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Four Uncorrelated Assets
1.) Stocks
2.) Long Term High Grade Corporate/Government Bonds
3.) Short Term Notes (Cash)
4.) Gold – Precious Metals Mining Companies
Four Assets Correlated to Four Economic Conditions
1.) Prosperity
2.) Deflation
3.) Recession
4.) Inflation
1.) Prosperity: Stocks become a clear winner during conditions of increasing employment, rising wages tied to increasing productivity along with rising profits. Junk bonds (they trade like stocks) are also winners in this environment despite their low quality; the economy is so good interest and principal payments are made – defaults are minimum – and a positive climate for refinancing. High quality corporate/ government bonds are secondary winners as prosperity is noted for stable or slowly declining rates. Gold is generally a loser in prosperity as inflation is minimized and investors seek higher returns in more traditional investments.
2.) Deflation: Deflation is the decease in the general price level of goods and services. The Great Depression is a standout example of deflation. The general cause is when excess debt is built up in the private sector that can no longer be increased and/or maintained resulting in massive bankruptcies. This creates an environment of panic as businesses scramble to become profitable by firing employees and cutting hours of remaining workers. In this deflationary episode interest rates decline, prices decline, and the almighty buck rises in value against softer currencies.
Long term high quality corporate bonds and long term U.S. government bonds are winners in this type of economy. Stocks, gold, and junk bonds generally will fall in price along with interest rates on short term notes.
3.) Recession: For DYI's purposes recessions are a period of increasing interest rates engineered by the Federal Reserve in order to quell inflation by slowing down an over heating economy. This condition is temporary as the economy will either adjust to the new economic environment bringing back prosperity or a deflationary period will begin.
High quality corporate/government bonds, stocks, gold, and junk bonds are all losers in this scenario. Short term notes and money market funds are clear winner as their principal value remains steady plus the interest income improves with the increasing interest rates.
4.) Inflation: Too much money chasing too few goods. When Federal government liabilities become onerous from financing of war(s) and/or social programs that are too great to be paid by taxation governments will resort to money creation to pay the remaining costs. After WWII, Korea, Vietnam and the war on Poverty inflation began slowly prices increased relentlessly (despite high taxes) as government liabilities expanded. When President Richard Nixon closed the gold window (1971) the last vestige of inflationary controls were removed with inflation peaking in the high teens only until Paul Volker was appointed as Fed Chairman (August 79) who crushed inflation with high interest rates.
Stocks, high quality long term corporate/government bonds, junk bonds are all losers as inflation soars along with interest rate increases (despite the Fed's efforts to suppress them). Cash (money market funds) or short term notes are neutral or slightly lag inflation rolling up to the higher interest rate quickly.
Gold is a winner when inflation breaks above 5%. When inflation goes double digit gold is marked up in price to reflect the debasement of the currency. Gold will also rise in price based upon fear of massive defaults as gold has no counter party risk.
This investment approach is an offshoot of Harry Browne's Permanent Portfolio which maintains a fixed 25% invested in the above four asset categories listed above. Harry's uncorrelated assets at the time were ground breaking. Today it is now taken for granted. As much as I was impressed with Harry's work it always made me uncomfortable to always own 25% in each asset. When valuations are at extreme lows a greater percentage in called for and conversely at historical nose bleed levels significantly less.
The DYI’s approach working through our four assets and determining with some measure of accuracy the percentage invested depending upon long term valuations. This is done by calculating our averaging formula for each asset. Excluding cash DYI will adjust its allocation from a range of 0% to 60%. There is a bull market among these four assets and yet with only the maximum of 60% not exposing yourself to undue risk.
Will DYI outperform the market??
A strong MAYBE! What I can tell you is a much smoother ride than the fully invested stock market, long term bond, cash equivalent, gold investor. Each of those investments has their moment of fame or shame. Value players reduce or eliminate the overvalued assets and increase the undervalued; simple as that!
Updated Monthly
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 3/1/17
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
DYI
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