Are bonds the Maginot Line of Modern Investing?

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betablocker
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Are bonds the Maginot Line of Modern Investing?

Post by betablocker » Fri Oct 19, 2018 8:04 am

Good read from Matt Topley about some comments by Jeremy Schwartz https://matttopley.com/topleys-top-ten-october-19-2018/. It's a truism that generals fight the last war and that investors prepare for the last down turn. I think we underestimate the chance of a 1970s type scenario where both bonds and stocks fall in real terms for a prolonged period. It's been so long that we all forget or in my case never remember. This is one of the dangers of the 3 fund portfolio and why I've chosen to incorporate factors, commodities, and a few carefully selected alternative investments in my portfolio. I wouldn't say the scenario is likely but certainly possible given inflationary pressures mounting. From my discussions with business owners across the country labor (particularly of the minimum wage variety) is scarce and they are turning down large amounts of business in industries as diverse as manufacturing. lawn care, home heath, etc. It's of course anecdotal evidence but I think we are foolish to think that strategies that have worked for 30 years will necessarily duplicate their performance in the next 30. They could but we certainly have evidence that they couldn't. Are bonds the Maginot line of modern investing?

Valuethinker
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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Fri Oct 19, 2018 8:27 am

betablocker wrote:
Fri Oct 19, 2018 8:04 am
Good read from Matt Topley about some comments by Jeremy Schwartz https://matttopley.com/topleys-top-ten-october-19-2018/. It's a truism that generals fight the last war and that investors prepare for the last down turn. I think we underestimate the chance of a 1970s type scenario where both bonds and stocks fall in real terms for a prolonged period. It's been so long that we all forget or in my case never remember. This is one of the dangers of the 3 fund portfolio and why I've chosen to incorporate factors, commodities, and a few carefully selected alternative investments in my portfolio. I wouldn't say the scenario is likely but certainly possible given inflationary pressures mounting. From my discussions with business owners across the country labor (particularly of the minimum wage variety) is scarce and they are turning down large amounts of business in industries as diverse as manufacturing. lawn care, home heath, etc. It's of course anecdotal evidence but I think we are foolish to think that strategies that have worked for 30 years will necessarily duplicate their performance in the next 30. They could but we certainly have evidence that they couldn't. Are bonds the Maginot line of modern investing?
The Maginot Line story is not what people think it was. The line was built in the late 1920s early 1930s, and had that money been spent on warplanes and aircraft, they would have been hopelessly obsolete in 1940.

As a defensive strategy, the Maginot Line served its purpose - the Germans made no significant advances on that front and the line served its protection purpose. The problem was for political reasons it did not cover the Belgian border, and it was assumed that the Germans would not be able to attack through the Ardennes Forest.

Had a German plane not crashed in Belgium with the original 1940 plan, the Germans would have gone into Belgium and run smack into well prepared British and French troops - and quite possibly been bogged down, just as they were in 1914. However they knew their secrecy had been compromised, and the original plan was jettisoned by Hitler and replaced with the Von Manstein plan - not to drive on Paris, but to sweep through the Ardennes and turn right (rather than left) and drive for the Channel to cut off the Allied forces in Belgium. That succeeded brilliantly, and Hitler came to completely trust his own intuition rather than the more formal military analysis of his generals. That would lead Nazi Germany to disaster and eventual defeat in Russia. Churchill had a similar tendency, which could be just as destructive, but Churchill was not the Supreme Commander of his forces, the mechanism of the War Cabinet reigned in many of his wilder ideas. FDR, a much shrewder strategic mind in my view, (taking strategy as the highest level of politico-military thinking), let General Marshall carry much of the weight, except for the biggest politico-military decisions (Germany first etc). The Americans also had the advantage of having 2 years post 1939 to think about the strategic situation without being directly engaged. The downside of that was it meant letting Admiral King run his own war, and later General MacArthur as well, but the Americans had the resources to do that (mostly) except for some key shortages (LSTs - landing ships in particular).

A "Maginot Line Mentality" is short form for a line of thinking that does not reflect a changed reality. The French High Command was guilty of that in 1940 but the Maginot Line itself does not deserve the opprobrium attached to it.

Over to bonds.

Who really knows? Japan would be another possible future.

The Fed seems very alert to signs of rising inflation. Through the Fed System the governors of the regional Feds hear directly from local businesses.

Barring overt political interference, the Fed is unlikely to let inflation get too far ahead of the curve. Some kind of geopolitical event in the Gulf, that sent oil shooting to $200/ bl, might have a bad effect.

If employers as a result invest in labour saving technologies or hire workers who are traditionally harder to employ, that may control the degree of wage inflation. For every job Amazon creates, I suspect traditional bricks-and-mortar retailers are losing 3.

Nonetheless, I believe most investors (US) should have up to half their bond weighting in TIPS bonds. And that USians should generally buy the maximum number of ibonds they are allowed, every year (assuming other investing priorities are met).

Inflation may be a risk the market is insufficiently discounting, however that would probably be manifested as stronger, sooner, Fed action than otherwise and perhaps than the market expects.

betablocker
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Re: Are bonds the Maginot Line of Modern Investing?

Post by betablocker » Fri Oct 19, 2018 8:33 am

Thanks for the clarification on the Maginot Line history. It makes the point exactly. The Ardennes are bonds. I'm not sure TIPS will really offset inflation. It's relatively untested and there is some evidence they might not work that well. I'm not saying we should all for 50% into gold or start being perma-bears but I think it's just a good reminder to diversify more than the 3 fund. Factors, reinsurance, alt lending, bonds, stocks, etc. and any new products that add additional diversification at a reasonable price with a decent expected return.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by goblue100 » Fri Oct 19, 2018 8:36 am

Nice read by Valuethinker. I've always been interested in WW II history, but couldn't have summed up the war as nicely as he did.

I thought the reasons we are Bogleheads is we don't have to worry about that which is unknowable? I don't believe anyone here knows what the next disaster is going to be, because unless time travel has been invented it is unknowable. I mean, who predicted the World Trade center being brought down as the cause of the 2001 crash? Ahead of time, I mean.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by bottlecap » Fri Oct 19, 2018 8:47 am

I agree that the Maginot Line is falsely attributed a negative connotation. It worked as it should have. The rest of the Allied thinking and strategy was what was out of date. Still, the German plan was risky, and had to be risky, in part due to the Maginot Line. That it succeeded was not because of the Maginot Line.

It’s a certainty that the Fed will do something wrong or create a situation that cannot continue, assuming it already hasn’t. It is impossible for us to know how or when it will manifest itself. I don’t think there is a reliable long term alternative to bonds for safety.

JT

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Re: Are bonds the Maginot Line of Modern Investing?

Post by DartThrower » Fri Oct 19, 2018 8:49 am

Isn't it also true that we've never been in an economy where the Fed has had to unwind QE? As that happens what impact will that have on intermediate and long term rates? Right now the yield curve is pretty flat so perhaps short term bonds would be a good idea.

By the way, kudos to Valuethinker for such a well thought-out reply. Posts like that are what make this site so great.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by GammaPoint » Fri Oct 19, 2018 9:12 am

Valuethinker wrote:
Fri Oct 19, 2018 8:27 am
Nonetheless, I believe most investors (US) should have up to half their bond weighting in TIPS bonds. And that USians should generally buy the maximum number of ibonds they are allowed, every year (assuming other investing priorities are met).
I personally own no Series I bonds. I'm not sure if that's ideal or not, and I appreciate you putting it back on my radar for me to consider. When I first joined the BHs a decade ago, I didn't have the investment funds to fill up tax advantaged space, but now that I do, I should probably reconsider this.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by warner25 » Fri Oct 19, 2018 9:39 am

goblue100 wrote:
Fri Oct 19, 2018 8:36 am
I mean, who predicted the World Trade center being brought down as the cause of the 2001 crash?
While we're debunking myths... I've seen this casually mentioned a few times on this forum, but I don't think there's much evidence to associate 9/11 with a crash. S&P 500 earnings and the value of the index peaked more than a year before 9/11, with earnings multiples that clearly demonstrated a bubble of historical proportions (in retrospect, of course). The crash was nearly complete by the time 9/11 happened, and the S&P 500 actually went up for six months after 9/11 before continuing to the bottom.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Fri Oct 19, 2018 9:44 am

goblue100 wrote:
Fri Oct 19, 2018 8:36 am
Nice read by Valuethinker. I've always been interested in WW II history, but couldn't have summed up the war as nicely as he did.

I thought the reasons we are Bogleheads is we don't have to worry about that which is unknowable? I don't believe anyone here knows what the next disaster is going to be, because unless time travel has been invented it is unknowable. I mean, who predicted the World Trade center being brought down as the cause of the 2001 crash? Ahead of time, I mean.
On the latter the signs were all there - Saudi nationals taking pilot training (FBI was warned) but not interested in landing procedures; attempt to ram a plane into a major landmark (terrorist hijacking of an Air France plane and the Eiffel Tower); obsession with WTC which had been bombed before with an attack that tried to collapse it; known AQ operatives scouting in the USA (CIA knew that but would not identify them to the FBI); AQ attacks (the USS Cole in Yemen). And then the final terrifying "going dark" as AQ shut down its communication channels - like the radio silence of the Japanese fleet sailing towards Pearl Harbor, and the radio silence of its planes on the way to the sleeping base until the radio signal "Banzai" as they turned and dove out of the sun on the unsuspecting sailors*. But no one "connected the dots" in the intelligence community and they were not believed at the highest level ("bin Ladin determined to strike the USA"). It's all in Lawrence Wright's book and in the Presidential Commission report.

The dot com bust had long and truly started. The market peaked in late April 2000 with the flotation of Last Minute dot com and early May with the Barons' article about cash burn in dot coms.

In some ways, because it unleashed the floodgates of government spending, 2001 marked the nadir - although the bear market would go on for another 18 months, until March 2003. I'd have to look up the dates of the actual recession.

Taleb talks about "Black Swans" and Mandelbrot about distributions without a mean and a variance. And there's "fat tails".

That's really what this is about, in the end. Stocks pay these amazing high returns because they have these risks associated with them - no free lunch.

The problem is we have finite lives in an infinite world. A shock to our wealth can permanently lower our consumption - we don't have time to wait for the stock market to recover. Thus low risk assets are overpriced, and risky assets are underpriced. But knowing that doesn't help you if you are planning to retire in the next 10 years (or 30 years, or 100 years).

* I may have invented that latter, or vaguely remember it from "Tora, Tora, Tora".
Last edited by Valuethinker on Fri Oct 19, 2018 9:52 am, edited 1 time in total.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Fri Oct 19, 2018 9:46 am

warner25 wrote:
Fri Oct 19, 2018 9:39 am
goblue100 wrote:
Fri Oct 19, 2018 8:36 am
I mean, who predicted the World Trade center being brought down as the cause of the 2001 crash?
While we're debunking myths... I've seen this casually mentioned a few times on this forum, but I don't think there's much evidence to associate 9/11 with a crash. S&P 500 earnings and the value of the index peaked more than a year before 9/11, with earnings multiples that clearly demonstrated a bubble of historical proportions (in retrospect, of course). The crash was nearly complete by the time 9/11 happened, and the S&P 500 actually went up for six months after 9/11 before continuing to the bottom.
Quite. We are conflating events in our minds - nearly 18 years ago.

It's a good point. The bear market was already well and truly in full bear mode.

In some ways 9-11 caused the final awful emotional blow off.

I had forgotten that S&P 500 then rallied, and then went back down again - I think that latter move was about the recession? 9-11 didn't seem to cause a huge blip in the trend for the US economy.

What it did do was define my generation as surely as President Kennedy's assassination - to the end of their days, people would remember what step of what building they were on when they heard the news. For my generation I can tell you where I was and what I was doing -- and I think most people aged 20-50 then can tell you that. The clock of history seemed to have paused, and then moved to the next second with a giant tick-tock - History woke up.

For my parents parents it was probably "War declared" in 1914, and "Armistice" on November 11, 1918 at 11 am. And then Prime Minister Chamberlain announcing that the Germans had refused to withdraw from Poland in September 1939 and we were once more at war (for Americans, FDR on the radio after Pearl Harbor).
Last edited by Valuethinker on Fri Oct 19, 2018 9:58 am, edited 1 time in total.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by nedsaid » Fri Oct 19, 2018 9:58 am

betablocker wrote:
Fri Oct 19, 2018 8:04 am
Good read from Matt Topley about some comments by Jeremy Schwartz https://matttopley.com/topleys-top-ten-october-19-2018/. It's a truism that generals fight the last war and that investors prepare for the last down turn. I think we underestimate the chance of a 1970s type scenario where both bonds and stocks fall in real terms for a prolonged period. It's been so long that we all forget or in my case never remember. This is one of the dangers of the 3 fund portfolio and why I've chosen to incorporate factors, commodities, and a few carefully selected alternative investments in my portfolio. I wouldn't say the scenario is likely but certainly possible given inflationary pressures mounting. From my discussions with business owners across the country labor (particularly of the minimum wage variety) is scarce and they are turning down large amounts of business in industries as diverse as manufacturing. lawn care, home heath, etc. It's of course anecdotal evidence but I think we are foolish to think that strategies that have worked for 30 years will necessarily duplicate their performance in the next 30. They could but we certainly have evidence that they couldn't. Are bonds the Maginot line of modern investing?
If you are saying that we might have a replay of the 1970's replay of Stagflation, it sounds to me like you are making a case for TIPS.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by nedsaid » Fri Oct 19, 2018 10:14 am

Valuethinker, my understanding was that the French loss in World War II had much to do with tactics. My understanding is that the French tanks were actually better than the German ones but that the Germans massed their tanks in Armored Divisions whereas the French spread the tanks out among the infantry. The Germans also had perfected their Blitzkreig tactics which relied upon massed armor, speed, and support from the air particularly from the Stukas. As you said, the Germans smashing through the Ardennes and then heading for the Channel was not expected by the Allies.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by goblue100 » Fri Oct 19, 2018 10:15 am

Yes, I guess I need to fess up on "misremembering " history. I guess using 9/11 as a proxy for the unknowable tides of history that can affect generations wasn't the best example. Still, I suspect it deepened that which was already in progress.
Sounds like we are starting to expect unexpected inflation? I have about 25% of my bond allocation in TIPS. I looked briefly at I-Bonds, but never bought any. Any reason that they are superior to TIPS?
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Re: Are bonds the Maginot Line of Modern Investing?

Post by HomerJ » Fri Oct 19, 2018 10:20 am

I do agree that inflation is something to worry about.

It's the one thing I'm not fully prepared for, and the only thing I still somewhat worry about.

I think a short-term bond fund, or a short-term CD ladder offers some protection again inflation, correct?

We do buy $10,000 of i-bonds every year. And I probably should invest some in TIPS.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by nedsaid » Fri Oct 19, 2018 10:38 am

HomerJ wrote:
Fri Oct 19, 2018 10:20 am
I do agree that inflation is something to worry about.

It's the one thing I'm not fully prepared for, and the only thing I still somewhat worry about.

I think a short-term bond fund, or a short-term CD ladder offers some protection again inflation, correct?

We do buy $10,000 of i-bonds every year. And I probably should invest some in TIPS.
Since I overcame my ultra-conservative ways as a young investor, I have regarded inflation as public enemy number one. Even mild 2% inflation will erode the purchasing power of a dollar by 22% over a decade. This is why, unlike other Bogleheads, I didn't give up on REITs and I didn't give up on TIPS.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by betablocker » Fri Oct 19, 2018 10:50 am

One issue I have with TIPS is that it is linked to federal measures of inflation and I don't think they accurate reflect increases in costs in HCOL areas particularly with college education, health care, and real estate.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Oicuryy » Fri Oct 19, 2018 10:51 am

Those interested in history and 1970s inflation might enjoy this article.
Arthur Burns and Inflation

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Re: Are bonds the Maginot Line of Modern Investing?

Post by rich126 » Fri Oct 19, 2018 11:01 am

DartThrower wrote:
Fri Oct 19, 2018 8:49 am
Isn't it also true that we've never been in an economy where the Fed has had to unwind QE? As that happens what impact will that have on intermediate and long term rates? Right now the yield curve is pretty flat so perhaps short term bonds would be a good idea.

By the way, kudos to Valuethinker for such a well thought-out reply. Posts like that are what make this site so great.
I think that is true (regards to QE). It is a big unknown. You also have a rapidly growing debt which no one really wants to try and fix since it doesn't help them win at the ballot box.

I also have my doubts with TIPs.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by letsgobobby » Fri Oct 19, 2018 11:09 am

betablocker wrote:
Fri Oct 19, 2018 8:04 am
Good read from Matt Topley about some comments by Jeremy Schwartz https://matttopley.com/topleys-top-ten-october-19-2018/. It's a truism that generals fight the last war and that investors prepare for the last down turn. I think we underestimate the chance of a 1970s type scenario where both bonds and stocks fall in real terms for a prolonged period. It's been so long that we all forget or in my case never remember. This is one of the dangers of the 3 fund portfolio and why I've chosen to incorporate factors, commodities, and a few carefully selected alternative investments in my portfolio. I wouldn't say the scenario is likely but certainly possible given inflationary pressures mounting. From my discussions with business owners across the country labor (particularly of the minimum wage variety) is scarce and they are turning down large amounts of business in industries as diverse as manufacturing. lawn care, home heath, etc. It's of course anecdotal evidence but I think we are foolish to think that strategies that have worked for 30 years will necessarily duplicate their performance in the next 30. They could but we certainly have evidence that they couldn't. Are bonds the Maginot line of modern investing?
I agree it is a risk that many discount. There are many others, like a prolonged downturn in all assets with no rapid recovery, driven by outrageous indebtedness. My solution is also to diversify. I hold bonds, but very diverse with an overall short duration. High exposure to international, unhedged.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by frugalecon » Fri Oct 19, 2018 11:23 am

The problem I have had with Series I savings bonds has been that, at their annual fixed rate, they seem to offer guaranteed inflation-adjusted after-tax loss of wealth. The fixed rate just doesn't make up for the Federal tax I would need to pay upon selling them. Am I missing something?

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Fri Oct 19, 2018 11:30 am

nedsaid wrote:
Fri Oct 19, 2018 10:14 am
Valuethinker, my understanding was that the French loss in World War II had much to do with tactics. My understanding is that the French tanks were actually better than the German ones but that the Germans massed their tanks in Armored Divisions whereas the French spread the tanks out among the infantry. The Germans also had perfected their Blitzkreig tactics which relied upon massed armor, speed, and support from the air particularly from the Stukas. As you said, the Germans smashing through the Ardennes and then heading for the Channel was not expected by the Allies.
Between tactics and strategy (and Grand Strategy - which is the sort of Roosevelt- Marshall - Stalin - Churchill level) there is the Operational art.

It is something that the Russians have always paid a lot of attention to, but wasn't really taught (I don't think) in Anglo Saxon military colleges.

So, was it tactics? Or was it at the Operational level? Was it how the individual platoons companies and battalions fought, or was it how the armies the divisions and corps moved to and organized for battle?

Yes to both. The British had experimented with combined arms tactics & operations in the early 1930s but Army politics then led to that being dropped -- the Germans had watched avidly those manoeuvres. (And the Royal Air Force was the first independent Air Force, and focused on strategic bombing as a way to preserve its independence; rather than the close support mission the Luftwaffe was targetted with). France just froze in the mud (or concrete ;-)) . De Gaulle was associated with the move to an independent armoured force, but also with some very right wing politics (as was JFC Fuller the British general associated with mobile warfare theories) - in a society as badly divided politically and socially as interwar France (down to, literally, killing each other in the streets) -- that was poison to military reform.

And armoured forces in French and British armies, coming out of a cavalry tradition, focused on pure tank units. Whereas the Germans integrated infantry, anti tank, close air support etc. The key to armoured tactics was to go on the defensive behind a shield of anti tank guns when encountering the enemy armoured forces. Rommel did that brilliantly in the Western Desert (having learned to do it when the British counterattacked him at Arras in France, with tanks (Matildas) with armour so thick the German shells bounced off them - it was the one moment when the Germans were truly afraid their gamble would fail)*.

The other great innovators were the Red Army (who had helped the Germans train with tanks when it was still illegal for Germany to have tanks). But Stalin then staged the Great Purge, starting in 1937, and wiped out the entire senior officer corps of the Red Army (except for a handful of cavalry generals who had fought with him against the Poles in 1921). Set the Red Army back 5 years if not 10.

* someone once said God created Belgium so that Germany and France would have a battleground to settle their differences. The British counterattack at Arras mustered in the shadow of the Canadian War Monument at Vimy Ridge (1917), and I have little doubt the ghosts of Marlborough and some of Louis XIV's generals were there.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by HomerJ » Fri Oct 19, 2018 11:44 am

rich126 wrote:
Fri Oct 19, 2018 11:01 am
You also have a rapidly growing debt which no one really wants to try and fix since it doesn't help them win at the ballot box.
The easiest way to fix the debt (for politicians) is to inflate it away.

But obviously, hyper-inflation would be bad. But a nice steady inflation will definitely help with debt.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by letsgobobby » Fri Oct 19, 2018 12:08 pm

HomerJ wrote:
Fri Oct 19, 2018 11:44 am
rich126 wrote:
Fri Oct 19, 2018 11:01 am
You also have a rapidly growing debt which no one really wants to try and fix since it doesn't help them win at the ballot box.
The easiest way to fix the debt (for politicians) is to inflate it away.

But obviously, hyper-inflation would be bad. But a nice steady inflation will definitely help with debt.
Not really, since most of our structural deficits areinflation linked (SS, Medicare in particular)

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Dottie57 » Fri Oct 19, 2018 12:39 pm

Valuethinker wrote:
Fri Oct 19, 2018 9:46 am
warner25 wrote:
Fri Oct 19, 2018 9:39 am
goblue100 wrote:
Fri Oct 19, 2018 8:36 am
I mean, who predicted the World Trade center being brought down as the cause of the 2001 crash?
While we're debunking myths... I've seen this casually mentioned a few times on this forum, but I don't think there's much evidence to associate 9/11 with a crash. S&P 500 earnings and the value of the index peaked more than a year before 9/11, with earnings multiples that clearly demonstrated a bubble of historical proportions (in retrospect, of course). The crash was nearly complete by the time 9/11 happened, and the S&P 500 actually went up for six months after 9/11 before continuing to the bottom.
Quite. We are conflating events in our minds - nearly 18 years ago.

It's a good point. The bear market was already well and truly in full bear mode.

In some ways 9-11 caused the final awful emotional blow off.

I had forgotten that S&P 500 then rallied, and then went back down again - I think that latter move was about the recession? 9-11 didn't seem to cause a huge blip in the trend for the US economy.

What it did do was define my generation as surely as President Kennedy's assassination - to the end of their days, people would remember what step of what building they were on when they heard the news. For my generation I can tell you where I was and what I was doing -- and I think most people aged 20-50 then can tell you that. The clock of history seemed to have paused, and then moved to the next second with a giant tick-tock - History woke up.

For my parents parents it was probably "War declared" in 1914, and "Armistice" on November 11, 1918 at 11 am. And then Prime Minister Chamberlain announcing that the Germans had refused to withdraw from Poland in September 1939 and we were once more at war (for Americans, FDR on the radio after Pearl Harbor).
From my perspective, 9/11 generated fear and a lot of it. All planes grounded. Silence in the skies was deafening. My brother and a neighbor sat outside drinking a beer and watching the U.S. fighter planes occasionally passing overhead.

Fear is not good for the market. Which is probably why I remember 9/11 as the beginning of bear market.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by MarkRoulo » Fri Oct 19, 2018 1:19 pm

betablocker wrote:
Fri Oct 19, 2018 8:33 am
...I think it's just a good reminder to diversify more than the 3 fund. Factors, reinsurance, alt lending, bonds, stocks, etc. and any new products that add additional diversification at a reasonable price with a decent expected return.
The tricky bit is 'decent expected return.' I still have some marketing literature on Managed Futures from the 1990s. The expected/projected returns were stock-like, but uncorrelated. I haven't tracked over the last 20 years, but I *think* that your typical CCF fund has done poorly? Money poured in and instead of the investors being paid to take risk (ie, acting as insurance companies), they were instead paying to take risk.

I also remember viatical investments as a thing. Today, not so much.

Timber was a thing in the 1990s. I worked with someone who had a number of acres of some sort of tree that would mature in 20-30 years (I'm going from memory). I don't know how this has turned out. Maybe well? The pitch was, as it often is, stock-like returns, low correlation to the stock market (and with timber, and inflation hedge).

Some of us are skeptical about these new-fangled products because (a) we've seen new-fangled products before and they often didn't perform as well going forward as they did restrospectivly, and (b) we remember that we get the ones left over after the professionals and their lawyers get first dibs.

This doesn't mean that they are rejected automatically. The US treasury started selling iBonds in 1998 (?) and when I found out about them (1999), I took the plunge and purchased some (in 2000 and 2001). I felt that I understood how they were supposed to work, didn't need to worry about sampling and backtesting and wasn't competing with Wall Street for who got 1st dibs.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Fri Oct 19, 2018 4:16 pm

MarkRoulo wrote:
Fri Oct 19, 2018 1:19 pm
betablocker wrote:
Fri Oct 19, 2018 8:33 am
...I think it's just a good reminder to diversify more than the 3 fund. Factors, reinsurance, alt lending, bonds, stocks, etc. and any new products that add additional diversification at a reasonable price with a decent expected return.
The tricky bit is 'decent expected return.' I still have some marketing literature on Managed Futures from the 1990s. The expected/projected returns were stock-like, but uncorrelated. I haven't tracked over the last 20 years, but I *think* that your typical CCF fund has done poorly? Money poured in and instead of the investors being paid to take risk (ie, acting as insurance companies), they were instead paying to take risk.

I also remember viatical investments as a thing. Today, not so much.

Timber was a thing in the 1990s. I worked with someone who had a number of acres of some sort of tree that would mature in 20-30 years (I'm going from memory). I don't know how this has turned out. Maybe well? The pitch was, as it often is, stock-like returns, low correlation to the stock market (and with timber, and inflation hedge).

Some of us are skeptical about these new-fangled products because (a) we've seen new-fangled products before and they often didn't perform as well going forward as they did restrospectivly, and (b) we remember that we get the ones left over after the professionals and their lawyers get first dibs.

This doesn't mean that they are rejected automatically. The US treasury started selling iBonds in 1998 (?) and when I found out about them (1999), I took the plunge and purchased some (in 2000 and 2001). I felt that I understood how they were supposed to work, didn't need to worry about sampling and backtesting and wasn't competing with Wall Street for who got 1st dibs.
There was a thread 're timber this last week or do. Turns out it has done quite poorly. Prices still below 2008. Local sawmill s dont even want the wood.

Inflation linked bonds are nothing new in this world.

US was late to the party. "Newfangled " only to Americans.

Not so to Canadians Brazilians British Israelis French etc.

Of course American ones are somewhat better than most others because they redeem at 100 even if there is deflation.

A Canadian pension fund, one of the world's largest after CALPERS, Ontario Teachers (100 something billion) loaded up on 4% TIPS after the Canadian government legally prevented it from buying so many of the Canadian equivalent. They did well out of US taxpayers on that trade;-)

Btw Robert Shiller found an inflation linked bond from US revolutionary war days so it's not even that new in America.

Commercial Real Estate is also seen as a good inflation hedge. Better than stocks.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by fredflinstone » Fri Oct 19, 2018 7:07 pm

I have no opinion on the future of bonds, but I would take issue with the consensus here that "As a defensive strategy, the Maginot Line served its purpose."

The purpose of the Maginot Line, I would suggest to you, was to prevent France from being invaded by Germany. That is, the point of the dumb thing was to protect France. That is what you would have been told if you had asked some French General about it in the early 1930s.

Of course, France was invaded and was quickly defeated. So clearly, the Maginot Line did NOT serve its purpose.

Moreover, the Maginot Line gave France a false sense of security that was dangerous. If not for the stupid and worthless Maginot Line, perhaps France would not have declared war on Germany in the first place.

The negative connotation associated with the Maginot Line is fully warranted.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by KlangFool » Fri Oct 19, 2018 7:22 pm

OP,

Besides stocks and bond, I held cash, physical gold, and 30 years fixed rate mortgage.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by garlandwhizzer » Fri Oct 19, 2018 7:49 pm

The following is the web source for the Vanguard Research Paper on how various asset classes hedge for inflation, both expected inflation and unexpected inflation based on historical research from 1970 through 2010. This article is definitely worth reading for those seeking inflation protection.

https://personal.vanguard.com/pdf/icruih.pdf

I'll give a brief review as I understand it. For unexpected inflation the only asset classes that provide significantly positive returns in the short term until inflation becomes expected are TIPS and Commodity futures. Nominal bonds of significant duration do worst. For expected inflation cash (MMF and T Bills) has the highest return correlation with inflation level. Commodity futures return less because inflation expectations get baked into their prices rather quickly. Nominal bonds of significant duration perform poorly with unexpected inflation or persistent expected long term inflation. There is no data that I can find on how factor diversification or alternates perform during inflation, expected or unexpected.

Of interest is how quickly the market responds to unexpected inflation and it becomes expected inflation. Over long periods of time defined as 3 years, total inflation (which equals expected inflation plus unexpected inflation) approaches the value of expected inflation alone. Once again nominal bonds are the big loser over 3 years and cash is the big winner. Commodity futures lose their inflation protection superiority as inflation sets in and becomes expected but TIPS and gold hold up better. Finally all assets that provide significant short/intermediate term inflation protection tend to underperform stocks in the very long run when stock returns catch up with inflation. Important to remember that commodity futures and gold (both of which have close to zero long term expected returns) reduce total long term portfolio returns, so their protection from inflation comes at a significant cost in the absence of increasing inflation. Important to recognize that if stagflation sets in, the goal is merely to limit total portfolio damage as much as possible and to survive. I remember the 1970s, no matter where you put your money your portfolio real inflation adjusted returns usually failed to reach zero. After it's over, the good days return and you catch up, that is if you hadn't already jumped off the Golden Gate.

Taking it all into account, Vanguard recommends using both TIPS and cash, the latter of which has essentially zero duration and rapidly adjusts to rising rates, as perhaps the most cost effective protection for both expected and unexpected inflation in the short and long term.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by nisiprius » Fri Oct 19, 2018 8:43 pm

I don't see where either Matt Topley or Jeremy Siegel says anything about bonds being a "Maginot Line," and I don't see how this analogy does much to illuminate anything. Sure, it's a way of saying that confidence in the protection of bonds might be ill-placed, but as an analogy it doesn't say why or what the structural similarities might be. One could just as well as ask whether they are the Johnstown Flood, or the Peshtigo Fire, or the Tacoma Narrow Bridge of investing.

Topley does say "the biggest risk for bond market investors is sky-high inflation." I can't take this sort of thing seriously if the writer doesn't even mention the existence of TIPS.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by GRP » Fri Oct 19, 2018 9:06 pm

Agree with you, OP, about the confidence being placed in bonds being potentially misplaced.

The "bonds for safety" narrative has only gained credence because the 1970s and prior seems like it was so long ago.

The advent of TIPS and gold ETFs does change the considerations though.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by nisiprius » Sat Oct 20, 2018 5:55 am

GRP wrote:
Fri Oct 19, 2018 9:06 pm
...The "bonds for safety" narrative has only gained credence because the 1970s and prior seems like it was so long ago...
I don't think this is true. As a matter of fact, it was only in the 1950s, following Markowitz's work, that pension funds began investing in stocks at all. Before that, only bonds were thought to be safe enough.

The CRSP was originally founded in 1960, and sponsored by Merrill Lynch, for the specific purpose of giving Merrill Lynch data that would pass SEC muster so that they could publish a full-newspaper-page ad/article--an "infomercial" of its day--saying that stock market investments were suitably safe for retail investors to buy as long-term investments.

The relative safety of bonds stems directly from fundamentals. It isn't just an empirical observation of past price movements, it goes to the distinction between debt and equity. Bonds are contracts enforceable in court, and bondholders interest must be paid before the company can consider paying stock dividends.

Indeed, the safety is safety in nominal dollars. Both the bonds themselves and, I assume, the fixed-dollar pensions they funded were severely damaged by inflation after World War II.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by vineviz » Sat Oct 20, 2018 8:26 am

nisiprius wrote:
Sat Oct 20, 2018 5:55 am
GRP wrote:
Fri Oct 19, 2018 9:06 pm
...The "bonds for safety" narrative has only gained credence because the 1970s and prior seems like it was so long ago...
I don't think this is true. As a matter of fact, it was only in the 1950s, following Markowitz's work, that pension funds began investing in stocks at all. Before that, only bonds were thought to be safe enough.
I don't want to put words in someone else's mouth, but I suspect what GRP was alluding to is a notion (which I commonly observe in this forum) that the ONLY role that bonds play in the portfolio is safety. The implication seems to be that lower volatility fixed income instruments are monotonically superior to higher volatility fixed income instruments.

That might not be the majority view, but I think for a vocal group it manifests in the notion that ultrashort bond funds, short-term CD ladders, money market funds, and even stable value funds are functionally equivalent to more traditional bond investments (such as intermediate and long-term corporate bonds and treasuries) regardless of the length of the investor's time horizon.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by longinvest » Sat Oct 20, 2018 9:51 am

vineviz wrote:
Sat Oct 20, 2018 8:26 am
I think for a vocal group it manifests in the notion that ultrashort bond funds, short-term CD ladders, money market funds, and even stable value funds are functionally equivalent to more traditional bond investments (such as intermediate and long-term corporate bonds and treasuries) regardless of the length of the investor's time horizon.
In the 1940's and early 1950's, cash and short-term bonds were slaughtered. All fixed income securities were slaughtered due to the government not allowing yields to go up to reflect ongoing high inflation. Gold ownership was illegal. There were no obvious shelters, people having been just burned badly with stocks and leveraged real estate in the 1929 and 1937 severe bear markets. Interestingly, longer-term bonds had slightly higher yields than short-term bonds and cash, obviously resulting in higher long-term returns than short-term bonds and cash.

We live in a different world. Many investors now think that "stocks are safer than bonds". Some investors seem to ignore that TIPS and I Bonds are inflation-indexed securities; that they are contracts to pay specific CPI-adjusted amounts on specific future dates, and as a result, they carry no inflation risk.

TIPS are bonds, not cash, though. They are exposed to interest rate risk. In other words, their market value fluctuates proportionally to their duration. But, they have no inflation risk.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Sat Oct 20, 2018 10:04 am

fredflinstone wrote:
Fri Oct 19, 2018 7:07 pm
I have no opinion on the future of bonds, but I would take issue with the consensus here that "As a defensive strategy, the Maginot Line served its purpose."

The purpose of the Maginot Line, I would suggest to you, was to prevent France from being invaded by Germany. That is, the point of the dumb thing was to protect France. That is what you would have been told if you had asked some French General about it in the early 1930s.
Rather, the Allied strategy was to pin the German Army on the frontiers, isolate Germany from supplies of food and raw materials via a complete naval blockade, bombard Germany with strategic bombers (which were believed to be much more decisive than they actually proved to be), and allow the buildup of British & French resources from their empires to eventually overwhelm the Germans (offensive actions in the 2nd or 3rd year of the war).

This was in fact a repeat of what had worked in WW1, without the disastrous French offensive at the start that there was in 1914, and the loss of a big chunk of France's industrial base.

There was always an awareness that, as in 1914, the Germans would invade Belgium. Their invasion of the Netherlands surprised everyone (most notably the Dutch themselves) because a neutral Netherlands had been extremely helpful to Germany during WW1 - allowing precious food and raw materials to slip past the Allied blockade.

So the best Allied Armies, the French 7th Army and the British Expeditionary Force, were to sweep forward into Belgium, faster than they had in WW1, and pin the German advance on various river lines.

France had suffered proportionately the worst casualties of any major participant in WW1 - they quite literally did not have enough manpower of conscription age, to confront Germany. Eventually, the manpower of their large empire would have supplied Moroccans, Africans, Vietnamese to have fought the Germans - but that would take time. The Maginot Line was conceived as a way of holding the Germans at the frontier, with as low casualties as possible.

(the British manpower situation was similar. India was part of the British Empire, and the Indian Army in WW2 was larger than the British Army and bore a huge chunk of the fighting in North Africa, Italy, the Middle East & the Pacific theatre (along with the Australians)).
Of course, France was invaded and was quickly defeated. So clearly, the Maginot Line did NOT serve its purpose.
But it was not the failure of the Maginot Line that led to that. It was that the Germans cut through Luxembourg, passed through a forest thought impenetrable to massed tanks, and crossed at the thinly defended part of the Meuse, which was also at a juncture of 2 French armies, thus maximizing confusion and coordination problems.

The Maginot Line served its purpose. The Germans made no serious effort to attack the Maginot Line directly.

It was the Allied strategy on the eastern flank that failed disastrously. Had that plane not crashed with the plans, the Germans would have tried to rerun the Moltke plan they used in WW1. France might still have fallen, but they would have been confronting 2 armies of high quality troops trained in mobile warfare, on a series of river lines, plus the French armoured reserves.
Moreover, the Maginot Line gave France a false sense of security that was dangerous. If not for the stupid and worthless Maginot Line, perhaps France would not have declared war on Germany in the first place.
France declared war on Germany because Germany invaded Poland, its ally. A strategy of appeasement, of throwing Czechoslovakia to the dogs in September 1938, had failed. When Hitler then occupied the rest of the country in March 1939 (it having been shorn of its strong border fortifications by the 1938 Munich Treaty) war had become inevitable.

Remember France had (re)-annexed Alsace and Lorraine at the end of WW1 (having lost them in 1871 at the end of the Franco Prussian War). The majority of the populations were German-speaking, and Hitler had made it clear that he intended to unify all German speakers in Europe (hence the "justification" for Czechoslovakia and Poland)- -although post March 1939 it was clear he would not stop there. So France was faced with the inevitability of confronting Hitler's territorial ambitions, whatever it chose to do.

There was no evidence Hitler would stop with anything less than the complete domination of Europe. With the Soviet-German Non Aggression Pact, the last check to his ambitions was gone.

Giving Germany any more time to get even stronger was pointless. In the event, Poland fell faster than anyone expected - in part because of a Soviet invasion from the east.

Can we really say the French were wrong to choose war with a regime of monstrous dimensions, bent on dominating all of Europe (and even beyond)?
The negative connotation associated with the Maginot Line is fully warranted.
Maginot Line mentality - yes. A failure to adapt to changed ways of warfare, fast enough.

Maginot Line? I think recent historiography is kinder to it. The French had a vast frontier to defend with Germany, they constructed a strong set of defences.

Hitler paid it the ultimate complement of duplicating it as the Siegfried Line - to some extent a propaganda artifice, but also to cover his weak flank whilst he annexed Czechoslovakia and conquered Poland.
Last edited by Valuethinker on Sat Oct 20, 2018 10:21 am, edited 1 time in total.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by z3r0c00l » Sat Oct 20, 2018 10:15 am

longinvest wrote:
Sat Oct 20, 2018 9:51 am

In the 1940's and early 1950's, cash and short-term bonds were slaughtered. All fixed income securities were slaughtered due to the government not allowing yields to go up to reflect ongoing high inflation. Gold ownership was illegal. There were no obvious shelters, people having been just burned badly with stocks and leveraged real estate in the 1929 and 1937 severe bear markets. Interestingly, longer-term bonds had slightly higher yields than short-term bonds and cash, obviously resulting in higher long-term returns than short-term bonds and cash.
Isn't it true that much of this supposed multi-decade bear market in bonds can be attributed to this artificially bad 40's-50's period? Sure the late 70's to early 80's were the worst of it, but that was a pretty short span of time that more resembled a few bad years in stocks.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Sat Oct 20, 2018 10:16 am

GammaPoint wrote:
Fri Oct 19, 2018 9:12 am
Valuethinker wrote:
Fri Oct 19, 2018 8:27 am
Nonetheless, I believe most investors (US) should have up to half their bond weighting in TIPS bonds. And that USians should generally buy the maximum number of ibonds they are allowed, every year (assuming other investing priorities are met).
I personally own no Series I bonds. I'm not sure if that's ideal or not, and I appreciate you putting it back on my radar for me to consider. When I first joined the BHs a decade ago, I didn't have the investment funds to fill up tax advantaged space, but now that I do, I should probably reconsider this.
2 points raised by another poster, related:

1. re CPI U inflation and personal inflation. CPI U could never be anything other than an approximation of personal inflation.

This is particularly true for retirees. Who will consume services like healthcare, property taxes, travel but relatively less of cars, diapers, home furnishings than a fast growing young family.

Yale Endowment uses a formula of CPI + 1% to estimate long run inflation for Yale U. That strikes me as fairly sensible and not a bad rough rule of thumb for retirees.

That gap between personal inflation and CPI inflation can be called "basis risk" if we abuse an analogy in commercial finance - basis risk is the difference between the way you measure something and the way the market measures it, roughly. So for example if you borrow at 365 day sterling LIBOR, but your assets are in 360 day dollar LIBOR. You've got 5 days difference, pa, in interest paid v. credited, as well as currency risk.

It's also very difficult to hedge, if not impossible.

2. I am no expert on US taxes, but my understanding of the position is that you pay taxes on nominal income & gains, outside of tax deferred accounts, and so real return securities suffer a greater tax burden as inflation rates rise and the income & gains from indexation are taxed even though they are not real gains in buying power.

So the higher the inflation rate, the higher the taxes, and thus the less inflation protection.

AFAIK that's absolutely true.

There's no easy way to hedge inflation in a taxable account - the same problem applies to dividends and capital gains on stocks, although one can defer capital gains taxes by not realizing gains (except when a fund does it for you).

In terms of correlation with inflation, in descending order:

ibonds & TIPS
regulated infrastructure assets like roads, bridges etc. which have contractual revenues linked to inflation
commercial real estate
timber but see recent thread
commodities (maybe - the actual correlations are not great I don't think)
gold (maybe - I think the data is too volatile to assert that)

Short term bond funds probably have a better correlation with inflation than long term bonds. The reason being we presume the Fed will raise rates, and that will increase returns. From memory, T Bills did about the best of any financial instrument during the 1970s.

Stocks are not highly correlated with inflation. The period of rising inflation 1968-1980 saw very poor returns for stocks c. -40% real? It was only when inflation decisively fell that stocks began their exceptional performance. Part of which we should expect given that 40 year US Treasuries have also had a phenomenal nearly 40 year run -- stocks are long duration investments, just like long bonds.

The thing with stocks is they pay high real returns -- a concomitant of their high volatility. Because they are high risk, they are rewarding to hold in the very long run.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by vineviz » Sat Oct 20, 2018 10:27 am

Valuethinker wrote:
Sat Oct 20, 2018 10:16 am
1. re CPI U inflation and personal inflation. CPI U could never be anything other than an approximation of personal inflation.

This is particularly true for retirees. Who will consume services like healthcare, property taxes, travel but relatively less of cars, diapers, home furnishings than a fast growing young family.

Yale Endowment uses a formula of CPI + 1% to estimate long run inflation for Yale U. That strikes me as fairly sensible and not a bad rough rule of thumb for retirees.
Keep in mind, though, that the typical retiree has annual spending that grows at LESS than the rate of inflation (as measured by CPI-U). The typical rule of thumb is something like CPI minus 1%.

Because CPI estimates only changes in prices, not changes in the level of consumption, I think it's important that investors be conscious about what they are trying to protect. If the goal is protecting their standard of living, inflation is only one piece of the equation and it is quite possible that the combination of Social Security (which is fully hedged against CPI) and a balanced portfolio which includes US stocks, international stocks, TIPS, and nominal treasuries (which I'd describe as weakly hedged against CPI) is likely to be a reasonable and sufficient inflation strategy for the typical retiree.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by GrowthSeeker » Sat Oct 20, 2018 10:53 am

betablocker wrote:
Fri Oct 19, 2018 8:33 am
Thanks for the clarification on the Maginot Line history. It makes the point exactly. The Ardennes are bonds. I'm not sure TIPS will really offset inflation. It's relatively untested and there is some evidence they might not work that well. I'm not saying we should all for 50% into gold or start being perma-bears but I think it's just a good reminder to diversify more than the 3 fund. Factors, reinsurance, alt lending, bonds, stocks, etc. and any new products that add additional diversification at a reasonable price with a decent expected return.
I think the actual history of the Maginot Line is somewhat irrelevant to this post. The oversimplified view of the Maginot Line is the point: i.e. something that protects from an attack here but does not protect from an attack there.

So the question is "if not Treasuries, then what"? Where do we put money so it is:
  • safe, (ha ha ha ha)
  • gets some return that at least matches inflation and
  • is not correlated with stock market.
TIPS? Gold? Something else?
And if gold, what form of gold: physical gold, gold ETFs, gold mine stocks?

And what are we preparing for? An economic downturn where bonds go down just as much as stocks? Or a full blown SHTF zombie apocalypse? This time it's gonna be different?
Just because you're paranoid doesn't mean they're NOT out to get you.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by longinvest » Sat Oct 20, 2018 10:58 am

z3r0c00l wrote:
Sat Oct 20, 2018 10:15 am
longinvest wrote:
Sat Oct 20, 2018 9:51 am

In the 1940's and early 1950's, cash and short-term bonds were slaughtered. All fixed income securities were slaughtered due to the government not allowing yields to go up to reflect ongoing high inflation. Gold ownership was illegal. There were no obvious shelters, people having been just burned badly with stocks and leveraged real estate in the 1929 and 1937 severe bear markets. Interestingly, longer-term bonds had slightly higher yields than short-term bonds and cash, obviously resulting in higher long-term returns than short-term bonds and cash.
Isn't it true that much of this supposed multi-decade bear market in bonds can be attributed to this artificially bad 40's-50's period? Sure the late 70's to early 80's were the worst of it, but that was a pretty short span of time that more resembled a few bad years in stocks.
Yes, exactly.

In the 1970's, yields went up with inflation. This caused short-term losses, as usual, but bonds recovered relative to inflation because of the increased yields.

By meddling with natural bond pricing, in the 40's-50's, not allowing for short-term losses, the government caused significant long-term losses. A foreseeing investor (e.g. a unicorn) would have taken the opportunity to sell his bonds at artificially inflated prices (low yields relative to inflation) to buy stocks and real estate which were (relatively) on sale.

Anyway, all this to say that looking at historical returns without understanding the wider historical environment can be misleading.

Personally, I don't know what will happen in the future. I invest in a 50/50 stocks/bonds portfolio, splitting stocks equally between domestic and international, and bonds equally between nominal and inflation-indexed.

I know that it won't be the highest returning portfolio out there, but it won't be the least returning one either, regardless of what happens. That's good enough for me.
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Re: Are bonds the Maginot Line of Modern Investing?

Post by Valuethinker » Sat Oct 20, 2018 12:56 pm

longinvest wrote:
Sat Oct 20, 2018 10:58 am
z3r0c00l wrote:
Sat Oct 20, 2018 10:15 am
longinvest wrote:
Sat Oct 20, 2018 9:51 am

In the 1940's and early 1950's, cash and short-term bonds were slaughtered. All fixed income securities were slaughtered due to the government not allowing yields to go up to reflect ongoing high inflation. Gold ownership was illegal. There were no obvious shelters, people having been just burned badly with stocks and leveraged real estate in the 1929 and 1937 severe bear markets. Interestingly, longer-term bonds had slightly higher yields than short-term bonds and cash, obviously resulting in higher long-term returns than short-term bonds and cash.
Isn't it true that much of this supposed multi-decade bear market in bonds can be attributed to this artificially bad 40's-50's period? Sure the late 70's to early 80's were the worst of it, but that was a pretty short span of time that more resembled a few bad years in stocks.
Yes, exactly.

In the 1970's, yields went up with inflation. This caused short-term losses, as usual, but bonds recovered relative to inflation because of the increased yields.
I am puzzled. Do the data not show real losses of c 40 per cent on bonds held through the 1970s? The capital losses on low coupon bonds were quite real.

Adjusted for taxes returns on stocks and bonds were a lot worse. There were few tax exempt accounts then and marginal tax rates were much higher.


By meddling with natural bond pricing, in the 40's-50's, not allowing for short-term losses, the government caused significant long-term losses. A foreseeing investor (e.g. a unicorn) would have taken the opportunity to sell his bonds at artificially inflated prices (low yields relative to inflation) to buy stocks and real estate which were (relatively) on sale.

Anyway, all this to say that looking at historical returns without understanding the wider historical environment can be misleading.

Personally, I don't know what will happen in the future. I invest in a 50/50 stocks/bonds portfolio, splitting stocks equally between domestic and international, and bonds equally between nominal and inflation-indexed.

I know that it won't be the highest returning portfolio out there, but it won't be the least returning one either, regardless of what happens. That's good enough for me.
I don't know enough about the period of formal financial repression but a lot more things were state controlled in those days. John Kennedy's famous row w the steel companies over their price increase comes to mind.

Your strategy is admirable and simple to implement.

It accepts the fundamental uncertainty of future economic events and investment returns.

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Re: Are bonds the Maginot Line of Modern Investing?

Post by longinvest » Sat Oct 20, 2018 1:29 pm

Valuethinker wrote:
Sat Oct 20, 2018 12:56 pm
longinvest wrote:
Sat Oct 20, 2018 10:58 am
z3r0c00l wrote:
Sat Oct 20, 2018 10:15 am
longinvest wrote:
Sat Oct 20, 2018 9:51 am

In the 1940's and early 1950's, cash and short-term bonds were slaughtered. All fixed income securities were slaughtered due to the government not allowing yields to go up to reflect ongoing high inflation. Gold ownership was illegal. There were no obvious shelters, people having been just burned badly with stocks and leveraged real estate in the 1929 and 1937 severe bear markets. Interestingly, longer-term bonds had slightly higher yields than short-term bonds and cash, obviously resulting in higher long-term returns than short-term bonds and cash.
Isn't it true that much of this supposed multi-decade bear market in bonds can be attributed to this artificially bad 40's-50's period? Sure the late 70's to early 80's were the worst of it, but that was a pretty short span of time that more resembled a few bad years in stocks.
Yes, exactly.

In the 1970's, yields went up with inflation. This caused short-term losses, as usual, but bonds recovered relative to inflation because of the increased yields.
I am puzzled. Do the data not show real losses of c 40 per cent on bonds held through the 1970s? The capital losses on low coupon bonds were quite real.
Valuethinker

I'll be lazy. I'll recopy an old post:
longinvest wrote:
Sat Dec 09, 2017 7:39 pm
First, for investors really worried about inflation, there now exist inflation-indexed bonds (TIPS) and inflation-indexed cash investments (I-Bonds).

Second, I think it's important to deconstruct an investment myth: that nominal bonds are vulnerable to inflation. Things are not as simple as a quick glimpse at an inflation-adjusted growth chart could lead one to think. One has to go beyond the chart and understand what happened in the real world and the choices a bond investor could have made at the time.
nedsaid wrote:
Sat Dec 09, 2017 4:31 pm
Inflation spikes are tough on most things except for maybe commodities. Bond investors, according to Bill Bernstein, lost about 50% of purchasing power from about 1946-1982.
Actually, the only worrisome bond losses happened in the 1940s and early 1950s, because interest rates were subject to price controls and interest rate pegging* **. In other words, during a period when inflation went, sometime, near 20%, the government forced all interest rates (short-term to long-term) to remain low near 2% to 3%. During this period, a 10-year ladder-like bond fund (selling its bonds on the market 1 year prior to maturity) would have lost almost 35%, in inflation-adjusted terms. And that was it. It was a one-time government-caused loss of purchase power.

* Interest Rate Controls: The United States in the 1940s on JSTOR
** Before the Accord: US Monetary - Fiscal Policy 1945 -1951

Losses weren't due to free bond market pricing. The bond market wasn't allowed to set prices normally by devaluing bonds (due to high inflation) which would have caused yields to immediately spike. Losses were due to deliberate government action to keep bond prices high (yields low). But, here's the important point: The bond investor was perfectly aware of the situation at the time. He knew that money left into bonds was losing purchase power. He had the ability to act. The bond investor could have accepted the government's offer to buy back his bonds at a 2% to 3% yield to maturity in a high-inflation environment and invest his money elsewhere. The bond investor didn't have to accept low yields in a high-inflation environment. Of course, the question was: Where to invest it? Cash had lower yields than bonds, so it was no refuge. Private gold possession was outlawed since 1934. I guess that left little choice other than to invest the money into real estate and stocks.

Here's a chart I've shown, recently, in another thread:
longinvest wrote:
Tue Dec 05, 2017 11:15 am
Here's a historical inflation-adjusted bond total-return chart for 1940 to 1985:
Image
(Source data for constructing the chart: VPW backtesting spreadsheet)

We see the loss of purchase power in the 1940s, due to yields significantly trailing inflation. We also see a few years dip, in the late 1970s, when inflation was raging up and yields were following up. As expected, it took a few years lag for the impact of higher yields to be fully reflected into total returns; nothing surprising, here. What's actually surprising is how yields kept a big spread over trailing inflation afterwards, explaining a gain equivalent to the losses of the 1940s in a few years, in the early 1980s. My point is that both events are completely unrelated. There was a government-imposed real loss in the 1940s. In the 1980s, bond investors became very demanding for higher yields.
The government finally allowed the market to price bonds normally since 1952. If we look at the above chart starting in 1952, we see that nominal bonds did preserve their value on a total-return basis, in inflation-adjusted terms, and even gained additional purchase power over inflation. There was a dip in the second half of the 1970s, due to bond yields going continuously up, adjusting for inflation. As bond math tells us, this was normal. The higher yields explain the surge in total returns that followed.

In the 1970s, bonds actually did better than stocks; they were less volatile and yet delivered almost as much in returns. Here's a chart I've shown in another thread that makes this pretty obvious:
longinvest wrote:
Fri Aug 26, 2016 8:46 am
Just for reference, here's a total-return chart I made, on another thread, to show the comparative growth of an intermediate-duration ladder-like bond fund and the S&P 500 in the worst high-inflation part of the 1970s to mid-1980s:

viewtopic.php?f=10&t=198104#p3027801
Image

By looking at a nominal chart, we can clearly see that all along, the bond fund had positive annual total returns. The S&P 500 (with dividends reinvested), on the other hand, did as it always does, it fluctuated. In 1973-1975, it had a big down fluctuation, losing 30% while inflation was going up 20%, for example.

We're almost never shown such charts. Usually, the nominal fund returns are combined with the impact of inflation and we're shown inflation-adjusted charts, leading to the impression that bonds are volatile. This impression is compounded, of course, when long-term bonds (which are volatile) are used to represent bond returns.

People invested in intermediate bonds, during the above period, just saw an increasing portfolio balance on their annual statements, unlike stock investors who didn't fare much better, in the end, over that period.
In summary, I think that nominal bonds are way less risky than often portrayed. What's actually risky, for nominal bond investors, isn't inflation; it's to leave money into nominal bonds when their yields are way below current inflation... assuming that one knows of a better place where to put the money, of course...
As for this:
Valuethinker wrote:
Sat Oct 20, 2018 12:56 pm
Adjusted for taxes returns on stocks and bonds were a lot worse. There were few tax exempt accounts then and marginal tax rates were much higher.
This shifts the discussion from total returns to after-tax total returns.

For current-day accumulating investors, they can put securities in tax-advantaged accounts. Only the richest run out of tax-advantaged space enough for taxes to matter.

For retirees (and this even applied in the 1970s), taxation isn't really an issue in decumulation mode. It ends up taxing retirement income.
Valuethinker wrote:
Sat Oct 20, 2018 12:56 pm
longinvest wrote:
Sat Oct 20, 2018 10:58 am
Personally, I don't know what will happen in the future. I invest in a 50/50 stocks/bonds portfolio, splitting stocks equally between domestic and international, and bonds equally between nominal and inflation-indexed.

I know that it won't be the highest returning portfolio out there, but it won't be the least returning one either, regardless of what happens. That's good enough for me.
Your strategy is admirable and simple to implement.

It accepts the fundamental uncertainty of future economic events and investment returns.
Thanks for the compliment.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic / international) stocks / domestic (nominal / inflation-indexed) long-term bonds | VCN/VXC/VLB/ZRR

GRP
Posts: 46
Joined: Wed Nov 22, 2017 5:35 pm

Re: Are bonds the Maginot Line of Modern Investing?

Post by GRP » Sun Oct 21, 2018 4:16 pm

vineviz wrote:
Sat Oct 20, 2018 8:26 am
nisiprius wrote:
Sat Oct 20, 2018 5:55 am
GRP wrote:
Fri Oct 19, 2018 9:06 pm
...The "bonds for safety" narrative has only gained credence because the 1970s and prior seems like it was so long ago...
I don't think this is true. As a matter of fact, it was only in the 1950s, following Markowitz's work, that pension funds began investing in stocks at all. Before that, only bonds were thought to be safe enough.
I don't want to put words in someone else's mouth, but I suspect what GRP was alluding to is a notion (which I commonly observe in this forum) that the ONLY role that bonds play in the portfolio is safety. The implication seems to be that lower volatility fixed income instruments are monotonically superior to higher volatility fixed income instruments.

That might not be the majority view, but I think for a vocal group it manifests in the notion that ultrashort bond funds, short-term CD ladders, money market funds, and even stable value funds are functionally equivalent to more traditional bond investments (such as intermediate and long-term corporate bonds and treasuries) regardless of the length of the investor's time horizon.
Right and right to you both! I should have been more specific. :beer

betablocker
Posts: 440
Joined: Mon Jan 11, 2016 1:26 pm

Re: Are bonds the Maginot Line of Modern Investing?

Post by betablocker » Thu Nov 01, 2018 1:45 pm

GrowthSeeker wrote:
Sat Oct 20, 2018 10:53 am
betablocker wrote:
Fri Oct 19, 2018 8:33 am
Thanks for the clarification on the Maginot Line history. It makes the point exactly. The Ardennes are bonds. I'm not sure TIPS will really offset inflation. It's relatively untested and there is some evidence they might not work that well. I'm not saying we should all for 50% into gold or start being perma-bears but I think it's just a good reminder to diversify more than the 3 fund. Factors, reinsurance, alt lending, bonds, stocks, etc. and any new products that add additional diversification at a reasonable price with a decent expected return.
I think the actual history of the Maginot Line is somewhat irrelevant to this post. The oversimplified view of the Maginot Line is the point: i.e. something that protects from an attack here but does not protect from an attack there.

So the question is "if not Treasuries, then what"? Where do we put money so it is:
  • safe, (ha ha ha ha)
  • gets some return that at least matches inflation and
  • is not correlated with stock market.
TIPS? Gold? Something else?
And if gold, what form of gold: physical gold, gold ETFs, gold mine stocks?

And what are we preparing for? An economic downturn where bonds go down just as much as stocks? Or a full blown SHTF zombie apocalypse? This time it's gonna be different?
In my mind I am preparing for the chance that there is a long term (more than a year or two) downturn or sideways market in both equities and bonds. Something like the 1970s. Might not have been a zombie apocalypse but it was a tough time. I don't think that outcome is likely but I want to be as prepared as possible despite the form a downturn takes. I think investors including those on Bogleheads are engaging in recency bias with how crises have played out (stocks down and bonds up). I'd say TIPS have problems with the way inflation is calculated. Gold might be an option or general commodities as well as some alternative investments.

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