“Flight to Quality:” the old way of thinking?

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simplesauce
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“Flight to Quality:” the old way of thinking?

Post by simplesauce » Sun Nov 12, 2017 6:19 pm

Hi all. I was speaking with some people about the market today. I mentioned that I have plenty of money in US Treasuries, just in case of a market crash. I would expect a flight to safety, and an opportunity to rebalance into stocks.

However, it was said that Flight to Quality is an old way of thinking. And this may not happen again in the same way.

The reasoning is because if stocks crash, the flight to safety happens largely because foreign investors buy US Treasuries in those scenarios.

However, with BitCoin, other countries having strong government bonds now, etc, it is being said that foreign investors may not flock to US Treasuries. Leaving the FED to be the only ones to help. With our current poor balance sheets, it would only get worse.

Can someone explain why Flight to Quality has always been the norm, and do you agree that it may not continue? Thank you.
Last edited by simplesauce on Sun Nov 12, 2017 9:18 pm, edited 1 time in total.

dbr
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Re: “Flight to Safety:” the old way of thinking?

Post by dbr » Sun Nov 12, 2017 6:27 pm

I don't think you hold Treasuries because you expect to market time a purchase of stocks at a market bottom while market timing the sale of Treasuries. You hold Treasuries to dilute the range of loss (and gain) in volatile stocks. You rebalance to keep risk within a comfortable range. I would not say this has anything to do with an obsolete view of asset allocation.

Someone could have a different idea of some sort of market driven tactics.

BuyAndHoldOn
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Re: “Flight to Safety:” the old way of thinking?

Post by BuyAndHoldOn » Sun Nov 12, 2017 7:12 pm

@ simplesauce: I think posting these topics on Bogleheads is fine, but a deeper analysis would come from other sources. --> e.g., blogs by professorial types and/or research topics you can read from your brokerage. Or actual academic research. Etc. I know you have probably done some research already; and I know these resources are still just opinions --> but that is my opinion :happy for what it's worth.

@dbr: Agreed. And yet: I think having some non-equity correlated assets to lean on in a recession and/or bear market is one of the appeals of Treasuries.

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Re: “Flight to Safety:” the old way of thinking?

Post by dbr » Sun Nov 12, 2017 7:16 pm

BuyAndHoldOn wrote:
Sun Nov 12, 2017 7:12 pm

@dbr: Agreed. And yet: I think having some non-equity correlated assets to lean on in a recession and/or bear market is one of the appeals of Treasuries.
It could be that from an MPT point of view an asset that is actually negatively correlated with stocks and sufficiently volatile to matter would make sense. Some people would want long Treasuries combined with stocks on that possibility.

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Doc
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Re: “Flight to Safety:” the old way of thinking?

Post by Doc » Mon Nov 13, 2017 10:00 am

dbr wrote:
Sun Nov 12, 2017 6:27 pm
I don't think you hold Treasuries because you expect to market time a purchase of stocks at a market bottom while market timing the sale of Treasuries. You hold Treasuries to dilute the range of loss (and gain) in volatile stocks. You rebalance to keep risk within a comfortable range. I would not say this has anything to do with an obsolete view of asset allocation.

Someone could have a different idea of some sort of market driven tactics.
I hold a portion of my FI portfolio in Treasuries to rebalance in a stock market crash, flight to quality situation. but it is not market timing. It is rebalancing with assets that have better buying power than a TBM type fixed income portfolio.

In the "normal" course of events where the need to rebalance comes from the higher normal returns of stocks vs. bonds a TBM type fixed income portfolio fits the rebalancing bill well because you are selling stocks not buying.

How many times did you rebalance during "Lehman" when the TSM dropped some 40 plus percent?

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dbr
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Re: “Flight to Safety:” the old way of thinking?

Post by dbr » Mon Nov 13, 2017 10:04 am

Doc wrote:
Mon Nov 13, 2017 10:00 am
I hold a portion of my FI portfolio in Treasuries to rebalance in a stock market crash, flight to quality situation. but it is not market timing. It is rebalancing with assets that have better buying power than a TBM type fixed income portfolio.

[/quote]

I understand rebalancing during a market crash. I don't understand what you mean by a "flight to quality situation." I would have assume that to mean demand for bonds would go up in the "flight" and that bond prices would rise so much that there would be a special advantage to selling bonds just then. Your green line seems to be flat as a pancake relative to the movement of the stock price. Is that a flight to quality?

Random Walker
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Re: “Flight to Quality:” the old way of thinking?

Post by Random Walker » Mon Nov 13, 2017 10:25 am

I think the role of Short treasuries as the riskless asset is not changing anytime soon. They are basically uncorrelated with equities. What is very significant is that when equities take it on the chin, the correlation between equities and treasuries tends to turn strongly negative. This brings up an important point in asset allocation and portfolio design. One needs to consider not only the correlations between portfolio components, but also when and how the correlations tend to change.

Dave

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Re: “Flight to Quality:” the old way of thinking?

Post by dbr » Mon Nov 13, 2017 10:41 am

Random Walker wrote:
Mon Nov 13, 2017 10:25 am
I think the role of Short treasuries as the riskless asset is not changing anytime soon. They are basically uncorrelated with equities. What is very significant is that when equities take it on the chin, the correlation between equities and treasuries tends to turn strongly negative. This brings up an important point in asset allocation and portfolio design. One needs to consider not only the correlations between portfolio components, but also when and how the correlations tend to change.

Dave
Correlation benefit depends on the volatility being large. I suppose there is a useful effect for long treasuries, aka bonds, and no particular benefit to short treasuries other than the variation and the correlation are nearly zero.

Can you help me understand what "flight to safety" and "flight to quality" mentioned in the OP are all about?

Random Walker
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Re: “Flight to Quality:” the old way of thinking?

Post by Random Walker » Mon Nov 13, 2017 10:50 am

US government debt obligations are considered the least risky of investments. To pay back its obligations the government can always raise taxes or print more money. The short term 1 year treasuries are considered the riskless asset. When things in the investing world get scary, investors will want safety. They will flock to the least risky bonds, likely raising their prices, just at the time when stocks are crashing.

Dave

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nisiprius
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Re: “Flight to Quality:” the old way of thinking?

Post by nisiprius » Mon Nov 13, 2017 10:51 am

I've learned to pretty much ignore all the stuff about "When X happens, Y will happen, so investors will do Z, resulting in Q." All the "tends to" statements. None of it is reliable. It is all after-the-fact "rational actor" explanations of what happened the last time. I hold Vanguard Total Bond (and Vanguard Inflation-Protected Securities) because I think they are safe enough, and I think I have gotten and probably will get enough extra return out of them to justify the fairly small extra risk. I could just as well hold PIMCO Total Return or Vanguard Intermediate-Term Treasury or what have you.

With regard to flight to quality (? I've always heard "flight to safety,") I just don't think it matters because it's not really that big an effect. Not from the point of view of a retirement saver with a 60/40 portfolio or anything like that. Look at the actual numbers from 2008-2009 and do some math. Even if it is true it doesn't matter that much.

Yes, if you chart the funds by themselves, during 2008-2009 Total Bond basically went straight across while Intermediate-Term Treasury had a definite, visible upward bulge. But how big was it? I think one of the big sins of investing is paying attention to direction ("up") but not magnitude ("how far?") You can say "every little bit helps" I guess, but, seriously, even if you knew for sure you would get the bulge, how much would you have needed to hold to offset the 50% drop in stocks?

Intermediate-term Treasuries enjoyed about a 15% boost from the "flight to safety" while stocks were falling 50%. Stocks fell three times as much as Treasuries rose. And they didn't perfectly synchronize.

Overall, the results from PortfolioVisualizer are that in a 60/40 portfolio, substituting intermediate-term Treasuries for total bond meant the maximum drawdown, instead of being -30.72%, was "only" -27.97%. Big deal.

In order to have your portfolio sail pretty much straight through, you needed to have a portfolio of about 20% stocks, 80% intermediate-term Treasuries. That's what it actually would have taken for the "flight to safety" in Treasuries to counteract the stock drop.

Portfolio 1, blue: 60% Total Stock, 40% Total Bond.

Portfolio 2, red: 60% Total Stock, 40% Vanguard Intermediate-Term Treasury, VFITX, which had a noticeably "flight to safety" when you look at it in isolation.

Portfolio 3, orange: 20% Total Stock, 80% VFITX. Now the "flight to safety" in the bonds really does pretty well counteract the drop in stocks--but, of course, at a very high cost in total return.

source
Image

So I just don't see it as a big deal. You shouldn't count on a flight to safety effect in Treasuries, but even if it occurs it's just not that big an effect, unless you have an very conservative portfolio.
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betablocker
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Re: “Flight to Quality:” the old way of thinking?

Post by betablocker » Mon Nov 13, 2017 11:31 am

There two parts to your question. First what is a flight to quality? Investors get scared and dump stocks and buy something safe. The US treasury is the safest asset in the world. It is literally used by investors as a proxy for the "risk free rate." Sure permabears are going to try to scare you but look at Bitcoin's 25% loss in 4 days. Also see how every government in the world is even less reliable than the US. US Treasuries are all there is. Feel free to believe in dark theories about quantitative easing and debasing the currency but most of this can be ignored in my opinion.

Second, there is the issue of "fighting the last war" as they say. A flight to quality is one way markets go down but you can also have inflation shocks as we did in the 70s. If inflation moves up more than expected you'll see losses with treasuries at least in the short term. People hold commodities, managed futures, and REITs for this reason. My sense is everyone has forgotten about that (and the permabears have a point here) scenario because it hasn't happened in a while.

Random Walker
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Re: “Flight to Quality:” the old way of thinking?

Post by Random Walker » Mon Nov 13, 2017 11:32 am

Nsiprius makes some good points. One should expect to see the equity side of his portfolio take 1,2, maybe 3 50% declines in the course of an investing lifetime. At these times bonds will rise maybe 5%. So one could expect a 60/40 portfolio to lose about 25% under these circumstances. Even a 50/50 portfolio has about 85% of the risk on the equity side. A 60/40 portfolio easily has 90% of the risk on the equity side.

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Re: “Flight to Quality:” the old way of thinking?

Post by Doc » Mon Nov 13, 2017 11:46 am

dbr wrote:
Mon Nov 13, 2017 10:04 am
Your green line seems to be flat as a pancake relative to the movement of the stock price. Is that a flight to quality?
The green line is just a gimmick to make Morningstar's charts show the data of interest as a percent change instead of an absolute number like price or total return.

The "green" data is also useful when using Morningstar's rolling return charts to get rid of the annoying "bar chart" used for the first item in the list which can often make the rest of the data of interest hard to use.

My "green data" is just an ultra short bond fund which should have very little movement. It just makes a wide near zero line on the chart.

If you know of a flatter pancake with long time data please let me know.
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Re: “Flight to Quality:” the old way of thinking?

Post by SimpleGift » Mon Nov 13, 2017 12:56 pm

simplesauce wrote:
Sun Nov 12, 2017 6:19 pm
The reasoning is because if stocks crash, the flight to safety happens largely because foreign investors buy US Treasuries in those scenarios.

However, with BitCoin, other countries having strong government bonds now, etc, it is being said that foreign investors may not flock to US Treasuries.
Yes, in times of crisis, active investors will seek safe bonds to preserve the value of their portfolios. But my understanding is that, in reality, because there is a limited supply of safe government bonds outside of U.S. Treasuries (chart below), investors end up chasing liquidity in times of crisis, not strictly credit quality. So better to call this phenomenon a flight-to-liquidity.
Even if one believed in the superior creditworthiness of the U.K. gilt or the German bund (or Bitcoin!), these markets are just not large enough or liquid enough during crisis periods to handle the global demand for safe assets. Fortunately, the U.S. Treasury market is large and liquid enough — so there should never be a concern about holding Treasuries during crises.
Cordially, Todd

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Re: “Flight to Quality:” the old way of thinking?

Post by pkcrafter » Mon Nov 13, 2017 10:30 pm

simplesauce wrote:
Sun Nov 12, 2017 6:19 pm
Hi all. I was speaking with some people about the market today. I mentioned that I have plenty of money in US Treasuries, just in case of a market crash. I would expect a flight to safety, and an opportunity to rebalance into stocks.

However, it was said that Flight to Quality is an old way of thinking. And this may not happen again in the same way.

The way you described this is a flight to safety, not quality. They are different. A flight to safety is what happens in a market crash, and it will happen again, and in the same way.

The reasoning is because if stocks crash, the flight to safety happens largely because foreign investors buy US Treasuries in those scenarios.

Bunk. The flight to safety happens because investors can't take the heat and they get out, and that certainly goes for U.S. investors. Simplesause, you said you have plenty of money in treasuries. Have you always held plenty of money in treasuries, or is that a recent move?

However, with BitCoin, other countries having strong government bonds now, etc, it is being said that foreign investors may not flock to US Treasuries. Leaving the FED to be the only ones to help. With our current poor balance sheets, it would only get worse.

Flight to safety has nothing to do with any of that, it's simply loss aversion in action.


Can someone explain why Flight to Quality has always been the norm, and do you agree that it may not continue? Thank you.

It's the norm (flight to safety) because investors react the same way under stress and pressure. Sometimes a flight or fight response is triggered, which is extremely hard to control. It causes an investor to react and think later.
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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patrick013
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Re: “Flight to Quality:” the old way of thinking?

Post by patrick013 » Mon Nov 13, 2017 10:50 pm

There's always going to be some extra movement when stocks
go down. Logically demand is greater for bonds then.

So, generally you can follow the money :
- when earnings go up bonds go down as money moves to stocks
- when earnings go down bonds go up as money moves from stocks

Some movements cancel each other out and nobody can prevent that.
Rising rates lowers bond prices but increased demand pushes them
up again - a flight to quality.
age in bonds, buy-and-hold, 10 year business cycle

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Re: “Flight to Quality:” the old way of thinking?

Post by venkman » Mon Nov 13, 2017 10:55 pm

Random Walker wrote:
Mon Nov 13, 2017 10:50 am
US government debt obligations are considered the least risky of investments. To pay back its obligations the government can always raise taxes or print more money. The short term 1 year treasuries are considered the riskless asset. When things in the investing world get scary, investors will want safety. They will flock to the least risky bonds, likely raising their prices, just at the time when stocks are crashing.
But in an economic downturn, don't most investors flock toward intermediate or longer-term Treasuries? They want safety, but they know the Fed is likely to lower short-term rates in order to stimulate the economy, so they dump short-term bonds and try to lock in current higher rates for a longer period. This behavior is why the yield curve tends to invert when the market thinks a recession is imminent.

That's my understanding of how it works. But I could be wrong. :happy

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