Why Investors Should Fear The Permanent Portfolio

[Coffee]

Apologies if this has been posted already.  I have a google alert set for the PP, and this just came through:

http://www.advisorperspectives.com/news ... tfolio.php

I don't have enough mental horsepower right now to really understand if his argument holds weight or not?  He seems to suggest that the PP may not deliver significant enough returns for a retirement portfolio?

- Adam.

[craigr]

He is making a lot of assumptions about "expected" return in his projections (both for and against). This is pretty nebulous. I'm expecting a gold medal in women's figure skating, but it doesn't mean I'm going to get one.

The portfolio has been working for several decades now. I'm not going to change it unless someone can come up with some pretty compelling reasons. This article isn't one of them. IMO.

[AdamA]

To me, it's just another example of the financial media getting it wrong.  The fact that someone in this camp is saying to fear the PP is all the more reason to believe it will continue to do well. 

If you read the article, the guy doesn't really understand PP.  He makes some interesting points, but in the end draws a weird conclusion that doesn't really make any sense. 

[Bongleur]

Considine's article seems to have been dismissed without actually showing why he might be wrong.

He says that going forward we can expect a rising interest rate environment; and that gold and treasuries will under performs in that environment compared to what has occured since the PP was created in the 1970's.

He concludes that it may not meet the needs of retirees who must keep up with inflation.

So can someone please refute his assertion

[moda0306]

One of the PP's weaknesses is rising real rates and their negative affect on gold... this showed in 1981, but resulted in decades of disinflationary prosperity that really juiced the bond and stock portion of the PP, so it was forgiven.

I see how he can be afraid of that risk.  His assertion that gold, now at all-time highs and without a previous price control to give it its 1970's bounce, could probably not keep up with inflation in a rising rate environment is legitimate.

I think his "planner" is a bit of a joke, though.  Also, since the short end of the bond curve is surpressed the most, it's likely to rise the most.  I doubt we'll see long-bonds go from 4.1 to 7.1 as we see cash go from 0% to 3%.  That, and the type of environment that's going to push a rising of interest rates and a suppression of gold is/should be very prosperous from where we are now.  The fed can keep rates very low when the economy is ill without seeing inflation.

That's my retort... take from it what you will.

[MediumTex]

Considine's article seems to have been dismissed without actually showing why he might be wrong.

He says that going forward we can expect a rising interest rate environment; and that gold and treasuries will under performs in that environment compared to what has occured since the PP was created in the 1970's.

He concludes that it may not meet the needs of retirees who must keep up with inflation.

So can someone please refute his assertion

I can't refute his assertion, since anyone can assert anything they want to.  I can, however, say that the assertion that gold will underperform in a rising interest rate environment is pure speculation.  It would all depend on why interest rates were rising and whether they were ahead of or lagging actual inflation.

I can also say that the confident expectation of a rising interest rate environment is just one more belief in what the future holds that is nothing but pure speculation.  This market narrative has been with us for many years, and has been wrong for many years.  Some day it may prove to be correct, but I don't know when that day will be.

In general, I think that people who find theoretical flaws with the PP that for whatever reason never actually manifest in actual problems with the portfolio may ultimately find that it was their theory that was defective, and not the PP itself.

To paraphrase Reverend Blankfein, "In a world full of competing market narratives, the only final measure is performance."  The PP has performed and continues to perform.  What more than that do you need?

It almost seems like we get sidetracked with people who say that the PP shouldn't work, when what I am more interested in is whether it does work.  As I suggest above, often the people who say that something shouldn't work are providing more of a commentary on their own level of understanding than any kind of factual statement about the nature of the world itself.

[Roy]

If the PP had an un (expectedly) bad year, authors like this would point and say, "see?".  But after 40 years of stellar performance, all that is left is to point and say, "just wait and you'll see."  Lots of discussion about expected returns here, and the easiest part of his analysis is what has already happened and why, and even there you might get debate.  Going forward, he has nothing but guesses.  Though I have some questions.

Why should you ("you" meaning anyone) care what he thinks—even though he uses the formidable forward-looking Quantext Portfolio Planner?  What is he saying that has not been said before, and how is it even possible that this constitutes usable information?  And if a hypothetical portfolio(s) exists that supposedly corrects the problems he describes, what are its vulnerabilities to the pointing fingers of others? 

Bongleur and others:  Here's the deal.  As to refuting his assertion, the burden of proof lies with the claimant.  It is not up to anyone to refute his unsupported guesses on what will come (which guesses are old news, incidentally, as any trip through Mr. Peabody's WABAC machine can tell us), and when you get past the authoritative analytical techno-blathering, guesses are what you have with this piece.  And until things come to pass when he can point to evidence and say, "see?" just as I told you", then he'll just have to keep writing Quantext-supported fodder for his advisory newsletter. 

[Bongleur]

WRT to predicting the effect of rising LTT interest rates on the PP performance:

Clive calculated that the declining interest rates of LTT have provided about 2.14% of the performance.

If rates remain stable, that 2.14 goes away.

Does it not follow that if rates rise at the same rate as they have fallen, there will be a negative 2.14% effect, for a net change of twice that  when compared to the falling-rate period (thus -4.28% from the falling-rate period average).

Which results in an average negative yield for the PP going forward.

http://gyroscopicinvesting.com/forum/in ... pic=897.15

Reply #29 on: May 04, 2011, 02:24:07 AM

>
SNIPPED GRAPHIC
The first part shows a summary of the average of averages for all time periods of ten years or more

The second two show the effect of a fixed 5% yield price when 'current' rates are 10% and 5%

The last part shows the annualised effect of transitioning from a 10% rate down to a 5% rate over a 30 year period.

The last two in my mind reflect a (very loose) guideline overall average gain effect that might generally have been encountered from transitioning from 1980's type high base rates to more recent low rates.

The way I read this is, as an example, the PP averaged a (real gain) 1.2% annualised, but ranges through -1.14% to 3.54% at the 3 sigma (standard deviation) boundaries. So some PP'ers average -1.14%, others 3.54%, but the majority cluster around 1.2% rewards. In addition to that declining base rates have provided a 2.14% p.a. floatation effect. Which uplifts the PP extremes to 0.86% to 5.68%, with an average of 3.34%.

To reiterate, these are just ballpark guidelines only.

Unless we repeat a high to low base rate transition however then that 2.14% annualised real high to low base rate transition part could just disappear going forward in time. I'd suggest it might be better to discount that historic bias and just assume the average 1.2% figure for the PP.
>

[stone]

Clive, wouldn't cranking short term rates to high levels be purely a central bank mediated chosen decision (as by Volcker in the early 1980s) done specifically to strengthen the currency especially relative to gold. Back then it hit gold hardest so wouldn't it do the same now? I thought the cash portion was specifically in the PP because that was the only part likely not to get devastated in such circumstances?

[stone]

Clive, was your scenario the central bank trying but failing to halt a slide in the value of the currency and so gold still doing better than cash? I suppose the hypothetical future currency tussle that would be like that would have to be versus some emergent new contender as a reserve currency????

[stone]

Clive, is it high real, inflation adjusted rates that hit gold rather than nominal rates? Didn't the 1970s often have high nominal rates that were actually negative in real terms?

[MediumTex]

I think that Volcker raising rates in the face of a very weak economy is something we are unlikely to see again.

People just don't do things like that anymore.

If you look back at the totality of circumstances Volcker was operating within, I'm not even sure how much effect what he did actually had on reducing inflation.  What seems more likely to have helped the economy get back on its feet was the dramatic fall in the price of oil starting around 1982 and continuing for the next 15 years or so.

In other words, inflation might have fallen on its own as oil prices fell, whether Volcker had raised rates or not.  In fact, one might even argue that Volcker delayed the onset of economic recovery by raising rates when it wasn't even necessary to do so.

[AdamA]

If you look back at the totality of circumstances Volcker was operating within, I'm not even sure how much effect what he did actually had on reducing inflation.  What seems more likely to have helped the economy get back on its feet was the dramatic fall in the price of oil starting around 1982 and continuing for the next 15 years or so.

I've wondered about this before.  If the Fed can't create inflation with QE, then why should we think that they could stop it by doing the opposite? 

[HB Reader]

Considine's article seems to have been dismissed without actually showing why he might be wrong.

He says that going forward we can expect a rising interest rate environment; and that gold and treasuries will under performs in that environment compared to what has occured since the PP was created in the 1970's.

He concludes that it may not meet the needs of retirees who must keep up with inflation.

So can someone please refute his assertion

I respect Considine's general point that the PP may not perform as well the next few years as it has the last few years and he may or may not be right about whether we're facing a rising interest rate environment.  But even if he is right, this retiree doesn't know of any other practical alternative out there that even comes close to the PP in terms of safety, stability and simplicity.
   
Having lived through the late 1979 to early 1982 period, I don't know of any safe or reliable way to hedge against something like that other than to hold a lot of Treasury bills.  A PP has (or should have) 25% in T-bills.  I suppose you could come up with an asset allocation with a higher cash allocation, but I suspect you'd receive the same criticism from the same source that it "wouldn't meet the needs of retirees who must keep up with inflation." 

I think it's also important to point out that "a rising interest rate environment" can describe a pretty wide variety of economic conditions.  For instance, rates can rise slowly in response to general market forces or quickly from Federal Reserve moves designed to squash inflation.  Depending on the exact conditions and the duration of "the environment" in question, you could see some pretty big swings up and down (and possibly a rebalance or two) in gold, stocks and bonds in the interim.

The bottom line is Considine's assertions are based on his proprietary "forward-looking" black box.  I'm not going to manage my safe money based on predictions.

[stone]

I think that Volcker raising rates in the face of a very weak economy is something we are unlikely to see again.

People just don't do things like that anymore.

I thought that Australia was undergoing such "treatment" right now. They have a mining boom at the mines but for most of the country it looks like a plain old high unemployment slump. I totally agree that Volker treatment didn't help with consumer price inflation but he did state that "gold is the enemy" and he did succeed at stopping people globally from saving in gold for a generation. I find the current high rates in Australia baffling though.

[MediumTex]

I think that Volcker raising rates in the face of a very weak economy is something we are unlikely to see again.

People just don't do things like that anymore.

I thought that Australia was undergoing such "treatment" right now. They have a mining boom at the mines but for most of the country it looks like a plain old high unemployment slump. I totally agree that Volker treatment didn't help with consumer price inflation but he did state that "gold is the enemy" and he did succeed at stopping people globally from saving in gold for a generation. I find the current high rates in Australia baffling though.

Maybe that's the U.S.-centric in me coming out.

What is Australia's current unemployment rate?

What is Australia's current inflation rate?  If there is high inflation, what is driving it?

Where is Australia in terms of economic recovery?  (how long since last recession ended?  how robust has economic growth been?)

Maybe people are still doing stuff like Volcker did, just not in this hemisphere.

[doodle]

I am in the process of helping my parents try to get ready for retirement. I am trying to get them to go from a throw money at the market and hope approach to something that will protect them for the rest of their lives.

They have enough that they don't need a lot of growth to get them through retirement. In their case it is really a preservation with a little return strategy.

I am quite apprehensive about destroying my parents retirement but I know that if we don't get some plan in place its going to be a rocky road.

I was thinking about the following breakdown. Not quite PP but pretty close:

20% US Stocks
10% All World Except US (VEU / VSS)

50% US 5 year bond ladder for now. I am really sweating on the LT treasuries with them considering we are looking more for capital preservation.

GLD 20% - Another asset which makes me nervous but with political nonsense right now everyone needs catastrophe insurance.


Maybe I am trying to tweak perfect....any input would be appreciated. They are alittle uncomfortable at the moment but I am trying to make them NOT fear the PP!

[Pkg Man]

I think that Volcker raising rates in the face of a very weak economy is something we are unlikely to see again.

People just don't do things like that anymore.

If you look back at the totality of circumstances Volcker was operating within, I'm not even sure how much effect what he did actually had on reducing inflation.  What seems more likely to have helped the economy get back on its feet was the dramatic fall in the price of oil starting around 1982 and continuing for the next 15 years or so.

In other words, inflation might have fallen on its own as oil prices fell, whether Volcker had raised rates or not.  In fact, one might even argue that Volcker delayed the onset of economic recovery by raising rates when it wasn't even necessary to do so.

I have to disagree with you on this one MT.  In my opinion Volcker (and secondarily the new administration) deserves great credit for taming inflation. I don't have the data in front of me, but I don't doubt that oil prices fell before inflation did, but that would have been due to the Fed-induced recession which lowered the demand for oil. 

To lower the inflation rate required a sustained effort to change inflation expectations, which was brought about by keeping short-term interest rates higher than the inflation rate.  Repairing a damaged reputation (which the Fed certainly had at the time) always takes a long time.

[doodle]

Thanks, Clive.

Regarding the 5 year treasury ladder, I have a few questions below:

5 Year ladder though is a rate tart version. Buy each rung at near face value. Hold each rung to maturity unless its clear that a switch prior to maturity is beneficial, and at each maturity/roll just pick what yields the best net rate at the time out of 3 month to 5 year maturity/duration from safe investments to roll the proceeds into. If that's (undated) cash (Fed insured) deposit then just set a yearly review.

#1 What does rate tart version mean?

#2 Why is the rolling of bonds so strategic? Couldn't I just go in and buy 5 bonds that mature in 1, 2, 3, 4, and 5 years? And then just buy the longest maturity once every year? Is there a downside to doing this? I would prefer to buy the bonds without using an ETF or Mutual fund to save a bit on the expense ratio but if there is a complicated strategy to this I might have to rethink that.

[Bongleur]

I was thinking about the following breakdown

Why don't you start a thread for your question instead of going off topic here?

[Bongleur]

People seem to be going off on an irrelevant tangent of how & why interest rates might change.

Clive's point is that the secular trend of declining rates added 2.14% to the PP returns.

Anyone disagree that this free lunch has ended?

So that's the new PP rate if interest rates stay constant, at any level.

If interest rates begin a secular rise, then it seems to me that if they rise at the same rate at which they declined, then there will be a symmetrical negative 2.14% from that lower "constant interest rate" yield.

If interest rates rise at a faster rate, then... would that negative 2.14% be multiplied by some factor depending on the rate of change of the interest rate?

If rates "spike" and then go back to "neutral" then we are still left with a long term yield 2.14% lower than the historic rate.

So how can the 4x25% ratio be changed to get back to the efficient risk parity asset correlations, with the assumption that interest rates will be constant?

And again with the assumption that interest rates will rise at the inverse of the rate they have been falling?

***

I like that some people have tried to break down the yield coming from each of the 4 parts.

EDIT:  Rising interest rates do not necessarily come from inflation.  Real rates might rise.  The last secular trend of lower bond rates was what ratio of: real rates going down + inflation + deflation ?

[doodle]

I apologize if my question seemed to go off on a tangent.

I thought the thrust of my question regarded the 5 year treasury ladder option for an investor that fears capital loss going forward due to rising interest rates.

My parents "fear" the PP and I fear the danger of rising rates on LT treasuries to their capital. I was looking for a less "scary" version of the PP for them that would potentially reduce the possibility of capital loss with the tradeoff that they might reduce the CAGR slightly. I thought maybe I could tap into that part of the thread.

[MediumTex]

People seem to be going off on an irrelevant tangent of how & why interest rates might change.

Clive's point is that the secular trend of declining rates added 2.14% to the PP returns.

Anyone disagree that this free lunch has ended?

I disagree.  LT rates could easiy fall another 200 basis points.

So that's the new PP rate if interest rates stay constant, at any level.

If interest rates begin a secular rise, then it seems to me that if they rise at the same rate at which they declined, then there will be a symmetrical negative 2.14% from that lower "constant interest rate" yield.

If interest rates rise at a faster rate, then... would that negative 2.14% be multiplied by some factor depending on the rate of change of the interest rate?

But we've already been there and done that in the 1970s--we had a secular bear market for bonds and the PP had the same stable and steady returns as it had during the more recent secular bull market for bonds.

[MediumTex]

I think that Volcker raising rates in the face of a very weak economy is something we are unlikely to see again.

People just don't do things like that anymore.

If you look back at the totality of circumstances Volcker was operating within, I'm not even sure how much effect what he did actually had on reducing inflation.  What seems more likely to have helped the economy get back on its feet was the dramatic fall in the price of oil starting around 1982 and continuing for the next 15 years or so.

In other words, inflation might have fallen on its own as oil prices fell, whether Volcker had raised rates or not.  In fact, one might even argue that Volcker delayed the onset of economic recovery by raising rates when it wasn't even necessary to do so.

I have to disagree with you on this one MT.  In my opinion Volcker (and secondarily the new administration) deserves great credit for taming inflation. I don't have the data in front of me, but I don't doubt that oil prices fell before inflation did, but that would have been due to the Fed-induced recession which lowered the demand for oil. 

To lower the inflation rate required a sustained effort to change inflation expectations, which was brought about by keeping short-term interest rates higher than the inflation rate.  Repairing a damaged reputation (which the Fed certainly had at the time) always takes a long time.

I understand that the perspective I am offering is not the conventional wisdom, but if you look at the way 1970s inflation more or less tracked the rise in the price of oil, is it not reasonable to suggest that when oil entered a secular decline in price that inflation (including inflation expectations) might also go dormant?

The basic underlying reality with our economy seems to be that when oil prices are high it struggles and when oil prices are low it performs well, which is what one would expect in an economy so heavily dependent upon cheap energy inputs.

I am not saying that this narrative should displace Volcker-killed-inflation-through-a-tight-money-recession, but it's worth a little thought.

[MediumTex]

My parents "fear" the PP and I fear the danger of rising rates on LT treasuries to their capital. I was looking for a less "scary" version of the PP for them that would potentially reduce the possibility of capital loss with the tradeoff that they might reduce the CAGR slightly. I thought maybe I could tap into that part of the thread.

Any time I am trying to persuade someone of something that I believe to be true, I always try to understand what evidence the person I am talking to would need to be persuaded.

What evidence would you or your parents need to be persuaded that the PP works as advertised?

Do you find fault with the PP's past returns?

Do you not like the PP's historical volatility (or lack thereof)?

Do you find the theory behind the PP deficient in any way?

Do you think that there is some new combination of economic and monetary conditions today that Harry Browne didn't anticipate?

Does the PP's performance in 2008 not settle any question about how the portfolio performs under extreme conditions?

If I understood the rationale for not simply following the PP recipe I might be able to respond to it more directly.  As it is, though, it appears as if you are tweaking just to tweak.

Note that the fear you articulated above is EXACTLY what everyone was saying in the first half of 2008.  People who went along with this conventional wisdom and lightened up on LT treasuries in their PP would have seen losses in their modified PP in 2008, while traditional PP investors moved through 2008 completely unharmed.

I underestand the impulse to tweak, but I am asking you to understand the danger and unintended consequences that this impulse can bring.

Improving upon the PP is harder than it looks.