LTT paralysis

[BearBones]

This is a play on Dualstow's topic about new cash paralysis. Due to my aversion of LTTs, I have been buying in over a 2 year period (in retrospect, a bad decision). Now, coming up to the final purchase to make 4x25, I am PARALYZED. Like many of you, I favor LTTs as the "least likely to succeed" asset class going forward. I just have a gut feeling that I will find myself continuously rebalancing out of other assets into a declining LTT market over a decade or two. Ugh.

Here's my epiphany, and I would appreciate others opinion about this (I suspect that most of you got this a long time ago). It does not really matter if LTTs are in a long term decline as long as it is a bumpy road. One can still make money with them by capturing gains during rebalancing, even if a buy-and-hold person would get slaughtered. Has this, in fact, been born out from past long term bear markets in an asset class?

If this is the case, I may finally jump in, since I anticipate an unhealthy economy going forward. And, as we have seen over the past few years, unhealthy economies are very bumpy.

[Alanw]

This is a play on Dualstow's topic about new cash paralysis. Due to my aversion of LTTs, I have been buying in over a 2 year period (in retrospect, a bad decision). Now, coming up to the final purchase to make 4x25, I am PARALYZED. Like many of you, I favor LTTs as the "least likely to succeed" asset class going forward. I just have a gut feeling that I will find myself continuously rebalancing out of other assets into a declining LTT market over a decade or two. Ugh.

Here's my epiphany, and I would appreciate others opinion about this (I suspect that most of you got this a long time ago). It does not really matter if LTTs are in a long term decline as long as it is a bumpy road. One can still make money with them by capturing gains during rebalancing, even if a buy-and-hold person would get slaughtered. Has this, in fact, been born out from past long term bear markets in an asset class?

If this is the case, I may finally jump in, since I anticipate an unhealthy economy going forward. And, as we have seen over the past few years, unhealthy economies are very bumpy.

After reading the posts on this site for the past several years, it appears that DCAers are somewhat unhappy as compared to the "all at once" PPers.  After reading Harry Browne's and Craig and MT's books, I have come to the conclusion that you may as well go all in at once simply because we do not know what the future holds and doing it any other way, results in a market timing mindset that rarely works.  DCAing may temporarily give you peace of mind but will seldom give you more favorable returns.
As far as LTT's going into a long term decline and continuously rebalancing into a declining asset, check out gold in the 80's and 90's.  The PP had acceptable returns, in my mind, even though gold was taking a hit for two decades.  Of course we don't know if this will be true of LTT's going forward but if we want to be long term investors, we have to place our  faith in some form of investment strategy.  The PP looks as good as any that I had researched for my retirement funds and peace of mind.
I established my PP about two years ago and went all in with 80% of my funds (20% in a VP).  Being conservative and new to the PP strategy, I chose rebalance bands of 30/20.  Since that time , I have rebalanced out of LTT's once and last week rebalanced out of stocks to put my portfolio back at 4x25.  So far it has worked well.  What will the future hold?  Your guess is as good as mine.

[melveyr]

Another alternative is that LTT yields bounce between 2-6% for the next 3 decades or so.

More importantly I wouldn't spend my time fretting about the possibilities of giant bear market in bonds because it is just one scenario. And besides, the PP has already survived a bear market in bonds in the past and it did just fine. 

The way I see it, long term bond yields are simply the markets forward prediction of the average short term interest rate that will occur for the next 30 years. The US central bank has been amazingly transparent about the future of short term interest rates. The Fed will keep rates low until inflation rises faster than expected (gold would do well) or the unemployment number gets better (stocks would do well). Nothing about the PP is broken, if anything Bernanke is a PP holders best friend because the last thing he is planning on causing is a tight money recession which is the real Achilles heel of the PP.

[BearBones]

As far as LTT's going into a long term decline and continuously rebalancing into a declining asset, check out gold in the 80's and 90's.  The PP had acceptable returns, in my mind, even though gold was taking a hit for two decades.

I have some faith the PP will have "acceptable" returns. I just do not have faith that it will do as well as a similar portfolio without a long-term declining asset (in this example, LTTs).

There has been plenty of the, "you never know" discussion before. That is not my point here. My question is simply: Can the PP actually benefit from a declining asset in a long term bear market if the road is bumpy enough to capture LTT gains by rebalancing?

[Pointedstick]

My question is simply: Can the PP actually benefit from a declining asset in a long term bear market if the road is bumpy enough to capture LTT gains by rebalancing?

Even without needing to do that, the PP's history shows that it can tolerate a multi-decade sinking asset so long as two other ones rise, which I think is likely.

If you rebalance aggressively, I think you could absolutely capture the gains from a single asset's "bumpy ride," but you'd have to adjust your bands. 35/15 requires a 40% gain or loss to trigger a rebalance, necessitating very large bumps indeed. Moving to 30/20 cuts that in half, triggering a rebalance with a 20% gain or loss.

Of course, a treasury bond with a duration of 30 years responds with approximately a 30% rise or fall with every percentage point change in the interest rate. The high duration provides quite a bit of "synthetic leverage," which melveyr has written quite a bit about.

[BearBones]

Thanks.
I will state my question more directly. f one knew that LTT yields would be 8% in 10 years but there would be lots of volatility along the way, could one put together a scenario where the PP is better off with LTTs as compared to one without? Or would one invariably be better with a 3x33 portfolio without LTTs?

[Pointedstick]

Thanks.
I will state my question more directly. f one knew that LTT yields would be 8% in 10 years but there would be lots of volatility along the way, could one put together a scenario where the PP is better off with LTTs as compared to one without? Or would one invariably be better with a 3x33 portfolio without LTTs?

In that situation, one would probably be better without LTTs at all, unless you were able to buy at the troughs and sell the whole position at the peaks (not just rebalancing), which should be no problem at all with a crystal ball that accurately shows you interest rates at 8% within 10 years. 

In other words, I would get rid of LTTs entirely if you really fear a large rise in interest rates during your time horizon. Of course, you wouldn't have a permanent portfolio anymore with 1/3 stocks, 1/3 cash, and 1/3 gold. You would have an "awesome-except-in-cases-of-deflation-and-falling-rates" portfolio.

[MediumTex]

Look at the year by year chart on Craig's blog showing the performance of each PP asset since 1972.

Note how gold stabilized the portfolio's returns between 1982 and 2000, even though this asset was in a secular bear market.  During this period gold was the leading PP asset in a couple of years, and during those years it was needed to stabilize the whole portfolio.

This is probably what would happen in a long term bear market for LT treasuries (i.e., they would still perform an important role in the portfolio).

Remember, the strongest upward moves in any asset normally occur in the midst of secular bear markets for that asset.  Look at what stocks have done in the last three years.

[dualstow]

Now, coming up to the final purchase to make 4x25, I am PARALYZED.

What is your LTT proportion now? Is it at least 20%

There has been plenty of the, "you never know" discussion before. That is not my point here.

But it is *the* point. That is, it should trump your question.
I sometimes find it painful to buy bonds because unlike stocks or gold, they seem so directly vulnerable to a policy change.  On the other hand, if I buy real treasuries directly and hold on I could move them to the pp in ten years if I don't have the stomach to sell them. (Of course that doesn't work for those who are disciplined enough to have 100% in pp, 0% in vp).

Perhaps it's helpful to focus on the "you never know" after all. It's like buying insurance. Plan to lose money on it but to do well overall?

[AgAuMoney]

My question is simply: Can the PP actually benefit from a declining asset in a long term bear market if the road is bumpy enough to capture LTT gains by rebalancing?

I think so.

Yet my LTTs are only about 20% of my PP.  (I went a bit light last fall when I just couldn't take it any longer, reducing them from around 30% to about 22%.)

[AgAuMoney]

In other words, I would get rid of LTTs entirely if you really fear a large rise in interest rates during your time horizon.

I would agree with that, except for one caveat...

If, and only if, you are willing to bet 100% on being correct.

I'm only certain enough to bet 90%, so I still hold about 10% LTTs.    (actually a bit light with the recent fall, but not yet light enough to rebalance.)

[AgAuMoney]

The duration of a 30 year bond is closer to 20 years than 30 (and TLT's duration is about 17 years),

How do you figure?

TLT follows an index which requires 20+ years remaining (they sell off under 20 years) which is just what Harry recommended.

If you hold a perfect mix of 30 year bonds and sell those that hit 20 years left, your average duration will be 25 years.  In no circumstance can it be less than 20 (or more than 30).

[BearBones]

If, and only if, you are willing to bet 100% on being correct.

I am not so naive at to bet 100% on many things, especially something as complicated as the economy. But I do make probability judgements, like most of you. Should I keep LTTs below 25%, I intend to maintain cash to replace, since this gives some real interest rate protection and something to rebalance out of in a deflationary environment. Make sense?

[AgAuMoney]

I am not so naive at to bet 100% on many things, especially something as complicated as the economy.

That's what I figured. 

Should I keep LTTs below 25%, I intend to maintain cash to replace, since this gives some real interest rate protection and something to rebalance out of in a deflationary environment. Make sense?

Yup.  But I don't keep extra cash.  I invest in companies with a long history of growing their dividend payout.  That way I have cash coming in.

I usually think of my PP as being about 40% of my assets because that is most true to the concept.  My PP is in a separate account with about that proportion.

However another way to think of it looking at my assets as a whole, is I am 100% in the PP, with only about 10% LTTs, 17% cash, 28% precious metals, leaving 45% in stocks at present.  But that is not PP proportions so isn't really valid unless I intend to do something about at least the LTTs.  But I don't, at least not to the required extent.

If I assume that LTTs must be at least 15% of the PP, I could say I'm presently 59% PP.  But I don't manage it that way.

I manage the one account as a PP, so my PP is about 40% of my assets, and that account is just over 25% cash.

[AgAuMoney]

A bond's duration is always less than its maturity, except for zero coupon bonds.

Oh, you are using 'duration' as a financial term of art instead of the common meaning.

I don't understand why they do that, but it doesn't really matter as long as I know that's what you mean so pay me no mind.  Carry on...

[Tortoise]

BearBones has mentioned probabilities here--i.e., he thinks the probability of LTT yields going up in the future is higher than the probability of the yields going lower. In the past, I have put forth that same argument on this forum.

But really, how does one estimate such probabilities in any kind of quantitative way? We're talking gut feelings here, not numerical probabilities.

As melveyr pointed out, the bond market is a relatively rational one, and it has already factored all available information into the price of LTTs. If there were some way to accurately compute that it is in fact more probable for LTT yields to rise over the next several years than to fall, wouldn't all the high-powered bond traders with their supercomputer-fueled algorithms dump and short LTTs accordingly in order to grab that easy money?

[AgAuMoney]

As melveyr pointed out, the bond market is a relatively rational one, and it has already factored all available information into the price of LTTs. If there were some way to accurately compute that it is in fact more probable for LTT yields to rise over the next several years than to fall, wouldn't all the high-powered bond traders with their supercomputer-fueled algorithms dump and short LTTs accordingly in order to grab that easy money?

"relatively rational" does not mean rational, and while the bond market may be more rational than some other markets, day to day prices are still driven in large part by the emotions of fear and greed.

I agree with you that calculating exact odds is impossible.  But the answer to your question is no, they wouldn't.  For the "high-powered traders" to trade as you suggest would require not only the odds, but the timing and the certainty.  Such a trade only works if the odds are favorable, the certainty is high and the timing is imminent.  "Several years" doesn't really work.

[BearBones]

As melveyr pointed out, the bond market is a relatively rational one, and it has already factored all available information into the price of LTTs. If there were some way to accurately compute that it is in fact more probable for LTT yields to rise over the next several years than to fall, wouldn't all the high-powered bond traders with their supercomputer-fueled algorithms dump and short LTTs accordingly in order to grab that easy money?

Could it be that the natural price yield of LTTs is quite a bit higher but being artificially depressed by QE?

(Edit 2/10 730PM)

[Reub]

But what if the sequestration takes effect? Or the euro crashes again? Or we slip back into recession? Or people realize that our population is getting older? Or Israel bombs Iran? Or unemployment starts to rise again? Or Al Qaeda attacks us?

Wouldn't these events likely cause LTT's to increase in value? 

The future is unknowable. Hence, the HBPP!

Sleep well, my friend!

[AgAuMoney]

TBH if you didn't know what duration was until 20 minutes ago your odds of outsmarting the bond market are pretty small and any outperformance would probably stem from luck.

Certainly.  But TBH with you, I was simply not expecting that kind of financial jargon here.  As I am not a bond expert or even had the topic covered in any required education or training, translating that jargon is non-reflexive and requires first recognizing that it is being used.

But I am capable of translating, and I do know what duration means in the different financial contexts in which it can be used, and I know how to look up and apply the equations.  But as I alluded to earlier, I don't want to. The theory leaves out critical factors, the math based upon that theory is of no use or applicability to me professionally, and personally I really can't be bothered to spend any more time learning it.

As for assuming I would want to outsmart the bond market, that presumes that my goals and timing are somehow coincident with that market, which they are not. My only use for bonds is the 10% I hold as required for my PP (40% of my assets, nominally 25% of which are bonds, thus nominally 10% of my assets are bonds).

Translated, all that means I have not the slightest interest in the bond market and I'll happily let those interested play with their numbers and talk in their jargon.

[AgAuMoney]

Could it be that the natural price of LTTs is quite a bit higher but being artificially depressed by QE?

Are you talking of the interest as the price (from the perspective of the issuer)?

Or the purchase cost being the price (from the perspective of the lender)?

The interest rate is being suppressed, but that seems like a rather odd perspective to take.

The purchase cost is high because the interest rate is low, so I would not say that purchase cost is suppressed.

But yes, the LTT market is not operating as a free market at present.

[AgAuMoney]

But what if the sequestor takes effect? Or the euro crashes again? Or we slip back into recession? Or people realize that our population is getting older? Or Israel bombs Iran? Or unemployment starts to rise again? Or Al Qaeda attacks us?

Wouldn't these events likely cause LTT's to increase in value?

Maybe.  Or maybe not.  All those things are triggering primarily emotional reactions, and there is no rational way to predict the actual scenario and resulting emotional reaction.  And there are numerous scenarios where LTTs decline further.  E.g. China continues to sell, the U.S. debt rating is further downgraded, increased commodity and other world trade outside of U.S. dollars, U.S. threatening to default either explicitly or implicitly, ...

The future is unknowable. Hence, the HBPP!

Exactly.

[BearBones]

Are you talking of the interest as the price (from the perspective of the issuer)?
But yes, the LTT market is not operating as a free market at present.

Careless mistake in my post. See edit. Thanks.

[moda0306]

As melveyr pointed out, the bond market is a relatively rational one, and it has already factored all available information into the price of LTTs. If there were some way to accurately compute that it is in fact more probable for LTT yields to rise over the next several years than to fall, wouldn't all the high-powered bond traders with their supercomputer-fueled algorithms dump and short LTTs accordingly in order to grab that easy money?

Could it be that the natural price yield of LTTs is quite a bit higher but being artificially depressed by QE?

(Edit 2/10 730PM)

I tend to think that the fed controls short-term interest rates (and therefore, effectively, the rate we get when we engage the fractional reserve banking system), but the market controls longer term rates based on the expectation of future fed short-term rates.  So really the fed controls long-term rates to the degree the market believes they'll continue to control short-term rates.

The market then decides how to price money as a store of wealth based on a combination of inflation and what they can earn risk-free (t-bills and savings accounts (though the latter may techinically not be "risk-free," most people that engage the banking sector see it as such).  The government may be able to set the floor cost of debt now and into the future, but they can't control the price the public will put on that debt and money in relation to other items in the economy (aka, inflation).

I almost think the term "natural rate" on government debt is a bit of a B.S. term.  As an entity that manages the issue of currency doesn't really need to "borrow" that currency from anyone.  In fact, currency is nebulous  enough that I don't really know if there's all that much natural about it.  I do strongly believe, though, that two phenominon spring directly from the societal creation of money and debt... those are 1) unemployment, and 2) inflation. 

Considering that, if there was such a thing as a "natural" rate of interest, it probably would be something that seeked to keep both the rate of unemployment and the real risk-free rate of return in light.  An unacceptably high level of either unemployment or inflation above the risk-free rate are inherant problems with our currency.  A "natural" rate would seek to manage both of those aspects.

[dualstow]

But what if the sequestration takes effect? Or the euro crashes again? Or we slip back into recession? Or people realize that our population is getting older? Or Israel bombs Iran? Or unemployment starts to rise again? Or Al Qaeda attacks us?

Wouldn't these events likely cause LTT's to increase in value? 

The future is unknowable. Hence, the HBPP!

So true. Rates could rise and bonds could fall. But, instead of trying to figure out *when* rates are going to rise, I have a cunning plan: I'm going to keep only 25% in bonds and put the rest in cash, stocks and gold. (And a vp with dividend-paying stocks).