The death of nominal bonds? Implications for the PP?

Discussion of the Bond portion of the Permanent Portfolio

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AllWeatherPP
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The death of nominal bonds? Implications for the PP?

Post by AllWeatherPP » Tue Aug 11, 2020 4:21 am

Hello,

I like both the Permanent Portfolio and the similar All Weather portfolio, I read a couple of Harry Browne's books and the whole thread about the PP on bogleheads, as well a lot here.
The following is of great importance for both portfolios in my opinion:

Ray Dalio recently said "you would be pretty crazy to hold bonds now". Bridgewater, the company that runs the famous All Weather fund, published the following a few weeks ago, where they explain Dalio's statement in detail: https://www.bridgewater.com/grappling-w ... everywhere

It basically says to avoid nominal bonds and advocates a shift to other portfolio diversifiers, like inflation linked bonds and gold.

What I'm a bit unsure of is the question if they abandon nominal bonds of developed countries completely in their porfolios from now on or only partly. English is not my first language, I would be thankful if somebody could clarify that for me.

They claim that with interest rates at zero, they have limited upside potential, unlimited downside potential if rates rise and would no longer be able to protect a portfolio if stocks crumble. Examples are bonds in Europe and Japan, where the protection during the COVID crash was very small (Europe) or nonexistent (Japan), unlike in the US, where they cut interest rates.

If interest rates go negative (they say -1% would probably be the upper limit, after that cash becomes more attractive), there is room for one last rally in bonds. In my personal opinion you could hold on to a little bit of bonds to be prepared if that scenario arrives, but if european circumstances are reached in the US, nominal bonds would be pretty useless.

A couple of quotes:

"it is pretty obvious that with interest rates near zero and being held stable by central banks, bonds can provide neither returns nor risk reduction"

"While the loss of nominal bonds as a source of return and diversification is a big deal for most asset allocations..."

"Near-zero interest rates changes the menu of choices that one has available" (I believe they are talking about their All Weater fund)

"...financed by money printing. If this does not succeed in reflating equities, logically we would expect this printed money to end up in inflation-hedge assets like inflation-linked bonds and gold"

"So while we continue to hold nominal bonds in markets where there is potential room for one more bond rally, we are increasingly using these inflation-hedge assets as well to get balance where we previously would have used nominal bonds." (all quotes p.11)

So are they still invested in US nominal bonds or not?!

"it’s also worth noting that Chinese bonds are one of the only remaining nominal bond markets in the world where yields have some room to fall. So, to take advantage of what little does remain in nominal bonds, we have increasingly shifted into Chinese bonds as developed world bonds have fallen to zero."

Apparently, they stay in Chinese bonds, but not sure if they remove european and US bonds completely.

What is your take on this? Do zero interest rates change your view on the PP and make it no longer "pemanent"?
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Re: The death of nominal bonds? Implications for the PP?

Post by Kriegsspiel » Tue Aug 11, 2020 6:42 am

I don't know about if the PP would function as it usually does under negative interest rates, but personally I'm not going to buy any. Government bonds are loans to the government, I'm not going to pay them to take my money.
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Re: The death of nominal bonds? Implications for the PP?

Post by mathjak107 » Tue Aug 11, 2020 9:03 am

basically negative rates in japan and Europe act as taxes by the central banks on the banks reserves ...they are not as free to loan as we are ...they have stricter requirements to loan and are no where near as prone to loan to more risky ventures .

we have none of the issues in our banking system they do .


so negative rates on bonds are very unlikely
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Re: The death of nominal bonds? Implications for the PP?

Post by Kevin K. » Sun Aug 16, 2020 11:29 am

I read the Bridgewater article carefully - twice - and highly recommend it to everyone.

There's a lot of discussion about the article and accompanying video over on Bogleheads. A lot of the comments are from idiots bashing the Tony Robbins All Seasons portfolio and incorrectly conflating it with Bridgewater/Ray Dalio's All Weather hedge fund, but there are enough insightful comments to make the slog worth it (IMHO).

The first chart in the article kind of tells you all you may need to know, in that it shows that 10 year Treasury's at zero are indeed unprecedented. I think the article as a whole makes a pretty compelling case for the notion that it really is different this time in that sustained zero-to-negative Treasury returns change many things about the investing landscape - and they do a good job of going into detail about some of the implications.

Obviously these guys are hedge fund managers who routinely pursue complex and often leveraged strategies that aren't going to appeal to (or even always be available to) "retail" investors. But where they end up (my take-away, anyway) isn't all that different from what Jonathan Clements talks about in a couple of recent posts (humbledollar.com) about tweaks to his own portfolio as the pandemic continues to unfold. His bonds holdings are all short-term Treasuries and TIPS and his stocks are globally diversified. Supplement (or partially replace) the equities with a fat slice of IAU and you've got a decent roll-your-own imitation of a Bridgewater fund minus the multi-million dollar minimum investment and hefty management fees.

Here's one of the better of the numerous B'heads threads on this in case of interest:

https://www.bogleheads.org/forum/viewto ... 0&t=322574
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Re: The death of nominal bonds? Implications for the PP?

Post by Kevin K. » Mon Aug 17, 2020 9:42 am

I've been rereading both the Permanent Portfolio book by Craig Rowland and J.M. Larson and William Bernstein's thoughtful meditation on the PP and its implications ("Deep Risk"). There's a nifty table in the latter book that summarizes the probability, consequence severity, method(s) of insuring against and costs of said insurance for four economic conditions.

Inflation: *** Probability. ** Consequence Severity * Cost of Insuring
Methods of Insuring: Global Equities, Commodity Producers, Gold, TIPS

Deflation: * Probability ** Consequence Severity *** Cost of Insuring
Methods of Insuring: Global Equities, Long Treasuries, T-bills, Gold

Confiscation ** Probability ** Consequence Severity ** Cost of Insuring
Methods of Insuring: Foreign-held assets and real estate

Devastation: * Probability *** Consequence Severity ** to *** Cost of Insuring depending on country of residence
Method of Insuring: Foreign-held assets (for local devastation only)

So Bernstein's quibbles with the PP are that the 4 x 25% allocates the same % of the portfolio to addressing economic conditions that are nowhere near being equally likely to occur and which also have widely-varying insurance costs. And he also points out that gold is far from being the best hedge against inflation as Browne contended,

Getting back to the Bridgewater paper on zero bond yields two of the assets they recommend in lieu of regular bonds are gold and TIPS. In the PP book TIPS are categorically rejected because "TIPS provide almost no protection against economic conditions involving deflation, which is the main risk that the bond portion of the Permanent Portfolio is designed to protect the investor against."

Meanwhile in his chapter on deflation, Dr. Bernstein points out:

"With the abandonment of the gold standard by the world’s nations in the aftermath of the First World War and Great Depression, deflation has almost disappeared. In fact, the only episode of prolonged deflation in the fiat currency era is that of Japan, with its poor real stock returns. In the era of fiat money, even the word “deflation” is relative. The Japanese CPI did not even begin to fall until 1995, five full years after the bubble burst. Between the beginning of that year and mid-2013, Japan’s CPI has fallen a grand total of 2.06%—deflation, to be sure, but barely a sneeze compared what developed economies experienced in the hard-money era.".....

In summary, in the fiat money era, the probability, and so the deep risk, of significant deflation is at least an order of magnitude less than the risk of inflation; we have only one modern example of deflation-associated long-lasting capital markets disaster, and that is Japan. The relevance of the Japanese deflationary episode, because of the extraordinarily high stock valuations at its start, with the 1989 nikkei P/E approaching triple digits, is questionable. The bursting of this speculative frenzy in stocks (as well as in real estate) precipitated Japan’s deflationary spiral. The stock and real estate bubbles, combined with the absence of an adequate central bank response and the failure of Japanese banks to write off their bad loans, seem more an isolated trifecta than something properly diversified investors should lose much sleep over."

That whole short chapter is worth a careful read, as he also goes into why deflation is much less likely in the fiat currency world recaps a lot of history in a concise way.

The take-away seems to be that in normal circumstances where LTT's offer a meaningful real return they're still in no way worth allocating 25% of one's resources to, while in today's world where they're yielding close to nothing and have limitless risk in terms of interest rate spikes and/or inflation they make no sense at all.

So for the defensive investor (surely most who are drawn to the PP) I'm guessing that a Bernstein-inspired, Bridgewater-informed portfolio (for these times - nothing "Permanent" about it - or the PP, it would seem) might be something along the lines of 30% STT's, 10% 1-5 year TIPS, 30% TSM, 15% Total International (e.g. VXUS) and 15% gold. Kind of a hybrid or mashup of the Golden Butterfly and Pinwheel on Portfolio Charts but without the complex equity tilts and with a boatload of (quasi) cash. There are surely better iterations and I'm still not sold on TIPS given their much greater correlation with the stock market and uselessness outside of tax-sheltered accounts.
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Re: The death of nominal bonds? Implications for the PP?

Post by AllWeatherPP » Mon Aug 17, 2020 11:27 am

Kevin K. wrote:
Mon Aug 17, 2020 9:42 am
So for the defensive investor (surely most who are drawn to the PP) I'm guessing that a Bernstein-inspired, Bridgewater-informed portfolio (for these times - nothing "Permanent" about it - or the PP, it would seem) might be something along the lines of 30% STT's, 10% 1-5 year TIPS, 30% TSM, 15% Total International (e.g. VXUS) and 15% gold. Kind of a hybrid or mashup of the Golden Butterfly and Pinwheel on Portfolio Charts but without the complex equity tilts and with a boatload of (quasi) cash. There are surely better iterations and I'm still not sold on TIPS given their much greater correlation with the stock market and uselessness outside of tax-sheltered accounts.
Regarding your suggested portfolio:
I think it is a really good portfolio, but there is not much similarity to the PP left.

Until recently, I really liked the following asset allocation, inspired both by the PP and All Weather:
30% stocks
15% gold
10% TIPS
45% Intermediate Treasuries/IEF (similar to 22,5% TLT + 22,5% cash)

With the recent Bridgewater publication (in a sense this is revolutionary for the investing world IMO) and reading a lot about Risk Parity, I'm thinking to change the bond part to the following allocation:

35% TIPS (TIP ETF)
10% TLT
10% IEF
+ 30% stocks 15% gold unchanged

The volatility/risk exposure of the nominal bond part is about the same as the volatiliy of the TIP part according to PortfolioVisualizer. So I would reach risk parity in the bond portion of the portfolio.

I don't know if you have heard about the Risk Parity ETF RPAR which is heavily influenced by Ray Dalio/All Weather, they recently did the opposite of Bridgewater's suggestion, they increased their nominal bond exposure, because they see a heightened DEFLATION danger when the yield of the 10-year is below 1% (they remove 15% of their TIPS exposure and put 7,5% more in nominal bonds and 7,5% more in gold in that case).
So this is quite confusing!

My portfolio suggestion is a compromise between the two, better prepared for inflation than before, but still protected for a deflation à la PP/ original All Weather / RPAR ETF.

Through the eyes of a Harry Browne PP I calculated the following:

30% stocks
10% TLT + 10% IEF similar impact to 15% TLT
15% gold
The TIP part serves somehow as a mixture between nominal bonds and inflation protection like gold. If you keep in mind the volatility of TIP ETF my portfolio would have a impact similar to
30% TLT
30% gold
30% stocks
Very much like the PP without cash and with lower risk/volatility than a PP of 33/33/33 without cash!

According to Bridgewater TIPS are for falling growth, much like nominal bonds, and rising inflation, like gold/commodities. I'm mixing the PP and All Weather here, but for me that is alright since they have so much similarities in their philosophy IMO.

35% TIP ETF has combined with 10% IEF and 10% TLT the volatility of 29,75% TLT -> falling growth assets

35% TIP ETF has combined with 15% gold the volatility of 26,22% gold -> rising inflation assets

This is how I calculated the approximate 30/30/30 stocks/TLT/gold.

Thoughts?
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Re: The death of nominal bonds? Implications for the PP?

Post by Kevin K. » Mon Aug 17, 2020 12:25 pm

I've read about RPAR but I've ended up mostly accepting William Bernstein's view that large-scale deflation is very unlikely in our fiat currency world. The Bridgewater paper, while not discounting any possible scenario, kind of supports his arguments too in making very clear how thoroughly the economy is being manipulated in what they call the M3 phase of monetary policy.

I like your thinking and can see why you've come up with the allocations you suggest but you haven't included the substantial allocation to international equities Bridgewater recommends. No cash is also a major problem in my opinion because (a) as Tyler points out it's one of the very best inflation hedges, and (b) having "oodles" of liquidity (Bernstein recommends 15-25 YEARS of residual living expenses) is pretty much the essence of risk parity.

Have a look at some of these iterations:

https://www.portfoliovisualizer.com/bac ... tion5_3=20

The first one is a riff on the 5 x 20% equal weighed Golden Butterfly, while the others include a bit more U.S. home country bias and shave a bit off the TIPS. Because of the TIPS the data is constrained to 2001-2020 (and that's probably also the reason Tyler doesn't include them as an asset class on Portfolio Charts). One also has to take into account that the TIPS on Portfolio Visualizer are the longer-duration ones (as in VIPSX).

I'm not in love with any of these allocations but I think they're probably pretty robustly defensive while avoiding some of the downside risk of 25% or more LTT's and a full 25% in gold. That said, my mother-in-law has 70% ITT's and 30% TSM and another friend is 100% Wellesley and I won't be surprised if both of them have better returns and lower drawdowns than anything we're discussing.
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Re: The death of nominal bonds? Implications for the PP?

Post by I Shrugged » Mon Aug 17, 2020 6:43 pm

One thing that rattles around in my head is that if I have to choose between loaning money to a government at zero or worse, or buying gold instead, well, that's a no brainer. I'd sure as heck rather own the good stuff.

I have to think Mr. Bond Market will have the final say on zero and negative yields. I would expect money to flee to gold like crazy. The problem is that the bond market dwarfs gold, probably by a gazillion times.
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Re: The death of nominal bonds? Implications for the PP?

Post by Kbg » Mon Aug 17, 2020 11:46 pm

Strongly considering adding some TIPS over time. Maybe just keep it simple LTTs and STTs/Cash by adjusting to 50% nominal bonds/50% TIPs...not like we are making huge amounts of interest or anything right now. Even simpler, just go with IT Ts/TIPS

It's a compromise, but the Bridgewater argument I thought was pretty good.
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Re: The death of nominal bonds? Implications for the PP?

Post by mathjak107 » Tue Aug 18, 2020 5:05 am

anything bridge water does , do the opposite ... their star attraction fund got hammered with wrong calls... they were down a whopping 64% the first two quarters , plus had years of mediocre performance
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Re: The death of nominal bonds? Implications for the PP?

Post by Kevin K. » Tue Aug 18, 2020 9:46 am

Kbg wrote:
Mon Aug 17, 2020 11:46 pm
Strongly considering adding some TIPS over time. Maybe just keep it simple LTTs and STTs/Cash by adjusting to 50% nominal bonds/50% TIPs...not like we are making huge amounts of interest or anything right now. Even simpler, just go with IT Ts/TIPS

It's a compromise, but the Bridgewater argument I thought was pretty good.
I tend to agree with your thinking. Now Jonathan Clements is obviously far removed from the PP universe but he's had a couple of pieces in the past two months that make for interesting parallels to the Bridgewater paper. Here's one:

https://humbledollar.com/2020/06/farewell-yield/

In a subsequent article he says that as he transitions from semi- to full retirement at age 57 he's swapped out his intermediate-duration TIPS and corporate bond funds for short-term TIPS and short-term Treasuries. He's got 5+ years of living expenses in those funds and is comfortable with everything else being in fully internationally-diversified, small and value tilted stock index funds with no interest in gold or other kinds of exotica that Bridgewater invests in but I think his basic conclusion about bonds being for ballast with no expected return for now are probably realistic.
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Re: The death of nominal bonds? Implications for the PP?

Post by AllWeatherPP » Thu Aug 20, 2020 10:10 am

Kbg wrote:
Mon Aug 17, 2020 11:46 pm
Strongly considering adding some TIPS over time. Maybe just keep it simple LTTs and STTs/Cash by adjusting to 50% nominal bonds/50% TIPs...not like we are making huge amounts of interest or anything right now. Even simpler, just go with IT Ts/TIPS

It's a compromise, but the Bridgewater argument I thought was pretty good.
Interesting.
Could you be more specific? "just go with IT Ts/TIPS" -> does that mean a "PP" with 25% IEF 25% TIPS (short term, long term like Bridgewater/All Weather?)
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Re: The death of nominal bonds? Implications for the PP?

Post by AdamA » Thu Aug 20, 2020 5:44 pm

Does anyone think that it might be okay to just keep by long term treasuries, even with negative rates?

Maybe if rates continued to drop, you'd make up what you'd lose in interest with what you'd make in capital gains.
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Re: The death of nominal bonds? Implications for the PP?

Post by Smith1776 » Thu Aug 20, 2020 6:40 pm

AdamA wrote:
Thu Aug 20, 2020 5:44 pm
Does anyone think that it might be okay to just keep by long term treasuries, even with negative rates?

Maybe if rates continued to drop, you'd make up what you'd lose in interest with what you'd make in capital gains.
What I know is that messing with the PP with proposed improvements rather than just trucking along with the strategy more often than not ends up with the person getting egg on their face. There just seems to be some intrinsic law in the universe that makes staying the course more profitable than the most earnest of efforts to improve results.

Somehow I think people who just keep sticking with 4 x 25 and regular rebalancing will do just fine.
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Re: The death of nominal bonds? Implications for the PP?

Post by AdamA » Thu Aug 20, 2020 7:51 pm

Smith1776 wrote:
Thu Aug 20, 2020 6:40 pm

What I know is that messing with the PP with proposed improvements rather than just trucking along with the strategy more often than not ends up with the person getting egg on their face. There just seems to be some intrinsic law in the universe that makes staying the course more profitable than the most earnest of efforts to improve results.

Somehow I think people who just keep sticking with 4 x 25 and regular rebalancing will do just fine.
Yeah, that's my instinct too.
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Re: The death of nominal bonds? Implications for the PP?

Post by Kbg » Fri Aug 21, 2020 9:46 am

Still looking into the pros and cons. I’m kinda choking on the fact they are mostly negative yielding right now in nominal and real is even worse.
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Re: The death of nominal bonds? Implications for the PP?

Post by Kevin K. » Fri Aug 21, 2020 10:13 am

The well-known and highly-regarded personal finance writer Jonathan Clements has had a couple of recent posts that bear on these issues:

https://humbledollar.com/2020/06/farewell-yield/

https://humbledollar.com/2020/07/my-four-goals/

Now obviously he's not involved in the PP world but I think his observations and personal choice on bonds dovetails well with what Bridgewater is talking about. For as long as we're in a zero-return world he's going with short-term U.S. government bonds only using a barbell of STT"s and short TIPS.

TIPS are of course vilified in the PP book because of their lack of deflation protection and their poor performance in 2008 (which turns out to be for reasons entirely different from those cited in the book - see link below). But there are good reasons that folks like Bridgewater, DFA and retirement planning specialists like Wade Pfau and Zvi Bodie recommend them for specific situations. Here's a link to a short series of articles that does the best job I've seen of explaining how short TIPs can be deployed:

https://movement.capital/history-of-tip ... onds-work/

All this said even Bridgewater if I recall says they're hoping for one more big LTT rally. But I sure don't see anything sacrosanct about putting a full 25% of one's assets in LTT's in this environment. I doubt Harry Browne would own them at all today.
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