The death of nominal bonds? All Weather without bonds?

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PicassoSparks
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Re: The death of nominal bonds? All Weather without bonds?

Post by PicassoSparks »

One of the persistent frustrations I have with articles and analysis like this is that it routinely fails to specify the time horizon of the analysis. This is a big part of why we're all having such fun at Bridgewater's expense, since the All Weather portfolio claimed an infinite time horizon and lasted less than a decade before the same people seemed to be arguing against it.

I re-read the article trying to suss out what time horizon they were thinking of when they made the claim that we need to all get out of nominal bonds. As far as I can tell, they never make that time horizon explicit, so we need to extract it via inference.

Here are their basic principles behind their balance:
The two key building blocks of balance for us are:
1. Select assets that will outperform cash over time;
2. Diversify those assets based on how they will react to future economic scenarios.
The new world they see us going into, they call the MP3 world.
Instead of interest rate cuts, policy has moved to MP3 (i.e., the coordination of monetary and fiscal policy). Understanding the nature of MP3 and how it will affect different asset classes allows us to logically balance assets for an MP3 world.
So they believe that under the new monetary policy regime, it's time to get away from nominal bonds. Here, in their explanation we get a first hint of their time horizon.
In an MP3 world, policy makers will respond to a downturn through coordinated monetary and fiscal policy—putting money to work in the real economy, financed by money printing. If this does not succeed in reflating equities, logically we would expect this printed money to end up in inflation-hedge assets like inflation-linked bonds and gold.
So we are talking about a shift in monetary policy which they predict will continue and which will have certain predictable effects.
In an MP3 world, in the event of a downturn, central banks and fiscal authorities will try to reflate by printing money and spending it in the real economy. This has already happened in response to the pandemic shock, and there will be more of it as necessary.
For analogies, they look to what happened in the 1940s.

Then they go further and start trying to factor in geo-politics.
Another important element of our approach to balance in this environment is geographic diversification, which we believe is taking on heightened urgency. For some time, we have spoken of the increasingly “tri-polar” world, with the US, Europe, and China of comparable global importance at this point and therefore deserving of much more similar weight in portfolios than they typically have had. Each pole has a distinct role: Europe is the largest exporter of capital, the US remains the primary reserve currency and therefore primary source of funding, and China contributes the most to global growth.
The virus has renewed US-China tensions and accelerated the broader dynamic of a rising power threatening an existing power, with the US at times directing blame at China over the virus and recently escalating sanctions, and China seeking to position itself in a leadership role of extending aid to other economies via its “Health Silk Road.” And we have started to see the repatriation of supply chains as the global shutdowns highlighted the vulnerabilities produced by global supply chains.

In other words, there is real risk that the secular trend toward increased globalization is reversing, a trend that has been an important force supporting global growth and productivity but also increased correlations across global markets.
So now we get to the meat of the problem. Bridgewater is thinking in the immediate to mid term, and trying to out guess what's coming in the next few years. This kind of strategizing is meant to be the value add of their active management. But I am not investing for the next few years, so the immediate unknowns of geopolitics and epidemiology and shifting manufacturing bases and all the rest of it don't concern me. We have plenty of evidence that this kind of market timing is unreliable to net-negative for long term investing.

If MP3 is truly a new regime, how long will it last? The interventions of the 1940s didn't last long at all, and the monetary policy regime changed again. I expect that this will happen too, but I have no particular insights into when or how. The new tri-polar geopolitical world, how long will that last? The Cold War lasted a few decades. American hegemony lasted a few couple decades. I expect geopolitics to change several more times in my lifetime.
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Re: The death of nominal bonds? All Weather without bonds?

Post by Always passive »

Seasonal wrote: Mon Aug 24, 2020 5:58 am Since no self-proclaimed bond experts are replying, I'll unilaterally open it to a wider response pool.

1. Returns depend on the rate of the bond you buy and the future of interest rates. Predicting interest rates is a fool's game. Risk reduction depends on your definition of risk, but bonds are certainly less volatile than stocks.

2. The raw distribution of potential returns might be skewed, but you'd have to consider the odds of movements in either direction and their likely magnitudes. That does not seem so skewed.

3. TIPS are fine. The only downside appears to be that they are less liquid than nominal treasuries (especially short-term treasuries) and tend to fall more in a crisis. Gold is a lump of metal with no intrinsic return.

The market likes bonds. The Fed is buying, but their purchases are a tiny fraction of total volume.
I agree with your comments, except item 1. 99% of the YTM of bonds depend on the present yield.
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Re: The death of nominal bonds? All Weather without bonds?

Post by edan »

I have worked hard against my own inclinations to tinker, tilt and ... can't think of another good word that starts with t.

Anyway, I am now a proud owner of a 3-fund portfolio, with equities at world-market-cap weights and 60% TBM, due to declining need to take risk.

The "bonds are dead" threads like this one always give me pause.

Should I consider moving some of my TBM to TIPS, or just stay the course with 3 funds? Will it make a big difference in the long run?

When nisiprius says he's got 50% of his bonds in TIPS, it makes we wonder if I'm a fool to stay at 100% TBM...

Thoughts?
Seasonal
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Re: The death of nominal bonds? All Weather without bonds?

Post by Seasonal »

Always passive wrote: Mon Aug 24, 2020 8:17 am
Seasonal wrote: Mon Aug 24, 2020 5:58 am Since no self-proclaimed bond experts are replying, I'll unilaterally open it to a wider response pool.

1. Returns depend on the rate of the bond you buy and the future of interest rates. Predicting interest rates is a fool's game. Risk reduction depends on your definition of risk, but bonds are certainly less volatile than stocks.

2. The raw distribution of potential returns might be skewed, but you'd have to consider the odds of movements in either direction and their likely magnitudes. That does not seem so skewed.

3. TIPS are fine. The only downside appears to be that they are less liquid than nominal treasuries (especially short-term treasuries) and tend to fall more in a crisis. Gold is a lump of metal with no intrinsic return.

The market likes bonds. The Fed is buying, but their purchases are a tiny fraction of total volume.
I agree with your comments, except item 1. 99% of the YTM of bonds depend on the present yield.
I don't know about 99%. For a bond you buy today, YTM is a function of the yield and price. For a fund, which is constantly rolling over bonds and reinvesting principal, your return will depend on future interest rates.
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DollarvsGold
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Re: The death of nominal bonds? All Weather without bonds?

Post by DollarvsGold »

PicassoSparks wrote: Mon Aug 24, 2020 7:53 am One of the persistent frustrations I have with articles and analysis like this is that it routinely fails to specify the time horizon of the analysis. This is a big part of why we're all having such fun at Bridgewater's expense, since the All Weather portfolio claimed an infinite time horizon and lasted less than a decade before the same people seemed to be arguing against it.

I re-read the article trying to suss out what time horizon they were thinking of when they made the claim that we need to all get out of nominal bonds. As far as I can tell, they never make that time horizon explicit, so we need to extract it via inference.

Here are their basic principles behind their balance:
The two key building blocks of balance for us are:
1. Select assets that will outperform cash over time;
2. Diversify those assets based on how they will react to future economic scenarios.
The new world they see us going into, they call the MP3 world.
Instead of interest rate cuts, policy has moved to MP3 (i.e., the coordination of monetary and fiscal policy). Understanding the nature of MP3 and how it will affect different asset classes allows us to logically balance assets for an MP3 world.
So they believe that under the new monetary policy regime, it's time to get away from nominal bonds. Here, in their explanation we get a first hint of their time horizon.
In an MP3 world, policy makers will respond to a downturn through coordinated monetary and fiscal policy—putting money to work in the real economy, financed by money printing. If this does not succeed in reflating equities, logically we would expect this printed money to end up in inflation-hedge assets like inflation-linked bonds and gold.
So we are talking about a shift in monetary policy which they predict will continue and which will have certain predictable effects.
In an MP3 world, in the event of a downturn, central banks and fiscal authorities will try to reflate by printing money and spending it in the real economy. This has already happened in response to the pandemic shock, and there will be more of it as necessary.
For analogies, they look to what happened in the 1940s.

Then they go further and start trying to factor in geo-politics.
Another important element of our approach to balance in this environment is geographic diversification, which we believe is taking on heightened urgency. For some time, we have spoken of the increasingly “tri-polar” world, with the US, Europe, and China of comparable global importance at this point and therefore deserving of much more similar weight in portfolios than they typically have had. Each pole has a distinct role: Europe is the largest exporter of capital, the US remains the primary reserve currency and therefore primary source of funding, and China contributes the most to global growth.
The virus has renewed US-China tensions and accelerated the broader dynamic of a rising power threatening an existing power, with the US at times directing blame at China over the virus and recently escalating sanctions, and China seeking to position itself in a leadership role of extending aid to other economies via its “Health Silk Road.” And we have started to see the repatriation of supply chains as the global shutdowns highlighted the vulnerabilities produced by global supply chains.

In other words, there is real risk that the secular trend toward increased globalization is reversing, a trend that has been an important force supporting global growth and productivity but also increased correlations across global markets.
So now we get to the meat of the problem. Bridgewater is thinking in the immediate to mid term, and trying to out guess what's coming in the next few years. This kind of strategizing is meant to be the value add of their active management. But I am not investing for the next few years, so the immediate unknowns of geopolitics and epidemiology and shifting manufacturing bases and all the rest of it don't concern me. We have plenty of evidence that this kind of market timing is unreliable to net-negative for long term investing.

If MP3 is truly a new regime, how long will it last? The interventions of the 1940s didn't last long at all, and the monetary policy regime changed again. I expect that this will happen too, but I have no particular insights into when or how. The new tri-polar geopolitical world, how long will that last? The Cold War lasted a few decades. American hegemony lasted a few couple decades. I expect geopolitics to change several more times in my lifetime.
Interesting analysis, thanks!
So you would suggest not to change the allocation to nominal bonds at all?
Topic Author
DollarvsGold
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Re: The death of nominal bonds? All Weather without bonds?

Post by DollarvsGold »

edan wrote: Mon Aug 24, 2020 8:33 am I have worked hard against my own inclinations to tinker, tilt and ... can't think of another good word that starts with t.

Anyway, I am now a proud owner of a 3-fund portfolio, with equities at world-market-cap weights and 60% TBM, due to declining need to take risk.

The "bonds are dead" threads like this one always give me pause.

Should I consider moving some of my TBM to TIPS, or just stay the course with 3 funds? Will it make a big difference in the long run?

When nisiprius says he's got 50% of his bonds in TIPS, it makes we wonder if I'm a fool to stay at 100% TBM...

Thoughts?
50% of your bonds in TIPS is a good solution, much better than 100% nominal IMO. You would be prepared for higher than expected inflation as well as lower than expected inflation.
RomeoMustDie
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Re: The death of nominal bonds? All Weather without bonds?

Post by RomeoMustDie »

edan wrote: Mon Aug 24, 2020 8:33 am I have worked hard against my own inclinations to tinker, tilt and ... can't think of another good word that starts with t.

Anyway, I am now a proud owner of a 3-fund portfolio, with equities at world-market-cap weights and 60% TBM, due to declining need to take risk.

The "bonds are dead" threads like this one always give me pause.

Should I consider moving some of my TBM to TIPS, or just stay the course with 3 funds? Will it make a big difference in the long run?

When nisiprius says he's got 50% of his bonds in TIPS, it makes we wonder if I'm a fool to stay at 100% TBM...

Thoughts?
Global bond fund
edan
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Re: The death of nominal bonds? All Weather without bonds?

Post by edan »

RomeoMustDie wrote: Mon Aug 24, 2020 9:29 am
Global bond fund
So you recommend 50% TBM and 50% TIBM?
edan
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Re: The death of nominal bonds? All Weather without bonds?

Post by edan »

DollarvsGold wrote: Mon Aug 24, 2020 9:26 am
50% of your bonds in TIPS is a good solution, much better than 100% nominal IMO. You would be prepared for higher than expected inflation as well as lower than expected inflation.
I'll have to think about this... I'll be happy if anyone else shares their thoughts on the matter, too.
What do you think of the other suggestion of adding global bonds? Any merit?
RomeoMustDie
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Re: The death of nominal bonds? All Weather without bonds?

Post by RomeoMustDie »

edan wrote: Mon Aug 24, 2020 9:37 am
RomeoMustDie wrote: Mon Aug 24, 2020 9:29 am
Global bond fund
So you recommend 50% TBM and 50% TIBM?
That's a good question that I'm also pondering.

I think diversifying is good, but inflation is a cyclical problem so I'm not sure you need to make adjustments to the portfolio based on it.

The more interesting problem is the rising rates environment, so I'm taking a look at VWOB and FLOT as potential solutions there.

I'm also semi interested in market neutral strategies like arbitrage funds as a replacement or supplement to the bond portion of a portfolio.
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Re: The death of nominal bonds? All Weather without bonds?

Post by Always passive »

Seasonal wrote: Mon Aug 24, 2020 8:36 am
Always passive wrote: Mon Aug 24, 2020 8:17 am
Seasonal wrote: Mon Aug 24, 2020 5:58 am Since no self-proclaimed bond experts are replying, I'll unilaterally open it to a wider response pool.

1. Returns depend on the rate of the bond you buy and the future of interest rates. Predicting interest rates is a fool's game. Risk reduction depends on your definition of risk, but bonds are certainly less volatile than stocks.

2. The raw distribution of potential returns might be skewed, but you'd have to consider the odds of movements in either direction and their likely magnitudes. That does not seem so skewed.

3. TIPS are fine. The only downside appears to be that they are less liquid than nominal treasuries (especially short-term treasuries) and tend to fall more in a crisis. Gold is a lump of metal with no intrinsic return.

The market likes bonds. The Fed is buying, but their purchases are a tiny fraction of total volume.
I agree with your comments, except item 1. 99% of the YTM of bonds depend on the present yield.
I don't know about 99%. For a bond you buy today, YTM is a function of the yield and price. For a fund, which is constantly rolling over bonds and reinvesting principal, your return will depend on future interest rates.
In a zero interest rate environment the reinvesting of dividends has a very small impact.
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Re: The death of nominal bonds? All Weather without bonds?

Post by nisiprius »

Always passive wrote: Mon Aug 24, 2020 12:09 pm...In a zero interest rate environment the reinvesting of dividends has a very small impact...
What "zero interest rate environment?" What you mean is "I am predicting that interest rates for all terms will to drop to zero for all terms and will stay there for decades, and therefore I am predicting that reinvesting bond interest will have a very small impact."

Meanwhile, a correspondent has pointed out to me that within the world of mutual funds, there is an outflow from stock funds and an inflow into bond funds, so I may be "pretty crazy to hold bonds now," but at least I am not the only crazy one.

Source

Image

If you think that the market psychology around bonds is bubble-like, OK, but at worst the bubble amounts to only +5% to +7% or so, so if it bursts I lose -5% to -7%, and it is just losing an undeserved bonus I got within the last year. That would not ruin my whole retirement.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: The death of nominal bonds? All Weather without bonds?

Post by Robot Monster »

nisiprius wrote: Mon Aug 24, 2020 12:20 pm If you think that the market psychology around bonds is bubble-like, OK, but at worst the bubble amounts to only +5% to +7% or so, so if it bursts I lose -5% to -7%, and it is just losing an undeserved bonus I got within the last year. That would not ruin my whole retirement.
What kind of bursting bubble only has a -5% to -7% loss? Maybe that metaphor--at least, in relation to bonds--needs to be axed. Otherwise it's a whole lot of unnecessary fear.
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Re: The death of nominal bonds? All Weather without bonds?

Post by PicassoSparks »

DollarvsGold wrote: Mon Aug 24, 2020 9:23 am Interesting analysis, thanks!
So you would suggest not to change the allocation to nominal bonds at all?
Haha oh god, don't come to me for recommendations! I have no earthly idea what should be done about bonds. I have barely wrapped my head around stocks, and the bond market seems so much crazier. So this is just a process of me slowly shaving away bad analysis in the hopes that I'll get to good advice.
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Re: The death of nominal bonds? All Weather without bonds?

Post by mptfan »

This reminds me of the famous "Death of Equities" headline in BusinessWeek in 1979.

https://www.bloomberg.com/news/articles ... resurgence.
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Re: The death of nominal bonds? All Weather without bonds?

Post by TPIR »

Not sure the idea that there are times long bond yields move less when growth slows is new

In their article there's a chart showing in 1937 and 1946 declines in growth, but little bond yield change, implying not much ballast to equity prices

https://bridgewater.brightspotcdn.com/d ... -pt2-2.png

The 'master' all weather PDF from Bridgewater back in 09 doesn't show a backtest prior to 1970, other than a 1929-1933 look - so this mid 1930s - 1970 period appears in the dark from official Bridgewater sources, although you could use tools to run your own scenario

http://sdcera.granicus.com/MetaViewer.p ... ta_id=9141.

Inflation linked bonds have always been part of all weather including the the falling growth / falling inflation scenario that traditionally benefits nominal bonds in more traditional portfolios

I do scratch my head when I see Bridgewater execs beyond Dalio doing more frequent media appearances. I suppose that could help them marketing to pension funds, but wonder if they are gearing up for something closer to retail offerings.
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Re: The death of nominal bonds? All Weather without bonds?

Post by Always passive »

nisiprius wrote: Mon Aug 24, 2020 12:20 pm
Always passive wrote: Mon Aug 24, 2020 12:09 pm...In a zero interest rate environment the reinvesting of dividends has a very small impact...
What "zero interest rate environment?" What you mean is "I am predicting that interest rates for all terms will to drop to zero for all terms and will stay there for decades, and therefore I am predicting that reinvesting bond interest will have a very small impact."

Meanwhile, a correspondent has pointed out to me that within the world of mutual funds, there is an outflow from stock funds and an inflow into bond funds, so I may be "pretty crazy to hold bonds now," but at least I am not the only crazy one.

Source

Image

If you think that the market psychology around bonds is bubble-like, OK, but at worst the bubble amounts to only +5% to +7% or so, so if it bursts I lose -5% to -7%, and it is just losing an undeserved bonus I got within the last year. That would not ruin my whole retirement.
Let us agree on the following:
Yesterday (8.24.2020) i checked data on AGG (the iShares Total Bond Index ETF). The effective duration = 5.9 years and the YTM =1.1%. So, if you had purchased AGG yesterday, waited its duration and reinvested the ETF dividends, your before tax return at the end of this period would be about its current YTM, meaning 1.1% annual. I say "about", because the reinvested dividends would will be at whatever the future interest rate maybe, so the YTM would be slightly different, but not much.
People invest in bonds for many other reasons than yield, so the fact that the market is buying bonds does not mean that my above statements are not correct.
If you do not agree with my logic, actually there is a classic article discussing this subject that goes into the details. Please google "Portfolio Strategy Duration Targeting: A New Look at Bond Portfolios" by Martin Leibowitz in 2013. Also, if you have a subscription to the WSJ, check https://www.wsj.com/articles/how-to-pre ... 1393871478
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Re: The death of nominal bonds? All Weather without bonds?

Post by GRP »

columbia wrote: Wed Aug 12, 2020 7:40 am
Heck, even the Permanent Portfolio wasn't permanent. :P
Still looks plenty permanent to me.
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Re: The death of nominal bonds? All Weather without bonds?

Post by nisiprius »

mptfan wrote: Mon Aug 24, 2020 2:45 pm This reminds me of the famous "Death of Equities" headline in BusinessWeek in 1979.
It shouldn't. This article is often misinterpreted as a ludicrous mistaken pessimistic prediction; it isn't. It's the fault of the cover design, of course, but the title--even on the cover--is not "The Death of Equities." It is "The Death of Equities: How inflation is destroying the stock market." So, first of all, it is not really about stocks, it is about inflation. And second, it is not a prediction, it is a description of how inflation "is" destroying the stock market, something that was happening in the present and which is supported in the article. "At least 7 million shareholders have defected from the stock market since 1970" was a fact, not a prediction.

BusinessWeek would have done a much better service if they had simply run the article again, rather than someone handwringing with a phony non-apology apology for a good article.

The present day has little resemblance to 1979, because we are not coming out of a seventeen-year period of inflation so high that the real return of the stock market was zero. The main resemblance is a resurgent interest in alternatives, but as an alternative to bonds, not to stocks

Fortunately the article itself is available here at ritholtz.com: The Death of Equities: How inflation is destroying the stock market.

The closest thing to a capsule summary is:
The one rule whose demise did the stock market in could be summed up thus: By buying stocks, investors could beat inflation. Stocks were a reasonable hedge when inflation was low. But they proved helpless against the awesome inflation of the past decade. “People no longer think of stocks as an inflation hedge, and based on experience, that’s a reasonable conclusion for them to have reached,” says Richard Cohn, an associate professor of finance at the University of Illinois. Indeed, since 1968, according to a study by Salomon of Salomon Bros., stocks have appreciated by a disappointing compound annual rate of 3.1%, while the consumer price index has surged by 6.5%. By contrast, gold grew by an incredible 19.4%, diamonds by 11.8%, and single-family housing by 9.6%. At least 20 banks now include hard assets in their pension accounts.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: The death of nominal bonds? All Weather without bonds?

Post by mptfan »

I respectfully disagree that the article is not about stocks. I just read it, and it clearly talks about stocks throughout the article and refers to the decline of the average person investing in stocks....

The problem is not merely that there are 7 million fewer shareholders than there were in 1970. Younger investors, in particular, are avoiding stocks. Between 1970 and 1975, the number of investors declined in every age group but one: individuals 65 and older. While the number of investors under 65 dropped by about 25%, the number of investors over 65 jumped by more than 30%. Only the elderly who have not understood the changes in the nation’s financial markets, or who are unable to adjust to them, are sticking with stocks.
...
For better or for worse, then, the U.S. economy probably has to regard the death of equities as near-permanent condition—reversible some day, but not soon.


And then the article goes on to list "at least four good reasons why inflation is killing equities."

Today, the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared. Says a young U.S. executive: “Have you been to an American stockholders’ meeting lately? They’re all old fogies. The stock market is just not where the action’s at.”

Sure, the article talks about inflation as one of the things killing equities, but to say the article is not about stocks?
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