Gyroscopic Investing

A lot of people on this forum are way better than I am at calculating this stuff... I am wondering how much upside there is for the long bond if rates go to, say, 2.5% or 2%. And I realize that if rates get that low and stay there, my 3.75% coupons will look good. Just wondering (worried a bit) about the risk/reward at these levels. Thanks.

To clarify, how much would LTTs go up between here (3.24% yield, I believe) and 2.5% or 2%?

barrett, you provided a starting interest rate (3.24%), an ending interest rate (2.5%/2.0%) and a coupon rate (3.75%), but did not provide a time frame.  I'll assume 12 months.  If my formulas are right, a decline to 2.5% will cause the present value of your bonds to increase 15.2%.  Adding to that your coupon rate of interest gives a total 12-month return of about 19%.  A decline to 2.0% would result in a total 12-month return of about 31%.

FB, thanks for that and sorry to have forgotten to give a timeframe. Hmm, those are nice returns but not really enough to carry the PP if we really hit a deflationary period... at least that is what it seems to me. What am I missing here?

Let's see... cash at 0% means that that asset is gaining in relative value during deflation. Ditto with gold if it doesn't go down, right? Just thinking out loud here because it seems like assets in general just don't have a lot of upside currently. I'm guessing the consensus answer will be that anything that doesn't lose money is doing well.

I guess I am (pleasantly!) surprised at how well the PP is doing this year. Man, I am really talking out my backside on this post so feel free to ignore it.

We had a deflationary period from July 2008 through January 2009 when the CPI dropped 3.2%.  Stocks dropped 35%, long bonds were up 20%, and gold was flat.  So your conclusion sounds valid based on recent history.

Hoisington is predicting that the yield on  LTT's may decline to as low as 1.7% over the next several years and considers them undervalued!

http://www.hoisingtonmgt.com/pdf/HIM2014Q2NP.pdf

Thanks for posting that, Reub.

Hoisington doesn't come right out and say it but they are also essentially predicting a "Japan-style" economy for the US. In FB's example from July of 2008 to January of 2009, LTTs carried the PP. That was pretty clearly covered in Craig & MT's book as well. I guess I am wondering - as many have on this forum - what sort of performance is the PP likely to deliver during a protracted deflationary period? I have always read that the portfolio consistently stays ahead of inflation by about 3% to 5%. If the economy is contracting by 3% to 5%, we would expect/hope for a nominal return of zero, correct?

And, in this case, LTTs would likely be king just because they are still kicking off interest payments, no?

Speaking of Hoisington,

Texas’s Hoisington Investment Management Has Been Wagering for More Than a Decade That Yields Will Fall

- WSJ - http://online.wsj.com/articles/rally-in ... 1413754652

Barrett - well put!

Are we really in a deflation though?  Inflation is still tracking at about 2%, and GDP has been increasing (4.6% in 2nd and 3rd quarters 2014, after decreasing 2.1% in the first quarter).  I'm inclined to think that this particular bump in long bonds happened because the stock market sold off in the face of concerns about ISIS and Ebola.  Since much of the latter is mainly due to a media frenzy that is bound to die down, I expect the markets to go back up - which indeed they've been doing this week.  That's not to minimize the tragedy in West Africa, but in all honesty it's unlikely to affect Wall Street.

Still leaves us with the question of where the economy is going to go in this environment of increasing growth and near zero interest rates.  If you look at the 10 year Treasury rates following the Great Depression, they stagnated at about 2.6% in the 1930s, then dropped below 2% as World War II got underway.  And then stayed below 3% until 1956.  I don't think you can describe that entire period as deflationary, but it may well be that interest rates aren't going anywhere for a long, long time.

Devil's Advocate
Saw this on the front page of Yahoo Finance this morning:
Why I Won’t Own Bond Funds in My Retirement Portfolio
Ruth Davis Konigsberg  Oct. 20, 2014
https://time.com/money/3524487/retireme ... unds-avoid

When you look at the decline in bond yields over the last three decades, I don’t understand how it is mathematically possible for Treasuries—known as the safest bond possible—to protect a stock portfolio against major shocks over the next 20 years.

dualstow wrote: Devil's Advocate
Saw this on the front page of Yahoo Finance this morning:
Why I Won’t Own Bond Funds in My Retirement Portfolio
Ruth Davis Konigsberg  Oct. 20, 2014
https://time.com/money/3524487/retireme ... unds-avoid

When you look at the decline in bond yields over the last three decades, I don’t understand how it is mathematically possible for Treasuries—known as the safest bond possible—to protect a stock portfolio against major shocks over the next 20 years.

Really IMO not a good argument.  Any argument that consists of you putting all your eggs in one basket (one with very weak earnings yields (4-5%), mind you), to avoid the low return and interest rate volatility of the bond market is setting someone's retirement up for massive potential loss.

Money has diminishing returns in our (or my, at least) happiness as it grows. It's far more, to me, about protecting downside.


And perhaps instead of LTTs people could throw in a SPIA to help take pressure off of other assets to produce income.  But the equity markets are not exactly overflowing with massive earnings ratios themselves.  It certainly doesn't warrant not diversifying yourself.

I agree with you, moda, that Konigsberg's argument above is not a good one. At least, it's not convincing me to go all equities.
I do respect young investors who have the guts to just hold 100% equities for decades and ride out the storms when they hit. I can't do it. I don't trust myself to do it.

And, as many posters have shown, bond yields can go lower.

dualstow wrote: I do respect young investors who have the guts to just hold 100% equities for decades and ride out the storms when they hit. I can't do it. I don't trust myself to do it.

They usually can't either.  Young stock investors always declare their "high risk tolerance" right up to the point they experience their first market correction or cut in dividends.  I'm convinced the golden investor who has actually stuck with 100% stocks over decades without churning strategies in the meantime is largely a myth.

I know two at Bogleheads. Unless they're lying, they've done it. But, I know I never could.

dualstow wrote: I know two at Bogleheads. Unless they're lying, they've done it. But, I know I never could.

Well, two out of 40k Bogleheads members it still a very rare breed. 

Yeah, it's not for me either.  Been there, done that.

Even if you could do it, for me, given an uncertain future, and the diminishing returns for financial abundance in a future with stable financial markets (and a good stock market), is it worth it?

And a market down-turn is one thing... What about decades of economic stagnation that leave you flat.  That's a different animal to deal with.  Further, what about the same down-turn when you're 65 that you had the balls to withstand when you're 35.  If you look at the affects of taking a steady income from a volatile asset, it can be quite alarming.  The benefits of stability in a portfolio producing income really shine through when you show what happens as you try to take a steady income stream from a volatile asset.

To me, an all equity portfolio at retirement is less about "the balls to get through a downturn without selling" than "the wisdom to understand that life is about more than dying the richest man in the graveyard at the expense of catastrophic downside risk."

moda0306 wrote: Even if you could do it, for me, given an uncertain future, and the diminishing returns for financial abundance in a future with stable financial markets (and a good stock market), is it worth it?

One can only know that afterwards. 

dualstow wrote:

moda0306 wrote: Even if you could do it, for me, given an uncertain future, and the diminishing returns for financial abundance in a future with stable financial markets (and a good stock market), is it worth it?

One can only know that afterwards. 

And in the face of lack of knowledge, do we take a more conservative, or more aggressive form of action, knowing that severity of loss of our wealth, generally, has an exponentially negative affect on our happiness.  I mean we can talk about how we "feel" about something, but as HB would say, we have to make sure that we're actively separating what ACTUALLY makes us happy or scared with the stuff that is just a potential means to that end.

Wealth is just a means to the end of happiness, and it only can contribute so much to it.  Bringing on a ton of downside risk for upside potential is a toxic strategy to that entire concept.

Well, this is where strategies diverge based on risk tolerance.
There are pure pp'ers, 100% equity investors, and everyone in between.

dualstow wrote: I know two at Bogleheads. Unless they're lying, they've done it. But, I know I never could.

I'm one that actually did it.  I rode the tech bubble up in the 1990's then lost 50% of my assets in 2000-2003 then lost 50% again in 2008.  Despite all the sleepless nights and my wife being terrified, I stayed the course and kept my 100% stock allocation.  I always figured I had a long time horizon and I also understood timing markets is pointless.  These experiences are a big reason I'm in the PP now. 

Ouch! I think not sleeping and having a wife who is terrified of what the family's financial future will be is an awfully high price to pay for a strategy that is only sometimes on the plus side of a more balanced approach. Good that you stayed the course and then got the hell out of there. 2008 is obviously the freshest memory for a lot of investors but those bad patches in stocks come along fairly often.

dualstow wrote: Well, this is where strategies diverge based on risk tolerance.
There are pure pp'ers, 100% equity investors, and everyone in between.

They also diverge a lot depending on when you need the money. As has been detailed on other threads, using a strategy of diversification like the PP dramatically increases the odds that you don't have to work another ten years just because the basket your eggs are in is the wrong one at the moment.

FarmerD wrote:

dualstow wrote: I know two at Bogleheads. Unless they're lying, they've done it. But, I know I never could.

I'm one that actually did it.  I rode the tech bubble up in the 1990's then lost 50% of my assets in 2000-2003 then lost 50% again in 2008.  Despite all the sleepless nights and my wife being terrified, I stayed the course and kept my 100% stock allocation.  I always figured I had a long time horizon and I also understood timing markets is pointless.  These experiences are a big reason I'm in the PP now.

You've probably already done this, but can you describe how this all felt?  Obviously sleepless nights and an upset wife, but anything else you can tell us?  I'm 30 so 2008 was an "opportunity" for me and 2001... Well I think I knew what the Dow jones was then .

FarmerD wrote:

dualstow wrote: I know two at Bogleheads. Unless they're lying, they've done it. But, I know I never could.

I'm one that actually did it.  I rode the tech bubble up in the 1990's then lost 50% of my assets in 2000-2003 then lost 50% again in 2008.  Despite all the sleepless nights and my wife being terrified, I stayed the course and kept my 100% stock allocation.  I always figured I had a long time horizon and I also understood timing markets is pointless.  These experiences are a big reason I'm in the PP now.

So at what point did you switch to the PP?  After stocks rebounded a couple years ago?

Here is some food for thought. A few months ago the Swiss government issued a 50-year bond which matures in 2064 with a coupon rate of 2%. Since then the bond has risen in value and it is now trading at a yield to maturity of 0.95%.

Is there still upside in the bond? Sure. The yield could go down to 0%, resulting in a price increase of around 40%.