Gyroscopic Investing

So I've been listening to the radio archives and I noticed that Harry Browne makes the assertion that there will always be 1 of the 4 investments that is strong enough to save the entire portfolio.  

I understand how and why each investment is tied to a certain market phase, but I'm having a hard time believing that during a given market phase the drop in the other investments will be less than the gain in whichever investment is strong during that phase.  

Is there any market principle that causes this, or is it just based on observation ("well last few times we had inflation, gold rose 100% while stocks and bonds only declined 25% each")?

My only theory is that as the market changes from one cycle to another, people are surprized, realize how risky their investments are, and start moving into the least risky investments they can find.  This demand for lowest-risk investments causes them to become temporarily overvalued, and since the PP owns the lowest-risk investments, this causes one of the 4 to rise dramatically.  Hopefully, the rise is high enough to trigger a rebalance and we take money out of the investment before its value returns to normal.

Curious to hear what other people think about this.

tiga wrote: So I've been listening to the radio archives and I noticed that Harry Browne makes the assertion that there will always be 1 of the 4 investments that is strong enough to save the entire portfolio. 

Of all four asset classes, Cash is the one that won't really respond strongly to the economic condition of recession. This is generally regarded as a temporary market condition (lasting around 12-18 months) though and can be ridden out. So the cash is more of a buffer than something expected to appreciate sharply in value.

Is there any market principle that causes this, or is it just based on observation ("well last few times we had inflation, gold rose 100% while stocks and bonds only declined 25% each")?

Investing is, unfortunately, not a science. We cannot predict what will happen in the future. So part of this process is knowing how people respond to certain economies and part of it is just kind of saying "Well that amount seems to work OK based on passed experience."

I know it may not be what people want to hear, but it's just what the reality dictates. And, frankly, when I read about portfolio allocations that seem too precise I become very skeptical. I saw one portfolio recently that had people buying 1% of this asset, 3% of this, 7.5% of another, etc. Something like that is attempting to impart a level of precision on investing that can't possibly exist. It tells me that the proponent of the strategy really doesn't understand the problem. IMO.

My only theory is that as the market changes from one cycle to another, people are surprized, realize how risky their investments are, and start moving into the least risky investments they can find.  This demand for lowest-risk investments causes them to become temporarily overvalued, and since the PP owns the lowest-risk investments, this causes one of the 4 to rise dramatically.  Hopefully, the rise is high enough to trigger a rebalance and we take money out of the investment before its value returns to normal.

We know that in an environment of falling interest rates the winning investment are those that are paying in a long term fixed interest rate higher than what the market currently is paying. So in that case LT bonds are what the economic analysis says the market will desire. For inflation it is known that tangible items of value are what the market wants to shelter themselves from falling value in paper assets. Traditionally gold has been seen as a very compact form of tangible wealth that people also treat as money. So economic analysis says the markets will desire gold for bad inflation because this has historically been viewed as a good alternative for storing wealth. Etc.

I wouldn't say the economy moves in cycles though. That presumes there is some pattern that can be discerned from what is effective a series of random events. It's probably better to say that the assets perform according to the economy regardless of what got us to that particular place. The assets the portfolio holds are all risky in their own ways. Gold is very risky in a prosperous economy as people would rather risk their money on growth assets like stocks. Bonds are very risky in inflationary markets because the value of the money is falling and nobody wants to risk locking themselves into a losing interest rate. Stocks are risky for a variety of random reasons that can be good for gold or bonds. Etc.

But yes there can certainly be times when an asset spikes in value as people flee to it (2008 and LT bonds). But mostly I see that you'll just have a long stretch where Asset X is steadily climbing and eventually starts to dwarf the other pieces. Eventually you'll hit a rebalancing band and it's often around this time that Asset X starts to lose favor and a new asset starts to hold prominence. Is it a cycle? Well, no. It's not predictable how long these things last and cycles imply a predictable pattern which the markets really don't have.

As it were, in the past one or more assets have been enough to offset the losses in the others. It's entirely possible that this may not always happen,  but I think there is a good likelihood that an investor that holds all four assets over time will end up recovering losses and growing their portfolio.

craigr wrote: I know it may not be what people want to hear, but it's just what the reality dictates.

Actually that's exactly what I wanted to hear.  I wanted to make sure I understand the risks before staring my own PP.

Gold is very risky in a prosperous economy as people would rather risk their money on growth assets like stocks. Bonds are very risky in inflationary markets because the value of the money is falling and nobody wants to risk locking themselves into a losing interest rate. Stocks are risky for a variety of random reasons that can be good for gold or bonds. Etc.

This is very well said.  I'd completely missed this point in my statement about having the PP having the lowest-risk investments.  While I may own the lowest risk bond with the Treasury Bond, I still have to accept the risk that I own a bond at all.

Yesterday is an example where one asset class (LT Treasuries) helped mitigate losses, which I think happens frequently and perhaps better than in other portfolio designs.  I would not necessarily view one PP class as "saving" the portfolio (except in unusual circumstances like Gold with hyperinflation, though even there ST Treasuries did their part). The correlations of the 4 classes—over time—have produced a portfolio that hangs in like a terrier yet rises steadily over time.  But you need properly rebalanced time in to get those benefits.

3 of the 4 PP asset classes are often viewed as "safe havens" even as 2 of them are quite volatile.  Few portfolio designs have that feature, especially with the "massive" weighting given them, and yet the portfolio as a whole has produced returns that rival strategies using a much higher Beta (equity percentage) with far greater risk.

Roy

As HB has mentioned numerous times in his radio show — when the assets go down, they tend to lose -20% or -30% and rarely lose more than -40% or -50% of their value. And technically, they can't lose more than 100% of their value.

But, When investments go up, they have much more upside potential. An investment can go up 200% or 300%. And gold has the potential to go up much more than that.

So, you have to consider the fact that while there is a floor to a loss, there is no ceiling for gains.