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Cyclically adjusting between bonds and stocks – is there any point?

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I was wondering whether there is any correlation between long term bond yields, inflation and stock returns at all? Because there seems to be none in long time frames. Stocks seem to rise regardless of high or low inflation.

The stock market has risen to considerable heights since the 1900s despite bond yields and inflation fluctuating between considerable highs and lows between 2 world wars, a great depression, oil price shocks, stagflation and the great recession.

There is even this chart which shows the long term trend of stock prices over the past 500 years. The only trend is only up it seems.
https://ei.marketwatch.com//Multimedia/2016/11/03/Photos/NS/MW-EZ413_sharep_20161103133502_NS.jpg?uuid=d9a282e0-a1eb-11e6-8b3f-001cc448aede

https://trader535.files.wordpress.com/2016/07/share-prices8.pdf

So why invest in bonds at all if stocks such have a long term positive bias?

It seems to me if one just invests in the stocks of any one of the global superpowers in any century or era they are living in, they’ll just do fine in the long term.

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Posted by Incognito 7
Posted on 06/28/2017 7:09 AM
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Well, it depends on your profile. The stock market is like a 25 year high yield bond. That is, if you hold it for 25 years there’s a near 100% chance that you’ll earn about 8-10% per year on average. That does not mean, however, that that is appropriate for you. Most people have far less than a 25 year time horizon so they have to hedge that equity risk somehow.

The default way to hedge equity risk is to own bonds. But this raises different problems. If you are 60/40 and you want to maintain a proper risk profile then you need to rebalance. But when you rebalance a 60/40 you aren’t always rebalancing to the same level of risk. That is, when 60/40 grows into 70/30 then rebalancing back to 60% stocks might actually result in a riskier portfolio if the new 60 is riskier than the old 60 (think 1999, 2007, etc). I say that the way to fix this is to rebalance in a countercyclical manner by rebalancing at times to something less than your benchmark allocation. That way you maintain an equity allocation, but reduce its exposure to risk.

This serves not only as a smart risk profiling tool, but an important behavioral tool as it gives you more confidence in the plan you’re adhering to.

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Cullen Roche Posted by Cullen Roche
Answered on 06/28/2017 1:40 PM
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    Cullen, every time someone questions your doctrine of counter cyclical indexing, you repeat the exact same thing.

    Looks like many people are wising up to your equivocation.

    At the same time, you also say there is no such thing as “market timing” or “active/passive investing”. Why? Because your countercyclical indexing doctrine is simply active market timing. You talk down these two concepts, so they cannot be used as criticisms of your doctrine.

    So I am now saying that Countercyclical indexing is low-fee smart-beta.

    Upton Sinclair: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

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    Posted by Furion Lfg
    Answered on 06/29/2017 10:21 AM
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      Furion, it looks like you don't actually understand my strategy OR smart beta....Everything is active and market timing to some degree. This is an irrefutable point once you understand it. And yes, i am pointing out that there are smart ways to be active and stupid ways to be active. Again, nothing too controversial there. I obviously think my way is a pretty smart way of doing it. There is a huge amount of evidence showing that a low fee and tax fee efficient market cap weighted portfolio is a smart way to implement a portfolio. All I do is change a few features like how we rebalance and how the specific bond piece is allocated. This isn’t a secret and if you actually read things I write then you would know all of this instead of writing (another) inane comment about something you don’t understand.

      Also, smart beta is factor investing. It is an attempt to generate alpha by assuming there are “factors” that you can invest in that will beat the market. I am not trying to beat the market. I don’t care what
      “the market” does. I am just trying to build portfolios that are appropriate for someone’s risk profile that will match their financial goals and improve their chances of sticking with that plan.

      You literally don’t even understand the strategy you’re criticizing. Why do you spend so much time criticizing things you don’t take the time to understand?

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      Cullen Roche Posted by Cullen Roche
      Answered on 06/29/2017 11:40 AM
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        Countercyclical Indexing strikes me as a pretty rational way to manage an index fund portfolio. Please correct me if I am wrong, but all you’re really doing is rebalancing away from stocks during a bull market, right?

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        Posted by Lars Svensen
        Answered on 06/29/2017 1:13 PM
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          Well, it really depends on your risk profile and the relative risks of the asset classes. CI is a really simple and logical strategy. If stocks boom 50% in a year like they did in 1999 then you will rebalance your portfolio in a way that accounts for the asymmetric risk exposure. So, instead of going into 2000 will a 60/40 portfolio where the 60% now fully reflects the risk from the 50% boom, you might underweight the stock piece to something like 50/50. This reduces the risk of the overall portfolio. But more importantly, what it does is build a portfolio that manages some of your inherent behavioral risks. This reduces the risk, when your 60/40 falls by 30%, that you will overreact.

          Now, I should be very clear. CI is going to tend to rebalance away from stocks on average over a cycle. So you will very likely underperform a benchmark like a 60/40. The point isn’t outperformance though. The point is appropriateness. I am just fixing a flaw that I see in the 60/40….And since it’s all done in a low fee and tax efficient manner it kinda seems like a no brainer to me. I mean, if 60/40 worries you then CI fixes the problems. It’s not right for everyone, but nothing is….

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          Cullen Roche Posted by Cullen Roche
          Answered on 06/29/2017 1:51 PM
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            Its true that both stocks and bonds respond to inflation expectations as yield drivers, but what got commonly overlooked is that all assets have separate periods of time periods when they underperform each other due to different political-macro-economics. Each time you add on a new asset to a portfolio you’re adding an additional risk vector compared to just being all in stocks. All stocks would be simplest but if you can’t tolerate 50%-80% maximum drawdowns and up to 12 years of underperformance (in terms of beating inflaton), you have no choice but to diversify by assets. Once you add on sovereign bonds, you’ve leveraged up your risk exposure to inflation risk which is doubly bad when both stocks and bonds are underperforming inflation (think 1970’s). So you’ve got to add on another layer of complexity, since as managing the duration exposure so that you’re not overexposed to either inflation regime extremes. And when you got to go beyond even that, you have to start looking at real assets because when those are the only things going up in real terms, you better have exposure if you don’t want your portfolio imploding in a sea of red. If you were attempting to time which of the assets to be in at any given time, then that would be “market timing”. But having exposure to all assets is just a common sense hedge instead and fully acknowledging that the future is unpredictable.

            Counter-cyclical indexing is a way of dealing with overvaluation/bubbles by integrating it into the rebalancing decision. It’s actually very in tune with a “passive” market-cap weighted approach because it does the least amount of damage. The devil is in the details such as how much of a “chunk” is necessary before triggering a rebalancing because frequent small rebalancings incur costs and kill gains. In my view, what is problematic with the CI approach is deciding on what is the appropriate base level to reference. We’ve been so chronically overvalued for so long in stocks and in a bond bull market for so long, I’d say it can be tricky. If you set it wrong, it will cost you.

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            Posted by MachineGhost
            Answered on 07/14/2017 7:07 PM
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              Oh yeah, I also wouldn’t expect more than a marginal improvement from using counter-cyclical indexing in a portfolio. It’s not momentum, value, etc. with large relatively alphas. It’s not a factor so much as indirect risk control, so I wouldn’t expect it to add more than .5% CAGR max to a portfolio using it. So it’s not worth all the drama thrown at it.

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              Posted by MachineGhost
              Answered on 07/14/2017 7:14 PM
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                CI isn’t designed to generate alpha. It’s designed as a form of permanent portfolio that adjusts the relative risks in the portfolios so an investor can feel confident sticking with the portfolio regardless of where we are in a market cycle. It is designed to create behavioral alpha by reducing the risk that you will switch your portfolio at the worst time.

                Machine, if you don’t understand the things being discussed on this website then please don’t comment on them. You have a history of commenting here in the forum and saying things that are just flat out wrong.

                Thanks.

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                Cullen Roche Posted by Cullen Roche
                Answered on 07/14/2017 7:18 PM
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