Gyroscopic Investing

Kevin K. wrote: ↑Fri Nov 29, 2024 9:15 am Inflation is the next biggest threat, but as we also know Browne was mistaken in claiming that gold is an effective inflation hedge.

glennds wrote: ↑Fri Nov 29, 2024 12:21 pm

Kevin K. wrote: ↑Fri Nov 29, 2024 9:15 am Inflation is the next biggest threat, but as we also know Browne was mistaken in claiming that gold is an effective inflation hedge.

I know this thread is primarily about LTT, but would you elaborate on why you are saying this?
I was worried about the same, but looking at how gold has responded in the past year or so, to what has been a clearly inflationary environment, I'm surprised at your statement.

yankees60 wrote: ↑Fri Nov 29, 2024 2:08 pm William Bernstein is one among many who have shown that gold is not an effective inflation hedge. It is a severe circumstances hedge.

glennds wrote: ↑Fri Nov 29, 2024 12:21 pm

Kevin K. wrote: ↑Fri Nov 29, 2024 9:15 am Inflation is the next biggest threat, but as we also know Browne was mistaken in claiming that gold is an effective inflation hedge.

I know this thread is primarily about LTT, but would you elaborate on why you are saying this?
I was worried about the same, but looking at how gold has responded in the past year or so, to what has been a clearly inflationary environment, I'm surprised at your statement.

Benjamin Graham wrote:For every investor it means that when he limits his return to a small figure -- as formerly, at least, in a conventional bond or preferred stock -- he must demand convincing evidence that he is not risking a substantial part of his principal.

dualstow wrote: ↑Fri Nov 29, 2024 10:01 am

Kevin K. wrote: ↑Fri Nov 29, 2024 9:15 am As William Bernstein and others have pointed out, the four economic scenarios Browne was concerned about are not even close to being equally likely to occur,
…
I mean I get the appeal of equal weighting in terms of simplicity and rebalancing but IMHO it makes no sense otherwise.
…

It’s an agnostic portfolio, and I think having an equal weighting is more about having proper protection than about predicting the future or calculating the likelihood of one event occuring.

Imaging wearing linen armor instead of kevlar because, well, the risk of getting shot is unlikely. I think that’s the protection that some long term bonds will bring instead of something closer to 25%.

Of course, that protection comes at a cost: underperforming something like a 100% equities portfolio. It’s not like buying inexpensive life insurance with a large payout. You get a smooth ride but are very likely to underperform, even though the pp has shown to perform decently over time if you stick with it.

I could be wrong, but that’s how I see it. I don’t think it’s only about simplicity.

P.S. I reread this, Kevin, and thought that it might look like I thought you were pushing for LTTs but as a smaller proportion. That is not the case. It’s simply why I think Harry didn’t link % of assets to probabilities of events.

welderwannabe wrote: ↑Fri Nov 29, 2024 2:23 pm

yankees60 wrote: ↑Fri Nov 29, 2024 2:08 pm William Bernstein is one among many who have shown that gold is not an effective inflation hedge. It is a severe circumstances hedge.

Well Bill Bernstein is a huge huge huge fan of TIPS. Ive heard him speak about it several times.

Regardless, look over the years since TIPS were out. Pick reasonable time periods. Do backtesting. See what you think.

Circumstances cause inflation. Pandemic anyone?

Kevin K. wrote: ↑Fri Nov 29, 2024 3:05 pm

dualstow wrote: ↑Fri Nov 29, 2024 10:01 am

Kevin K. wrote: ↑Fri Nov 29, 2024 9:15 am As William Bernstein and others have pointed out, the four economic scenarios Browne was concerned about are not even close to being equally likely to occur,
…
I mean I get the appeal of equal weighting in terms of simplicity and rebalancing but IMHO it makes no sense otherwise.
…

It’s an agnostic portfolio, and I think having an equal weighting is more about having proper protection than about predicting the future or calculating the likelihood of one event occuring.

Imaging wearing linen armor instead of kevlar because, well, the risk of getting shot is unlikely. I think that’s the protection that some long term bonds will bring instead of something closer to 25%.

Of course, that protection comes at a cost: underperforming something like a 100% equities portfolio. It’s not like buying inexpensive life insurance with a large payout. You get a smooth ride but are very likely to underperform, even though the pp has shown to perform decently over time if you stick with it.

I could be wrong, but that’s how I see it. I don’t think it’s only about simplicity.

P.S. I reread this, Kevin, and thought that it might look like I thought you were pushing for LTTs but as a smaller proportion. That is not the case. It’s simply why I think Harry didn’t link % of assets to probabilities of events.

Actually I think a smaller allocation to LTT's makes perfect sense. Monetary policy expert Cullen Roche (Discipline Funds) made this point when we were corresponding about the PP and GB:

"I've always liked "lazy portfolios", but the problem there is they don't always bucket allocations in a sensible manner which creates a lot of uncertainty. Specifically, I'd argue that 20% in long-term bonds is way too much. Long bonds and gold are like insurance in a portfolio. Your portfolio should never be comprised of 40% insurance." I find it helpful to look at where gold and LTT's fit in his Defined Duration chart:

https://disciplinefunds.com/defined-duration-investing/

You can see how both gold and LTT's are super long-duration assets that act as insurance when anomalous or "black swan" type events occur.

Regarding Browne's approach, it just doesn't make any sense IMHO to not take into account both the likelihood of various macroeconomic conditions happening and the costs of insuring against them when designing a portfolio.

Interestingly enough the original PP (PRPFX) holds bonds with an average duration of just over 4 years:

https://permanentportfoliofunds.com/per ... folio.html

Kevin K. wrote: ↑Fri Nov 29, 2024 3:05 pm Actually I think a smaller allocation to LTT's makes perfect sense. Monetary policy expert Cullen Roche (Discipline Funds) made this point when we were corresponding about the PP and GB:

"I've always liked "lazy portfolios", but the problem there is they don't always bucket allocations in a sensible manner which creates a lot of uncertainty. Specifically, I'd argue that 20% in long-term bonds is way too much. Long bonds and gold are like insurance in a portfolio. Your portfolio should never be comprised of 40% insurance."
…
You can see how both gold and LTT's are super long-duration assets that act as insurance when anomalous or "black swan" type events occur.

Regarding Browne's approach, it just doesn't make any sense IMHO to not take into account both the likelihood of various macroeconomic conditions happening and the costs of insuring against them when designing a portfolio.

Interestingly enough the original PP (PRPFX) holds bonds with an average duration of just over 4 years:
https://permanentportfoliofunds.com/per ... folio.html

yankees60 wrote: ↑Fri Nov 29, 2024 3:22 pm

welderwannabe wrote: ↑Fri Nov 29, 2024 2:23 pm

yankees60 wrote: ↑Fri Nov 29, 2024 2:08 pm William Bernstein is one among many who have shown that gold is not an effective inflation hedge. It is a severe circumstances hedge.

Well Bill Bernstein is a huge huge huge fan of TIPS. Ive heard him speak about it several times.

Regardless, look over the years since TIPS were out. Pick reasonable time periods. Do backtesting. See what you think.

Circumstances cause inflation. Pandemic anyone?

Was there any time period when one held TIPS were held to maturity that you did not get what was promised? A rate of return plus the inflation during that period? That is all I want from them. I'm not comparing them to the return of any other investment because any other investment has no guarantee like that.

dualstow wrote: ↑Fri Nov 29, 2024 3:30 pm (1) If the interest were 5% or higher, I would do the opposite of what I wrote earlier, feeling comfortable “sticking my wife with them.” CraigR had enough to live off the the interest. I don’t, but the wife could do worse than collecting 5% on a bunch of treasuries for years to come. (Alternatively, Jack Jones wrote above about abandoning the idea of purchasing them if the interest got too low and I’m sympathetic to that).

yankees60 wrote: ↑Fri Nov 29, 2024 3:22 pm
Was there any time period when one held TIPS were held to maturity that you did not get what was promised? A rate of return plus the inflation during that period?

welderwannabe wrote: ↑Sat Nov 30, 2024 6:32 am

yankees60 wrote: ↑Fri Nov 29, 2024 3:22 pm
Was there any time period when one held TIPS were held to maturity that you did not get what was promised? A rate of return plus the inflation during that period?

Yes, the entire time. The 'inflation' metric the government has invented and constantly changes, with some changes major, does not measure true inflation fully. Miraculously their changes always seem to lower the measured inflation. Thats why the large gap between gold and TIPS over the years.

Among some changes, the BLS changed from a pure Cost of goods method to a Cost of Living method, not to mention other tweaks.
This Cost of Living method factors in product features/product quality. As a very high level example, say you bought an iphone that has a 3megapixel camera for $500. When your phone dies and its time to replace it, the replacement phones are now $750 and come with a 5mp camera. The BLS would say well its got a better camera, so thats why it costs $250 more, so no inflation, so they don't count the price increase. Or you have to replace your car, it costs 50% more but came with a bunch of extra emissions features your previous car didnt have because of new EPA requirements...they consider this a 'new feature'. So, they dont count the whole price increase towards inflation. Im making these examples up, to give you an idea of how it works, but this is what they do.

This whole process tends to really understate the inflation in things like housing, automobiles, fixed goods etc. The exact type of things peope tend to 'bid up' the price on when they have a bunch of extra money in their pocket when the money supply is increased. Take a look at car prices and housing prices since 2019, and compare that to the performance of TIPS over the same time. Those TIPS have NOT kept up with actual inflation.

The whole thing is rigged because its in the governments best interest to show low inflation. Politically it helps them, then financially it also helps as a bunch of government expenses are indexed against CPI. TIPS, Social Security, Pensions etc. Why do you think they keep changing it, versus indexing it against something that more accurately measures inflation such as total money supply?

I am not anti-tips. I put my parents in tips and build a tips annuity ladder for them. Thats a decent approach to take out some of the risk of the variability of gold, and some of the risk with nominal bonds. However, I'm under NO illusion that it protects them against money supply increases or government defaults as well as gold does. it doesnt. tips do not replace gold.

For a real example, someone who stored their $350,000 house fund in TIPS in January of 2019 would have approximately $434,105 today. However, that $350,000 house now actually costs $500,500 based on non government data that tracks actual housing prices, versus the CPI hocus pocus Owners Equivalent Rent metric they invented.
Therefore CPI has only tracked the increase to $455,492. Notice how that close that is to the value of your TIPS but understates the actual housing cost increase?

Had you put your $350,000 house fund in gold, you'd have $708,925.

welderwannabe wrote: ↑Sat Nov 30, 2024 6:32 am

yankees60 wrote: ↑Fri Nov 29, 2024 3:22 pm
Was there any time period when one held TIPS were held to maturity that you did not get what was promised? A rate of return plus the inflation during that period?

Yes, the entire time. The 'inflation' metric the government has invented and constantly changes, with some changes major, does not measure true inflation fully. Miraculously their changes always seem to lower the measured inflation. Thats why the large gap between gold and TIPS over the years.

Among some changes, the BLS changed from a pure Cost of goods method to a Cost of Living method, not to mention other tweaks.
This Cost of Living method factors in product features/product quality. As a very high level example, say you bought an iphone that has a 3megapixel camera for $500. When your phone dies and its time to replace it, the replacement phones are now $750 and come with a 5mp camera. The BLS would say well its got a better camera, so thats why it costs $250 more, so no inflation, so they don't count the price increase. Or you have to replace your car, it costs 50% more but came with a bunch of extra emissions features your previous car didnt have because of new EPA requirements...they consider this a 'new feature'. So, they dont count the whole price increase towards inflation. Im making these examples up, to give you an idea of how it works, but this is what they do.

This whole process tends to really understate the inflation in things like housing, automobiles, fixed goods etc. The exact type of things peope tend to 'bid up' the price on when they have a bunch of extra money in their pocket when the money supply is increased. Take a look at car prices and housing prices since 2019, and compare that to the performance of TIPS over the same time. Those TIPS have NOT kept up with actual inflation.

The whole thing is rigged because its in the governments best interest to show low inflation. Politically it helps them, then financially it also helps as a bunch of government expenses are indexed against CPI. TIPS, Social Security, Pensions etc. Why do you think they keep changing it, versus indexing it against something that more accurately measures inflation such as total money supply?

I am not anti-tips. I put my parents in tips and build a tips annuity ladder for them. Thats a decent approach to take out some of the risk of the variability of gold, and some of the risk with nominal bonds. However, I'm under NO illusion that it protects them against money supply increases or government defaults as well as gold does. it doesnt. tips do not replace gold.

For a real example, someone who stored their $350,000 house fund in TIPS in January of 2019 would have approximately $434,105 today. However, that $350,000 house now actually costs $500,500 based on non government data that tracks actual housing prices, versus the CPI hocus pocus Owners Equivalent Rent metric they invented.
Therefore CPI has only tracked the increase to $455,492. Notice how that close that is to the value of your TIPS but understates the actual housing cost increase?

Had you put your $350,000 house fund in gold, you'd have $708,925.

Jack Jones wrote: ↑Sat Nov 30, 2024 3:55 am

dualstow wrote: ↑Fri Nov 29, 2024 3:30 pm (1) If the interest were 5% or higher, I would do the opposite of what I wrote earlier, feeling comfortable “sticking my wife with them.” CraigR had enough to live off the the interest. I don’t, but the wife could do worse than collecting 5% on a bunch of treasuries for years to come. (Alternatively, Jack Jones wrote above about abandoning the idea of purchasing them if the interest got too low and I’m sympathetic to that).

I think Craig said he would abandon them at 1%. However, w/ the Federal Reserve mandated to produce 2% inflation, I don't want to be betting that they will fail to create enough money or find recipients of it.

The paper, Government Debt in Mature Economies: Safe or Risky?, explores the dynamics of government debt in advanced economies, particularly in response to shocks like the COVID-19 pandemic. It contrasts two debt regimes—safe debt (low risk, borne by taxpayers) and risky debt (higher risk, borne by bondholders). Key findings and themes include:

Risky Debt Regime Fit for Current Economies:

The paper argues that recent fiscal and monetary policies in the U.S. and other mature economies align more closely with a risky debt framework.
Large-scale asset purchases and rising government debt led to increased bondholder risk premiums.
COVID-19 Case Study:

During the pandemic, U.S. Treasury yields rose as bondholders absorbed risks from increased government spending unaccompanied by tax increases.
From March 2020 to October 2023, real losses on U.S. Treasuries reached 26%, reflecting the revaluation of government debt amidst fiscal expansions.
Historical Comparisons:

The fiscal response during COVID mirrored wartime policies, where bondholders often absorbed a significant fiscal burden, unlike the financial crisis of 2008.
U.S. Treasury valuations fell due to shifts in inflation expectations, convenience yields, and real rates.
Policy Implications:

Governments face a trade-off: shielding taxpayers (risky debt) versus ensuring stable debt valuations (safe debt).
Central bank interventions, while stabilizing markets in the short term, may shift fiscal burdens to taxpayers or delay necessary repricing of debt.
Fiscal Dominance and Monetary Interactions:

The analysis links fiscal dominance (governments driving fiscal policies without constraints) to risky debt. Such regimes expose bondholders to volatility as fiscal surpluses fail to back debt adequately.

The paper raises important considerations about the evolving role of U.S. Treasury bonds, particularly within investment strategies like the Harry Browne Permanent Portfolio, which relies on Treasuries to provide safety and stability during economic downturns. Some key takeaways that relate to this question include:

1. Increased Risk of Treasury Bonds:
The shift toward a risky debt regime, as described in the paper, suggests that Treasuries are no longer the universally "safe" assets they were in the past.
Rising yields and significant markdowns in Treasury values during the COVID-19 pandemic (-26% real return) indicate that Treasuries can experience volatility and losses, undermining their traditional role as a hedge in times of crisis.

2. Correlation Dynamics:
Historically, Treasuries have been negatively correlated with stocks, making them a natural diversifier. However, the paper notes that the stock-Treasury correlation turned positive during COVID-19. This suggests that Treasuries may not provide the same diversification benefits in future crises, especially in fiscal dominance regimes.

3. Erosion of Convenience Yields:
The paper highlights declining "convenience yields" on Treasuries, meaning investors now view them as less attractive relative to other assets. This could reduce their ability to act as a refuge during market turbulence.

4. Impact of Inflation Expectations:
In the Harry Browne framework, Treasuries serve as protection against deflation. However, the paper notes a significant rise in long-term inflation expectations during COVID, which contributed to the devaluation of Treasuries. Persistent fiscal expansions without matching revenues could expose Treasuries to inflationary risks, weakening their deflation hedge.

5. Monetary and Fiscal Policy Interactions:
The Harry Browne portfolio assumes that Treasuries will benefit from central bank support during crises. However, the paper suggests that such interventions increasingly transfer risk to taxpayers or delay necessary market corrections, which could alter Treasuries' behavior in future crises.

Conclusion for the Permanent Portfolio:
The evolving risk profile of Treasuries raises valid questions about their reliability in a Permanent Portfolio strategy. While they may still serve as a hedge in certain conditions, their traditional role as the "safe" asset may be less dependable due to:

Higher volatility and risk premiums.
Eroding diversification benefits.
Sensitivity to fiscal policy dynamics.
Investors using the Permanent Portfolio may need to reassess whether Treasuries still provide the intended stability and protection, or if alternative low-risk assets or modified allocations are necessary in the current economic environment.

Kevin K. wrote: ↑Sat Nov 30, 2024 10:07 am While I don't entirely disagree with your sentiments the dates you chose to compare TIPS and gold are arbitrary and obviously chosen to favor your argument for gold and against TIPS. I mean if we're going to just choose arbitrary dates to base our arguments on, here's a comparison of short-TIPS (VTIP), gold and total stock market from 2012 (VTIP's inception date) to the present:

Kevin K. wrote: ↑Sat Nov 30, 2024 10:07 am And it's not like it isn't subject to a ton of scrutiny by owners of TIPS bonds and managers of TIPS funds.

yankees60 wrote: ↑Sat Nov 30, 2024 8:27 am July 2018: $183,100
January 2022: $131,500

welderwannabe wrote: ↑Sat Nov 30, 2024 11:17 am

Kevin K. wrote: ↑Sat Nov 30, 2024 10:07 am While I don't entirely disagree with your sentiments the dates you chose to compare TIPS and gold are arbitrary and obviously chosen to favor your argument for gold and against TIPS. I mean if we're going to just choose arbitrary dates to base our arguments on, here's a comparison of short-TIPS (VTIP), gold and total stock market from 2012 (VTIP's inception date) to the present:

I chose a period of right before high inflation to now. Not sure when else we are supposed to be testing TIPS for...they are insurance against inflation. It has been the biggest period of inflation since TIPS were created. When else would you suggest?

Also your link for me is limited to 2015, not 2012 because I dont have the paid version of portfolio visualizer. Do you? If not yours was from 2015 too. Because all I see in your link is gold kicking VTIPs ass exactly proving my point.

Regardless, here is a portfolio visualizer link comparing asset classes instead of specific tip fund so we arent limited to the funds inception date and get around the 10 year limit for the free version of visualizer. I challenge you to find a period between tips founding and now, of any significant duration, where tips don't lose to gold.

https://www.portfoliovisualizer.com/bac ... HiwNgbbjc7

glennds wrote: ↑Sat Nov 30, 2024 10:35 am This is a timely thread for me. I have been invested in a Permanent Portfolio since 2012. The only bucket in the portfolio that has accumulated consistent (unrealized capital) losses is the Treasury Bond component, especially stark since the stunning gains in gold over the past year.

I have been wondering for a while whether or not long Treasuries will continue to function in the way they were intended to function in this portfolio. If central bank behavior or investor/market behavior has changed from Harry's time, and thus the bond component does not respond to shocks or changing economic conditions as it did before, it is a concern as to whether long Treasuries might lose their historical diversification role. I was particularly disappointed to see little evidence of a flight to safety T bond gain during the Covid pandemic. So the paper's contention that maturity aversion may be negating perceived safety is a valid question.

In light of the above referenced academic paper, I continued my conversation with GPT about it and received some interesting feedback that I thought might be worth sharing. Whether it is right or wrong is for you to judge, but suffice to say, I am not an enthusiastic long bond holder at this time.

The paper raises important considerations about the evolving role of U.S. Treasury bonds, particularly within investment strategies like the Harry Browne Permanent Portfolio, which relies on Treasuries to provide safety and stability during economic downturns. Some key takeaways that relate to this question include:

1. Increased Risk of Treasury Bonds:
The shift toward a risky debt regime, as described in the paper, suggests that Treasuries are no longer the universally "safe" assets they were in the past.
Rising yields and significant markdowns in Treasury values during the COVID-19 pandemic (-26% real return) indicate that Treasuries can experience volatility and losses, undermining their traditional role as a hedge in times of crisis.

2. Correlation Dynamics:
Historically, Treasuries have been negatively correlated with stocks, making them a natural diversifier. However, the paper notes that the stock-Treasury correlation turned positive during COVID-19. This suggests that Treasuries may not provide the same diversification benefits in future crises, especially in fiscal dominance regimes.

3. Erosion of Convenience Yields:
The paper highlights declining "convenience yields" on Treasuries, meaning investors now view them as less attractive relative to other assets. This could reduce their ability to act as a refuge during market turbulence.

4. Impact of Inflation Expectations:
In the Harry Browne framework, Treasuries serve as protection against deflation. However, the paper notes a significant rise in long-term inflation expectations during COVID, which contributed to the devaluation of Treasuries. Persistent fiscal expansions without matching revenues could expose Treasuries to inflationary risks, weakening their deflation hedge.

5. Monetary and Fiscal Policy Interactions:
The Harry Browne portfolio assumes that Treasuries will benefit from central bank support during crises. However, the paper suggests that such interventions increasingly transfer risk to taxpayers or delay necessary market corrections, which could alter Treasuries' behavior in future crises.

Conclusion for the Permanent Portfolio:
The evolving risk profile of Treasuries raises valid questions about their reliability in a Permanent Portfolio strategy. While they may still serve as a hedge in certain conditions, their traditional role as the "safe" asset may be less dependable due to:

Higher volatility and risk premiums.
Eroding diversification benefits.
Sensitivity to fiscal policy dynamics.
Investors using the Permanent Portfolio may need to reassess whether Treasuries still provide the intended stability and protection, or if alternative low-risk assets or modified allocations are necessary in the current economic environment.

Kevin K. wrote: ↑Fri Nov 29, 2024 9:15 am Deflation is the least likely scenario: it has happened just twice in U.S. history (1930-33 during the Great Depression and briefly from 2007-2009 during the GFC). It makes the least send of all to allocate a full quarter of the portfolio, at great expense, to combat this least likely scenario.

I mean I get the appeal of equal weighting in terms of simplicity and rebalancing but IMHO it makes no sense otherwise. I think the GB is a significant improvement on the original PP but historically it has worked even better if you switch out the bond barbell with a true intermediate term (i.e. 5 year not 10) Treasury fund like VFITX. But the biggest improvement comes from not just upping the stocks but including SCV and in so doing creating a stock allocation that is going to be successful without relying on the outsized returns from a few big tech firms as TSM is.