I will take a crack at a few of these. These are just my opinions, of course.
Lbill wrote:MT - I'm trying to understand this. Let's suppose, for purposes of argument, that we have strongly rising treasury interest rates.
Why would interest rates be rising? Only two reasons I can think of--(1) the stock market is doing well, which means the bond market has to pay more to lure money away from equities, or (2) inflation and inflationary expectations have taken hold and the market is asking for higher rates to compensate for perceived loss of future purchasing power.
Since stocks are, IMHO, in a secular bear market, I think that the current rally will stall at some point and I don't see sustained pressure for higher rates due to equities providing even higher returns.
With respect to inflation and inflationary expectations, I don't see that either. With a secular deleveraging trend taking shape, I think we will see moderate deflationary forces for quite some time being driven by overcapacity, structural unemployment, and continued credit contraction. Remember, too, that globalization is a deeply deflationary force on developed economies since anything that CAN be offshored WILL be offshored.
First, the Prechter paper speculates that rising rates would cause investors to flee most other investments in order to buy bonds that are paying high interest rates.
I'm not sure that's how it would go down. I don't recall that investors were flocking into treasurys in the early 1980s, even though they could have locked in 12%-14% for 30 years if they had chosen to do so. Higher rates suggest that investors DON'T want to buy bonds. For example, I don't see people selling their stocks right now to buy Greek bonds.
That would cause stocks, commodities, and gold to lose value because they are being sold.
Only if the initial premise is true. I don't think it is.
I recall that it is often said that stocks and bonds compete for investor dollars: when rates are low, investors are forced into equities because they are getting low returns on bonds and vice versa. So, I can imagine that rising bond rates would attract money out of stocks, commodities, and gold into bonds. In fact, there's a lot of "hot money" going into these investments because interest rates have been zero, and money can be borrowed for next to nothing and leveraged into the stock market, commodities, and gold. That money will come out like a scalded rat when rates start increasing.
I think that depends. In the late 1980s and all of the 1990s rates were relatively high compared to where they are today and world equity markets did very well.
The mechanics and psychology of the bond market are more complex than I think people realize. I think a lot of conventional bond market wisdom is based upon narratives that were anything but obvious at the time--e.g., who was screaming that treasurys were starting a 30 year secular bull market in 1982? Nobody.
The reason bonds become attractive to investors when rates are going up is because rising rates have cut the price of existing bonds.
I think this may sometimes be the case, but other times it is just the opposite--when rates go up, investors sell their existing bonds, which makes rates go up even more; see Greece.
So, if you were sitting there when rates ramped up it seems like you'll lose on stocks, commodities, gold, and your existing long term treasuries.
See my suggestion above regarding the two potential causes for interest rates to rise--inflationary expectations, a surging stock market, or both. In the current environment I see neither. Thus, I don't think rates will rise dramatically in the first place. See the Japanese, German and UK yield curves. Are they so much better off than the U.S.? Their yield curves suggest that they are, but common sense suggests otherwise (especially with respect to Japan and the U.K.).
Assuming that T-bill rates go up commensurately with long bonds, then the interest paid goes up as you (or your fund) rolls T-bills, so that portion of the PP would gain value as interest rates increase.
That is true.
Small comfort though, since the other 75% of your PP is in the tank.
I don't think such a scenario is possible for any length of time. We saw a temporary set of such conditions in the fall of 2008, but the level of fear during that period isn't sustainable--at some point people get "disaster fatigue" and stop freaking out, no matter how bad things get. That's what we saw after the market bottomed last spring. Things weren't necessarily any better, but people were starting to adjust to it (and put narratives around what had just occurred).
Of course, everyone else in non-PP land is taking gas too. In a relative sense the PP rock may not be dropping as fast as the other investment rocks because of the 25% in T-Bills.
Or it might be floating on the surface like a happy little cork while everything else sinks around it.
I always like to play out possible unexpected scenarios with any asset allocation plan to imagine "what can go wrong." I don't recall that this scenario has been played out anywhere relative to Harry Browne's PP was it? It certainly isn't an impossible scenario - rare though it might be.
I lean a bit toward the doomer side of things, which makes me great fun at parties. The truth is, though, life has a way of reverting to the mean. No matter how bad things may seem on a given day, over time they tend to improve. Similarly, just when you think you are on the verge of Utopia, the market crashes, or someone flies a plane into a building. The story of human civilization is like a great soap opera playing out against a series of artificial social and cultural backdrops which are consistently mistaken for permanent institutions.
All it requires is that interest rates ramp up without inflation, or with actual deflation. I don't think this has occurred historically in the U.S.
When have there been rising interest rates with deflation? How could businesses survive in an environment where borrowing costs were increasing when prices were falling? I don't see how that could happen for more than a short period.
In the last period of strongly rising interest rates, we had high inflation (1970s). Rising rates killed stocks and treasury bonds, but gold and commodities did great because of inflation. In the last deflationary period, we had falling interest rates (1930s). Stocks and commodities got killed, but long bonds did great because of falling rates. I don't think we've had a period where rising rates were accompanied by zero inflation or by deflation - that is uncharted territory.
I don't think that territory will be charted, other than on a very temporary basis. No market economy could survive such conditions for very long.
There's been some speculation lately that this could happen if bond investors, particularly foreign investors, become less willing to purchase treasury debt in the massive quantities required to fund unprecedented deficit spending in the U.S.
As long as the U.S. runs a trade deficit and Uncle Ben is in charge there will buyers of treasurys.
The result would be rising interest rates, but not driven by inflation (as in the 1970s). There could even be outright deflation in the U.S. due to a weak or failing economy, at the same time interest rates are being forced up. I for one certainly don't discount this scenario - in fact, it seems at least moderately likely to me in this Alice-in-Wonderland screwed up world economy we are living in these days.
One reasonable assumption to make is that however bad a shape the U.S. is in, Japan and the U.K. are in worse shape, no matter what economic or other metric you want to use. As long as those countries are selling long term debt at lower rates than the U.S., I'm not too concerned about treasury rates increasing dramatically.
All major economies are praying for inflation right now. Germany has figured out a backdoor way of devaluing its currency by playing this Greece mess for all it is worth (which is a gift to German manufacturers in the form of a lower euro). Short of gimmicks and gadget plays like Germany's Greek tragedy, I think finding inflation is going to be much harder than anyone imagines, and that's part of the reason that Uncle Ben has been willing to print so much money--he knows that in a secular deflationary trend inflation is the last thing to be worried about.
) that the FDIC is NOT backed by the full faith and credit of our government, so that choice, while tempting, is another "warranty violation." Then again, MT feels okay with a slice of the cash in the Vanguard Total Bond Market Index, which is intermediate in duration and not guaranteed by anyone. 
