Realistic Expectations for Long Bonds

Discussion of the Bond portion of the Permanent Portfolio

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Cortopassi
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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Sat Mar 17, 2018 9:29 am

Thanks, Barrett!
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buddtholomew
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Sat Mar 17, 2018 10:14 am

All that knowledge and only in High School... O0
That was my initial reading haha
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Re: Realistic Expectations for Long Bonds

Post by barrett » Sat Mar 17, 2018 12:21 pm

buddtholomew wrote:All that knowledge and only in High School... O0
That was my initial reading haha
Yeah, pretty clunky wording. Sorry about that. He was actually my 7th grade Chemistry lab partner (always droning on about inverted yield curves and convexity!).
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Sat Mar 17, 2018 12:32 pm

Barrett, I hope you make a decision you are comfortable with soon. It weighs on the mind...nice day outside going to play football with my 8 year-old daughter.
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sophie
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Re: Realistic Expectations for Long Bonds

Post by sophie » Tue Mar 20, 2018 7:38 am

I'm still buying long bonds, although I'm sticking with bond funds like TLT for now.

I have also noticed that disparity between US and European bond prices, and I don't understand why international investors aren't piling into US bonds. Perhaps they are and this is the reason why the bond yield curve is flat beyond 10 years. If European bonds drop further, it's possible this effect will increase.

The other reason is that what we know about the future (Fed planning to increase rates) is already factored into bond prices. If you notice, the last couple times the Fed raised rates, T bill prices didn't change much.

Maybe the criterion should be whether long bonds could increase enough to trigger a rebalance - this would require them to double in price while the rest of the portfolio drops. No reason why that couldn't happen. If long bonds got to the point where doubling in price would require a historically extremely unlikely event, like yields going negative or < 1%, that would make me stop buying them.
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Tyler
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Re: Realistic Expectations for Long Bonds

Post by Tyler » Tue Mar 20, 2018 10:54 am

stuper1 wrote: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.
Keep in mind that the initial gold correction after Bretton Woods was repealed ended in December 1974. Gold fell about 50% off of that high over the next three years before the late-70's spike kicked in, so I think it's reasonable to attribute everything from 1975 on to normal gold behavior in a fiat currency market.

Long-term treasury rates skyrocketed in the late 70's and returns were appropriately pummeled. Starting in 1975 they saw a 10-year real return of -1% a year even with coupon payments topping well into double digits. The worst timeframe was the 5 years starting in 1977 when long term treasuries lost 10.4% a year in real terms. Talk about painful! I can only imagine the bond scream room snail mail threads back then. ;)

So yes the skyrocketing gold price helped the PP immensely when bonds cratered but I would not attribute it to coming off the gold standard. It's just what gold does when financial chaos hits and it has come to the rescue more than once. Even if long term bonds lose money for the next decade just like they did starting in 1975, the PP is much better designed than most other portfolio options to ride that scenario out without worry.
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Re: Realistic Expectations for Long Bonds

Post by stuper1 » Tue Mar 20, 2018 3:03 pm

Tyler, I certainly hope you are right about gold prices in the 1970s. That would be wonderful, if accurate. An alternative viewpoint could be that prices ran up quickly, pulled back a bit, and then continued running up until 1981, but still based on gold trying to find an equilibrium price after being artificially priced for so long.
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Re: Realistic Expectations for Long Bonds

Post by Tyler » Tue Mar 20, 2018 3:52 pm

For reference, here's the gold price history since 1971:

Image

You can see that the volatility picked up in 1972 when Bretton Woods ended. Prices jumped through Jan '75 before calming down for the next 4-5 years. Pay particular attention to the red nominal line between '75 and '79. That seems like a reasonable equilibrium to me.

(As an aside, people like to attribute the entire rise between '72-'75 to coming off the gold standard while forgetting that inflation spiked from 3% to over 11% in that timeframe. I don't doubt that the market finding the right level for gold after it had been held down for so long accounts for a good percentage of gold performance over that timeframe, but I think it's naive to believe it's 100%).

Now something definitely happened in 1979 or so to shoot gold through the roof before slapping it back down by 1983. I don't disagree that multiple factors may be at play, but I'd argue that inflation spiking from about 7% in 1978 to 14% in 1980 before retreating all the way back to 3% in 1983 was a major factor. How else would you expect gold to react in that situation? Attributing the entire rise to Bretton Woods seems silly to me.
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Re: Realistic Expectations for Long Bonds

Post by Desert » Tue Mar 20, 2018 10:25 pm

stuper1 wrote: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.
Yes, exactly. Nobody knows. Backtesting is interesting, but can't predict the future.
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Re: Realistic Expectations for Long Bonds

Post by sophie » Wed Mar 21, 2018 7:36 am

Desert is right: backtesting is useless is in this situation because this exact scenario has never happened before. But keep in mind: the PP assets don't exist in a vacuum, and you have to consider how all four assets will react to a given scenario. Any guesses on likely scenarios? here's mine:

1) Bond rates continue to rise but very slowly, nudged along by a conservative Fed. Bond prices will fall slowly enough that coupon payments will limit losses. Stocks will continue to do well. Gold will stay flat. The PP will chug along at 4-5%/year and inflation will stay around 2%. The PP will look increasingly unattractive. Investments will continue to shift more and more toward stocks, which will turn out badly when the next big stock market correction comes along.

2) The Fed gets a bit impatient and hikes interest rates too fast. Bond prices will drop accordingly (but won't crater). The stock market will get jittery between the interest rate situation and concerns about the deficit, and the market will pull back. Gold will run up just long enough to provide a nice rebalance opportunity. Sort of like February's pullback but durable enough to take advantage of.

3) The financial system/house of cards gets itself into trouble again. Drastic shifts in asset prices will occur, like 2008 but maybe with a different mix. PP holders will look like geniuses.

I figure that long bonds won't set the world on fire unless #3 happens, but they also won't lose much. It's not a huge price to pay for protection, if you want it. It wouldn't be unreasonable to limit bonds to 15-20% of the portfolio, just enough for said protection in scenario #3 but low enough that the long interest rate rise won't damage returns much. I'm also leaving new money in funds like TLT in retirement accounts, so that you get the benefit of increased interest payments as the yields increase.
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Re: Realistic Expectations for Long Bonds

Post by ochotona » Fri Mar 23, 2018 7:01 pm

On macrovoices.com there is a great podcast with Jeff Snider on why long bond rates are not going to go much higher, and he doesn't think we've seen the low in interest rates yet. https://www.macrovoices.com/
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Re: Realistic Expectations for Long Bonds

Post by ochotona » Fri Mar 30, 2018 7:16 am

ochotona wrote:On macrovoices.com there is a great podcast with Jeff Snider on why long bond rates are not going to go much higher, and he doesn't think we've seen the low in interest rates yet. https://www.macrovoices.com/
On the other hand, Julian Brigden thinks the bottom in LT yields is in. New podcast. https://www.macrovoices.com/

Julian dropped a gem early in the talk... watch the 100 month moving average on 30 year Treasury yields. The yields have not busted above that line for decades.
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