Gyroscopic Investing

Gumby wrote:

MediumTex wrote:We would miss Clive if he was gone.

I appreciate him, even though it drives me crazy that he deletes all of these intricate and thoughtful posts.

Yes, but his posts are gone. We do miss them. Isn't there a setting to prevent users from destroying entire sections of the forum in that manner? Most forums I've been to don't let you edit or delete a post after a day has elapsed.

I am not aware of such a setting here.

You are right.  Part of clive is gone.

Thanks Clive... would you mind suggesting an alternative?  I realize getting him into some more short-term bonds will be a great way to avoid volatility, but anything else on top of that would be appreciated in terms of advice for a retired couple's portfolio.

He's already up 6% for the year, so at least he started with a boost... and he was in a stock-heavy portfolio before, so he's WAY better off than he would have been.

That's no reason to be lazy, but simply helps psychologically that what he would have had tanked, and what I put him in started off with a bang... it'll be much easier to swallow portfolio losses at this point.

The problem I have with the whole "you might see a big drawdown in your PP as soon as you start using it" narrative is that this way of thinking is true of ANY investment approach--it just happens to be a lot less true for the PP than for almost anything else.

If I did start using the PP and saw a decline in value, from a historical perspective I would still have reason to be pleased, since small PP drawdowns often correspond to large drawdowns in other asset allocations.

MT,

I tend to think of the PP as trying to accomplish the same thing as, say, a short-term mid-quality corporate bond fund (or basically any strategy that tries to combine "economic cycles" into one or a few assets, such as using blue-chip dividend stocks, high-yield munis, or foreign bond funds), but instead of using 4 extremely diverse assets, they try to do it with one instrument:

Inflation? You're ok, as you'll be refinancing into new rates relatively quickly
Deflation? You're ok, as it will be very unlikely that you lose much principal
Recession? As long as it's not too bad, you'll be fine, as the corps will mostly stay solvent
Prosperity? You'll benefit as yield spreads tighten and you will have been collecting decent yields

Of course, too much of either one of these cycles and you'll likely run into trouble that you wouldn't have seen in the PP.

I think if someone really doesn't think the PP will continue to work, but doesn't really know which asset disgusts them and will ruin the portfolio, a short-term mid-grade corporate bond fund should offer some kind of muddled protection from the different cycles above.

I am much more scared of a drawn out PP malaise than I am of a complete failure in some kind of crazy economic even.  If we eventually have hyperinflation, I'm not going to be cursing myself for only having 25% gold in my portfolio, by any means.  What I'm afraid of is either 1) we somehow have a reinvigored stock market and LTT's and gold drop like crazy, in unison, or 2) We muddle along with 2/3 of the volatile assets dragging the PP returns down to low single digits for some reason.

The former will leave me regretting leaving stocks for the two other bubble assets.

The latter will leave me thinking that some kind of "tweener approach" (high yield bonds, dividend blue-chip stocks, foreign bonds, etc) would have been a better play.

So I guess when I want to "hedge against the PP" I tend to think that either a more stock-heavy or "tweener asset"-heavy strategy should be considered, the latter probably carrying less risk.  

I tend to want to envision & illustrate a "spread" illustration showing the earnings yield (1 year projected, maybe) of VTI on one end 30-year treasuries on the other, and some sort of corporate bond fund in the middle, and see how the pieces move, and if any indication of value can be pulled out from the three.  I tend to do this with VTI & TLT, but having a "tweener" asset in the middle would maybe help detail things a bit.

Clive,

I'm sorry to hear about your dad, and it's good to be reminded of how important family is, especially when the years going forward are in short supply.  I'll definitely consider your comments, and as his investing approach is definitely most weakened by so little cash, I'll continue trying to put the cash piece in perspective for him.  I feel lucky to have gotten him in just in time, but I'll definitely be devastated if the volatile PP assets should fail, even if it's just for a year, and even if cash would have saved him (and I'd suggested a move to more cash).

Clive wrote:
The PP has enjoyed the benefits of (very) good conditions over the last 40 years. There's no assurance that those conditions will be sustained in the future. 5% real gains are perhaps an exception rather than the rule - my best guess being that 2.5% real gains might be a more reflective value of longer term (full cycle) rewards. In that context the PP might endure a period of 0% real or perhaps worse results for a period of time at some point in time and that might span a decade, two or more.

Have the last 40 years been good conditions?

We've had a bull market for gold, followed by a bear market, followed by a bull market.

We've had a bear market for stocks, followed by a bull market, followed by a bear market.

We've had a bear market for bonds, followed by a bull market.

That all seems about average for the assumptions on which the PP is based.

Clive wrote:The PP reducing -10% of total fund value out of one holding that has risen 40% to add those proceeds to another that has declined -40% is pure belief in mean reversion (believing that you're adding-low/reducing (taking profits) high).

Except these aren't just some randomly diverse assets that happened to perform well over the past 40 years. Each of the PP assets are the most powerful asset for an equally possible corresponding economic condition that we are moving towards and we will eventually experience. You make it sound like either inflation/deflation/prosperity/recession will never happen again and we should prepare for that possibility somehow.

Agreed MT... the conditions haven't been all that unfairly biased towards the PP.

The PP, judged from 1972, came into existence in the middle of a bear stock market and the beginning of bull gold market.

I'll concur with someone saying that gold's suppressed prices from 1972 were a factor, but a 1974 or 1976 PP is hardly a failure.

In fact, if you cut gold's gains in half, or significantly reduce your hypothetical holdings from 25% of the portfolio in the 70's, it still did an exceptionally good job at protecting one's portfolio.

Gumby,

Your point hits exactly what really is the big trump card in the end.  These aren't just 4 random back-tested assets that we're crossing our fingers for in the future, so unless we see something like 1981, someone has to get pretty creative to think of a situation where the PP suffers in comparison to some other portfolio with a balanced risk/reward allocation.

Our balance sheets, demographics, labor negotiating power, and demand for loanable fund, though, seem to me to indicate another 1981 is unlikely, and if it is more than remotely likely, investing in short-term treasuries is ones only real "safe hedge" against an action that could send stocks, gold and LTT's all negative.

I just don't think the PP doing predictably poorer than some other asset allocation is macroeconomically feasable.  We saw it in years past, we saw it in 2008 and we saw it numerous times throughout the year: When stocks go to crap, non-treasury bonds and industrial commodities do a piss-poor job of protecting an otherwise stock-heavy portfolio, while LTT's and gold do what they're macroeconomically destined to do.

When one tries to decide "what's better?" than the PP given an uncertain world, and just a mere hope of reversion to a mean, non-treasury bonds that are less volatile and industrial commodities will feel pretty scary to invest in, and there is no evidence to me that if the Dow were to drop to 6,000 over the next couple years, that oil & copper wouldn't go right down with it, and that AAA corporate bonds would offset your stock losses (other than some interest paid out) one bit.  In fact, contrary to popular thinking within modern portfolio management, it seems to me to be downright inappropriate to pair non-volatile assets (cash & ST corporate bonds & munis) with one volatile asset (stocks) and call that a balanced portfolio when stocks often make up well over 50% of someones investments year after year.

I'm not saying the PP has to be everyone's conclusion, but I tend to think, without question, gold & LTT's should be a decent portion of anybody's portfolio, even if they're not sold on the PP and don't like the 25/25 allocation of those two assets.  I agree that 4% real return over the coming years seems unlikely.  I don't think anyone's claiming that going forward, any investment is likely to have the real return it did during our economic expansion since the early 80's... I just can think of nothing better suited, at this point, to deliver at least SOME real return with as minimal downside risk as possilbe.

moda0306 wrote: Now, if Rick Perry or Ron Paul are elected (or appear likely to be), I will definitely move my PP, as well as my dad's (if he'll let me), much more heavily into cash.  Until then, I see little evidence to the effect that the correlations will break down, or that any one PP asset is significantly over/underpriced.

Was this a bit tongue-in-cheek or would you actually tweak your asset allocation based on how a Presidential election turns out?  Do you not currently sit at 4x25?

LW,

I don't really know why I included myself in that... I DO hold a 4x25 but as soon as I obtain what I deem to be enough "emergency fund cash" I don't think I'll continue to keep it at 25%.  The fact that I'm saving to refinance is also keeping me a bit more conservative than I'd otherwise be.

I meant moreso my dad's very cash-light portfolio and the possibility that one of those men as president would nominate a much more Austrian-esque fed chairman who wouldn't be afraid to tighten money supply in a recession.

Do you think it'd be a bad move at that point?  Don't you see a 1981 scenario much more likely with one of those men in the white house?

moda0306 wrote: Do you think it'd be a bad move at that point?  Don't you see a 1981 scenario much more likely with one of those men in the white house?

Ron Paul won't be elected.

Rick Perry would probably turn out as President about like Obama has--most of the campaign rhetoric would evaporate once elected and we would find that he's just another big government politician with few deep convictions.

moda0306 wrote: I meant moreso my dad's very cash-light portfolio and the possibility that one of those men as president would nominate a much more Austrian-esque fed chairman who wouldn't be afraid to tighten money supply in a recession.

Do you think it'd be a bad move at that point?  Don't you see a 1981 scenario much more likely with one of those men in the white house?

I see.  Assuming he is comfortable with the idea, bringing Dad up to 4x25 seems like a worthy thing to do.  Setting aside tax implications, I always feel pretty good going back to 4x25.

Also, I certainly understand the motivation to shrink the cash slice.  With 0% interest rates, cash just isn't much fun right now.  Personally, I just leave it all alone and don't worry about it too much.

Your observation that Ron Paul (absolutely) and Rick Perry (maybe??) could be strong dollar Presidents is worth considering.  Certainly Bush and Obama have demonstrated virtually no interest in defending the dollar (unlike Reagan and to a lesser extent, Clinton.)  Still, for those unforeseen situations where all 3 assets might drop at once, I do keep that 25% powder dry.  It also helps smooth the ride out a bit, which suits me just fine.

Cash is definitely the asset I'm most tempted to mess with but I still resist the temptation to fart around.  Trying to predict the future can be fun, but I'm treating it as a "for recreational purposes only" activity! 

LW,

Do you really think Reagan and Clinton "defended" the dollar so much as got lucky with trends?

I mean Reagan said before being elected he thought shrinking the deficit would help cut inflation, which he then proceeded to do the exact opposite of, and I think it's believed that it was moreso Volcker's policy (Carter appointee) and the end of the oil crisis (along with computer technology maybe) that brought prices back into reason.

I understand Clinton was good on deficits, mostly because of booming economy and high tax receipts, but I don't think that was more than luck of productivity and abundance of oil.

The only reason I say Perry is because he seems to be beating the anti-fed drum... do I think he's genuine?  No, but he could nominate a realy Austrian-thinking fed chairman.

If Paul wins the nomination, or even looks like he'll win, I'll immediately let my dad know that I think it's much more likely we'll see strong dollar policy and we should rethink his portfolio.  Not to sound like I "know better than the market," but I really don't think the market will react much until Ron gets a little closer to the white house.... I simply can't see ST treasury rates jumping and gold falling on him winning Iowa & NH or something like that, but if that were to happen that's when I'd start to react.

MT,

I understand it's extremely unlikely that Ron Paul get elected, and my comment on Perry was more of an acknowledgement of his rhetoric towards Bernanke... I wouldn't be surprised if he put in an inflation hawk, but I also wouldn't be surprised if he were just another status quo politician.

moda0306 wrote: Do you really think Reagan and Clinton "defended" the dollar so much as got lucky with trends?

Certainly both men experienced headwinds and tailwinds that are too complex to treat fully (or even understand fully), but their strong dollar policies were IMO the real deal.

For both of them, consider the dog that didn't bark.  Namely, you rarely heard a peep out of them when other countries devalued their own currencies.  For example, the fact that the Clinton Administration was content to let the dollar rise as the Yen was aggressively devalued speaks volumes.

In addition to that, Reagan certainly deserves credit for sticking steadily with Volcker even as high interest rates brought on the recession of 1981.  In the face of this recession, Reagan took a lot of political heat for his 1981 budget cuts.  The robust recovery that followed are a large part of what allowed Reagan to heal from this political bruising.

It appears to me that for these two Presidents, a strong dollar was more than simple rhetoric.

Lone Wolf wrote:
It appears to me that for these two Presidents, a strong dollar was more than simple rhetoric.

When the price of oil is falling it's very easy to maintain a strong dollar policy.

When the price of oil is rising it's virtually impossible to maintain a strong dollar policy.

The price of oil was falling through Reagan's and Clinton's administrations.

The price of oil was rising through all of Bush II's and thus far through Obama's administrations.

The price of oil is just one of many factors, of course, but this part of the equation doesn't get much coverage.

I am quite sure Reagan was not a big fan of Volcker's rate hikes.  I don't know how politically feasable it is to ever oust a sitting fed chairman, but I'm quite sure based on things I've heard/read that he was pretty pissed at Volcker for his "on-purpose recession."  I can't say I blame him, as any politician would be a bit angry about that.

He also vastly increased deficits, which he himself said (probably incorrectly) were causing the horrible inflation.

So between vastly increasing our deficits and his antipathy towards Volcker, I just don't see him as a "strong dollar" president.

Clinton's era, he at least had deficit control on his side, but the economy was so good for him that I just don't see him being tested in terms of devaluation.  I mean there were so many good things happening at once that I can't really assume Clinton had the same pressures as Bush or Obama to do something about the economy.

MediumTex wrote: When the price of oil is falling it's very easy to maintain a strong dollar policy.

When the price of oil is rising it's virtually impossible to maintain a strong dollar policy.

The price of oil was falling through Reagan's and Clinton's administrations.

The price of oil was rising through all of Bush II's and thus far through Obama's administrations.

The price of oil is just one of many factors, of course, but this part of the equation doesn't get much coverage.

This is a great point, but let me add something.  President Bush assumed office on January 20, 2011.  The day before, the price of gold was $264.00.  Oil was about $23.00.  An ounce of gold bought you 11.5 barrels of oil.

Today, gold is $1806.  Oil is $87.  An ounce of gold buys you nearly 21 barrels of oil.

In terms of gold, oil has become nearly twice as cheap.  This implies that a significant component of the higher nominal cost of oil today is down to currency debauch.

In other words, one could also say that a falling price of oil is easier to maintain with a strong dollar policy.

LW,

As much as I like gold for what it does, I tend to be very much outside the realm of "gold doesn't change in price, the dollar does" thinking.

This line of thinking basically views gold as a constant, and all price moves around it are the real price moves of the economy.

I just don't buy it.  Gold is always negotiating its price somewhere between its industrial value and its monetary value assuming fiat currencies aren't "working."  At least that's how I view it.  There was plenty of monetary expansion from 1980-2001, but gold suffered a 2/3 price decrease during that time.  I don't really see that as a massive deflation of the fiat money supply, but simply an adjustment in the value of gold as a monetary option in the face of what appeared to be very safe and sustainable fiat money throughout the world.

moda0306 wrote: As much as I like gold for what it does, I tend to be very much outside the realm of "gold doesn't change in price, the dollar does" thinking.

No price is fixed.  Every price is relative and completely dynamic.

My point is simply to recognize that the weak dollar policy itself is a significant contributing factor to the rising cost of oil.  Considering that gold and the dollar are competing forms of money, it's a striking comparison IMO.

Devaluation has consequences, not all of them immediately felt or recognized.  (Thus its appeal to politicians.)

And what was the price of gold and oil the day before Obama took office, a mere two and a half years ago? And what was the national debt on that day?

Reub wrote: And what was the price of gold and oil the day before Obama took office, a mere two and a half years ago? And what was the national debt on that day?

Gold was at $833.00.  (Versus, again, $1800 today.)

National debt was at $10,626,877,048,913 on inauguration day.  (At the moment it's $14,745,112,201,450.)

Frankly, for a 2.5 year span, it's hard to describe those numbers as anything but a total horror show.

Reub,

Do you think the last two years would have been that much different with McCain in office?  We still would have seen a stimulus and bailouts of similar sizes, methinks, with the former maybe tilted more towards tax cuts.

Further, most of our deficit is structurally built into the tax code & safety nets when we have a recession.  Our tax receipts have gone down immensely, safety net programs have had to pay out much faster, and it would have taken congressional action to raise taxes or cut spending to prevent those major causes of our deficits.

I think we have to accept that whether it's appropriate or not, our government tax/spending system is designed to "self-correct," to some degree, recessionary activity in our economy, and that's going to result in large deficits.  To judge newly elected political officials on those results seems wildly inappropriate, especially since the other arm of inflationary pressure, the federal reserve, has BB in charge for a while now.

LW, for me the horror show has been 30 years in the making... the extra 4 trillion in total debt being just an indication of society finally collectively realizing where we are at and acting as individuals would normally do when they see troubled times ahead.  I don't see 9%+ unemployment as any less a horror show than 100% debt/gdp ratio.  I also think the horror show is the worsening of private sector balance sheets over the last decade (and, to be honest, beforehand).  Maybe this is a wrong time to get in another deficits debate, but the real horror show, on top of unemployment, seems to me to be the private sector balance sheet problem in this country (not that it's the private sector's fault, but simply acknowledging their macro-inability to all get out of it at the same time without massive liquidation of debt).  The national deficit/debt is only a problem insofar as it limits our options or prosperity going forward.

At 1.94% interest for 10 years and 9% unemployment, much of which is in the construction sector, is our government anything but insane not to take advantage of unused construction labor and loanable fund capacity (just sitting there, both of them (the people and the money), wanting to work but not) to build/upgrade infrastructure for the growth of the next bull private sector market?  Should we wait until the private sector eventually recovers, and we have full employment, packed streets and freeways, and 6% interest rates?

I'm not saying that perpetual growth is possible or ideal, but to suggest that we will have growth eventually, and to say we're not in a position to prepare for it now (if not bring it about sooner to boot) seems a bit of a stretch.

moda0306 wrote: Do you think the last two years would have been that much different with McCain in office?

I'm not sure they would have been much different with even Ron Paul in office.

It seems like a lot of this is the result of 30-40 years of overspending...probably doesn't matter that much
who is in office.

Adam1226 wrote:

moda0306 wrote: Do you think the last two years would have been that much different with McCain in office?

I'm not sure they would have been much different with even Ron Paul in office.

It seems like a lot of this is the result of 30-40 years of overspending...probably doesn't matter that much
who is in office.

Yep.

We are simply seeing the manifestation of design flaws that were built into the system a long time ago.  In many ways, the system was designed to fail, so long as the failure occurred on someone else's watch.

If we were honest with ourselves, we would see that our current problems started at least as far back as Lyndon Johnson's naive belief that a war and a welfare state could be administered without any bad consequences down the road, and has been added to by each succeeding presidential administration.  In many ways, our entire approach to governmental functions has for decades been an elaborate game of kick the can down the road.

Or, putting it another way, a Ponzi scheme.