PP for European Investors (once again)

[barrett]

The interest does not compensate for the duration as well as rate risk, even at the utmost deflation.
If I put banknotes in a safe desposit box, at least I have instant access to my money all the time.

This lunatic policy will by the way kill all European pension plans within 5-10 years.

Meaning that the pension plans will be filled up with bonds that don't pay anything, correct?

Pfanni, how has a European PP worked, say since the beginning of 2014 while holding German bonds? And going forward have you decided to go bondless or buy US bonds and gamble with the currency exchange?

[barrett]

Me again. The reason I don't like the idea of a European buying US bonds has been nicely illustrated in the last few days where a strengthening Euro would have wiped out any gains from bond interest. I would be loading up on cash and giving up on bonds if I were in your situation. Not sure if I would add extra gold and stocks but those bonds are just a bad deal all the way around.

[Pfanni]

In Germany we have a saying that in general, you don't have to be 100% accurate & right.
Roundabout right, close to accurate does it as well.

Following this idea, I think as long as I keep the 4x25% allotment, the portfolio might still balance out and work for me.

25% stocks - MSCI World ETF, the broadest index of the Western world (60% US stocks)
25% gold
25% bonds - 1/2 30yr US Treasury, 1/2 2yr US Treasury
25% cash - 1/2 EUR savings account, 1/2 USD call money account at German bank

We Germans got punked to share a common currency with failed dead-beat states like Portugal, Greece & Italy.
EUR is a dead man walking. I refuse to be part of that scam.

FX risk? I'd rather call it FX lifeboat.

[dkalder]

Going for external-currency-bonds means to not keep to a real PP anymore.

In the real PP, the own-everydaylife-currency-bonds are countered by gold and stocks concerning currency fluctuations.

Going for external-currency-bonds means to put aside that kind of hedging, inherent to the PP and to speculate for or against the currency. One can do that, but it is not a true PP anymore, with the full gyroscopic dynamics!

Nobody truly knows, what will happen concerning FX in the event of a Eurozone disintegration in the different countries. Nobody even knows, how a Eurozone disintegration will look like. Well, it is quite likely, it will come some day. But when and how is still a very wild guess. 

The real PP is historically the best bet for such special events. Yet, I still have the opinion that shielding from political instabilities in such an event (excessive taxation, gold confiscation, etc.) is the most important aspect beyond the real PP to address.

[Lang]

In Germany we have a saying that in general, you don't have to be 100% accurate & right.
Roundabout right, close to accurate does it as well.

Following this idea, I think as long as I keep the 4x25% allotment, the portfolio might still balance out and work for me.

25% stocks - MSCI World ETF, the broadest index of the Western world (60% US stocks)
25% gold
25% bonds - 1/2 30yr US Treasury, 1/2 2yr US Treasury
25% cash - 1/2 EUR savings account, 1/2 USD call money account at German bank

We Germans got punked to share a common currency with failed dead-beat states like Portugal, Greece & Italy.
EUR is a dead man walking. I refuse to be part of that scam.

FX risk? I'd rather call it FX lifeboat.

I really don't like that portfolio. 87.5% of your portfolio (stocks, bonds, gold and half of cash) is denominated in foreign currency (mostly USD). If the euro strengthens significantly this will absolutely kill your returns. If you insist on investing in foreign bonds and stocks then I suggest that you use currency-hedged ETFs.

I think that you are underestimating the euro and the eurozone. The eurozone is currently in deflation. Almost all countries in the eurozone have zero inflation or high deflation. This is not an erosion of purchasing power, this is an increase (!) in purchasing power. And a deflationary currency is a good investment! Inflation tends to erode a currency's value over time, while deflation raises a currency's value. Yes, yes, I know that the euro lost 30% against the dollar in just a year. But this is mostly a dollar issue. Almost every currency lost 10-30% of its value against the dollar in the last 12 months. If you look at EUR/GBP for example, it only lost 12%.

I agree with the others that you shouldn't invest into long term Bunds - too much risk and not enough reward. Regardless, you need some asset that will rise in value in a deflationary environment. It is unfortunate that Germand bonds can no longer serve this purpose. One option that might work is to put the money into an ETF tracking the EUR/USD exchange rate (so it increases in value if the euro goes up against the dollar). Like I said, countries with persistent deflation usually see their currency strengthen over time (look at Japan and Switzerland). So I would use something like this:

25% Euro area stocks (so EuroStoxx 50 or some other index)
25% Gold
25% Long EUR/USD ETF
25% Cash in EUR

Another option is to use Italian/Spanish bonds, but this may be very risky.

[Lang]

This lunatic policy will by the way kill all European pension plans within 5-10 years.

It is probably the pension funds that are buying the bonds for such ridiculous yields. They don't really have any alternative...

[barrett]

This lunatic policy will by the way kill all European pension plans within 5-10 years.

It is probably the pension funds that are buying the bonds for such ridiculous yields. They don't really have any alternative...

I think that was Pfanni's point... that the pension funds will have to load up on these bonds with ridiculously low or negative yields and then not be able to make their promised payouts.

I question whether the low low rates on the long end are actually a policy. Seems like it's just deflation at work (see Ben Bernanke's blog post from another thread regarding long-term yields). Investors are bidding those rates down.

Lastly, I am still surprised that more of the regular posters on this forum haven't weighed in on this thread. I believe most of us live in the US but the Eurozone is not some remote third-world area. It's true that the Eurozone faces issues that we don't here in the US because individual countries can't all have their own monetary policies. But the question of what to do with the LTT portion of the PP in an extreme low-rate environment is something we could face here in the US as well.

[Lang]

It depends on the country. I think that in the Netherlands the pension funds are still doing okay. In the US there are many public pension funds with billions in unfunded liabilities, despite the "high" interest rates. From what I understand, European pension funds are very conservative and cautious, so low yields on government debt can really hurt them.

[Pfanni]

Some thoughts come to my mind in regards to low interest rates.

Back in the 70s, with nominal long-term yields in the US around 7%, people called LTTs "certificates of confiscation", because the real, inflation-adjusted yield was negative. So we have to be careful to dismiss negative nominal yields as negative real yields today, because deflation can still take place big time.

As a young person in the thirties, I acutally would like to see some inflation, because the baby boomer generation still owns way too much in high-yielding assets. Intergenerational wealth is way too skewed towards old people, thanks to thirty years of falling rates. Throw on top safe jobs for the most part of their life and defined company penion plans, we young people are really screwed.
My parents' generation worked most part of their lives for the same company, or when they switched jobs, they usually did it for better payment, not becaue they got laid off or their fixed-term contract ran out (unheard of in their generation to work as a temp).

Back to monetary policy. I think the FED does a much better job than the ECB, for keeping ultra-short term yields in the (nominally) positive realm. This creates a feeling of calmness and sanity for market participants.

One of the unintended consequences of ECB negative rate policy will be to destroy the German (private) health care scheme for the self-employed & state employed (lawyers, doctors, store owners, artisans, government employees). The insurance companies used to collect fees from the young, buy government bonds and use the proceeds to pay for their care when they got old and sick. With negative yields up to seven years and pitiful returns up to thirty years, the taxpayer will have to bail out the insurers to pay for a few million Germans' health care.

I nevertheless understand Mister Draghi's decision to push savers out of government bonds, to make those bonds unattractive, in order to force them to invest in the real economy.

[Lang]

As a young person in the thirties, I acutally would like to see some inflation, because the baby boomer generation still owns way too much in high-yielding assets. Intergenerational wealth is way too skewed towards old people, thanks to thirty years of falling rates. Throw on top safe jobs for the most part of their life and defined company penion plans, we young people are really screwed.
My parents' generation worked most part of their lives for the same company, or when they switched jobs, they usually did it for better payment, not becaue they got laid off or their fixed-term contract ran out (unheard of in their generation to work as a temp).

I concur. There is a problem in that people now live longer and as they age their healthcare expenses become bigger and bigger. So I understand old people who try to save a lot and keep the value of their savings. I don't know what can be done about this.

[barrett]

Intergenerational wealth is way too skewed towards old people, thanks to thirty years of falling rates. Throw on top safe jobs for the most part of their life and defined company pension plans, we young people are really screwed.

I think the key is for more and more people to think of income in the same way that self-employed workers have always had to do, i.e. investors need to set aside money early and often so that it is there when their incomes are diminished.

Pfanni, do you think that long bonds are a better deflation hedge than extra cash with rates this low? Implicit in my question is that one needs to consider interest rate risk as part of the overall picture.

[Pfanni]

do you think that long bonds are a better deflation hedge than extra cash with rates this low? Implicit in my question is that one needs to consider interest rate risk as part of the overall picture.

That is the big conundrum in a nutshell. PP diehards would buy their home country bonds nevertheless, but I won't. As some guy wrote, PP is an investment approach, not a blueprint. Even Craig Rowland wrote in his book that there isn't the one perfect PP implementation, that one has to work out the asset vehicles for oneself.

Germany 1yr is at negative -0.19% - if I refuse to buy those bonds, I have left the orthodox PP behind already.

German 30yr at 0.61% is not worth the rate/duration risk, as I stated before. Sick currency.

Switzerland 30yr at 0.37% seems like a much better deal in comparison, as it seems to be a well-run country with strong fundamentals and companies (Novartis, Nestle..) opposed to deadbeats like Greece and Portugal, whose currency you buy with that German bond.
On the other hand it is too small of a country, therefore I wouldn't buy those bonds.

USA 30yr at 2.55% seems reasonably priced. Yield is high enough to offer bond upside in case yields go down.
USD still the cleanest of all the dirty shirts.

[Lang]

Switzerland also has a 50 year bond with a yield of 0.487%. Maybe try to convince your government to issue 50 year bunds

[Pfanni]

I will abandon the Permanent Portfolio and lend all my money to Ireland for 2 years at negative -0.02% yield. (source: http://pigbonds.info/Staatsanleihen/Irland)

That seems like a great deal!!!

[frugal]

Why so many problems?

In 2013 you could be thinking in the end of the world (PP) but now?

regards

[taipalag]

Hi Pfanni,

I'm also still a newbie here. I use DBXG for my bonds allocation. So far with the yield going down their value has increased nicely. And with the new QE program of the ECB the yield could go further down and the value of those bonds increase yet more. And after rebalancing we can capture those gains and redistribute them on other asset classes.

So maybe I'm naive but I fail to see the problem with LTB for now. We don't know how far the yield can go down and the value of hose LTB up. The only problem I see is if European nations start to default on their bonds, but then investors most likely will flee to short term bonds and our cash allocation should nicely go up I think.

[Lang]

The problem is that DBXG contains Spanish, Italian and other of-lesser-quality bonds.

[barrett]

And with the new QE program of the ECB the yield could go further down and the value of those bonds increase yet more.

Yes, that could happen, but the intent of Quantitative Easing is not to drive up bond prices. It is to encourage lending which is supposed to lead to spending, and - it's almost guaranteed that the ECB is hoping for this - a bit of inflation. Any inflation is terrible for long bond prices when yields are as low as they currently are in Europe.

[frugal]

The problem is that DBXG contains Spanish, Italian and other of-lesser-quality bonds.

that is not a problem!

Europe is stronger now.

No country will default. They don't let it fall.

EUPP is GOOD

[Lang]

If you think that no country will default then why not buy Greek bonds? 11% yield!

[dutchtraffic]

The problem is that DBXG contains Spanish, Italian and other of-lesser-quality bonds.

that is not a problem!

Europe is stronger now.

No country will default. They don't let it fall.

EUPP is GOOD

I think you are missing a sarcasm smiley here...?

and:

No country will default. They don't let it fall.

"They" don't decide what falls or doesn't fall.

That etf is full of toxic bonds, it won't behave like a PP should behave when stuff gets nasty, spanish and italian bonds are anything but a 'safe' haven.

[Pfanni]

European long-term bonds - you get a very low yield in a depreciating currency. Unheard of in decades of financial history.

ECB QE is competetitive devaluation. Exporting deflation. Onshoring jobs. Driving up inflation, devaluing debts.
That's all fine by me - but I wouldn't put my savings into EUR bonds.

That's my PP by now - I had to take into account FX risk as well as duration risk.. I aimed to err on the low risk side, meaning I reduced bond duration. The makeshift solution I could come up with.

A) Stocks, 25% - MSCI World ETF
B) Gold 25% - Physical
C) Bonds 25% - 1/2 US 30yr, 1/2 US 2yr
D) Cash 25% - 1/2 EUR savings account 0.4% yield, 1/2 US 2yr

This might underperform the original PP because of lower bond yields, but I can live with that.

[European Son]

After reading the posts on European bond allocations for the PP, I am confused about which ETF to go for.
I think we are a year or 2 before a rate rise in Europe, so theres time to choose the best fund.  What about a broad market fund such as IEAG? That way, I would not be exposed fully to the long dated bonds, but would get the hedging aspect of bonds.
I am not taking on currency risk. I mentioned the 20 year bond fund, but that will be too sensitive to interest rates movements, planned or actual.

[Lang]

I think we are a year or 2 before a rate rise in Europe

The market disagrees with you:



and I agree with it.

[Pfanni]

I'm happy to see some other PPs admitting that European government bonds are toxic for the most part and that the yields don't justify buying a 30yr bond.

As the blogger FOFOFA wrote, a fiat currency regime always depends on human greed and the subliminal lust for more. Save your money, lend it to the bank, collect the fat yield - not thinking where that yield acutally came from (the printing press or credit expansion). This promise of more money or free stuff in the future is at the heart of fiat.
These low yields start to not justify saving in fiat currency, or other people's debt instruments. So I guess gold will see a strong run in the coming decade.