The
Problem with Harry!
[Not really!]
DYI: To
say that I’ve stood on top of the shoulders of past great author(s)/investor(s)
would be far too grandiose. Standing on
a soap box in the village square [my blog] explaining my investment method for
anyone who has happened to stumble upon me is far more appropriate.
What I have developed is an off shoot of
Harry Browne’s Permanent Portfolio a static allocation for 25% stocks, 25% long
term bonds, 25% short term bonds [CASH] and 25% gold. The problem that I always encountered with
Harry’s – forever fixed – hence “Permanent” Portfolio was what to do if an
asset category was wildly over or undervalued.
This would doom monies placed into that asset to either severe
underperformance – or out right long term losses or far too little monies
[capped at 25%] when that asset category was on the-give-away-table hence lavish
future long term returns.
The beauty of Harry’s 4 assets is that at
anytime one of them (possibly 2) will be insanely undervalue [or soon be] and
conversely one or two will be insanely overvalued
[or soon to be].
Market Sentiment
Looking at today’s U.S. markets such lopsided
categories with money market funds and short term bonds firmly in DYI’s
sentiment location [give-away-table] Despondency, Max-Pessimism, and
Depression. And yet we have stocks and
long term bonds wildly overvalued both within those three levels – Delusional,
Max-Optimism and Denial of Problem.
Push-Pull of Different Economic Conditions
This constant divergence between these
categories is the beauty of Harry’s assets as they either pushed up or pulled
down by totally different economic conditions.
Hence driving the movement overtime to polar opposites as each condition
moves through it’s lifecycle of Birth – Growth – and Death.
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 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.
Starting Point
The starting point is the theoretical assumption
that if stocks, long term bonds, and gold were all trading at average [fair
value] simultaneously then our 4 asset portfolio would be exactly as Harry’s
Permanent Portfolio with 25% in each category.
But alas markets are not like that due to long term economic forces that
play themselves out from birth – growth – and then die off as the other
asset(s) becoming the driver of future returns with very few market
participants recognizing the change well into the growth phase for that asset.
Model Portfolio
DYI’s Model Portfolio is simply measuring how
far above or below fair or average value that our 3 assets, stocks, long term
bonds and gold [cash is our default option] to determine the percentage
invested into each category. This math
formula was devised by John Kingham of England.
And while I’m giving out accolades this was sent to me by Irish57 to
whom I owe so much; that could never be repaid. Thanks’ Irish57, thank you!
Updated Monthly
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 11/1/18
[See Disclaimer]
Let’s play pretend just for a moment and this
is 1997 with everyone playing the latest hot growth fund or brand new computer/software
or dot.com company, but you being a hard nosed value driven investor due to
insane stock valuations you know this economic driving force is now very close
to death.
How did you know?
DYI’s averaging formula is measured between
either 100% above or 100% below average value to determine percentage
allocation. In the case of stocks the dividend yield we use dividends. Back in 1997 the average dividend yield since
1871 was around 4.5% or a price to dividends of 22 to 1 however the current
yield in 1997 was a scant 1.61 or 62 to 1!
That is 170% (rounded) above its mean showing stocks as insanely
overvalued.
Or just look at the Shiller PE chart that
would tell you everything you needed to know about U.S. stocks on a generalized
basis.
Wow what a Moon Shot!
DYI’s averaging formula would have kicked you
out – and rightfully so – out of the U.S. stock market so you said let’s take a
look at long term bonds as measured by the bell weather 10 year Treasury
bond. The average yield since 1871 was
around 22 to 1 interest with current yield for 1997 at 15 to 1 which is below
average making long bonds a bargain. How
much of a bargain? Our formula for 1997
would have your allocation at 35%. You’ve
look at stocks and bonds but what about gold?
DOW/GOLD RATIO
Wow, wow, and wow! Stocks cranked up to the moon and gold
sinking fast leaving the bargain level moving to the give-away-table. This is a bargain just as stocks were a
bargain back in 1974 to 1982. Gold and
the precious metals mining companies didn’t lift off until 2002. That was fantastic for our knowledgeable value
player as it gave him time to accumulate bullion and mining shares all on the
give-away-table! Our formula back in
1997 would have gold allocation at 73%!
Since our maximum is 50% our portfolio would look like this is 1997.
Model Portfolio
1997
Active Allocation Bands (Excluding Cash) 0%
to 50%
15% - Cash -Short Term Bond Index - VBIRX
50% - Gold- Global Capital Cycles Fund -
VGPMX
35% - Lt.
Bonds- Long Term Bond Index - VBLTX
0%
-Stocks - Total Stock Market Index Fund - VTSAX
To say the least other less informed – or should
we call them closet speculator (realized or not) – would have thought of you as
being crazy. You might even have your
greed button touched a few times as your neighbor drives home in a brand new
high performance sports car that he just bought playing the high tech
stocks. It all looked so easy. Then the bottom dropped out and you find out
why your neighbor moved as he defaulted on his house and had to file bankruptcy
because he leveraged everything speculating in overvalued assets!
Leverage
The majority of financial commentaries say
stay away from borrowing money for investments.
For those who have no idea what is a bargain, overvalued and everything
in between that is sound advice. But for
our value player – doesn’t mean you have to – borrowing money can be very sound
to use [and you don’t go crazy] if the borrowed money interest rate is low
enough. Going back to our 1997 investor
opening up a margin account with a broker our clever and value driven knowledgeable
investor could have produced a portfolio looking like this:
1997 Brokerage Account Portfolio
15% Two year Treasury Notes
25% Selected mining companies
25% Adams Natural Resource Fund symbol PEO
35% 30 year Treasury bonds
0% Generalized stock investments
The best time to use margin is when gold,
stocks or long term bonds are an obvious historical value based bargain and
especially when they are on the-give-away table. Unfortunately today short term bills and
notes are the bargain but the cost of margin would be greater than the return. So we wait until better values arrive.
Till Next Time
DYI
This blog site is not a registered financial advisor, broker or securities dealer and The Dividend Yield Investor is not responsible for what you do with your money.
This site strives for the highest standards of accuracy; however ERRORS AND OMISSIONS ARE ACCEPTED!
The Dividend Yield Investor is a blog site for entertainment and educational purposes ONLY.
The Dividend Yield Investor shall not be held liable for any loss and/or damages from the information herein.
Use this site at your own risk.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
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