Realistic Expectations for Long Bonds

Discussion of the Bond portion of the Permanent Portfolio

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Hal
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Re: Realistic Expectations for Long Bonds

Post by Hal » Wed Mar 14, 2018 8:57 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.
Exactly !

That's why I like to understand the principles behind the PP (or any other portfolio method Eg: Bogle Portfolio), and just not blindly follow the method.
Have learnt so much since discovering Harry Browne.

What worked in the past may not work in the future - life is never predictable.
Eg; Father lived in Germany through WW2. No portfolio allocation would have been profitable. - Got out alive, he was happy.
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Re: Realistic Expectations for Long Bonds

Post by drumminj » Wed Mar 14, 2018 11:30 pm

Hal wrote:Father lived in Germany through WW2. No portfolio allocation would have been profitable. - Got out alive, he was happy.
I suspect physical gold, especially if held in another country, would have helped significantly?
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Re: Realistic Expectations for Long Bonds

Post by Hal » Thu Mar 15, 2018 4:29 am

drumminj wrote:
Hal wrote:Father lived in Germany through WW2. No portfolio allocation would have been profitable. - Got out alive, he was happy.
I suspect physical gold, especially if held in another country, would have helped significantly?
Agree with you there ! Not profitable, but definitely helpful.
Couldn't see him filling a bag full of German Long Duration Bonds would have been much use ;D

B.T.W, seeing this is a Bond Forum. What happened to the Bonds during the American Civil War? I believe the US went of the gold standard to greenbacks (fiat) at the same time
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Re: Realistic Expectations for Long Bonds

Post by barrett » Thu Mar 15, 2018 9:20 am

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?
I think the discussion is more nuanced that than, glennds. We aren't really trying to predict the future... just discussing what bonds are capable of when starting from a base level of 3%. Also, I think Harry Browne would approve of discussions like this as even he did a lot of tweaking on his way to the 4X25 allocation.

I reread the bond section in Craig and MT's book last night. In addition to the great performance by bonds in 2008, they also highlighted their performance in 2011 when they went up 33% and the stock market was choppy, but ultimately flat, for the year. But in both of those cases, the run ups were short lived (meaning these are not multi-year trends). One of my contentions is that a PP investor has to look at their portfolio more than once a year, or risk missing the opportunity of rebalancing out of bonds when they are high. They have upside limits that just aren't the same as with stocks and gold.
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Re: Realistic Expectations for Long Bonds

Post by glennds » Thu Mar 15, 2018 9:45 am

barrett wrote:
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?
I think the discussion is more nuanced that than, glennds. We aren't really trying to predict the future... just discussing what bonds are capable of when starting from a base level of 3%. Also, I think Harry Browne would approve of discussions like this as even he did a lot of tweaking on his way to the 4X25 allocation.

I reread the bond section in Craig and MT's book last night. In addition to the great performance by bonds in 2008, they also highlighted their performance in 2011 when they went up 33% and the stock market was choppy, but ultimately flat, for the year. But in both of those cases, the run ups were short lived (meaning these are not multi-year trends). One of my contentions is that a PP investor has to look at their portfolio more than once a year, or risk missing the opportunity of rebalancing out of bonds when they are high. They have upside limits that just aren't the same as with stocks and gold.
Very fair and valid points!
Help out a simpleton (me) here - could the analysis be less binary that interest rate outlook=bond performance? Might there be other unpredictable factors that could influence the bond market one way or another? Examples - market forces of supply and demand brought about by: flight to safety, comparatively less attractive alternatives elsewhere, economic conditions as HB outlined? Or perhaps other reasons capital might tend to flow from one asset class to another. Maybe you buy the dog because it suddenly has less fleas than the one you currently own. Sometimes I think of those times when I'm driving on the highway, my speed doesn't change, but suddenly it seems like I'm going faster simply because everyone else is going slower. In relative terms I'm now outperforming (in speed) even though I haven't changed.

On a partially unrelated note, I think there may be much more influence in the T30 market today than there was in HB's time, as a result of foreign government purchasing, sovereign wealth funds, and other massive buyers. Granted it's a huge market but I wonder if the size of the holdings and sheer buying volume of these institutional and governmental buyers isn't a material influence, and possible distortion, all on it's own. If there's any merit to this observation, then what's a little HBPP fella to do if such forces restrict the protective features of the one asset class from pulling the load when you need it?

Thanks in advance for any insight on either of these two points,
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Thu Mar 15, 2018 12:34 pm

Theoretically LTT’s have a ceiling at 0%, but in practice fixed income investments can have -ve yields. Is that realistic to expect, I don’t know.
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Re: Realistic Expectations for Long Bonds

Post by dualstow » Thu Mar 15, 2018 2:50 pm

barrett wrote: So, what ARE realistic expectations for long bonds at the moment?
Great question, barrett. I know less than you, which is why I haven't had much to say.
I recently decided not to buy any new long bonds, but I haven't sold any either. I've got some reaching their "best before" date in 2020, where "best before" = only 20 years left on them.

Instead, I may put new money toward gold, an asset that I have also previously thought about not adding to. :-) That's my own situation. Because of the vp, gold is nowhere near 25% of my total holdings (but it *is* 25% of my pp).
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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Thu Mar 15, 2018 4:14 pm

I've asked before, without any answers I understand:

--Why are US long treasuries at such a higher interest rate than various European and Asian countries? Only European country with a higher yield is Greece! I would think the US should be the lowest of virtually anywhere except what, Japan and Germany?

--So looking at it this way, I would say US bonds still have a better than 50/50 chance of increasing in value and dropping yield.

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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Fri Mar 16, 2018 2:43 pm

And this from Mish:

https://www.themaven.net/mishtalk/econo ... z2PU_1Jx9Q

Takeaway:

Debt Deflation Coming Up

I expect another round of asset-based deflation with consumer prices and US treasury yields to follow.

Buy long-term treasury calls or long-duration Treasury ETFs.

The higher rates get, the better those calls and ETFs look, even if we do not hit convergence.
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Re: Realistic Expectations for Long Bonds

Post by ochotona » Fri Mar 16, 2018 2:46 pm

Having taken tax losses from bonds, I am going to rebuy them after the 30 day period is over. Thank you interest rate demigods for the little tax loss.
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Re: Realistic Expectations for Long Bonds

Post by dualstow » Fri Mar 16, 2018 2:52 pm

ochotona wrote:...
Thank you interest rate demigods
...
How about the bond vigilantes?
https://en.wikipedia.org/wiki/Bond_vigilante
✓ I should put them in my sig.
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Re: Realistic Expectations for Long Bonds

Post by barrett » Sat Mar 17, 2018 7:30 am

Cortopassi wrote:I've asked before, without any answers I understand:

--Why are US long treasuries at such a higher interest rate than various European and Asian countries? Only European country with a higher yield is Greece! I would think the US should be the lowest of virtually anywhere except what, Japan and Germany?

--So looking at it this way, I would say US bonds still have a better than 50/50 chance of increasing in value and dropping yield.
Hey Cortopassi,

I put your question to a high school friend of mine who works for Pimco. Here is his response:


There is a lot underneath your question. Intl Govt Bond yields are impacted by:
Inflation Expectations in each country
Growth Expectations in each country
Short Term borrowing rates in each country
Perceived safe haven status
Central Bank bond buying actions (known as QE)
Currency expectations
Amount of debt issuance

All of these are in play in the answer today. But I do not have time to type a whole book. A few key points for now:

-US deficits will be growing due to new tax law; there needs to be more US treasury issuance to accommodate; more issuance (supply) means price goes down (and yield goes up)

- Foreign governments are still VERY active in QE; ECB continues to buy almost $60 billion per month; Japan’s MOF keeps 10 year yields at 0% by mandate and buys whenever they rise to 0.10% and sells whenever they reach -0.10%; for a few years, German Bunds were negative yields too as everyone was afraid to keep money in the banks, they all bought Bunds

- a more regular impact is from short rates in each country; when an institutional investor buys a Euro Gov’t Bond, they must sell dollars, buy euros, then buy the bond; many do this as a financed trade, so calculation must include borrowing in Euro with short rate (detractor) from return; and receiving short US rates

Lastly today has an interesting twist. One would think with the much higher US rates, the currency would be doing well (it hasn’t). This conundrum is discussed in a short blog on our website pimco.com from Mohsen Fahmi.


This is me writing again. My guess would have been that the yield disparity between countries was mostly a result of currency risk. I guess that is only one factor but it's pretty easy to imagine that a person living in Europe, say, and buying US bond yielding 3% annually, could get hammered by a 5-10% drop in the Euro.
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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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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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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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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 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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Re: Realistic Expectations for Long Bonds

Post by ochotona » Fri Mar 30, 2018 7:26 am

ochotona wrote:
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 gave out 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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Re: Realistic Expectations for Long Bonds

Post by ochotona » Fri Mar 30, 2018 11:19 am

MangoMan wrote:
ochotona wrote:
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 gave out 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.
Where can you chart the 100 month MA?
If you have a pay account at Stockcharts.com, you can do it. below is the chart from Julien Brigden. The green line is the 100 month MA. The 435 week moving average works, too, for free on Stockcharts.com. Symbol is $UST30Y. It shows if we break above 3.25% on the 30 year, it will be the first time that moving average has been broken in 33 years.

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