Wednesday, June 10, 2009
A great discussion broke out yesterday in the comments about the merits of the Permanent Portfolio concept which has been a bit of a hot topic here of late. I wrote about this on Saturday and you can check also check out yesterday's comments here if you are so inclined.
A little later in the day one reader asked whether something like Larry Swedroe's portfolio concept of what the reader described as "using low correlated equity sectors such as 12.5% in US small value and 12.5% in international small value and 70% in short term treasuries" might be the answer. The reader said the return and volatility numbers would be very compelling.
As an administrative note the reader did not leave a link and I'm sorry for not taking the time to find an article by Swedroe on this. I don't know if the reader has his facts correct or not which will not be important for the direction I take with this post but you will enhance the conversation if you provide a link to go with your comment when a link is appropriate like with referencing someone else's work.
In the post on Saturday I talked about one reason I choose not to go with a permanent portfolio is that I believe the (investing) world continually evolves. That which worked for one period of time may not work for a different period of time. Another aspect of this that came to me as I read the Swedroe comment is the notion of complete reliance on something that should work because...
I'm not taking a poke at the permanent portfolio but generally speaking when did Browne come up with it? Was it the 1970s (really don't know)? How much has the world changed since Browne had the idea? How much do you suppose it will change in the next 30 years? It certainly could continue to work in the future but a lot of things malfunctioned in this bear market so why couldn't there be some combination of events that causes the permanent portfolio to malfunction? Complete denial of even the possibility is not well advised.
As a simpler example from this bear market; one strategy that should work is rotating into value stocks (or funds) later in the stock market cycle. The businesses tend to be more mature, obviously the valuations are cheaper and value stocks generally yield more than growth stocks. This worked in the last bear market as growthier funds were heavy in tech so people assumed it would work in this bear market.
Just as growth funds were heavy in tech nine years ago value funds were heavy in financial stocks one and half years ago so many value funds (also similar dividend-centric funds) got crushed in this bear market worse than the S&P 500.
This gets us to the title of this post. Over-reliance on something that should have worked ended up hurting people. There was a failure to see the forest which was that something was very wrong with financial stocks. This was not difficult to see from a big picture standpoint. I was on this very early in terms of there being trouble but never was correct about the magnitude but there was no need to be correct about the magnitude. "Trouble is coming for financials so I better be underweight" is easily copied. Being underweight means looking under the hood of your funds, if you use funds, and adding up the exposure to the thing you want to be underweight then selling to get to where you want to be.
Reliance on and utilization of market truthisms is perfectly valid but blind trust without verifying makes no sense to me at all. Before someone gets on me about blind faith in the 200 DMA, well we went above it a week or two ago and so far I've only bought one ETF, still have a lot of cash and a tiny little bit of SDS. Blind devotion would have me all in already.