Kudos for the PP

General Discussion on the Permanent Portfolio Strategy

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Rien
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Re: Kudos for the PP

Post by Rien » Mon Oct 14, 2013 2:56 am

Kshartle wrote: If you run it from Jan 1st 1981 through today without rebalancing it's CAGR of 8.16

With rebalance it's 35/15 it's 8.05

That's 32 years and not re-balancing returned higher.

There's no such thing as volatility capture. Rebalancing can hurt returns just as easily as improve them.

It does reduce volatility though. There's a logical reason for that, not for any volatility capture.

You can always data mine any set of returns and find a superior rule that would have worked for that set of data.

Rebalancing or not has the same chance of working going forward. Imagine stocks or gold tripling while everything else stays put. Not rebalancing will return a lot more. It will subject you to risk beyond what you might be able to bear though.......
That is a pretty interesting result. I expected more volatility capture.
You are right when you say that mechanical rebalancing can hurt as much as it adds.
Especially in the given time period where the three asset classes each held the same direction for many years: stocks up, gold down, interest down. Volatility capture is very difficult under such conditions, while the dampening effect is quite strong.

I do compare this to the AIM algorithm which does try to capture volatility and does it quite well. But with AIM the investor is much more active. The algorithm is typically run about once a month. Almost all returns stem from volatility capture, and are typically around 7%-15% (note: this is from memory...). Somehow I expected the same from PP. AIM is usually an all-stock portfolio, though it can be used for gold and bonds as well. (I used it for bitcoins once and that went very well)

Not sure what the point of this post is though. I am still rather rattled by the lack of volatility capture....
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Re: Kudos for the PP

Post by Kshartle » Mon Oct 14, 2013 5:38 am

Rien wrote:
Not sure what the point of this post is though. I am still rather rattled by the lack of volatility capture....
Not sure about the point of my post or yours?  :o
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Re: Kudos for the PP

Post by Rien » Mon Oct 14, 2013 6:55 am

Kshartle wrote:
Rien wrote:
Not sure what the point of this post is though. I am still rather rattled by the lack of volatility capture....
Not sure about the point of my post or yours?  :o
LOL, mine of course  ;D
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Re: Kudos for the PP

Post by christina » Tue Oct 15, 2013 9:05 pm

MediumTex wrote:
frommi wrote:
MediumTex wrote: If money was leaving the stock market, where would it be going?
Abroad, but not into gold. Or paying back debt.
Historically (in the U.S. anyway), if money is leaving the stock market it's going into treasuries, gold or cash.

And note that as dollars are leaving the stock market, they don't necessarily have to go directly into treasuries or gold for treasuries or gold to still react to it, primarily because money would typically be leaving the stock market due to a shift in underlying economic conditions, which would set the stage for another one of the PP's asset to take the lead.
What if it all goes into cash? Can that happen for an extended period of time? If everybody goes into cash, that's not good for the PP, is it?
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Re: Kudos for the PP

Post by Rien » Wed Oct 16, 2013 1:15 am

MediumTex wrote: Historically (in the U.S. anyway), if money is leaving the stock market it's going into treasuries, gold or cash.

And note that as dollars are leaving the stock market, they don't necessarily have to go directly into treasuries or gold for treasuries or gold to still react to it, primarily because money would typically be leaving the stock market due to a shift in underlying economic conditions, which would set the stage for another one of the PP's asset to take the lead.
It is a myth that there is money in any market. There is no money in the stock market, and no money in the bond market.
If you buy a stock, then that trade is money for stock: you give money to the stock holder, he gives you the stocks. The market is simply a place where the transaction is recorded.
If you sell a stock and buy a bond instead, the money is recorded in two markets: the stock market and the bond market.

What people generally mean by "money leaving the bond market and entering the stock market" is simply stating: people prefer stocks over bonds.

In that sense, people don't have to buy anything, but they may be forced to sell things.
However there are institutions (funds) that receive a steady inflow of money that they are forced to buy stocks or bonds with. (The great engine behind the stock market since somewhere in the 70's or 80's)
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Re: Kudos for the PP

Post by Marc De Mesel » Mon Oct 28, 2013 7:34 pm

Kshartle wrote:
Pointedstick wrote:
dragoncar wrote: I am curious what this bonus has been over the last 30 years (vs buy and hold 25x4).  Perhaps I'll run the numbers today.
You can use this tool to find that out: http://www.peaktotrough.com/hbpp.cgi

No rebalancing:  CAGR 8.06% and max DD 36.09%
Std rebalancing: CAGR 8.97% and max DD 19.83%
If you run it from Jan 1st 1981 through today without rebalancing it's CAGR of 8.16

With rebalance it's 35/15 it's 8.05

That's 32 years and not re-balancing returned higher.

There's no such thing as volatility capture. Rebalancing can hurt returns just as easily as improve them.

It does reduce volatility though. There's a logical reason for that, not for any volatility capture.

You can always data mine any set of returns and find a superior rule that would have worked for that set of data.

Rebalancing or not has the same chance of working going forward. Imagine stocks or gold tripling while everything else stays put. Not rebalancing will return a lot more. It will subject you to risk beyond what you might be able to bear though.......

OMG I was not aware of this after studying PP for years.

What a great post. I love your critical independent thinking. :)

Thanks for sharing! :)
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Re: Kudos for the PP

Post by craigr » Mon Oct 28, 2013 9:38 pm

Actually with the Permanent Portfolio rebalancing can help capture higher returns as you are in fact selling high and buying low in many market cycles. We looked at this for the book and rebalancing not only reduces volatility, but can in fact boost returns over time. When you do a review of the various stock, bond, gold, real estate, tech, etc. bubbles through the years you can see the effect quite clearly.

In table 11.1 and 11.2 in the book we review the data which I quote below:

Unrebalanced from 1972-2011 had CAGR of 8.8%
Rebalance from 1972-2011 had CAGR of 9.5%

Table 11.2 shows that with rebalancing the worst loss you experience over the same time is -4.9% in 1981. Without rebalancing the worst loss you experience is -21.6% in 1981. In 2008 the loss to the portfolio would have been -2% if you were a rebalancer. But the loss was -12.2% if you were letting it all ride and not rebalancing.

In fact for the Permanent Portfolio there were only four years with minor losses over the 1972-2011 time period, but without rebalancing there were 11 losing years with much larger losses at times.

So rebalancing is in fact very important not only because it absolutely reduces portfolio risk, but could (but not always) boost returns by forcing you out of popular assets into less popular ones that are likely to be a better value at the time.
Last edited by craigr on Mon Oct 28, 2013 9:42 pm, edited 1 time in total.
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 7:04 am

craigr wrote: Actually with the Permanent Portfolio rebalancing can help capture higher returns as you are in fact selling high and buying low in many market cycles.
It can help you or hurt you, depends on what the investments do. Did you see how it's returned more to not rebalance over the last 33 years or so?

Rebalancing does not guarantee higher returns over any time period. Not saying it's not a good idea, I think it is, particularly as time horizons get shorter, but there's no such thing as a volitility capture bonus. I knew that was wrong when i first heard it here and argued against it several times from a logical standpoint. Logic never proves very convincing so luckily PS (I think) pointed to this calculator which demonstrates my point quite clearly.
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 7:06 am

Marc De Mesel wrote:
Kshartle wrote:
Pointedstick wrote: You can use this tool to find that out: http://www.peaktotrough.com/hbpp.cgi

No rebalancing:  CAGR 8.06% and max DD 36.09%
Std rebalancing: CAGR 8.97% and max DD 19.83%
If you run it from Jan 1st 1981 through today without rebalancing it's CAGR of 8.16

With rebalance it's 35/15 it's 8.05

That's 32 years and not re-balancing returned higher.

There's no such thing as volatility capture. Rebalancing can hurt returns just as easily as improve them.

It does reduce volatility though. There's a logical reason for that, not for any volatility capture.

You can always data mine any set of returns and find a superior rule that would have worked for that set of data.

Rebalancing or not has the same chance of working going forward. Imagine stocks or gold tripling while everything else stays put. Not rebalancing will return a lot more. It will subject you to risk beyond what you might be able to bear though.......

OMG I was not aware of this after studying PP for years.

What a great post. I love your critical independent thinking. :)

Thanks for sharing! :)
Hey Thanks Marc. I always read your posts as well. Even if I disagree with you or anyone I appreciate independant thought and analysis based on logic and reason rather than accepting the collective "wisdom".
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 8:30 am

Marc De Mesel wrote:
Kshartle wrote:
Marc De Mesel wrote:
OMG I was not aware of this after studying PP for years.

What a great post. I love your critical independent thinking. :)

Thanks for sharing! :)
Hey Thanks Marc. I always read your posts as well. Even if I disagree with you or anyone I appreciate independant thought and analysis based on logic and reason rather than accepting the collective "wisdom".
Welcome Kshartle :)


A lot is changing in my investments. I've read many of your posts yesterday and I think you make a convincing case to drop the bonds and cash and just have stocks (global) and gold.

Logically I can't bring myself anymore to hold long term bonds since all indicators are flashing extremely overvalued. The cash, short term bonds, do bring volatility down but due to a lower and lower interest rate you are losing more and more purchasing power with it. And they are still just gov bonds that can default. The risk/reward sucks big time. 

With just global stocks and gold, on first impression you would have done better in all scenarios, even in Iceland, thanks to more gold, in Cyprus recently, thanks to more gold. You would even have survived Japan deflationary collapse of the 90's thanks to your stocks being global.

I like very much your approach to inflation. Instead of arguing how much prices are going up just go back to basics. Inflation = amount of money being printed. If you keep it simple like this it is clear that bonds and cash are a no-go as they are the one paying the bill.

Ofcourse such portfolio will be more volatile, so larger losses from time to time, but if I get overall larger profits that is fine for me. I am starting to prefer safety via favorable risk/reward over safety via lower volatility.


What global stocks do you prefer? Do you prefer certain funds for this?
I keep it rather simple. I own VWO and VEU. I actually have rotated completely out of US Stocks (even though a significant portion of the S&P derives it's revenue from overseas markets). Now US stocks have been the big winner this year so I've lagged behind, even though last year was fantastic for me (I had 1/3 of my investments in a global real estate fund which was up around 25%, 1/3 gold and silver and 1/3 in global stocks. I just think the US consumer is spending borrowed money, even if it's just the government doing the borrowing and sending out the checks. Rising interest rates will squash this and kill the businesses catering primarily to the Americans.

I also own GDX also because I think it's most likely the FED with continue printing and even up the amount of purchases. I expect Gold to break $2,000 within the next few years so the gold miners should have a big reversal. I've purchased at $42, $37, $25, and recently just above $23. Still losing money on these Canadian and Aussie companies for the most part. I probably have 25% of my investments in GDX now because it's the only thing I've been buying in the past 6 months.

To clarify, I think this will all end in a deflationary crash and cash/gold will be king. I just think they will not crash it until everyone is screaming about the inflation. I think they will inflate until it no longer serves their purpose. That being said if the FED actually announces a taper I am selling ALL stocks and going to cash/gold. Even if they come back and announce a 2 trillion dollar stimulus in response to the crash Gold should protect me, or if they let the DOW crash 60% or more It'll be a chance to get back in cheaply.

We'll see. It's active management based on what I think is most likely for the FED to do and what the results of their actions should have on the markets. I'm still diversified across two broad asset classes in all scenarios. If I were less confident I would have 1/3 in cash. I have the luxury of not being concerned with volitility since I have no kids and no mortgage and make a lot more than I spend every month, for now.
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Re: Kudos for the PP

Post by Pointedstick » Tue Oct 29, 2013 11:15 am

I have to concede this one to Kshartle. He's right about rebalancing, unless peak2trough's calculator is wrong. Even from 1972 to 1981, in fact, rebalancing actually reduced the returns. Try it yourself. Now it also dramatically reduced the volatility, which is important as well, especially as Kshartle says, if you have a shorter time horizon.
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 11:27 am

Pointedstick wrote: I have to concede this one to Kshartle. He's right about rebalancing, unless peak2trough's calculator is wrong. Even from 1972 to 1981, in fact, rebalancing actually reduced the returns. Try it yourself. Now it also dramatically reduced the volatility, which is important as well, especially as Kshartle says, if you have a shorter time horizon.
Hey thanks man! It just makes logical sense that you can't automatically raise returns by re-balancing.

No free lunches.
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Re: Kudos for the PP

Post by buddtholomew » Tue Oct 29, 2013 12:15 pm

Kshartle wrote:
Pointedstick wrote: I have to concede this one to Kshartle. He's right about rebalancing, unless peak2trough's calculator is wrong. Even from 1972 to 1981, in fact, rebalancing actually reduced the returns. Try it yourself. Now it also dramatically reduced the volatility, which is important as well, especially as Kshartle says, if you have a shorter time horizon.
Hey thanks man! It just makes logical sense that you can't automatically raise returns by re-balancing.

No free lunches.
Re-balancing assets returns the portfolio to its original risk profile. An unbalanced portfolio may or may not return a higher percentage depending on the back-tested time frame. As a PP investor, I am more interested in managing volatility than reaching for higher gains. Perhaps I am my own worst enemy, but I don't know when I will have to draw on these funds and it could be at the least opportune time.
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Re: Kudos for the PP

Post by frommi » Tue Oct 29, 2013 1:18 pm

As now everybody seems to agree that rebalancing doesn`t add to returns, we can look at possible returns for the whole PP going foreward for the next 3-10 years:

US Stocks (at current levels projected forward returns): negative/zero real return (source mebane faber)
Cash: negative real return
T-Bonds: zero real return
Gold: zero real return

So you can expect to not beat inflation going foreward with the PP, you can only expect to break even nominal. But for that you don`t need a PP.  ;)

But there are plenty of other ways to make money as investor, you just have to search them.  8)
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Re: Kudos for the PP

Post by moda0306 » Tue Oct 29, 2013 1:57 pm

frommi,

Where are you getting all these conclusions?

I don't think we agree with that.  Rebalancing can add to returns, and SIGNIFICANTLY reduces risk.  In fact, not rebalancing is simply asinine. Why start with 4x25 if 10/60/10/20 is remotely acceptable.

The current P/E:10 of the stock market, if memory serves, flips to yield about 4.5%.  So even if earnings don't increase, the stock market will yield earnings of 4.5% over time... if that's not beating inflation, then we are truly using the higher rates proposed by folks on this board, which I don't think many people have agreed are accurate.

But even with your premise being valid (which it doesn't appear to me as such), saying that the PP will be "expected" to break even (nominally), and that other assets can do that, is looking at this in a vacuum.  Even if I "expect" the PP to "break even nominally," just like a savings account, it's what the PP doesn't when the UNEXPECTED happen that makes it so robust.  I don't think my life, disability, long-term care or liability insurance will EVER break even based on what I "expect" to happen.  Luckily, I'm very, very prepared for the "unexpected."

So now that you've glossed over the robust nature of the PP by adding a couple false premises, and an over-simplified RoR analysis, we come to the last piece, that "if we try," we can find better investments.

Surely, we can... but let's please analyse those investments for the same robustness of the PP in UNexpected events, or, maybe more useful, as an addition to the PP, as a very robust "insurance-like" portfolio vs a speculative portfolio that we identified and priced based on some micro-economic assumptions, and risk.

This is usually the point that some kind of "technically-proven" strategy of adding SCV/EM combo works historically, or that inserting gold miners SHOULD improve return, or that land is "the only thing they're not making more of," or that if you read Warren Buffett's book and do X, you'll do great.

I have some problems with the PP... I think the gold allocation is too high, and it might be a little bit too assumptive regarding treasury debt and not diversifying into foreign fiat currency arrangements, but as a macro-guy I can't stand investment strategies based on technicals or "historically, XYZ has recovered to a Q% return by 36 months and blah, blah, blah," as a CORE investment strategy... definitely as an option for a speculative piece beyond "what I can afford to lose" (thought that's a tough line to draw), but as a core, you need something robust as all-f*ck.  I refuse to be the guy holding nothing but his d*ck and a "historical rate of return" chart.  No chance... or no chance that's within my control, anyway. 

So I love value investing and technical trades as my speculative venture of money that I don't need...

But if you get too far away from macroeconomic fundamentals, you have an increasingly fragile beast that simply cannot be judged on the same qualities of the PP.  Even if the PP fails to provide real returns for some more extended period, it's still got fundamentals working for it that NO other strategy I've seen truly does.  Show me a -1% real yield in the PP over a 3-year stretch, and I'll 1) probably be wanting to throw a ton of money into it to grab the bounce, and 2) not shedding one tear, as I'll be looking all the systemic risk people are taking on in their wealth to obtain their 2% positive real number... all the time people are putting into it that could go into honing their skills or budgeting better or enjoying the time they have on this earth... they time they might spend stressing about their strategy that they heard "if they try" will work for them... trying to decide when to buy or sell, and in what quantities.

There's always some "reason" that some investment should beat the PP.  Then there's always a VERY easy-to-design scenario where you loose most of your original investment in those "strategies" (that unfortunately leaving you in a position of competing with supercomputers and billionaire fund-managers to get an edge that one of them). 

Sorry folks. I'm not going to be the guy inclined to jump out of a building just so a few years earlier I could be the "tech-stock" babbler at the local BBQ, talking about how my $150,000 in Tesla just grew to $160,000.  Systemic risk just ain't worth it.  Always leave yourself a back-door if you can, and the 3 non-stock assets within the PP are my back-door.  The RoR they earn me by making life/career/cash-flow-decisions along the way from a position of confidence and strength more than make up for the lack of RoR that they themself have.

Rant: Complete :).
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 2:15 pm

Well from my perspective the economy looks like it's slipping into recession and I expect the response to be an increase to QE.

I see no signs of any kind that the economy is improving here. Nominal GDP growth is lagging way behind government debt growth. The government is growing in size and turning more socialist/fascist daily. This is a cancer for the economy.

The government appears to be unwilling to prioritize debt payments over welfare payments so when it can no longer borrow it will choose to default at least partially or just print baby print.

In the meantime all fixed dollar instruments that do not have a lot of credit risk priced in will lose to inflation.

This is why I think the safe thing now is gold and stocks that focus on foreign markets. All stocks are scary now because the global economy looks shaky but at least foreign markets (especially emerging) are at much lower multiples. The massive amounts of QE seem to have blown up a US bond bubble and possibly a US stock bubble (though not as bad as 2007 yet - 22 PEish).

Please if someone disagrees state the reason why and not just that I'm a doo-doo head.

Does anyone think the economy is getting better? If not, does anyone think the government's response will not be to just print more and more?
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Re: Kudos for the PP

Post by moda0306 » Tue Oct 29, 2013 2:17 pm

Kshartle,

I guess if you really don't think that t-bills aren't that fundamentally dissimilar to reserves, and that demand can't lag productive capacity, we're going to have a massive chasm regarding how we think different assets will behave in real terms, going forward.

I think that's where our differences lie.
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 2:34 pm

moda0306 wrote: Kshartle,

I guess if you really don't think that t-bills aren't that fundamentally dissimilar to reserves, and that demand can't lag productive capacity, we're going to have a massive chasm regarding how we think different assets will behave in real terms, going forward.

I think that's where our differences lie.
I don't understand what you're trying to say. What part of my post do you disagree with and why? I am genuinly interested in hearing an oppsing viewpoint and the reasons for it.

What do you think the HBPP assets are going to do in real terms going forward and why? - Sincerely interested since I am certain it will be a different opinion than mine.
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Re: Kudos for the PP

Post by moda0306 » Tue Oct 29, 2013 2:58 pm

Your entire post is a dooms-day prediction implying our productivity issue is a productive-will or productive-capacity issue (due to a Socialist/Fascist government), when it's a demand issue (IMO, of course).

This difference in models is going come up with VERY different predictions about what investments are going to perform, going forward, and why.

I've explained before how I think inflation will be tame until we've reached somewhere near full-employment and productive capacity, so I think rates will stay low, and so will inflation, and any mention of "tapering" will merely be met with pulling back those comments because the recovery dried up.

However, our stock-market has healthy balance sheets and a ton of ingenuity.  I think they're poised well for the future.  If we avoid out-right deflation, gold might actually bounce up to 2,500 as well.

But these are all loose predictions.  I don't really act on them, much. If we begin to see deficits in excess of our trade deficit, I'll begin to have renewed faith in rising rates, but until then, I just think we'll Japanimate for awhile.
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Re: Kudos for the PP

Post by frommi » Tue Oct 29, 2013 3:02 pm

Kshartle wrote: Well from my perspective the economy looks like it's slipping into recession and I expect the response to be an increase to QE.

I see no signs of any kind that the economy is improving here. Nominal GDP growth is lagging way behind government debt growth. The government is growing in size and turning more socialist/fascist daily. This is a cancer for the economy.

The government appears to be unwilling to prioritize debt payments over welfare payments so when it can no longer borrow it will choose to default at least partially or just print baby print.

In the meantime all fixed dollar instruments that do not have a lot of credit risk priced in will lose to inflation.

This is why I think the safe thing now is gold and stocks that focus on foreign markets. All stocks are scary now because the global economy looks shaky but at least foreign markets (especially emerging) are at much lower multiples. The massive amounts of QE seem to have blown up a US bond bubble and possibly a US stock bubble (though not as bad as 2007 yet - 22 PEish).

Please if someone disagrees state the reason why and not just that I'm a doo-doo head.

Does anyone think the economy is getting better? If not, does anyone think the government's response will not be to just print more and more?
I think we are in exactly opposite camps regarding the future :). I am mostly in under-/fair valued US stocks, because i think that the US economy is much stronger currently than for example the economy in the EU (and now that german elections are over the old problems will re-arise). But the EUR/USD has run up 10% in the last 6 months, and i think that will correct back. So as a european going undervalued us stocks (but most of them get earnings all from over the world) is my way of playing that.
What is my risk?
a) I did my valuations wrong and mr. market turns depressive again. But as long as the underlying businesses are performing good i really don`t care about that anymore. (hint: my stocks own the top brands of the world)
b) The USD weakens more. But hurray i can buy more us stocks which report good earnings because the us dollar is down.  8)
c) The world goes under. Ok. Goodbye.  ;D
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Re: Kudos for the PP

Post by Kshartle » Tue Oct 29, 2013 3:20 pm

frommi wrote:
Kshartle wrote: Well from my perspective the economy looks like it's slipping into recession and I expect the response to be an increase to QE.

I see no signs of any kind that the economy is improving here. Nominal GDP growth is lagging way behind government debt growth. The government is growing in size and turning more socialist/fascist daily. This is a cancer for the economy.

The government appears to be unwilling to prioritize debt payments over welfare payments so when it can no longer borrow it will choose to default at least partially or just print baby print.

In the meantime all fixed dollar instruments that do not have a lot of credit risk priced in will lose to inflation.

This is why I think the safe thing now is gold and stocks that focus on foreign markets. All stocks are scary now because the global economy looks shaky but at least foreign markets (especially emerging) are at much lower multiples. The massive amounts of QE seem to have blown up a US bond bubble and possibly a US stock bubble (though not as bad as 2007 yet - 22 PEish).

Please if someone disagrees state the reason why and not just that I'm a doo-doo head.

Does anyone think the economy is getting better? If not, does anyone think the government's response will not be to just print more and more?
I think we are in exactly opposite camps regarding the future :). I am mostly in under-/fair valued US stocks, because i think that the US economy is much stronger currently than for example the economy in the EU (and now that german elections are over the old problems will re-arise). But the EUR/USD has run up 10% in the last 6 months, and i think that will correct back. So as a european going undervalued us stocks (but most of them get earnings all from over the world) is my way of playing that.
What is my risk?
a) I did my valuations wrong and mr. market turns depressive again. But as long as the underlying businesses are performing good i really don`t care about that anymore. (hint: my stocks own the top brands of the world)
b) The USD weakens more. But hurray i can buy more us stocks which report good earnings because the us dollar is down.  8)
c) The world goes under. Ok. Goodbye.  ;D
I'm not bullish on Europe, particularly Western Europe but at least their stocks are at lower multiples right? I also think they are closer to the bottom regarding the socialist disaster. I am overweight Australasia though.

Really you think the US is recovering? Based on what might I ask?
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craigr
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Re: Kudos for the PP

Post by craigr » Thu Oct 31, 2013 8:52 pm

Kshartle wrote:
craigr wrote: Actually with the Permanent Portfolio rebalancing can help capture higher returns as you are in fact selling high and buying low in many market cycles.
It can help you or hurt you, depends on what the investments do. Did you see how it's returned more to not rebalance over the last 33 years or so?
Rebalancing is #1 a risk management tool. It can reduce drawdowns and volatility. Bad volatility and big drawdowns often scare investors out of the market and into market timing, changing strategies, etc. So if rebalancing keeps them from doing those things, even if there is no volatility capture, they will still have higher returns. This is because they aren't monkeying around with their investments constantly and are able to emotionally stay in the markets fully invested.

But this is all a game of probabilities and when you rebalance you are can often harvest high flyers and move that money into out of favor assets. It may not happen all the time and it is time dependent. But if you're playing the odds, it's best to sell out of winners and buy losers with some kind of mechanical rebalancing band. Even if you don't win over every period, over time it's still the right strategy.

The problem with a backtest from Year X to Year Y is it assumes a lot of things about lump sum investing on Year X and pulling the plug at Year Y. But nobody really invests that way. Investors move money around in the portfolio over their lifetime and don't normally lump sum only once. So there are a ton of variables at play here. But none of those variables take away from the idea that rebalancing reduces risk as the #1 benefit in a diversified portfolio. And the #2 thing it can do is help returns by forcing you to sell high/buy low over time. It may not happen all the time, but it does happen. It happens especially when you hold several very volatile assets that tend to move against each other like the Permanent Portfolio.

But again, the #1 reason to rebalance is to control risk. If you don't rebalance the benefits of diversification go way down.
Last edited by craigr on Thu Oct 31, 2013 10:25 pm, edited 1 time in total.
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