Thoughts abound China and future returns of the PP

[frommi]

Hi,

I thought a little bit about the current problems of the PP and came to think about the role of China. Its currency is bound to the US-Dollar and China had inflation rates of around 10% in the past years. Perhaps that would explain why Gold run up from 2000->2010 despite the fact that there was no inflation in the US. Just now where China`s economy struggles, gold falls. In this case it would probably be good to own China-bonds and China-stocks to supplement the US-PP. But that is not possible at the moment. In the EU we have similar problems with Switzerland and the question which bonds and stocks to own.

Is it possible that the merging of different currencies can cause movings in the returns of the PP? For example that the PP performed much better in some times (like 2000-2012) as in others?

We had from 1980 to now falling interest rates, so backtesting doesn`t really help determining future returns because there is not enough data from times where interest rates on bonds where low (like 1940-1960) and not being on gold standard. I did some tests on longtermresults.com for the phase of 1945-1970 which showed only 0.5-0.8% real returns for the PP. (But obviously gold was nearly fixed there.) while stocks returned around 6-7% real returns.

I came up with the idea of guessing future returns for the next decade and calculate the future return of the PP like graham would probably do it:

Real returns:

Stocks: 5-6%
Gold:    0%
Bonds: 0% (german bonds for me), 2,5% currently in germany which fits to inflation so zero real gain.
Cash:  -2-0% (thats the hardest part, but obviously cash looses currently to inflation.)
Rebalancing: +1%

In a diversified depot the return of the whole depot is the geometric mean of all single parts. Rebalancing adds around 1% to the overall performance.
For the calculation i used the returns without inflation and assumed it to be 2%.
So ( 1,08*1,02*1,02*1)^-4 = 1,03. I added the rebalance bonus of 1% and came to 2% real returns for the coming decade.
And that is on the high side of the equotation. With stocks only returning 5% real returns, 0,5% rebalance bonus and cash loosing 2% to inflation this comes to 0,2% real return.
So the possible real return for the PP in the next decade should be around 0,2-2%. And this is the range if have seen for the PP in the years 1945-1970, so it seems not that far off.
Compared to the possible returns of stocks this looks really bad.

We have seen last month that the volatility in the PP can be high, too. So why don`t go just 100% stocks diversified above the whole planet?
The big crashes like 2008 or 1929 happen every 30 years so its not really imaginable that the next is just around the corner.

Maybe i am negativly biased from the last six month, but can someone see the flaw in my thoughts?

[Pointedstick]

Maybe i am negativly biased from the last six month, but can someone see the flaw in my thoughts?

Found it! Here you go:

I came up with the idea of guessing future returns for the next decade and calculate the future return of the PP like graham would probably do it

[frommi]

Are the guesses so far off from imagination? Its for a whole decade and should be a better approximation than the backtests some of the guys in this forum did.

The return for stocks are like in history.
The return of bonds is the coupon, this is proven historically to be the return above large time periods.
The return of cash should be not that far off ...
The only big unknown variable is the return of gold. But historically the return of gold was 0-1% real return, should i now estimate something else?

Here are the numbers starting in 2000:

real returns:
stocks: 5%, bonds 4,5%, cash 2%, gold 1% , +1% rebalance bonus.

This gives 3,5-4% real return, which fits nicely to the observed return of the PP from 2000-2010.

[dragoncar]

We have seen last month that the volatility in the PP can be high, too. So why don`t go just 100% stocks diversified above the whole planet?

This is what I've been wondering.  If I'm not going to look at my portfolio except once per year or less (advice commonly given here), then shouldn't I take the higher expected returns of the stock market?

The downside is no protection from crazy stuff (phys gold).  Also no guarantee that equities will perform as expected.  Then again no guarantee PP will perform as expected so... Still not sure. 

[Libertarian666]

We have seen last month that the volatility in the PP can be high, too. So why don`t go just 100% stocks diversified above the whole planet?

This is what I've been wondering.  If I'm not going to look at my portfolio except once per year or less (advice commonly given here), then shouldn't I take the higher expected returns of the stock market?

The downside is no protection from crazy stuff (phys gold).  Also no guarantee that equities will perform as expected.  Then again no guarantee PP will perform as expected so... Still not sure.

No matter how long your time horizon, there is no guarantee that the stock market will produce any particular level of return, or indeed any return at all. So if you believe that the basis for the lower expected variance of the PP is sound, it's less risky than putting everything in the stock market even over a long time period.

[Pointedstick]

No matter how long your time horizon, there is no guarantee that the stock market will produce any particular level of return, or indeed any return at all. So if you believe that the basis for the lower expected variance of the PP is sound, it's less risky than putting everything in the stock market even over a long time period.

Indeed. There's also a significant amount of survivorship bias in stock returns. In hindsight, would investing in the Austro-Hungarian stock market have been a good idea? Now, you could mitigate that to a certain degree with a global stock fund, but the world is now such a globalized place that the movement of the major world economies are going to have a disproportionate effect. If anything happens with the USA, China, or India, you're going to feel it. And of course, the global economy can fall into a synchronized depression such that diversifying across countries is no real protection if any of the big economies go. So you'll probably be protected from going to zero, but not from your typical huge stock market swings.

[koekebakker]

Indeed. There's also a significant amount of survivorship bias in stock returns. In hindsight, would investing in the Austro-Hungarian stock market have been a good idea? Now, you could mitigate that to a certain degree with a global stock fund, but the world is now such a globalized place that the movement of the major world economies are going to have a disproportionate effect. If anything happens with the USA, China, or India, you're going to feel it. And of course, the global economy can fall into a synchronized depression such that diversifying across countries is no real protection if any of the big economies go. So you'll probably be protected from going to zero, but not from your typical huge stock market swings.

I'm not sure if I agree with you on this. A Japanese PP investor would have benefited from global diversification the last 25 years. Without the recent goldrush (which had nothing to do with Japan) it would've been all over for the Japanese PP. Icelandic PP investors were saved by gold but would have done even better with a global PP.

I wonder how diversified the classic PP really is. It's basically:

Large Cap domestic stocks - domestic bonds - gold. It's a standard stock/bond portfolio with the added diversification of gold. But you're still betting 75% of your money on one country. US-investors might get away with this (although I believe home and survivor-ship bias is strong among US-investors), but for non-US investors this is a recipe for disaster. But even for US-investors, their only protection against a Japan-scenario is gold. The PP would be better diversified by adding global stocks and maybe some global bonds.

Investing only in your own country means having a lot of faith in what gold can do for you... I wouldn't bet on that.

[Pointedstick]

What I think you're getting at--and I would absolutely agree--is that the PP has some significant problems if you commit to domestic stocks and live in a country that isn't one of the major major players in the international markets. If I lived outside of the USA I'd definitely use an all-world stock fund. All I'm saying I guess is that if you happen to live in a major country that's a big part of the global economy, you're already getting a good deal of international exposure.

[koekebakker]

All I'm saying I guess is that if you happen to live in a major country that's a big part of the global economy, you're already getting a good deal of international exposure.

Thanks for your reply. I agree that you get some international exposure but is it enough to offer protection against a Japanese scenario? Japan is one of the only countries comparable to the US for PP investors, almost all others are too small/undiversified/have badly functioning markets etc.  But even with those economic giants international exposure seems crucial for investors during a long period of domestic stagnation. Gold won't always come to the rescue.

[systemskeptic]

Which would you guys rate as more diversified:

1. US Permanent Portfolio
2. 75% All-World Stock Market, 25% Gold

[AdamA]

Which would you guys rate as more diversified:

1. US Permanent Portfolio
2. 75% All-World Stock Market, 25% Gold

In 2008:

75% All-World Stock/25% gold:



US PP:



So, I'd say the PP, because I think its diversity that gave it the big cushion.