PP. 25% stocks 75% cash?

[Clive]

...

[stone]

Clive, what makes it different IMO is that the "non-stock" part is maximized for volatility. Selling that concept is selling the PP IMO.

[MediumTex]

The PP is just another mostly cash, some stock blend Stone. Nassim Taleb opts for 85% to 90% T-Bills (with 10% to 15% speculative Traded Options). Larry Swedroe opts for 70% Inflation Bonds/AAA's (with 30% spicier stocks). The PP opts for 75% 'cash' being invested across a T-Bill/LTT barbell and gold (with 25% stocks).

I wouldn't say that 25% cash is "mostly cash."

75% of the PP consists of very volatile assets.  That, to me, makes it very unlike some of the other portfolios out there with small stock allocations.

[craigr]

The PP is just another mostly cash, some stock blend Stone. Nassim Taleb opts for 85% to 90% T-Bills (with 10% to 15% speculative Traded Options). Larry Swedroe opts for 70% Inflation Bonds/AAA's (with 30% spicier stocks). The PP opts for 75% 'cash' being invested across a T-Bill/LTT barbell and gold (with 25% stocks).

I wouldn't say that 25% cash is "mostly cash."

75% of the PP consists of very volatile assets.  That, to me, makes it very unlike some of the other portfolios out there with small stock allocations.

It's also a portfolio that has a CAGR of around 9.5% the past few decades. And last year it was +11% when most stock heavy portfolios were flat. That's not the kind of thing cash does.

[craigr]

The long term yearly median real gain for gold is near enough 0%

The long term yearly average yields for 1 year T and 10 year T's are near enough the same - and marginally beat inflation on a gross basis (perhaps just pacing (or even lagging) inflation on a net basis).

That 0% real return expectancy against 75% of the PP's holdings is pretty much what most people would consider as being cash like assets. Of course its all open to semantics.

And yet the portfolio posts returns that are near identical to the historic average of 100% stocks with 1/4th the volatility.

[stone]

Clive, as a thought experiment, you more than anyone could come up with a portfolio that had four assets each with a zero long term inflation adjusted expected return and yet which as a portfolio gave a strong return thanks to rebalancing. Imagine cotton, sugar, cash, silver. Or cash in USD, Yen, Aus$, BrazilReal. I don't know myself but I'm sure you do.

We are measuring everything against cash in our own currency. If you have 25% stocks, 75% cash then you NEVER get opposing volatility for rebalancing. The PP almost invariably has one of the three volatile assets moving counter to the other two. I think the two way correlation statistics miss out on spotting the rarity of that lack of three way correlation. The economic condition concept is behind that rarity of three way correlation.

My understanding of your position was that you thought that the previous rarity of three way correlation was a fluke and that we might be in for a simultaneous long term secular bear market in all three of LTT, stock and gold

I also think the LTT, gold, cash combo is much more apocolypse proof that the short term treasury and TIPs combo. Where is their currency risk protection? Where is their Japan style deflation protection? To me the PP is like a Toyota Hilux, not classy or slick but robust.
http://www.youtube.com/watch?v=xnWKz7Cthkk

[craigr]

And yet the portfolio posts returns that are near identical to the historic average of 100% stocks with 1/4th the volatility.

But equally you could have said ... and yet the portfolio posts returns that are near identical to the historic average of cash .. with 1.5 times the volatility and the risk of a -30% (yearly based) relative drawdown.

That is if you measure the relative performance of the PP to ST (average of all 4 PP assets less the ST gain for each year) starting from the end of 1980 up to the end of 2005 (using your own data for US PP asset historic values).

Sourced from : https://web.archive.org/web/20160324133 ... l-returns/



If the PP performed relatively well over a 40 year period, but contained a 25 year period within that where it didn't even keep up with cash, then the indications are that the PP can be quite volatile, having some periods of exceptionally good rewards and other periods much less so.

The portfolio returned 7.5% (4% real) from 1981-2005.

100% T-Bills was 5.7% (2.2% real) over the same period.

100% ST Treasuries was 7.7% (4.2% real)

So we can cherry pick any date range to make anything look good or bad. 1981 happens to be a big year because all the major assets declined together (gold especially).

I mean why not just pick the date 2000-2010 and proclaim that cash beat stocks? It did. Therefore we shouldn't own stocks? Or that nearly the same thing happened in the 1970s?

Or maybe we just pick the biggest bull market in US history of 1980-1999 to show that nearly 20 years of data proves that stocks are all you need to own?

But these are all really bad ideas because we don't know what's going to happen. We only know it after the fact. How many investors would hold onto nothing but cash for 25 years?

The Permanent Portfolio strategy has had real returns in the 3-5% range over every rolling 10 year period nearly the last 40 years. This is something that many stock/bond allocations I've seen can't say. Cash can't say it either.

But that's my bogey personally. I want 3-5% real returns over time. If some other asset happens to have done the same or better then that is fine. Just as long as I hit my goals with the portfolio I don't care if Beanie Babies were a better investment. All that matters is that I got the performance I desired. So if the portfolio does 4% real from here and cash beats it for the next 25 years I just am not concerned. But that's not likely going to happen.

[stone]

Academics indicate longer term stock real gains to be around 6%, and with 25% exposure to that asset class = 1.5% relative to the whole. Which implies that a further 0.63% is derived from the other assets.

Clive don't you recognise that the Rainnaisciance Technologies medalion fund has gathered crazy levels of returns (30% CAGR ?) just by trading commodities and bonds etc that in themselves  show negligable real returns? As such it doesn't make sense to me to think about portfolio returns purely in terms of the returns of the constituent assets rather than the rebalancing bonus.

Anyway I'm sure that those 6% stock returns depend on all profits being spent by shareholders. We are not in that world anymore. Company profits now get ploughed back into buying stocks. In such a world might 6% real returns for stocks be macroeconomically impossible?

[stone]

Clive, I think you keep dashing around with the goal posts. The Japanese investor with the 75% Japanese STT, 12.5% US stocks, 12.5% gold would have done well. The Icelandic investor with 75% Icelandic STT, 12.5% US stocks, 12.5% gold from 1999 to 2009 would have done MASSIVELY worse than an Icelandic PP.

Like I said, the PP is like a hilux pickup. It often lags but it seems more bomb proof than anything else I've seen.

[BearBones]

But that's my bogey personally. I want 3-5% real returns over time. If some other asset happens to have done the same or better then that is fine. Just as long as I hit my goals with the portfolio I don't care if Beanie Babies were a better investment. All that matters is that I got the performance I desired. So if the portfolio does 4% real from here and cash beats it for the next 25 years I just am not concerned. But that's not likely going to happen.

And even more important for many is maximizing protection from the unexpected and the unknown. The future will not always behave like the past, especially when most industrial countries have generated potentially unsustainable debt burdens, when the world population is 7B and growing exponentially, and many critical natural resources are being rapidly depleted (especially easy petroleum).

For me it is pretty miraculous for an investment to afford the possibility of long term growth with 25% of assets buried under the old oak tree in the event of currency collapse and another 25% under the mattress in the event of a major depression.

If, on the other hand, one believes that the best investment can safely and reliably be built on back-testing models, then I suppose that the PP may look like a nerd at a college frat party.

[MediumTex]

When we talk about stock market returns, I think it's important to remember that not all stock markets provide the returns that the long term models suggest stocks should provide.

In the last few decades, an investment in stocks in Rhodesia, Lebanon, Cuba, and Argentina may have disappointed investors looking for that 6%+ that stocks are supposed to provide, even though at one time all of these countries were stable and prosperous.

It's hard to know beforehand which countries will be prosperous over the long term and which are on the edge of capital destroying upheaval.  France at the end of the 18th century and Spain at the end of the 19th century are great examples.

[stone]

http://en.wikipedia.org/wiki/Economic_h ... _Argentina
"During the first three decades of the 20th century, Argentina outgrew Canada and Australia in population, total income, and per capita income.[2] By 1913, Argentina was the world's 10th wealthiest nation per capita.[3]"

To me the PP is all about the oscillations  causing you to trim back the leading asset before it slumps.

[stone]

Clive, "Academics indicate longer term stock real gains to be around 6%"

To me there is a real quandry with this. If you plug 1.06^200 into your calculator you get 115,126. To me that says that if a good chunk of stock returns stay invested as stocks, 6% real CAGR just can not fit. It is like the old adage about 5% interest changing a penny at the time of Christ into being a sphere of gold the size of the solar system by AD 1850. Basically nonsense. The arithmetic shows real life HAS to screw up.

[gizmo_rat]

The PP is just another mostly cash, some stock blend.
Nassim Taleb opts for 85% to 90% T-Bills (with 10% to 15% speculative Traded Options). Larry Swedroe opts for 70% Inflation Bonds/AAA's (with 30% spicier stocks).

Also;
Tangent 20 - 80% T-Notes / Ibonds / foreign, 12% Low beta stocks, 8% Small/value stocks

If you entertain Clive's original assertion, then (at least in the US) you have a number of similar alternatives to consider. I think it's been suggested that a PP allocation has greater "extreme risk" tolerance.

Did anyone consider these other conservative portfolio approaches against the PP approach,
particularly in terms of "normal risk" / returns ? 

[moda0306]

The thing is with the PP, the assets may not be guaranteed to, on their own, do much better than inflation, if at all, so we're in effect relying on the MPT (modern portfolio theory) effect of higher returns as a result of rebalancing.

The nice thing is, we can rely on PP assets more than any other group of assets to offset each other... anything group of "diverse" assets that will "likely" do very well individually are often in the crapper at the same time (think stocks, REITS, and junk bonds).

Even if we can state that 75% of the portfolio is like cash, those three are extremely reliable, as a group, to not only offset each other through their waves of lagging and beating inflation, but offset stocks as well.  This will leave you with more than you originally thought.

If stocks are going to handily outrun the other PP assets in the next 40 years in a way that they didn't in the previous 40 (seems plausable, if not likely, though I'm not an economic optimist), we can still rely on macroeconomic correlations, IMO, and I'd still take a 50% stock, 16% bond, 16% gold, 16% cash balance over some kind of technical analysis that puts me in 5 year treasuries and one PP asset, or hopes emerging markets will explode, etc.

[MachineGhost]

Those 6% returns assume the dividends were reinvested, which is the same net effect as company buybacks and paying down debt.

But the actual reality in history was that those dividends were not automatically reinvested as the technology to do so was not available.  So the net actual returns were far worse than historical back simulation.  No one can afford to pay $100 brokerage fees (pre-deregulation) just to reinvest their dividends in more stock.

MG

Anyway I'm sure that those 6% stock returns depend on all profits being spent by shareholders. We are not in that world anymore. Company profits now get ploughed back into buying stocks. In such a world might 6% real returns for stocks be macroeconomically impossible?

[MachineGhost]

I may be nitpicking here, but you can't actually put the currency under the mattress.  It has to keep up with inflation over the long-term for the PP to work, so you've got to lend it out to the economy.

MG

For me it is pretty miraculous for an investment to afford the possibility of long term growth with 25% of assets buried under the old oak tree in the event of currency collapse and another 25% under the mattress in the event of a major depression.

[MachineGhost]

And don't forget Japan's stock market declined 90% during WWII.  The U.S. experience is truly exceptional.  Even so, as I've outlined in other threads, the PP lost substantially in real terms in the U.S. from 1937 to the mid 1950's.  But that's a lot easier to fix than finding the next exceptional experience.

MG

When we talk about stock market returns, I think it's important to remember that not all stock markets provide the returns that the long term models suggest stocks should provide.

In the last few decades, an investment in stocks in Rhodesia, Lebanon, Cuba, and Argentina may have disappointed investors looking for that 6%+ that stocks are supposed to provide, even though at one time all of these countries were stable and prosperous.

It's hard to know beforehand which countries will be prosperous over the long term and which are on the edge of capital destroying upheaval.  France at the end of the 18th century and Spain at the end of the 19th century are great examples.

[stone]

What I was trying to say was that apparent 6% historical returns only "existed" because they didn't actually happen for all the reasons you mention. In this day and age a lot of the stockmarket is owned in such a way that all returns are ploughed back into the stockmarket. That means that the arithmetic impossibility of long term 6% returns does come to bear. Likewise I'm sure that if the stockmarket was subjected to a 7% asset tax, then it would provide a before tax return of at least 7%. Basically actual, on the ground, long term real returns after drawdowns and expenses have to tread water or at least not out pace the real economy. It is just like, over the long term, cockroaches can only have an average of one descendant per cockroach -no more no less.

Those 6% returns assume the dividends were reinvested, which is the same net effect as company buybacks and paying down debt.
But the actual reality in history was that those dividends were not automatically reinvested as the technology to do so was not available.  So the net actual returns were far worse than historical back simulation.  No one can afford to pay $100 brokerage fees (pre-deregulation) just to reinvest their dividends in more stock.

Anyway I'm sure that those 6% stock returns depend on all profits being spent by shareholders. We are not in that world anymore. Company profits now get ploughed back into buying stocks. In such a world might 6% real returns for stocks be macroeconomically impossible?

[D1984]

And don't forget Japan's stock market declined 90% during WWII.

I presume you mean in inflation-adjusted terms, not nominal; although my understanding was that most of the actual inflation-adjusted decline came in the immediate postwar years rather than during the war itself; ff you look at http://www.finfacts.com/Private/curency ... rmance.htm and compare the Japanese stock market returns for each year from 1945-1949 with Japanese inflation during the same period you'll see what I mean; a nominal gain of roughly 74% was an actual inflation adjusted loss of upwards of 94%

Even so, as I've outlined in other threads, the PP lost substantially in real terms in the U.S. from 1937 to the mid 1950's.  But that's a lot easier to fix than finding the next exceptional experience.

Most of the loss during the late stages of the Depression, WWII, and immediate postwar years were due to the following:

1. Gold not being freely traded at market prices; free-market gold prices would have almost certainly spiked in 1941 and 1942 (fear due to Pearl Harbor and a war that some worried at least until the Battle of Midway that the US might not win, high inflation, negative real rates); commodities DID spike in 1941 until the OPA put a lid on them in early '42. Gold also probably would have soared in the double-digit inflation and negative real interest rates of 1946-47 (look at what platinum and commodities did) and in late 1950-early 1951 (again, look at commodities prices during this period) to offset inflation-adjusted stock, bond and cash losses during this period.

One might say "well, I will just use another metal or commodity for a PP backtest since gold wasn't traded at market prices" but there are several problems with this. The main one is that you can't use commodities, silver or platinum as a substitute for gold because they typically (being "industrial" and not purely monetary like gold is) perform more poorly in deflationary and/or recessionary times than gold does (see 1937, 2001, or 2008 for examples)....although to be fair they also aren't likely to fall as as much and can even stay flat or rise during some "prosperity" years, something gold rarely does...look at gold from 1995-1999 vs silver or platinum during that same period, or gold vs a 50/50 blend UBS-DJ/GSCI commodity index from 1982 to 1999. Also, these commodities had periods during WWII and the Korean War when they were controlled and might not have contributed as much to returns as they otherwise would have (and market prices after the wars might not have risen as much as they would have today; the OPA and OPS were ready to clamp down on "speculation" in commodities pretty hard and reinstitute some controls if the price got too high or frothy; government economic controls were rather more in vogue in the 1940s than they are now). Finally, gold's price was artificially jacked up by FDR in 1933 when he "revalued" it at $35 an ounce; it possibly would have risen a little in the mid and late 30s as the Depression eased somewhat but not nearly doubled from $20 to $35 an ounce. If it had hypothetically started 1941 at say, $26 an ounce it would have had more "room to run" and rise to maybe $95 or $100 an ounce (in bursts, first in 1941-42 and then in the immediate postwar years) and offset stock/bond inflation-adjusted losses during those years.

2. No true long-term bonds being available (longest I have data for is 15-year bonds from 1935-1951)

3. Related to the above is the fact of bond yields not falling as much as they could have during the later stages of the Depression and then into WWII (and maybe even in late 45 to early 46 when many thought that demobilization would mean another recession and the return of mass unemployment and deflation). Perhaps some of this was due to the fact that most government bond buying by individuals (and even by some banks) during these years came in the form of savings bonds and not intermediate or long-term T-bonds; if T-bonds were as easy to purchase then as they are now then perhaps people would have chosen to "thrash the Axis by buying bonds" at the 1940s equivalent of TreasuryDirect instead of buying War Savings Bonds. Most of it (and this is just a hypothesis; I admit it might be wrong but we'll never know since we can't re-live history) was more likely due to the fact that bond yields started the Depression in 1929 a lot lower than they probably would have had we never been on a gold standard. That hypothesis/theory is as follows:

During the WWI years and immediately after (roughly late 1916 to the end of 1919) the Fed expanded the money supply (in the process creating severe double-digit inflation) and served as a buyer of treasuries at a certain yield to keep borrowing costs low for the government in spite of inflation that would normally have driven rates through the roof (see "How the Fed Helped Pay for World War I" by John Konig for a detailed explanation of this). By 1920 the Fed was willing to (and did) rise rates to break the back of inflation much as Volcker did in the late 70s/early 80s. How much do you think the Fed had to raise rates to in order to accomplish this (considering inflation was at 15-20% during this time and rates were around 3-4%)? 10%? 15%? 18%? 20%? Nope...only to 7%. Since on a gold standard people were used to inflation spiking during times of war and crisis (1813-1814; 1861-1865) followed by long bouts of deflation (1815-1824; 1866-1879) rates didn't have to be raised to nearly the level they would have had to be raised to in a non-gold standard environment to accomplish the same thing (Paul Volcker raised rates to nearly 20% in 1981 IIRC). Since prices were supposed to decline after the inflation was over a rate hike to only 7% was enough to trigger recession and deflation; yields didn't need to rise any further than that. This makes sense in a gold standard since someone who in 1916 bought an AAA bond paying , say, 4.5% saw roughly half his REAL capital value and principal payments vanish in the 1916-early 1920 inflation but gained most of it back in the 1920-21 deflation, the flat prices and mild deflation of the 1920s, and the severe deflation of the Depression (assuming the company issuing the bond didn't go under).

However, under a fiat currency things would most likely be different. Rates would need to rise to at least the level of inflation (i.e. upwards of 15%) in order to induce people to save in fixed-income instruments like T-bonds again and to slow down the velocity of money (i.e. people spending money as soon as they get it in order not to lose any more value)...I am aware this could also have been done as well with tax hikes and spending cuts instead of rate hikes and money supply cuts but let's not turn this into another MMT discussion. It would have been just like the early 1980s with LT Treasuries paying double-digit interest rates as expectations were for either continued inflation or continued high ST interest rates (LT rates being set by the market as a function of discounted future inflation and future ST rate expectations).

This means that in this hypothetical fiat-currency world rates probably would have declined in the 1920s (as they did in the real 1920s) as inflation and interest rate expectations ebbed, but they would have done so from a proportionally much higher base. We would have perhaps entered the Depression with LT Treasury bonds still paying eight, nine, or even nine and a half percent and having a LONG way to fall from there to the near 2% rates at the end of WWII and into 1946. 1931 would have been rather different as everyone fled to Treasuries al la 2008 as the KreditAnstalt collapsed, most gold-standard countries suspended their war reparations to the US, the economy stalled further, deflation set in, and the US was NOT forced to tighten monetary policy as it was in the real 1931 (it did so to stem gold outflows...under a fiat currency gold outflows would be a moot point). 1937 would still have been a disaster for anything but cash but it was a "tight-money recession" year like 1920, 1969, or 1981 so that's to be expected. LT rates would have begin their long climb upward in the late 1940s (as they did in the real 1940s) when the Fed stopped suppressing long-term rates but LT bonds would have much better served their protectionary purpose to the PP during the difficult years from 1929-1941 in this hypothetical world than they did during the real Depression.

Thoughts?

[craigr]

As mentioned, during some of these times there were price controls on many commodities, very high war time taxes, excess profit taxes, price controls, etc. that greatly affected market pricing.

I think that people expect the Permanent Portfolio to do everything everywhere and every time. But no portfolio can do that. But it can provide you with options to deal with these unexpected events if they show up that many other approaches do not even consider.

[stone]

D1984, do you think there is any truth in the idea that consumer price inflation due to excess money supply depends on potential consumers having the excess money rather than it being in the hands of financial institutions and/or very wealthy individuals who are more likely to spend it on assets not consumables? I also wonder whether the Volker rate hike was mostly about luring in foreign buyers of USD. A lot of the inflation problems then were due to high prices for imported commodities. That was partly solved by importing commodities from countries that just used the revenue to buy American financial assets that were so attractive once the Volker rate hike was allowed to unwind over the following couple of decades. Basically commodities were traded for account statements.
To me the situation now might seem more 1930s than 1970s not withstanding us now having a fiat currency. The post WWII to 2000 boom looks to me to be living off the wealth equality that was a consequence of the WWII destruction and the financial repression used to pay for it. Unwinding that wealth equality gave a massive surge to asset prices. Now that it is unwound, what happens next?

[MachineGhost]

I've since discovered why the PP's performance of this period was so disastrous.  It's categorized as one of those infamous conditions where the stock market went nowhere in real terms, akin to the past decade.

MG

And don't forget Japan's stock market declined 90% during WWII.  The U.S. experience is truly exceptional.  Even so, as I've outlined in other threads, the PP lost substantially in real terms in the U.S. from 1937 to the mid 1950's.  But that's a lot easier to fix than finding the next exceptional experience.

MG

When we talk about stock market returns, I think it's important to remember that not all stock markets provide the returns that the long term models suggest stocks should provide.

In the last few decades, an investment in stocks in Rhodesia, Lebanon, Cuba, and Argentina may have disappointed investors looking for that 6%+ that stocks are supposed to provide, even though at one time all of these countries were stable and prosperous.

It's hard to know beforehand which countries will be prosperous over the long term and which are on the edge of capital destroying upheaval.  France at the end of the 18th century and Spain at the end of the 19th century are great examples.

[MachineGhost]

I find nothing to contest in your thesis, but I think Storm brings up the importance of capital flows.  That tends to get easily overlooked in our collective domestic myopia.

We're very fortuitous to be able to own gold and 30-year Treasuries.  It seems almost a thin margin that the PP may never have come about.

MG

Thoughts?