Gyroscopic Investing

Looking back historically, how does the NASDAQ 100 compare to the S & P 500? It seems to have higher returns, and very similar volatility.

The NASDAQ is almost 50% lower today than its all-time high from 11 years ago, while the broader market is close to flat over the same period.

I would have had a very hard time sticking with the NASDAQ over the last decade and watching the rest of the market consistently outperform.

If you have to do something besides a total market index, I might think about small cap value or something like that.  Other people have written on this topic a lot in this forum and the BH forum.  I don't think the extra gain is worth the extra risk, but some feel differently.

QQQ is almost a sector ETF for tech.  You can't substitute a single sector for the broad stock market in the PP.

MediumTex wrote: The NASDAQ is almost 50% lower today than its all-time high from 11 years ago, while the broader market is close to flat over the same period.

I would have had a very hard time sticking with the NASDAQ over the last decade and watching the rest of the market consistently outperform.

If you have to do something besides a total market index, I might think about small cap value or something like that.  Other people have written on this topic a lot in this forum and the BH forum.  I don't think the extra gain is worth the extra risk, but some feel differently.

The NASDAQ-100 is a stock market index of 100 of the largest non-financial companies listed on the NASDAQ. It is a modified capitalization-weighted index. The companies' weights in the index are based on their market capitalizations, with certain rules capping the influence of the largest components. It does not contain financial companies, and includes companies incorporated outside the United States. Both of those factors differentiate it from the Dow Jones Industrial Average, and the exclusion of financial companies distinguishes it from the S&P 500 Index.

At first I had only looked back 10 years, and it looked a lot better. That dot-com bubble was really killer for the Nasdaq 100...
How far back should a PP investor look back to determine these kind of things? Obviously, the longer the better...

Would having the stock part of the US PP being split evenly between QQQ and BerkshireHathaway make some sense. They seem to each be the converse of the other amongst US stocks and between them cover the field (unless you want Tobaco death stick pushers ). Having 12.5% Berkshire Hathaway and 12.5% QQQ might give greater rebalancing gains etc??

Just buy the total stock market for the Permanent Portfolio. Sector bets (like NASDAQ) are for speculating with variable portfolio money.

For the past 10 years, it has tracked very closely with the S&P 500, but with slightly higher returns, and slightly less volatility. I didn't look at it as a sector fund, but as a more broad market fund.

Of course, it is quite tech heavy, and that becomes painfully obvious when I look back further than 10 years.

I've been looking at VBK (small-cap growth) as an alternative to VTI.  That ETF has really flown for the past 10 years.  For some reason, people talk more about small-cap value than small-cap growth for the PP.  Why is that?

There was a long term study that found that small cap value did better than large cap value, large cap growth or small cap growth. Basically it's conclusion was that the difference was all down to which stocks transitioned from being classed as one type to being classed as another. Buying stocks when they were small cap value and then selling them when they classed as one of those other types amounted to buying low and selling high. By contrast, buying a large cap and then getting rid of it when it became a small cap amounted to buying high and selling low. Same thing with buying a "growth" stock and then getting rid of it when it becomes classed as a "value" stock- that is simply buying high and selling low.
From what I could see the conclusion could be summed up as "buy low, sell high" and holding an index of small cap value stocks is just a convoluted way to squeeze yourself into tending to do that. Maybe I'm missing something more profound though.

For the US PP, I have wondered whether a Russell 2000 index would better reflect the "prosperity in USA" economic condition mandate and so better counter the other PP classes
For the UK PP, the FTSE index really isn't anything to do with "prosperity in the UK" -it is full of Kazak and Mexican miners.

I think I've also seen something that said that illiquid stocks typically had a discount ie that typically buying an illiquid stock gave you better returns. The fact that the PP does not often entail buying or selling stocks and never really needs to sell them off in plumetting markets means that it is a good oportunity perhaps to take advantage of any such illiquidity benefit. I guess though that an open ended fund structure such as with etfs gets harmed by illiqidity (as the etf needs to buy and sell constituent stocks via authorized participants) and that creates a cost drag that is much worse for relatively illiquid stocks such as small cap value stocks. From what I could see a closed ended fund structure is much better at dealing with illiquid stocks such as small cap value or emerging market.

Extending Simba's spreadsheet to include silver and since 1972 a PP type blend of 12.5% in each of SCV, EM (more equal weighted type holdings), silver and gold and 25% weightings into 5 year treasury's (similar to a 5 year cash ladder) and LTT's, beat a Coffee House Portfolio (diverse 60% stock/40% bond type allocation) both on gains and risk adjusted rewards.

If you are using any EM data from before 1988 from Simba's spreadsheet then you may get some results that don't correspond too well with how well/poorly EM stocks actually performed in those years. Simba's spreadsheet (at least the last time I checked) used data from Index Fund Advisors for any EM returns prior to 1988. IFA "cheated" by synthesizing EM returns for said period by averaging half international value and half international small-cap for the 70s and most of the 80s until 1988..this wouldn't be so bad except the international value and international small-cap index they used were heavily weighted towards the stocks of EAFE countries (Western Europe, Japan, Canada, UK, Australia, etc) and contained little true EM exposure.

Real (i.e. actually correct) EM historical returns are available from 1975 to 1988 from S&P in the form of the S&P/IFC EMI and EMDB. From 1970 to 1975 data for individual EM countries is available via DataStream but will be very expensive to get unless you have DataStream access at a university or corporation available free gratis.

Also: When backtesting using a five-year ladder instead of cash/ 1-3 year STTs did you consider that never before since at least the 1940s have ST rates been as low as currently. A rise in ST rates to around 5 or 6% will indeed hurt the value of a four or five year Treasury paying, say, 2% or 3%, but not nearly as much as it would with rates where they are now (one year T-bills are paying nearly nothing and five-year Treasuries are paying less than 0.95% ). If rates rise to 5.25% (about where they were before the credit crunch began) a five year T-note paying 0.94% will lose some 15% of its value. The 2, 3, and 4 year notes will suffer somewhat less due to shorter duration and maturity but will still show a capital loss (or if they don't because you choose to neither sell them or mark them to market then you will be stuck for years with bonds in your ladder that are paying less than 1% when current bonds pay 5% plus).

Whilst still only enduring a -6.6% down in 2008 when the CHP lost -37%.

How did this portfolio do in 1981? IIRC silver did even worse than gold that year, losing nearly half its value in US dollars and about a third of its value in Pounds.

I suspect that had EDV or BTTRX been used instead of VUSTX it would have topped a 8% real annualised.

Quite possibly but the caveats are as follows:

1. True Treasury zeros (at least here in the US) didn't exist until 1985. Merrill Lynch and a few others were creating synthetic zeros called TIGRS, LIONS, CATS, etc back in 1982 but those were structured products not directly backed by the Treasury. Just look at what happened to holders of Merrill Lynch MITTS or Lehman PPNs in 2008 or consider how some people are-justifiably IMO-unwilling today to invest in ETNs (as those are obligations of the issuer and not quasi-ownership of the securities themselves like ETFs or open-end mutual funds) to see why investing in "synthetic" Treasury zeros might not be such a hot idea.

There may have been Agency (FNMA, GNMA, FHLMC, etc) zeros available to the public before 1985 but given how we all feel about the 20% agency paper in VUSTX I don't think they should be considered equivalent to Treasury zeros.

There were a few banks stripping principal and interest from LT treasuries to create zeros back in the 1970s but this was to book paper tax losses and as far as I know these strips/zeros were never offered to the investing public.

2. BTTRX only goes back so far as February 1996. You would need to use BTTTX (from January 1st 1990 to early 1996), BTFTX from January 1987 to the end of 1989, and BTTNX from March of 1985 (when the first true Treasury STRIPS were created) to the end of 1986. Also, you would have to substitute PEDIX, VEDTX, or EDV when they became available in 2007/2008 because by then BTTRX had less than 20 years left until maturity and HB said to sell LTTs when they reached less than 20 years.

3. Even after doing all the above you would still have a slight problem; using zeros for the LTTs starting only in 1985 or 1986 could be considered cheating (look at what LT rates have done from 1985 to the present vs what they did  from 1972 to 1981) by choosing the form of LTTs leveraged most to interest rates and only using them during a period of generally declining rates. I have done some quick and dirty computations for how 30-year US Treasury zeros might have performed from 1977 to 1981 (assuming LT zero rates were the same as LT coupon bond ones...perhaps not entirely accurate but I don't have zero-coupon rates since Treasury zeros didn't exist then) and the results weren't pretty:

1977 = -6.59% nominal; -13.04% real

1978 = -14.57% nominal; -22.18% real

1979 = -18.97% nominal; -30.24% real

1980 = -30.19% nominal; -43.71% real

1981 = -26.52% nominal; -36.90% real

In the interest of accuracy and fairness I should point out both that the returns on a 20-30 year zero-coupon Treasury ladder wouldn't have been quite so bad as a pure 30-year zero replaced with a new one each year as above and that in 1982 a simulated zero coupon 30-year Treasury basically doubled in value and began a long bond bull market that continues to this day. It's still rather sobering to compare the above returns with the 1977-1981 coupon-bearing LTT returns in Craigr's chart...the coupon LTTs lost/gained a few points or so each year in nominal terms and only lost high-single/low double digits each year in real returns but the zeros ended up losing a large majority of their value if you rolled into a fresh 30-year STRIP each year.

Clive,

If you hold each rung to maturity there's little difference between serial (buy all into a one year every year) or parallel (holding 1/5th in each). In some cases, such as in the UK, it can be more tax efficient to hold a ladder - for example we can buy Gilts with 5+ years inside an ISA (non taxable) and otherwise retain the amounts that would have otherwise been paid in tax.

True. I hadn't considered that each maturing "low-yielding" (i.e. at current low yields) t-bill would be replaced by a five-year one at the new "high-yield" (i.e. the yield when rates increased); in two or three years most of your STTs would be the ones with the newer, higher yield. With that said, unless 5-year Ts start yielding more than 1.5% or so vs the current less than 1%, I see little reason to start a ladder (the main benefit of the ladder being slightly higher interest rates than 1-year bills yield as you are theoretically taking more time to maturity interest rate risk) of them as FDIC insured liquid savings accounts yield 1% or so, reward checking yields around 3%, the stable value funds in most 401Ks yield 2.5% to 4%, and high cash value ULs and WLs yield 4 to 5%.

Our equivalent (sort of) of ISAs-the Roth IRA-has no restriction on the maturity of what kind of government securities you can put in it.

(Sorry about the formatting - that's just the way it cut and pastes), i.e. the last value in each row had

23.82
21.12
38.33
22.28
17.68

These don't look to be far off the mark. Morningstar's average category returns for the SCV category for 1977-1981 were as follows:

1977 =  2.56%

1978 =  11.29%

1979 =  20.76%

1980 =  33.82%

1981 = -7.75%

However, the only two SCV-type (or valuey SCB at least) funds I could find that had data back that far were PENNX and WPGTX which had returns as follows:

PENNX

1977 =  23.12%

1978 =  16.41%

1979 =  35.45%

1980 =  25.71%

1981 =  0.66%


WPGTX

1977 =  6.58%

1978 =  19.92%

1979 =  27.41%

1980 =  43.16%

1981 =  8.80%


Finally, Simba's spreadsheet (using Ibbotson SBBI data) gives SCV returns for these years as follows:

1977 =  21.52%

1978 =  21.52%

1979 =  35.09%

1980 =  25.11%

1981 =  14.64%

SCV appears to have done pretty well from 1977-1981 (although I bet it got slaughtered in 73-74)

In 1982 I believe there was a PP gain of +22%+, which would have re-raised the 1977 to 1982 real annualised back to north of 4%.

Overall, and considering the degree of interest rate rises/inflation over that period, I don't see that having held more volatile LTT's and Stocks over that period as having being particularly bad, despite the extremes.

Actually Craigr's webpage showed a gain of 23.30% for the PP for 1982 but that was using ordinary LTTs; I bet it was upwards of 30% for 1982 for the PP as a whole if using zeros when you consider that a 30-year zero-coupon Treasury bought in January 1982 would have more than doubled (again, assuming coupon LTT and zero LTT rates were equal) in value by December 31st 1982 as rates fell.

Keep in mind this was due to the mean reversion of the Nifty Fifty.  The similar cannot be said as of now as Large Caps are fair to undervalued and everything else overvalued.

MG

D1984 wrote: SCV appears to have done pretty well from 1977-1981 (although I bet it got slaughtered in 73-74)