TLT Study - Inverting History

Discussion of the Bond portion of the Permanent Portfolio

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pmward
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Re: TLT Study - Inverting History

Post by pmward » Sat May 04, 2019 10:06 am

Kevin K. wrote:
Sat May 04, 2019 9:54 am
pmward wrote:
Sat Apr 27, 2019 9:10 am
Another article that I came across today looking at the issue of bond returns going forward: https://movement.capital/analyzing-bond ... ded4b883a5
Thanks very much for posting this article.

Perhaps I'm drawing the wrong conclusion, but in reading this piece, the other article that the OP cited in starting this thread and other recent bond market analysis it seems pretty clear that with baseline Treasury interest rates so low and the yield curve inverted or close to it there's just not much incentive to hold T's with maturities much longer than a year or two. I understand and respect how the 30 year/STT barbell works in "normal" times, of course but with current 30 year rates at 2.93% (not even half a percent more than Tnotes) there's no way the long T's help in a flight-to-safety situation while any surge in interest rates would decimate them. Heck I don't even see any incentive to choose ITT's which would be the normal default choice (risk:reward sweet spot). I'm just not seeing a downside to keeping the entire bond allocation in STT's.
Be careful. I literally just posted in another thread on this same subject. The fed is on record in their minutes discussing going negative on rates in the next downturn. There could very well be another decade or more left in the great bond bull market. Also, don't forget that if this doesn't happen and inflation and rates start to pick up a bit, gold, stocks, and short term treasuries would benefit. So any losses in long bonds would be made up and then some. There are still a lot of global deflationary headwinds at the moment, I sure as hell would not remove my hedge for that (long term treasuries) because there is a chance that long term treasuries will be *THE* asset over the next few years if these deflationary trends continue, and we get another recession forcing the Fed to go negative. Nobody knows nothing. Markets are not logical. Just because it seems like bond rates should go up, doesn't mean they will. And even if they do, you are hedged against it, and will be able to rebalance to claim more yield and buy more bonds for when the pendulum eventually does swing the other way again. The PP is not a speculators portfolio, where people buy and sell the assets based on where they hypothesize the future will go. The VP is for that. I like to hypothesize on these things for potential future VP bets, but I always make sure I am properly hedged in my PP and do not let my fears or opinions effect this part of my portfolio.
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Re: TLT Study - Inverting History

Post by Kevin K. » Sat May 04, 2019 7:48 pm

A couple of quotes from Jazon Zweig's synopsis of William Bernstein's "Deep Risk" (the best analysis of the PP I've read) come to mind:

"Deflation, the persistent drop in the value of assets, is extremely rare in modern history, Mr. Bernstein says. It has hit Japan but almost nowhere else in the past century, thanks to central banks that print money to drive up prices. The best insurance against deflation is long-term government bonds. Diversifying your portfolio into international stocks also helps, since deflation often doesn’t hit all nations at once.

While bonds protect you from deflation, they expose you to inflation — far and away the likeliest source of deep risk. Mr. Bernstein notes that inflation can destroy at least 80% of the purchasing power of a bond portfolio over periods as long as 40 years.
That is deep risk at its deepest — a hole so profound most investors can’t get out of it in a lifetime. That happened in, among other places, France, Italy and Japan from 1940 through 1979, Mr. Bernstein says.
The best insurance against inflation, he says, is a globally diversified stock portfolio with an extra pinch of gold-mining and natural-resource companies. Treasury inflation-protected securities, U.S. bonds whose value rises with the cost of living, also can help."

Bernstein points out that not all of the events the PP is designed to protect against are equally likely to occur (or equally devastating if they do) so allocating equal parts of the portfolio to each threat doesn't make sense. Tyler's Golden Butterfly is, it seems to me, a sensible way to tilt towards prosperity while diversifying the stocks in a simple way. On the bond side, from playing around endlessly on Portfolio Charts and looking at actual returns during market panics I see little advantage to the PP barbell over holding almost entirely ITT's with perhaps a year or two in STT's or a Treasury MM account.

Remember that Browne recommended gold as an inflation hedge when it isn't that at all (that's what the stocks are for). I still believe in including it in the portfolio for the reasons that Tyler mentions but I think that Tyler and Desert have shown that intelligently tweaking the PP in light of the many changes in the markets that have occurred since Mr. Browne gifting us with the PP can work well. Browne was a genius but "paper" gold, 30 year treasuries yielding less than short term and a government so dysfunctional it's willing to make treasury defaults into a political football probably weren't visible in his crystal ball.
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Re: TLT Study - Inverting History

Post by pmward » Sat May 04, 2019 8:05 pm

Kevin K. wrote:
Sat May 04, 2019 7:48 pm
A couple of quotes from Jazon Zweig's synopsis of William Bernstein's "Deep Risk" (the best analysis of the PP I've read) come to mind:

"Deflation, the persistent drop in the value of assets, is extremely rare in modern history, Mr. Bernstein says. It has hit Japan but almost nowhere else in the past century, thanks to central banks that print money to drive up prices. The best insurance against deflation is long-term government bonds. Diversifying your portfolio into international stocks also helps, since deflation often doesn’t hit all nations at once.

While bonds protect you from deflation, they expose you to inflation — far and away the likeliest source of deep risk. Mr. Bernstein notes that inflation can destroy at least 80% of the purchasing power of a bond portfolio over periods as long as 40 years.
That is deep risk at its deepest — a hole so profound most investors can’t get out of it in a lifetime. That happened in, among other places, France, Italy and Japan from 1940 through 1979, Mr. Bernstein says.
The best insurance against inflation, he says, is a globally diversified stock portfolio with an extra pinch of gold-mining and natural-resource companies. Treasury inflation-protected securities, U.S. bonds whose value rises with the cost of living, also can help."

Bernstein points out that not all of the events the PP is designed to protect against are equally likely to occur (or equally devastating if they do) so allocating equal parts of the portfolio to each threat doesn't make sense. Tyler's Golden Butterfly is, it seems to me, a sensible way to tilt towards prosperity while diversifying the stocks in a simple way. On the bond side, from playing around endlessly on Portfolio Charts and looking at actual returns during market panics I see little advantage to the PP barbell over holding almost entirely ITT's with perhaps a year or two in STT's or a Treasury MM account.

Remember that Browne recommended gold as an inflation hedge when it isn't that at all (that's what the stocks are for). I still believe in including it in the portfolio for the reasons that Tyler mentions but I think that Tyler and Desert have shown that intelligently tweaking the PP in light of the many changes in the markets that have occurred since Mr. Browne gifting us with the PP can work well. Browne was a genius but "paper" gold, 30 year treasuries yielding less than short term and a government so dysfunctional it's willing to make treasury defaults into a political football probably weren't visible in his crystal ball.
Eh I don't agree with a lot of this.

First, deflation happened in 2008 here, it's happening currently in the EU and Japan, and we are still having some deflationary forces at play here (which is why growth and inflation have both been anemic over the last decade). It would be foolish to pass judgement on the likelihood of deflation, especially since it is the current global trend, and our population is going to continue to exhibit deflationary pressures for at least the next few years to decade while the boomers retire and millennials come of age. And since it's a global trend... good luck with international diversification helping you here. International diversification benefits become less and less as global economies over time become more and more integrated. Did global diversification help in the deflation of 2008? Nope, even though the deflation started in the U.S. international diversification actually hurt you, as the international stocks (especially emerging markets) dropped more than the U.S. and have recovered slower.

Bonds do expose you to inflation risk... but it's only 25% of your portfolio. The other 75% would benefit from an uptick in inflation. I don't disagree with the fact that over long periods 10 year treasuries tend to perform similar to the barbell, but I still think the barbell has benefits in the shorter term (with intermediate you expose 50% of your holdings to inflation risk, and LTT's provide a bit more oomph in a deflation) and is more flexible as the cash holdings give you some optionality (treasury bills, short term treasury notes, I-bonds, corporate short term debt, CD's, TIPS, etc).

As for gold and inflation... we all know that gold is not correlated to "inflation", gold is correlated to fear. Aside from periods of fear gold marches to the beat of it's own drum, sometimes going up and sometimes going down. But in times of fear (like high inflation) gold will shoot up and can be counted on.

Stocks are *NOT* an inflation hedge. Slightly increasing inflation within the normal ranges is good for stocks. Fast increasing or high inflation is not. Look at the 70s in the U.S. as an inflation adjusted chart to see how bad of a beating stocks took that decade. A nominal chart hides the true destruction. Also, see any country ever that went into a hyperinflation, stocks lose substantial money in real after inflation terms when inflation is high and/or increasing fast.

Modifying the PP is ok if your intentions are good. The principles matter much more than the exact 4x25 weighting’s. Desert swapped the barbell for intermediate (simply for simplicity is my understanding) and then did approximate risk parity on the weightings. Tyler in the golden butterfly did a PP with a 20% built in VP in a passive SCV tilt. I think these are fine, but their decisions to make these changes were not based on fear, greed, or what they expected the short to medium term trends in the market to be.
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Re: TLT Study - Inverting History

Post by Kevin K. » Sun May 05, 2019 9:18 am

Thanks for the wise perspective pmward! I really appreciate your thoughtful comments.

This article from just 4 days ago from Schwab supports what you and others here are saying about the dangers of going to only short duration bonds. They're not proposing barbells or ladders that go out to 30 years but I can see why a barbell of STT's and ~7 year bonds would be appealing.

https://www.schwab.com/resource-center/ ... ve-is-flat
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Re: TLT Study - Inverting History

Post by pmward » Sun May 05, 2019 10:47 am

Kevin K. wrote:
Sun May 05, 2019 9:18 am
Thanks for the wise perspective pmward! I really appreciate your thoughtful comments.

This article from just 4 days ago from Schwab supports what you and others here are saying about the dangers of going to only short duration bonds. They're not proposing barbells or ladders that go out to 30 years but I can see why a barbell of STT's and ~7 year bonds would be appealing.

https://www.schwab.com/resource-center/ ... ve-is-flat
Be careful with trusting predictions from Schwab or any other "expert" or entity. There are plenty of "experts" predicting bonds will perform poorly going forward, and just as many (if not more) that are predicting bonds to be the best asset going forward. Likewise there are plenty of experts predicting both bull and bear scenarios for both stocks and gold. How do we know who is right and who is wrong?

Harry said one of his favorite pastimes was collecting newsletters from "experts", then going back and looking at the newsletters from a year or more ago and seeing how the experts were wrong more than they were right. I've done this a few times in the past as well, and it is interesting to see. We can't really trust these people or their predictions. The best thing we can do is just hold a portfolio that is hedged against all the worst case scenarios in a way that will provide a good enough return going forward. I'm a big believer in having a VP for people (like me, and it sounds like you) that want to try to chase alpha. But it should be done responsibly, with "money you can afford to lose", and for most people they would be better off still with a VP like the golden butterfly that is a passive prosperity allocation. You should keep the money that you are counting on safe, and the best way to do that is including long term treasuries with stocks, gold, and cash. Going to a 7/1 barbell would seem pretty foolish if interest rates went negative, wouldn't it? Long term treasuries would absolutely sky rocket in that very possible scenario.

Really, I just want to play devil's advocate here more than anything. It may seem like I'm favoring a deflation scenario, but the truth is I am neutral and not sure what's going to happen. I'm just playing the other side to point out that the odds are just as good that we go the other way, and that long bonds could be the saving grace of the portfolio in the coming years. I personally could not picture removing either my LTT or gold hedge, because I think inflation and deflation are equally likely in the coming years. I see a compelling argument for both cases. If hedged properly though, it doesn't really matter which happens, there becomes no need to be fearful.
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