for my blood and I'll go very short on the yield curve until they recover. But this of course puts investors in the unfortunate situation of asking: "When do I get back in?" And that I don't have an answer for yet. I'll cross that bridge if I'm forced to part ways with my bonds.

Are we now basically at the point that Craig is describing above?

Vinny

[vnatale]

Any thoughts? Only that I'm in no position to criticize. Many's the time I considered the same, like every time TLT breaches 130. (I'm holding bonds directly, but TLT is a convenient and simple gauge). After Craig said he'd sell at 1%, I really got the bug.

FWIW. The reason I don't comment much on what I do is because I don't want people to blindly copy it.

Mostly though with unprecedented things going on with bonds, I just wanted to say that at some point you just have to take your chips and go home. Bonds are perhaps the only asset in the portfolio that the value risk vs. reward is pretty stark. Yields are what yields are and it's known what happens up or down as interest rates move. Gold doesn't have this indicator. Stocks don't either. Cash is cash and relatively stable and short interest rates moves can be waited out.

But again, with long bonds at 1% or less, the risk of holding them for me, is just not worth it. I bring up the issue now because I feel being quiet about it isn't doing any favors. You'll notice that I rarely ever comment on portfolio assets otherwise because mostly it's just noise. But long bonds below 1% is juggling nitroglycerin kind of risk in my mind and a horrible buy.

Again as others (and I) have pointed out. It's one thing to get out, but another to know when to get back in. I think it is safe to say though that bonds that are under 1% are probably not a hot buying opportunity and I'd avoid them regardless of portfolio theory. As when to get back in? I don't know. Again I haven't had to face this question yet. But I'll point out that people have been saying since 2008 that long bonds are a horrible idea and they've been wrong, wrong, wrong. So I could be joining that crowd if I sell out at 1%, but I'll just have to deal with that.

Hopefully Harry Browne will forgive me, but I think he'd be understanding when long bonds are paying 0.50% for 50 years that they aren't worth the risk.

These are interesting times, guys. We could be witnessing the endgame for Keynesianism. The ultimate race to the bottom where mere mortals are all losers.

Here we get.....Craig on the one hand.....


Vinny

[vnatale]

I have a different take on this issue.

Currently (and at all times), the market price represents a perfect balance between buyers and sellers, which means that there is no more upward pressure on prices than there is downward pressure.

It's true that there is not anywhere near the potential upside in LT bonds at this point that there was when rates were at 4%-4.5%, which is about as high as LT rates have been since 2008, but there is still plenty of upside that can be captured from here, even though that seems crazy.  When there are more buyers than sellers, rates will fall, regardless of where they are right now.

Any PP investor should be perfectly comfortable holding all four PP assets, even if he is certain that one of the assets is going to fall in value.  If one asset falls, another asset is likely to rise and protect you from overall portfolio losses.

If you sell now, you have the daunting task of deciding when to get back in.  You are just as likely to be right as you are to be wrong, which means that selling now and buying back in later might mitigate some future losses in this part of the portfolio, but it might also put you in a position of being paralyzed and failing to buy back in at, say, 2.5%, only to see rates drop back to 1%, which would cause you to miss out on a lot of gains when rates fell again.

I'm just holding tight.  I'm okay if LT treasuries take some losses.  At any given time, some part of the portfolio is always taking losses.

That's my two cents.

Don't put too much stock in anything Craig or I have to say on this topic, though.  We don't know anything that the rest of you don't know.  LT treasuries have provided outstanding service in recent years, and people have been hating them almost the whole way.  It's very hard to think clearly about something like this when fear and uncertainty begin to creep into your mind.  It seems unlikely that simply sticking with the basic PP recipe will lead to excessive future regret, but selling one of the assets hoping you can catch it at a good future re-entry point could easily lead to a series of bad decisions than could pollute your whole portfolio.

………...and, MediumTex on the other hand!!!

VInny

[ochotona]

Dr. Lacy Hunt on debt and economic growth. Not pretty. Macrovoices.com

[garya505]

My first post here!

Just had a thought after reading a bunch of posts on low interest rates. Rather than deciding whether to hold cash OR LTT because of the risk, has anyone considered adjusting the duration of the LTT part of their PP based on current interest rates? For example, use a duration of about 10X the long term rate or maybe the 10-year rate?

This is just an example of what might work.
Rate Duration
2.5% 25 years+ (any rate higher that 2.5% would call for LTT)
2% 20 years
1% 10 years
0 0 (cash)

Just a thought I had, since the contribution of the LTT part of the PP depends on some movement of interest rates, and holding LTT at 0 rates is very risky, with not much to be gained. Sure rates could go negative, but at some point they would reach a limit, and from there they could only go up.

I figure either 1) someone has thought of this before, or 2) it's just a dumb idea.

[Cortopassi]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

[vnatale]

My first post here!

Just had a thought after reading a bunch of posts on low interest rates. Rather than deciding whether to hold cash OR LTT because of the risk, has anyone considered adjusting the duration of the LTT part of their PP based on current interest rates? For example, use a duration of about 10X the long term rate or maybe the 10-year rate?

This is just an example of what might work.
Rate Duration
2.5% 25 years+ (any rate higher that 2.5% would call for LTT)
2% 20 years
1% 10 years
0 0 (cash)

Just a thought I had, since the contribution of the LTT part of the PP depends on some movement of interest rates, and holding LTT at 0 rates is very risky, with not much to be gained. Sure rates could go negative, but at some point they would reach a limit, and from there they could only go up.

I figure either 1) someone has thought of this before, or 2) it's just a dumb idea.

Welcome to the forum!

Looking forward to more posts like this from you!

Vinny

[garya505]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

[Cortopassi]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

https://www.weforum.org/agenda/2016/11/ ... d-to-know/

[Hal]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

Hi Gary,
Welcome to the forum. You may find this link useful regarding interest rates.
https://tradingeconomics.com/country-list/interest-rate

[garya505]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

https://www.weforum.org/agenda/2016/11/ ... d-to-know/

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?

[Mark Leavy]

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?

Hi Gary, welcome to the forum. And great questions!

Tyler and a few of the other folks have the subtlety of bonds down much better than I do, but here's my take:

Due to convexity, the volatility of bonds will remain high or even possibly increase as interest rates go down or negative. Regardless of the interest rate, you will need about the same percentage of long term bonds in your portfolio to cover swings in the other assets. I know it is counterintuitive, but bond protection is tied to the rate of change - and it is not linear. At low rates, small interest rate changes produce proportionally large swings in value. At higher interest rates, you need larger rate changes to produce the same swing in value.

[garya505]

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?

Hi Gary, welcome to the forum. And great questions!

Tyler and a few of the other folks have the subtlety of bonds down much better than I do, but here's my take:

Due to convexity, the volatility of bonds will remain high or even possibly increase as interest rates go down or negative. Regardless of the interest rate, you will need about the same percentage of long term bonds in your portfolio to cover swings in the other assets. I know it is counterintuitive, but bond protection is tied to the rate of change - and it is not linear. At low rates, small interest rate changes produce proportionally large swings in value. At higher interest rates, you need larger rate changes to produce the same swing in value.

Just to clarify, I was suggesting a 4x25 PP (CASH, LTT, Gold, and Stock), with the only "unconventional" thing being a reduction of duration in the LTT part as interest rates approach (or dip below) 0. And this would not be an all-or-nothing reduction in duration, but rather a stepped reduction as rates get lower and lower. The intention here would be to reduce the risk of very long bonds if interest rates were to increase from 0, without giving up ALL of the desired volatility. Would it do that?

I believe some have suggested that near-0 interest rates might "break" the PP, or at least make it not work as well as it has in the past. Did Harry Browne even consider that rates might go to 0 when he devised the PP?

[Mark Leavy]

Just to clarify, I was suggesting a 4x25 PP (CASH, LTT, Gold, and Stock), with the only "unconventional" thing being a reduction of duration in the LTT part as interest rates approach (or dip below) 0. And this would not be an all-or-nothing reduction in duration, but rather a stepped reduction as rates get lower and lower. The intention here would be to reduce the risk of very long bonds if interest rates were to increase from 0, without giving up ALL of the desired volatility. Would it do that?

I believe some have suggested that near-0 interest rates might "break" the PP, or at least make it not work as well as it has in the past. Did Harry Browne even consider that rates might go to 0 when he devised the PP?

Ah... thanks for the clarification. I completely missed that you were talking about modulating the duration and not the percentage of holding.

The math works out about the same either way. So my comments are unchanged. But I might still be wrong.

Probably best to wait until smarter people chime in, as we are in uncharted territory here. You are correct that there have been some good arguments that zero or negative interest rates could break the permanent portfolio, and it is probably something that Harry never considered. When I run the numbers, I don't see it. I'm holding a variant of the PP right now, but my exposure to long bonds is equal to my equity exposure. I can't imagine changing it. In fact, reducing my bond exposure seems dangerous as hell.

I'm interested in any other comments. Great discussion.

Mark

[boglerdude]

It looks like the fed wont let stocks drop more than 30%. A 1% rate change in EDV will move it 30%. You can balance the volatility, if they sell 100 year bonds you could hold less of them.

Its possible that eventually the 30 year will just swing from 1% to -1% like I suppose happens in Japan/germany?

[WhiteElephant]

It looks like the fed wont let stocks drop more than 30%. A 1% rate change in EDV will move it 30%. You can balance the volatility, if they sell 100 year bonds you could hold less of them.

Its possible that eventually the 30 year will just swing from 1% to -1% like I suppose happens in Japan/germany?

I think that's a possibility, and because of that I'm not sure if zero/negative rates will actually break the PP. I think LTT can still do what they are supposed to do within the PP framework.

I'm far more worried about the the current negative real returns. Dutch 30y bonds are yielding -1.8% real currently and cash -1.6%. And it's the same in many other European countries.

This problem is not unique to the PP of course, but with 50% of the portfolio in cash/bonds these yields provide a strong headwind to any future returns.

I'm wondering how Harry would have approached such a situation. My guess is that he just would have let it played out. Maybe he would have upped the PM allocation in his VP.
Me? I'm finding it pretty hard to hold on to my LTT's...

[Kbg]

The great thing about bonds is that they are incredibly predictable and by this I mean throw a scenario at them and you know what is going to happen because the math is all there to tell you what will happen. Without a doubt the best prediction for a bond is it's interest rate. It's not even a prediction, it's fact (unless it defaults). Now of course a PP rolls out of a LTT bond after X number of years so all that bond math begins to matter a lot.

LTTs are going to stay volatile and Tyler's convexity graphs are phenomenally good in allowing one to understand how all that works in a very intuitive way. Dialing down duration, dials down volatility so if you are looking for the punch of LTTs you aren't going to get it unless you dial up your allocation.

Bonds and cash all pretty much suck right now. Nothing we can do about that, it is what it is. We also know pretty much exactly what we are going to get from those assets, right now, in terms of return. There's really no guess work about this at all.

So for me the question of LTTs is do I still want their volatility in the portfolio or not? Over the short term, LTTs are an excellent diversifyer of stocks due to negative correlation. If we have a sustained rise in interest rates then they become positively correlated and we hope our gold pulls us through it.

[dualstow]

Gary, I don’t know if maintaining an otherwise perfect pp is explicitly mentioned, but check out Craigr’s post in ‘Slowly Bleeding’
viewtopic.php?f=1&t=8730&p=155349&hilit ... on#p155349

[garya505]

The great thing about bonds is that they are incredibly predictable and by this I mean throw a scenario at them and you know what is going to happen because the math is all there to tell you what will happen. Without a doubt the best prediction for a bond is it's interest rate. It's not even a prediction, it's fact (unless it defaults). Now of course a PP rolls out of a LTT bond after X number of years so all that bond math begins to matter a lot.

LTTs are going to stay volatile and Tyler's convexity graphs are phenomenally good in allowing one to understand how all that works in a very intuitive way. Dialing down duration, dials down volatility so if you are looking for the punch of LTTs you aren't going to get it unless you dial up your allocation.

Bonds and cash all pretty much suck right now. Nothing we can do about that, it is what it is. We also know pretty much exactly what we are going to get from those assets, right now, in terms of return. There's really no guess work about this at all.

So for me the question of LTTs is do I still want their volatility in the portfolio or not? Over the short term, LTTs are an excellent diversifyer of stocks due to negative correlation. If we have a sustained rise in interest rates then they become positively correlated and we hope our gold pulls us through it.

The PP needs the volatility, but my question is, how much volatility? So what I'm getting at is that at interest rates bear 0, LTTs become extremely volatile, very much more than at 5% or 10%. What were rates when HB designed the PP? It matters, because the PP needs volatile assets to get the rebalancing benefit. But does the PP machine need the extreme volatility of LTTs at near 0 rates, and is it worth the extreme risk?

For example, looking at Tyler's convexity chart, it would appear that you could get about the same volatility using 1) 20-year treasuries at around 8% or, 2) 10-year treasuries at near-0 rates (don't check my math as this is an approximation). So the volatility is about the same, but the difference is that in the with the 10-year bonds you are reducing the losses if/when interest rates rise.

I noticed that some have suggested using 50% ITT instead of 25/25 Cash+LTT. I wouldn't do that or even propose it as I think it breaks the workings of the PP machine.

For different Interest rate environments:
High: Cash, TLT, IAU, VTI
Mid: Cash, TLH, IAU, VTI
Low: Cash, IEF, IAU, VTI

Of course you can backtest all of these, but the results would be totally meaningless considering the decreasing interest rates of the last 40 years.

[Kbg]

But does the PP machine need the extreme volatility of LTTs at near 0 rates, and is it worth the extreme risk?

I noticed that some have suggested using 50% ITT instead of 25/25 Cash+LTT. I wouldn't do that or even propose it as I think it breaks the workings of the PP machine.

For different Interest rate environments:
High: Cash, TLT, IAU, VTI
Mid: Cash, TLH, IAU, VTI
Low: Cash, IEF, IAU, VTI

Of course you can backtest all of these, but the results would be totally meaningless considering the decreasing interest rates of the last 40 years.

This stuff is fun to talk about. Heck, I post here all the time but a couple of points.

The PP presumes we can not predict the future and it's components were selected based on historical data. It would be interesting to know if when HB's partner was backtesting this stuff how far back his bond market data went. If it went back to the 40s (which is plausible given treasury rate information has been public for a very long time) then rising interest rates were likely baked into the asset allocation recommendation. Philosophically/religiously almost the PP is about giving up the innate human need to predict/forecast. It's super hard to do. If it wasn't this part of the board (and probably the asset sections as well) should get maybe a couple of posts a year! Pretty much every new post is a speculation of the future in some form or fashion that then generates a discussion.

If any of us knew what interest rates were going to do, picking the correct bond length would be a no brainer. Rising interest rates, go to cash, falling interest rates buy the longest treasury bill/fund you can get...going nowhere/meandering, buy the highest interest bearing bond you can find.

As for ITTs and cash/LTTs it really is pretty much the same risk adjusted. With the mix you get higher performance and higher volatility than ITTs. I think the mix is preferable and especially so in the context of the rest of the PP's assets. If we were looking at the mix stand alone, then it would be the classic risk/reward trade off.

[garya505]

I'm going to to out on a limb here and make some predictions/suggestions.
1. Interest rates could go up, but I have no idea if they will.
2. Interest rates could go down, but I have no idea if they will.
3. Interest rates could stay near 0 forever, but I have no idea if they will.
4. There is probably some practical limit to negative rates based on economic forces.
5. The PP doesn't need the extreme volatility of LTT at near-0 rates to work properly.
6. At near-0 interest rates, ITTs provide similar volatility to LTTs at higher rates. (see Tyler's chart)
7. A PP of 4x25 Cash/ITT/Gold/Stock would work nearly as well at near-0 rates, as a PP of 4x25 Cash/LTT/Gold/Stock works at higher rates.

I confess that I haven't read either of Harry's or Craig's books. Did they ever discuss any of this?

[Smith1776]

6. At near-0 interest rates, ITTs provide similar volatility to LTTs at higher rates. (see Tyler's chart)

This is true, but central bank policy makers tend to make relative rather than absolute changes in interest rates when tightening and loosening. That should ameliorate concerns generally about how rates would affect the PP. They're well aware that a 1% change when rates are low is a bigger relative move than when rates are high. Personally I don't worry about it too much.

[I Shrugged]

I sure hope we don’t see LTT yields below 1%. It might not break the PP but it would sure test my resolve. Intuitively I think reducing the duration would not be of much real world benefit. This comment is worth what you paid for it.

[Mark Leavy]

Apropos of nothing, I have this weird disconnect with zero or negative interest rates.

A lifetime of math so I don't see "zero" as anything special. It is just one point on a number line continuum.

I started out at a very young age designing motor controllers for elevators, and zero velocity was just one transition point between going up and going down. The poor folks in the car probably felt that it was important, but it was just a smoothly differentiable position derivative to me. And it hasn't changed since then.

So, yea. There is a difference between up and down. But you couldn't tell it from the math. And my brain doesn't feel it.

Mark

[PrimalToker]

I remember in Harry Browne's radio show he mentioned LTT rates hit 1% or below during the great depression, and t-bills were negative. I believe a caller asked why would you buy negative rate bonds. Harry answered at the time banks were going bankrupt and were losing 100%, so if you only had to pay a percent to have a guarantee return of principal then it was worth the cost. You lose 1% when your neighbor lost 100%, not bad. I think he also noted your cash duration should be 1 year, because 3 month t-bills can go negative. I don't recall Harry talking long term being negative, only short term being mentioned about negative rates.