Maximum Bond Upside

Discussion of the Bond portion of the Permanent Portfolio

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garya505
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Re: Maximum Bond Upside

Post by garya505 » Thu Aug 06, 2020 7:38 pm

Cortopassi wrote:
Thu Aug 06, 2020 1:29 pm
garya505 wrote:
Thu Aug 06, 2020 12:53 pm
Cortopassi wrote:
Thu Aug 06, 2020 12:26 pm
Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/
Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.
https://www.weforum.org/agenda/2016/11/ ... d-to-know/
Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?
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Re: Maximum Bond Upside

Post by Mark Leavy » Thu Aug 06, 2020 8:53 pm

garya505 wrote:
Thu Aug 06, 2020 7:38 pm

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?
Hi Gary, welcome to the forum. And great questions!

Tyler and a few of the other folks have the subtlety of bonds down much better than I do, but here's my take:

Due to convexity, the volatility of bonds will remain high or even possibly increase as interest rates go down or negative. Regardless of the interest rate, you will need about the same percentage of long term bonds in your portfolio to cover swings in the other assets. I know it is counterintuitive, but bond protection is tied to the rate of change - and it is not linear. At low rates, small interest rate changes produce proportionally large swings in value. At higher interest rates, you need larger rate changes to produce the same swing in value.
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Re: Maximum Bond Upside

Post by garya505 » Thu Aug 06, 2020 9:39 pm

Mark Leavy wrote:
Thu Aug 06, 2020 8:53 pm
garya505 wrote:
Thu Aug 06, 2020 7:38 pm

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?
Hi Gary, welcome to the forum. And great questions!

Tyler and a few of the other folks have the subtlety of bonds down much better than I do, but here's my take:

Due to convexity, the volatility of bonds will remain high or even possibly increase as interest rates go down or negative. Regardless of the interest rate, you will need about the same percentage of long term bonds in your portfolio to cover swings in the other assets. I know it is counterintuitive, but bond protection is tied to the rate of change - and it is not linear. At low rates, small interest rate changes produce proportionally large swings in value. At higher interest rates, you need larger rate changes to produce the same swing in value.
Just to clarify, I was suggesting a 4x25 PP (CASH, LTT, Gold, and Stock), with the only "unconventional" thing being a reduction of duration in the LTT part as interest rates approach (or dip below) 0. And this would not be an all-or-nothing reduction in duration, but rather a stepped reduction as rates get lower and lower. The intention here would be to reduce the risk of very long bonds if interest rates were to increase from 0, without giving up ALL of the desired volatility. Would it do that?

I believe some have suggested that near-0 interest rates might "break" the PP, or at least make it not work as well as it has in the past. Did Harry Browne even consider that rates might go to 0 when he devised the PP?
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Re: Maximum Bond Upside

Post by Mark Leavy » Thu Aug 06, 2020 10:04 pm

garya505 wrote:
Thu Aug 06, 2020 9:39 pm

Just to clarify, I was suggesting a 4x25 PP (CASH, LTT, Gold, and Stock), with the only "unconventional" thing being a reduction of duration in the LTT part as interest rates approach (or dip below) 0. And this would not be an all-or-nothing reduction in duration, but rather a stepped reduction as rates get lower and lower. The intention here would be to reduce the risk of very long bonds if interest rates were to increase from 0, without giving up ALL of the desired volatility. Would it do that?

I believe some have suggested that near-0 interest rates might "break" the PP, or at least make it not work as well as it has in the past. Did Harry Browne even consider that rates might go to 0 when he devised the PP?
Ah... thanks for the clarification. I completely missed that you were talking about modulating the duration and not the percentage of holding.

The math works out about the same either way. So my comments are unchanged. But I might still be wrong.

Probably best to wait until smarter people chime in, as we are in uncharted territory here. You are correct that there have been some good arguments that zero or negative interest rates could break the permanent portfolio, and it is probably something that Harry never considered. When I run the numbers, I don't see it. I'm holding a variant of the PP right now, but my exposure to long bonds is equal to my equity exposure. I can't imagine changing it. In fact, reducing my bond exposure seems dangerous as hell.

I'm interested in any other comments. Great discussion.

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Re: Maximum Bond Upside

Post by boglerdude » Fri Aug 07, 2020 2:25 am

It looks like the fed wont let stocks drop more than 30%. A 1% rate change in EDV will move it 30%. You can balance the volatility, if they sell 100 year bonds you could hold less of them.

Its possible that eventually the 30 year will just swing from 1% to -1% like I suppose happens in Japan/germany?
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Re: Maximum Bond Upside

Post by WhiteElephant » Fri Aug 07, 2020 4:44 am

boglerdude wrote:
Fri Aug 07, 2020 2:25 am
It looks like the fed wont let stocks drop more than 30%. A 1% rate change in EDV will move it 30%. You can balance the volatility, if they sell 100 year bonds you could hold less of them.

Its possible that eventually the 30 year will just swing from 1% to -1% like I suppose happens in Japan/germany?
I think that's a possibility, and because of that I'm not sure if zero/negative rates will actually break the PP. I think LTT can still do what they are supposed to do within the PP framework.

I'm far more worried about the the current negative real returns. Dutch 30y bonds are yielding -1.8% real currently and cash -1.6%. And it's the same in many other European countries.

This problem is not unique to the PP of course, but with 50% of the portfolio in cash/bonds these yields provide a strong headwind to any future returns.

I'm wondering how Harry would have approached such a situation. My guess is that he just would have let it played out. Maybe he would have upped the PM allocation in his VP.
Me? I'm finding it pretty hard to hold on to my LTT's...
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Re: Maximum Bond Upside

Post by Kbg » Fri Aug 07, 2020 8:17 am

The great thing about bonds is that they are incredibly predictable and by this I mean throw a scenario at them and you know what is going to happen because the math is all there to tell you what will happen. Without a doubt the best prediction for a bond is it's interest rate. It's not even a prediction, it's fact (unless it defaults). Now of course a PP rolls out of a LTT bond after X number of years so all that bond math begins to matter a lot.

LTTs are going to stay volatile and Tyler's convexity graphs are phenomenally good in allowing one to understand how all that works in a very intuitive way. Dialing down duration, dials down volatility so if you are looking for the punch of LTTs you aren't going to get it unless you dial up your allocation.

Bonds and cash all pretty much suck right now. Nothing we can do about that, it is what it is. We also know pretty much exactly what we are going to get from those assets, right now, in terms of return. There's really no guess work about this at all.

So for me the question of LTTs is do I still want their volatility in the portfolio or not? Over the short term, LTTs are an excellent diversifyer of stocks due to negative correlation. If we have a sustained rise in interest rates then they become positively correlated and we hope our gold pulls us through it.
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Re: Maximum Bond Upside

Post by dualstow » Fri Aug 07, 2020 9:03 am

Gary, I don’t know if maintaining an otherwise perfect pp is explicitly mentioned, but check out Craigr’s post in ‘Slowly Bleeding’
viewtopic.php?f=1&t=8730&p=155349&hilit ... on#p155349
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Re: Maximum Bond Upside

Post by garya505 » Fri Aug 07, 2020 11:39 am

Kbg wrote:
Fri Aug 07, 2020 8:17 am
The great thing about bonds is that they are incredibly predictable and by this I mean throw a scenario at them and you know what is going to happen because the math is all there to tell you what will happen. Without a doubt the best prediction for a bond is it's interest rate. It's not even a prediction, it's fact (unless it defaults). Now of course a PP rolls out of a LTT bond after X number of years so all that bond math begins to matter a lot.

LTTs are going to stay volatile and Tyler's convexity graphs are phenomenally good in allowing one to understand how all that works in a very intuitive way. Dialing down duration, dials down volatility so if you are looking for the punch of LTTs you aren't going to get it unless you dial up your allocation.

Bonds and cash all pretty much suck right now. Nothing we can do about that, it is what it is. We also know pretty much exactly what we are going to get from those assets, right now, in terms of return. There's really no guess work about this at all.

So for me the question of LTTs is do I still want their volatility in the portfolio or not? Over the short term, LTTs are an excellent diversifyer of stocks due to negative correlation. If we have a sustained rise in interest rates then they become positively correlated and we hope our gold pulls us through it.

The PP needs the volatility, but my question is, how much volatility? So what I'm getting at is that at interest rates bear 0, LTTs become extremely volatile, very much more than at 5% or 10%. What were rates when HB designed the PP? It matters, because the PP needs volatile assets to get the rebalancing benefit. But does the PP machine need the extreme volatility of LTTs at near 0 rates, and is it worth the extreme risk?

For example, looking at Tyler's convexity chart, it would appear that you could get about the same volatility using 1) 20-year treasuries at around 8% or, 2) 10-year treasuries at near-0 rates (don't check my math as this is an approximation). So the volatility is about the same, but the difference is that in the with the 10-year bonds you are reducing the losses if/when interest rates rise.

I noticed that some have suggested using 50% ITT instead of 25/25 Cash+LTT. I wouldn't do that or even propose it as I think it breaks the workings of the PP machine.

For different Interest rate environments:
High: Cash, TLT, IAU, VTI
Mid: Cash, TLH, IAU, VTI
Low: Cash, IEF, IAU, VTI

Of course you can backtest all of these, but the results would be totally meaningless considering the decreasing interest rates of the last 40 years.
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Re: Maximum Bond Upside

Post by Kbg » Fri Aug 07, 2020 12:08 pm

garya505 wrote:
Fri Aug 07, 2020 11:39 am
But does the PP machine need the extreme volatility of LTTs at near 0 rates, and is it worth the extreme risk?

I noticed that some have suggested using 50% ITT instead of 25/25 Cash+LTT. I wouldn't do that or even propose it as I think it breaks the workings of the PP machine.

For different Interest rate environments:
High: Cash, TLT, IAU, VTI
Mid: Cash, TLH, IAU, VTI
Low: Cash, IEF, IAU, VTI

Of course you can backtest all of these, but the results would be totally meaningless considering the decreasing interest rates of the last 40 years.
This stuff is fun to talk about. Heck, I post here all the time but a couple of points.

The PP presumes we can not predict the future and it's components were selected based on historical data. It would be interesting to know if when HB's partner was backtesting this stuff how far back his bond market data went. If it went back to the 40s (which is plausible given treasury rate information has been public for a very long time) then rising interest rates were likely baked into the asset allocation recommendation. Philosophically/religiously almost the PP is about giving up the innate human need to predict/forecast. It's super hard to do. If it wasn't this part of the board (and probably the asset sections as well) should get maybe a couple of posts a year! Pretty much every new post is a speculation of the future in some form or fashion that then generates a discussion.

If any of us knew what interest rates were going to do, picking the correct bond length would be a no brainer. Rising interest rates, go to cash, falling interest rates buy the longest treasury bill/fund you can get...going nowhere/meandering, buy the highest interest bearing bond you can find.

As for ITTs and cash/LTTs it really is pretty much the same risk adjusted. With the mix you get higher performance and higher volatility than ITTs. I think the mix is preferable and especially so in the context of the rest of the PP's assets. If we were looking at the mix stand alone, then it would be the classic risk/reward trade off.
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Re: Maximum Bond Upside

Post by garya505 » Fri Aug 07, 2020 2:07 pm

I'm going to to out on a limb here and make some predictions/suggestions.
1. Interest rates could go up, but I have no idea if they will.
2. Interest rates could go down, but I have no idea if they will.
3. Interest rates could stay near 0 forever, but I have no idea if they will.
4. There is probably some practical limit to negative rates based on economic forces.
5. The PP doesn't need the extreme volatility of LTT at near-0 rates to work properly.
6. At near-0 interest rates, ITTs provide similar volatility to LTTs at higher rates. (see Tyler's chart)
7. A PP of 4x25 Cash/ITT/Gold/Stock would work nearly as well at near-0 rates, as a PP of 4x25 Cash/LTT/Gold/Stock works at higher rates.

I confess that I haven't read either of Harry's or Craig's books. Did they ever discuss any of this?
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Re: Maximum Bond Upside

Post by Smith1776 » Fri Aug 07, 2020 2:25 pm

garya505 wrote:
Fri Aug 07, 2020 2:07 pm

6. At near-0 interest rates, ITTs provide similar volatility to LTTs at higher rates. (see Tyler's chart)
This is true, but central bank policy makers tend to make relative rather than absolute changes in interest rates when tightening and loosening. That should ameliorate concerns generally about how rates would affect the PP. They're well aware that a 1% change when rates are low is a bigger relative move than when rates are high. Personally I don't worry about it too much.
I still find the James Rickards portfolio fascinating.
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Re: Maximum Bond Upside

Post by I Shrugged » Fri Aug 07, 2020 8:50 pm

I sure hope we don’t see LTT yields below 1%. It might not break the PP but it would sure test my resolve. Intuitively I think reducing the duration would not be of much real world benefit. This comment is worth what you paid for it.
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Re: Maximum Bond Upside

Post by Mark Leavy » Fri Aug 07, 2020 9:00 pm

Apropos of nothing, I have this weird disconnect with zero or negative interest rates.

A lifetime of math so I don't see "zero" as anything special. It is just one point on a number line continuum.

I started out at a very young age designing motor controllers for elevators, and zero velocity was just one transition point between going up and going down. The poor folks in the car probably felt that it was important, but it was just a smoothly differentiable position derivative to me. And it hasn't changed since then.

So, yea. There is a difference between up and down. But you couldn't tell it from the math. And my brain doesn't feel it.

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Re: Maximum Bond Upside

Post by PrimalToker » Fri Aug 07, 2020 9:44 pm

I remember in Harry Browne's radio show he mentioned LTT rates hit 1% or below during the great depression, and t-bills were negative. I believe a caller asked why would you buy negative rate bonds. Harry answered at the time banks were going bankrupt and were losing 100%, so if you only had to pay a percent to have a guarantee return of principal then it was worth the cost. You lose 1% when your neighbor lost 100%, not bad. I think he also noted your cash duration should be 1 year, because 3 month t-bills can go negative. I don't recall Harry talking long term being negative, only short term being mentioned about negative rates.
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Re: Maximum Bond Upside

Post by dualstow » Sat Aug 08, 2020 6:15 am

garya505 wrote:
Fri Aug 07, 2020 2:07 pm


7. A PP of 4x25 Cash/ITT/Gold/Stock would work nearly as well at near-0 rates, as a PP of 4x25 Cash/LTT/Gold/Stock works at higher rates.

I confess that I haven't read either of Harry's or Craig's books. Did they ever discuss any of this?
#7: In the books, probably not much, but a bullet of ITTs (versus a barbell of long bonds and cash) has come up many times over the years. If you do some searching, you’re sure to find discussions.
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Re: Maximum Bond Upside

Post by williswine » Sun Feb 28, 2021 7:21 pm

vnatale wrote:
Mon Apr 13, 2020 8:35 pm
craigr wrote:
Mon Feb 08, 2016 2:17 pm
Lang wrote: Switzerland's 50 year bond (to be precise, it's actually 48 years, due 2064) yield today fell to an all time low of 0.32%.

Yes, if you want to lend Switzerland money for the next 50 years, you're only going to get 0.32% interest per year.
Clearly at some point investors should just not be buying bonds.

In the case of the Permanent Portfolio, you'd have a hard time getting me to buy long term bonds under 1%. I say this knowing that it breaks the model. But I'd also say that 30 year bonds paying under 1% the risk is just far too high. 50 year bonds under 1% is an absurdly bad deal as well. Investors would be better in cash.
We do now have fairly recent evidence from Craig that he did drop this 1% threshold down to 0%!

Vinny
Revisiting older threads, like you Vinny. Where did you see that Craigr dropped his 1% threshold to 0%? Can you post a link?
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Re: Maximum Bond Upside

Post by vnatale » Sun Feb 28, 2021 7:44 pm

williswine wrote:
Sun Feb 28, 2021 7:21 pm

vnatale wrote:
Mon Apr 13, 2020 8:35 pm

craigr wrote:
Mon Feb 08, 2016 2:17 pm

Lang wrote:
Switzerland's 50 year bond (to be precise, it's actually 48 years, due 2064) yield today fell to an all time low of 0.32%.

Yes, if you want to lend Switzerland money for the next 50 years, you're only going to get 0.32% interest per year.


Clearly at some point investors should just not be buying bonds.

In the case of the Permanent Portfolio, you'd have a hard time getting me to buy long term bonds under 1%. I say this knowing that it breaks the model. But I'd also say that 30 year bonds paying under 1% the risk is just far too high. 50 year bonds under 1% is an absurdly bad deal as well. Investors would be better in cash.


We do now have fairly recent evidence from Craig that he did drop this 1% threshold down to 0%!

Vinny

Revisiting older threads, like you Vinny. Where did you see that Craigr dropped his 1% threshold to 0%? Can you post a link?


How about this one?

viewtopic.php?f=1&t=10446&p=187110#p187110
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Re: Maximum Bond Upside

Post by williswine » Sun Feb 28, 2021 7:53 pm

I see! Thank you Vinny!
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Re: Maximum Bond Upside

Post by vnatale » Thu Sep 09, 2021 1:37 pm

craigr wrote:
Thu Feb 11, 2016 9:51 pm

dualstow wrote:Any thoughts? Only that I'm in no position to criticize. Many's the time I considered the same, like every time TLT breaches 130. (I'm holding bonds directly, but TLT is a convenient and simple gauge). After Craig said he'd sell at 1%, I really got the bug.


FWIW. The reason I don't comment much on what I do is because I don't want people to blindly copy it.

Mostly though with unprecedented things going on with bonds, I just wanted to say that at some point you just have to take your chips and go home. Bonds are perhaps the only asset in the portfolio that the value risk vs. reward is pretty stark. Yields are what yields are and it's known what happens up or down as interest rates move. Gold doesn't have this indicator. Stocks don't either. Cash is cash and relatively stable and short interest rates moves can be waited out.

But again, with long bonds at 1% or less, the risk of holding them for me, is just not worth it. I bring up the issue now because I feel being quiet about it isn't doing any favors. You'll notice that I rarely ever comment on portfolio assets otherwise because mostly it's just noise. But long bonds below 1% is juggling nitroglycerin kind of risk in my mind and a horrible buy.

Again as others (and I) have pointed out. It's one thing to get out, but another to know when to get back in. I think it is safe to say though that bonds that are under 1% are probably not a hot buying opportunity and I'd avoid them regardless of portfolio theory. As when to get back in? I don't know. Again I haven't had to face this question yet. But I'll point out that people have been saying since 2008 that long bonds are a horrible idea and they've been wrong, wrong, wrong. So I could be joining that crowd if I sell out at 1%, but I'll just have to deal with that.

Hopefully Harry Browne will forgive me, but I think he'd be understanding when long bonds are paying 0.50% for 50 years that they aren't worth the risk. ;)


These are interesting times, guys. We could be witnessing the endgame for Keynesianism. The ultimate race to the bottom where mere mortals are all losers.


With long-term bond rates even lower 5 1/2 year later...I wonder if Craig was still active here what his thoughts would be today. Some of you still active here now were involved in this discussion during this time period.

How many times have we read mathjak telling us that we may be near the end of a 40 year bull market for long-term bonds?
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Re: Maximum Bond Upside

Post by Xan » Thu Sep 09, 2021 2:13 pm

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Re: Maximum Bond Upside

Post by dualstow » Thu Sep 09, 2021 3:59 pm

Wow. Negative rates don’t bother me that much, as I have stocked up on notes and bonds that will expire when I expire.
Taking away paper money- that bothers me. Off topic: Will we still be allowed to hoard gold?
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Re: Maximum Bond Upside

Post by Xan » Thu Sep 09, 2021 4:50 pm

dualstow wrote:
Thu Sep 09, 2021 3:59 pm
Wow. Negative rates don’t bother me that much, as I have stocked up on notes and bonds that will expire when I expire.
Taking away paper money- that bothers me. Off topic: Will we still be allowed to hoard gold?
Yes, killing cash would be ugly in many ways. I'm not sure it would have an impact on storing gold, though. Cash, yes!

Also as the article points out, negative rates (at least, deeply negative rates) have some really weird consequences. Down is up and up is down etc.
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Re: Maximum Bond Upside

Post by Mark Leavy » Thu Sep 09, 2021 7:42 pm

dualstow wrote:
Thu Sep 09, 2021 3:59 pm
Wow. Negative rates don’t bother me that much, as I have stocked up on notes and bonds that will expire when I expire.
Taking away paper money- that bothers me. Off topic: Will we still be allowed to hoard gold?
dual. I’m enjoying your increasing appreciation for physical gold. It’s not a panacea, but it has its uses. My mental model is ballast in a ship.
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Re: Maximum Bond Upside

Post by Smith1776 » Thu Sep 09, 2021 10:57 pm

Mark Leavy wrote:
Thu Sep 09, 2021 7:42 pm
dualstow wrote:
Thu Sep 09, 2021 3:59 pm
Wow. Negative rates don’t bother me that much, as I have stocked up on notes and bonds that will expire when I expire.
Taking away paper money- that bothers me. Off topic: Will we still be allowed to hoard gold?
dual. I’m enjoying your increasing appreciation for physical gold. It’s not a panacea, but it has its uses. My mental model is ballast in a ship.
And no ongoing expense ratio!
I still find the James Rickards portfolio fascinating.
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