Realistic Expectations for Long Bonds

Discussion of the Bond portion of the Permanent Portfolio

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barrett
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Realistic Expectations for Long Bonds

Post by barrett » Mon Mar 12, 2018 5:47 pm

Harry Browne used to talk about why owning four asset classes that perform well in different environments did not ultimately provide a return of zero. His reasoning was that a winner could increase several fold while a loser was unlikely to go to zero. Even if we just look at the last two decades, we can see that this thinking is clearly true for both gold in the 2000s and stocks so far in this decade.

Given a high enough starting point (in terms of yield) and a long enough time frame, 30-year treasuries could theoretically do the same thing (I believe that Craig and Medium Tex wrote in their book that long bonds actually outperformed stocks from 1981 to 2011).

My basic question here is, "What are realistic expectations for long-duration treasuries when starting from a yield of 3%?" I've seen a few posters on here write some version of, "I held my nose and bought some more bonds." I'm clearly not the only one who has issues with this quadrant of the PP.

While stocks can keep going up provided that earnings are increasing (and investors are willing to pay a certain P/E multiple), and gold will do very well in times of lack of faith in the USD, high inflation, etc., where are the extended gains in bonds currently supposed to come from?

We all know that long-duration treasuries saved the PP in 2008, BUT while their run up was quite dramatic at the very end of that year, it was not sustained. In fact, it really can't be beyond a certain point. There was actually a very short window to sell treasuries and buy stocks at the end of 2008. One not only had to be paying attention to their investments, but also had to get pretty lucky with their timing to really capitalize on this "flight to quality."

I've posted on here a couple of times (with very little interest, I have to say!) that long bonds with low yields seem to only benefit a PP if one is fairly active in buying them when yields are up and selling them when yields are down. Of course it's virtually impossible to get the timing right with any consistency, and this strategy would really only be effective if one bought and sold a large percentage of their bonds.

So, what ARE realistic expectations for long bonds at the moment?

Thanks in advance for any thoughts.
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Mon Mar 12, 2018 7:35 pm

LTT’s + Cash are the easiest to manipulate for peace of mind. Just increase or decrease cash to manage duration without removing one of the legs.

I recently bought LTT’s along with the other assets and this was easier than buying LTT’s alone.

I’ve struggled with this for a while and that’s how I resolved. YMMV.
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Re: Realistic Expectations for Long Bonds

Post by barrett » Tue Mar 13, 2018 7:06 am

buddtholomew wrote:LTT’s + Cash are the easiest to manipulate for peace of mind. Just increase or decrease cash to manage duration without removing one of the legs.

I recently bought LTT’s along with the other assets and this was easier than buying LTT’s alone.

I’ve struggled with this for a while and that’s how I resolved. YMMV.
All understood, but my question remains... what do you expect long bonds to do for your portfolio in, let's say, a best case scenario? Both stocks and gold can lift a PP for years, and have both had their day in the sun since 2000. I'm 59.5 and expect to live a long time. If gold has just one or two more good runs while I'm still on this planet, I'll feel that holding it during its long periods of underperformance will have been justified.

I started my PP at the beginning of 2014 with the long bond yield at about 3.75%, and the Fidelity website tells me that I am up 12.86% after yesterday. For whatever reason, Fidelity does not add in the coupon payments, but I've made probably another 15% on those. So I have a total nominal gain of around 28%. Not bad at all, but also not anything where I can take action and buy low or sell high unless I get lucky on the timing. I'm certainly not being forced to take action by a rebalancing band breach.

The standard response of "we hold long bonds for their volatility" just seems questionable to me given the unlikeliness that yields are going to plunge into negative territory for whatever reason. With yields hovering around 3%, I feel as if I am holding long bonds primarily for their yield, so the potential risk/reward doesn't seem worth it with rates on the short end of the curve being steadily pushed up by the Fed.

Why not just buy short duration issues?
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Tue Mar 13, 2018 8:39 am

We're in the same boat barrett, although my LTT gains were closer to 40%, now 15%.
As long as the portfolio is growing as a whole I am less inclined to remove one of the assets.
True that we may not re-balance out of treasuries anytime soon, but that isn't a reason to exclude them altogether.
Rates will rise and fall (not a straight line up) and with a 17+ year duration could outpace other assets in the years to come.
They're a better buy today than they were at 2.x%
No easy answers barrett other than to stick with the plan.
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Re: Realistic Expectations for Long Bonds

Post by Xan » Tue Mar 13, 2018 9:30 am

It does seem like bonds have a severely limited upside. But if we end up in a deflationary environment (see Japan) they could still be THE asset to own. Maybe they don't win nominally, but they sure can win in real terms.
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Re: Realistic Expectations for Long Bonds

Post by barrett » Tue Mar 13, 2018 10:09 am

Xan wrote:It does seem like bonds have a severely limited upside. But if we end up in a deflationary environment (see Japan) they could still be THE asset to own. Maybe they don't win nominally, but they sure can win in real terms.
Yeah, maybe you are right, Xan, but I guess I don't see the big opportunities in Japanese 30-year bonds either. This chart can be set to show the last 19-20 years of data (I wish it went back further but it's best one I found with a quick search):

https://tradingeconomics.com/japan/30-year-bond-yield

I guess if an investor bought at the absolute best times (the peaks) on that chart, and then held on to the bonds just for the interest payments and a bit of potential upside return from falling yields, the bonds would beat inflation most years... but only by a bit.

I'm just not seeing long bonds in the same league with stocks and gold in terms of upside potential. But they are clearly not cash, so what are they really? A second type of ballast?

I do hold them, but, after selling a property recently, I have what may be my last major chunk of cash to deploy (retirement looms). Just doing my due diligence/tire kicking.

Thanks so far for your replies.
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Re: Realistic Expectations for Long Bonds

Post by Hal » Wed Mar 14, 2018 5:26 am

barrett wrote:
Xan wrote:It does seem like bonds have a severely limited upside. But if we end up in a deflationary environment (see Japan) they could still be THE asset to own. Maybe they don't win nominally, but they sure can win in real terms.
. ................

I'm just not seeing long bonds in the same league with stocks and gold in terms of upside potential. But they are clearly not cash, so what are they really? A second type of ballast?

.
I must admit I have struggled with this as well......

So, here are my thoughts

Practice: Yes, in a Depression, the money supply shrinks. The base money stays the same but the "credit money" decreases. The value of the bond increases as does the value of the interest payments. Assuming the Government doesn't default, and they don't print money.
* Cough, except Australia defaulted, Cough... https://cuffelinks.com.au/australias-de ... ds-crisis/

Theory: Under our fiat currency system, cash is a debt instrument. ie. the Assets the Central Bank holds (eg. Gold, other Currencies etc) are offset by the Debt (currency) they issue. So a Government Bond is an IOU in which a debt instrument is lent to the Government. * My head hurts! *

I can follow it under a gold standard. I lend you a ton of gold, you give me an IOU (Bond) and pay me interest (extra gold) as payment for loaning it to you. After the bond matures I have more gold than before.

Anyway, back tp practicalities...

Classical Gold Standard. I cannot create more gold to increase the base money supply. Hence I cannot to counteract the decrease in "credit money"

Fiat Money System. I can increase the base money supply !

Here is the conundrum as I see it.

If the central bank does not create massive amounts of base money in a Depression, the HBPP works -> Bonds are good.
But if they do, both the bonds (which are like leveraged cash) and actual cash are destroyed. Cash ->Bad, Bonds -> Worse

And as a parting gift, listen to this talk on what Roosevelt did during the Depression (personally, I listen only to the presenters facts, NOT necessarily to all his conclusions). Think the Central Banks / Government would not print money if people were going hungry now ?

https://www.youtube.com/watch?v=jZVzA_ino7Q

And putting my money where my mouth is.....

I run a pure HBPP in my retirement fund, however I run a "Bondless" variant of the PP in my taxable account (and sleep better now ! )

Hal
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Re: Realistic Expectations for Long Bonds

Post by barrett » Wed Mar 14, 2018 2:16 pm

The more I rail against long bonds, the better they perform!
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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Wed Mar 14, 2018 4:09 pm

That's why I like the PP setup. It is forcing me to watch things like gold (never going up, until it did), bonds (down down down, until they didn't) and stocks (never a down day, until lately) and NOT DO ANYTHING STUPID! :D
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Re: Realistic Expectations for Long Bonds

Post by glennds » Wed Mar 14, 2018 6:08 pm

Let me get this straight... the discussion is among a group of believers in a defensive portfolio strategy built around the premise that nobody can predict the future.
And we are questioning one of the four components of that same portfolio because of our prognosis of the future?
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Re: Realistic Expectations for Long Bonds

Post by ochotona » Wed Mar 14, 2018 7:56 pm

glennds wrote:Let me get this straight... the discussion is among a group of believers in a defensive portfolio strategy built around the premise that nobody can predict the future.
And we are questioning one of the four components of that same portfolio because of our prognosis of the future?
Group of Believers? That sounds scary!
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Re: Realistic Expectations for Long Bonds

Post by stuper1 » Wed Mar 14, 2018 8:10 pm

I think the problem is that the PP hasn't really been tested in a situation where bond yields are on a long-term upward trend. The period prior to 1981 doesn't really count in my eyes because the U.S. was just coming off the gold standard, and the skyrocketing gold price helped the PP immensely. Nobody really knows whether the PP will be able to keep up satisfactorily against a long-term bond price-decline headwind.
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Re: Realistic Expectations for Long Bonds

Post by Hal » Wed Mar 14, 2018 8:57 pm

stuper1 wrote:I think the problem is that the PP hasn't really been tested in a situation where bond yields are on a long-term upward trend. The period prior to 1981 doesn't really count in my eyes because the U.S. was just coming off the gold standard, and the skyrocketing gold price helped the PP immensely. Nobody really knows whether the PP will be able to keep up satisfactorily against a long-term bond price-decline headwind.
Exactly !

That's why I like to understand the principles behind the PP (or any other portfolio method Eg: Bogle Portfolio), and just not blindly follow the method.
Have learnt so much since discovering Harry Browne.

What worked in the past may not work in the future - life is never predictable.
Eg; Father lived in Germany through WW2. No portfolio allocation would have been profitable. - Got out alive, he was happy.
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Re: Realistic Expectations for Long Bonds

Post by drumminj » Wed Mar 14, 2018 11:30 pm

Hal wrote:Father lived in Germany through WW2. No portfolio allocation would have been profitable. - Got out alive, he was happy.
I suspect physical gold, especially if held in another country, would have helped significantly?
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Re: Realistic Expectations for Long Bonds

Post by Hal » Thu Mar 15, 2018 4:29 am

drumminj wrote:
Hal wrote:Father lived in Germany through WW2. No portfolio allocation would have been profitable. - Got out alive, he was happy.
I suspect physical gold, especially if held in another country, would have helped significantly?
Agree with you there ! Not profitable, but definitely helpful.
Couldn't see him filling a bag full of German Long Duration Bonds would have been much use ;D

B.T.W, seeing this is a Bond Forum. What happened to the Bonds during the American Civil War? I believe the US went of the gold standard to greenbacks (fiat) at the same time
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Re: Realistic Expectations for Long Bonds

Post by barrett » Thu Mar 15, 2018 9:20 am

glennds wrote:Let me get this straight... the discussion is among a group of believers in a defensive portfolio strategy built around the premise that nobody can predict the future.
And we are questioning one of the four components of that same portfolio because of our prognosis of the future?
I think the discussion is more nuanced that than, glennds. We aren't really trying to predict the future... just discussing what bonds are capable of when starting from a base level of 3%. Also, I think Harry Browne would approve of discussions like this as even he did a lot of tweaking on his way to the 4X25 allocation.

I reread the bond section in Craig and MT's book last night. In addition to the great performance by bonds in 2008, they also highlighted their performance in 2011 when they went up 33% and the stock market was choppy, but ultimately flat, for the year. But in both of those cases, the run ups were short lived (meaning these are not multi-year trends). One of my contentions is that a PP investor has to look at their portfolio more than once a year, or risk missing the opportunity of rebalancing out of bonds when they are high. They have upside limits that just aren't the same as with stocks and gold.
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Re: Realistic Expectations for Long Bonds

Post by glennds » Thu Mar 15, 2018 9:45 am

barrett wrote:
glennds wrote:Let me get this straight... the discussion is among a group of believers in a defensive portfolio strategy built around the premise that nobody can predict the future.
And we are questioning one of the four components of that same portfolio because of our prognosis of the future?
I think the discussion is more nuanced that than, glennds. We aren't really trying to predict the future... just discussing what bonds are capable of when starting from a base level of 3%. Also, I think Harry Browne would approve of discussions like this as even he did a lot of tweaking on his way to the 4X25 allocation.

I reread the bond section in Craig and MT's book last night. In addition to the great performance by bonds in 2008, they also highlighted their performance in 2011 when they went up 33% and the stock market was choppy, but ultimately flat, for the year. But in both of those cases, the run ups were short lived (meaning these are not multi-year trends). One of my contentions is that a PP investor has to look at their portfolio more than once a year, or risk missing the opportunity of rebalancing out of bonds when they are high. They have upside limits that just aren't the same as with stocks and gold.
Very fair and valid points!
Help out a simpleton (me) here - could the analysis be less binary that interest rate outlook=bond performance? Might there be other unpredictable factors that could influence the bond market one way or another? Examples - market forces of supply and demand brought about by: flight to safety, comparatively less attractive alternatives elsewhere, economic conditions as HB outlined? Or perhaps other reasons capital might tend to flow from one asset class to another. Maybe you buy the dog because it suddenly has less fleas than the one you currently own. Sometimes I think of those times when I'm driving on the highway, my speed doesn't change, but suddenly it seems like I'm going faster simply because everyone else is going slower. In relative terms I'm now outperforming (in speed) even though I haven't changed.

On a partially unrelated note, I think there may be much more influence in the T30 market today than there was in HB's time, as a result of foreign government purchasing, sovereign wealth funds, and other massive buyers. Granted it's a huge market but I wonder if the size of the holdings and sheer buying volume of these institutional and governmental buyers isn't a material influence, and possible distortion, all on it's own. If there's any merit to this observation, then what's a little HBPP fella to do if such forces restrict the protective features of the one asset class from pulling the load when you need it?

Thanks in advance for any insight on either of these two points,
glennds
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Re: Realistic Expectations for Long Bonds

Post by buddtholomew » Thu Mar 15, 2018 12:34 pm

Theoretically LTT’s have a ceiling at 0%, but in practice fixed income investments can have -ve yields. Is that realistic to expect, I don’t know.
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Re: Realistic Expectations for Long Bonds

Post by dualstow » Thu Mar 15, 2018 2:50 pm

barrett wrote: So, what ARE realistic expectations for long bonds at the moment?
Great question, barrett. I know less than you, which is why I haven't had much to say.
I recently decided not to buy any new long bonds, but I haven't sold any either. I've got some reaching their "best before" date in 2020, where "best before" = only 20 years left on them.

Instead, I may put new money toward gold, an asset that I have also previously thought about not adding to. :-) That's my own situation. Because of the vp, gold is nowhere near 25% of my total holdings (but it *is* 25% of my pp).
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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Thu Mar 15, 2018 4:14 pm

I've asked before, without any answers I understand:

--Why are US long treasuries at such a higher interest rate than various European and Asian countries? Only European country with a higher yield is Greece! I would think the US should be the lowest of virtually anywhere except what, Japan and Germany?

--So looking at it this way, I would say US bonds still have a better than 50/50 chance of increasing in value and dropping yield.

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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Fri Mar 16, 2018 2:43 pm

And this from Mish:

https://www.themaven.net/mishtalk/econo ... z2PU_1Jx9Q

Takeaway:

Debt Deflation Coming Up

I expect another round of asset-based deflation with consumer prices and US treasury yields to follow.

Buy long-term treasury calls or long-duration Treasury ETFs.

The higher rates get, the better those calls and ETFs look, even if we do not hit convergence.
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Re: Realistic Expectations for Long Bonds

Post by ochotona » Fri Mar 16, 2018 2:46 pm

Having taken tax losses from bonds, I am going to rebuy them after the 30 day period is over. Thank you interest rate demigods for the little tax loss.
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Re: Realistic Expectations for Long Bonds

Post by dualstow » Fri Mar 16, 2018 2:52 pm

ochotona wrote:...
Thank you interest rate demigods
...
How about the bond vigilantes?
https://en.wikipedia.org/wiki/Bond_vigilante
✓ I should put them in my sig.
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Re: Realistic Expectations for Long Bonds

Post by barrett » Sat Mar 17, 2018 7:30 am

Cortopassi wrote:I've asked before, without any answers I understand:

--Why are US long treasuries at such a higher interest rate than various European and Asian countries? Only European country with a higher yield is Greece! I would think the US should be the lowest of virtually anywhere except what, Japan and Germany?

--So looking at it this way, I would say US bonds still have a better than 50/50 chance of increasing in value and dropping yield.
Hey Cortopassi,

I put your question to a high school friend of mine who works for Pimco. Here is his response:


There is a lot underneath your question. Intl Govt Bond yields are impacted by:
Inflation Expectations in each country
Growth Expectations in each country
Short Term borrowing rates in each country
Perceived safe haven status
Central Bank bond buying actions (known as QE)
Currency expectations
Amount of debt issuance

All of these are in play in the answer today. But I do not have time to type a whole book. A few key points for now:

-US deficits will be growing due to new tax law; there needs to be more US treasury issuance to accommodate; more issuance (supply) means price goes down (and yield goes up)

- Foreign governments are still VERY active in QE; ECB continues to buy almost $60 billion per month; Japan’s MOF keeps 10 year yields at 0% by mandate and buys whenever they rise to 0.10% and sells whenever they reach -0.10%; for a few years, German Bunds were negative yields too as everyone was afraid to keep money in the banks, they all bought Bunds

- a more regular impact is from short rates in each country; when an institutional investor buys a Euro Gov’t Bond, they must sell dollars, buy euros, then buy the bond; many do this as a financed trade, so calculation must include borrowing in Euro with short rate (detractor) from return; and receiving short US rates

Lastly today has an interesting twist. One would think with the much higher US rates, the currency would be doing well (it hasn’t). This conundrum is discussed in a short blog on our website pimco.com from Mohsen Fahmi.


This is me writing again. My guess would have been that the yield disparity between countries was mostly a result of currency risk. I guess that is only one factor but it's pretty easy to imagine that a person living in Europe, say, and buying US bond yielding 3% annually, could get hammered by a 5-10% drop in the Euro.
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Re: Realistic Expectations for Long Bonds

Post by Cortopassi » Sat Mar 17, 2018 9:29 am

Thanks, Barrett!
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