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The Permanent Portfolio Is Dead

Summary Permanent Portfolio has underperformed U.S. stocks, and several stock/bond allocations, since 2012. Gold has delivered most of Permanent Portfolio’s gains since 2007; as gold underperformed since 2012, so has the Permanent Portfolio. Permanent Portfolio worked in an age of booming credit-based consumption, but does not work in an age of secular stagnation. Even if we aren’t in an age of secular stagnation, the permanent portfolio’s three-year underperformance indicates that it is no longer permanent, and is best avoided. If you’ve never heard of the permanent portfolio, consider yourself lucky. If you have heard of it, I’m sorry to tell you this: it’s not permanent anymore. Which means it really never was. That doesn’t mean it had a great run, but the run is over and it’s time to move on. What is the Permanent Portfolio? The permanent portfolio was first designed by investment analyst and libertarian politician Harry Browne, who called it a “fail-safe” investment. The idea was simple enough to appear elegant: a portfolio of equal weightings of four asset classes: * 25% U.S. stocks-e.g., the SPDR S&P 500 Trust (NYSEARCA: SPY ) or Vanguard Total Stock Market ETF (NYSEARCA: VTI ) * 25% long-term Treasury bonds-e.g., the iShares Barclays 20+ Year Treasury Bond Fund (NYSEARCA: TLT ) * 25% cash-e.g. the Short Treasury Bond ETF (NYSEARCA: SHV ), or just cash * 25% precious metals (specifically, gold)-e.g. the SPDR Gold Trust ETF (NYSEARCA: GLD ) The stocks were for times of prosperity. The bonds were for times of deflation, the cash was for times of recession, and the gold was for times of inflation. An equal weighting of all of these, the theory went, would protect an investor from any one scenario and outperform a focus on any one asset class. Harry Browne dreamed up the permanent portfolio in 1982 when rampant inflation was eating into everyone’s purchasing power and stagnant economic growth was crimping most people’s ability to earn and save. Shortly after Browne’s vision, the U.S. gave up its steady savings rate and learned to love credit cards, causing the national savings rate to plummet: (click to enlarge) The 1980s were a time of high inflation and strong stock growth, providing tailwinds for Browne’s brainchild. Those who followed Browne’s lead had market-beating returns and shockingly little volatility. According to Crawlingroad.com , the permanent portfolio had a 11.5% average return from 1982 to 1990, and no negative years (it did however have a negative return in 1981 due to a 32.9% drop in gold). Backtesting the strategy, we see only three years of negative returns since 1971: Even more impressively, the permanent portfolio managed a positive return even in years when two asset classes had horrible years, like in 1973 when stocks and bonds fell, or 2000 when stocks and gold both fell. Performance Since 2008 This was part of the PP appeal back in 2011 and 2012. The memory of the 2008-2009 crash was fresh in everyone’s minds. Real estate seemed toxic and gold was soaring. Income was getting harder to find, and everything seemed too risky. A lot of people wanted to invest, but were still terrified of the stock market. Low volatility and diversification were hot topics, and this made the Browne’s permanent portfolio come back into vogue: (click to enlarge) The chart above tracks Google searches for “permanent portfolio”, and the steady rise in 2010 to 2012, to breach spikes in searches during the 2008 crisis, is partly an indicator of just how enduring Browne’s idea is in times of fear. Those who searched back then were probably pleased with what they saw. The permanent portfolio steadily provided strong returns throughout the 90s and 2000s, and even seemed to weather the storm of 2008 , when talk of apocalypse graced the lips of the financial press: (click to enlarge) It’s no surprise, then, that many turned to the permanent portfolio, which had held steady returns largely thanks to gold and U.S. Treasuries during and immediately after the crash. Of course past performance is no indicator of future results, and those who have stayed with Browne have had some stressful times since then. The portfolio has massively underperformed stocks since 2012, and has actually lost about 15% from then to the present. To make matters even worse, Morningstar rates the Permanent Portfolio Fund (MUTF: PRPFX ) one star for its 3-year and 5-year returns, with low returns and high risk. Yet its 10-year rating is high return and above average risk with four stars. Clearly something changed in the last three years to obliterate Browne’s strategy. So what happened? Why Permanent Portfolio Doesn’t Work Anymore A quick glance at one chart shows the problem. Taking together an ETF portfolio following the PP philosophy, our basket will contain SHV, GLD, TLT, and SPY in equal amounts. Looking at these funds’ performance since 2007 tells us one thing: gold is the biggest contributor to our returns: (click to enlarge) Gold rose over 180% from start to peak, and has erased over 100 percentage points of gains since then. The fall has decelerated in recent months, but the slide in gold’s value has hit our PP severely, while both TLT and SPY provide us with much smaller, but much steadier returns since 2009. Why is gold underperforming? The primary reason is simple: a lack of inflation. If we look at the urban consumer price index (CPI-U) and the personal consumption expenditure index (PCE), which are the two biggest indices for measuring inflation used by economists both in and outside the Federal Reserve, we see an average annual inflation rate of 1.81% since 2007–far below the historic norm and below the Federal Reserve’s target: (click to enlarge) As Browne told us, low inflation means underperformance for gold. If we are in an era of secular stagnation, as Professor Larry Summers confidently tells us , then it is unlikely that we will see inflation rates rise considerably beyond that. But we also won’t necessarily see broad prosperity either, which should put pressure on stocks if quantitative easing and low yields do not drive more money into the stock market. Thus two of the four major components of the permanent portfolio are likely to drag down returns. If you disagree with Larry Summers, as Ben Bernanke famously did in a recent series of blog posts , that doesn’t mean you will necessarily benefit from the permanent portfolio either. The fact that the PP has underperformed in the last three years, providing YTD returns of -1.5%, 1 year returns of -7.6%, and 3-year annualized returns of 0.5%, tells us that the permanent portfolio is no longer permanent. It also tells us that something fundamental has changed in the world since 1982, and last generation’s sound investment advice is folly for this generation. Don’t Invest Your Politics One of Browne’s biggest appeals is his libertarian character. A former libertarian presidential nominee, the late Harry Browne wrote several books about the failure of government, the importance of self-reliance, and the importance of freedom (his most popular book is titled “How I Found Freedom in an Unfree World”). I suspect many permanent portfolio investors are likewise libertarians, who find sense in Browne’s message and thus think that will somehow translate to market-beating returns. The guilt by association fallacy here has been a costly one for investors over the last three years. Libertarian or no, investors who understand that politics and markets are separate things that may sometimes intersect have been able to avoid the allure of a permanent portfolio, and move their strategy with the market. Those who did so in 2012 and saw value in equities have beaten the Permanent Portfolio. So did those who bought high yield bonds, or those who went into real estate. Even those who bought U.S. Treasuries have done better than Browne’s followers. It is clear that the Permanent Portfolio is not so permanent anymore. For those looking for low volatility and steady appreciation, it is time to look elsewhere. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Dogs Of The Dow Part II And The Return Of The Goldbugs?

Summary SunAmerica Focused Dividend has turned it around in 2015, are the Dogs of the Dow back? Can active managers catch up after a disastrous 2014? Can the Goldbugs find a way to shine in 2015? It has only been three weeks since our posting on SunAmerica Focused Dividend (MUTF: FDSAX ) and while the ‘Dogs of the Dow’ may have continued to slumber since then, something is definitely working for the fund. In the 7th percentile on a YTD basis, the fund has delivered a solid 2.79% return since our posting compared to 1.55% for the S&P 500 and .82% for the Russell 1000 Value iShares. While we always like to see ourselves proven right (who doesn’t?), the reasons why FDSAX has outperformed so far in 2015 could spell more trouble for active management in the year to come. The secret to FDSAX’s strong performance in 2015 really isn’t that hard to figure out; just head over to Morningstar.com and check it out. What’s in the secret sauce? Well it’s not the Dogs of the Dow although only 4 of the Dogs it holds are underperforming the Dow Jones Industrial Average so far this year. The secret to their success; video games and cigarettes or put another way a deeply discounted retailer (Gamestop (NYSE: GME )) and the 4 largest remaining cigarettes manufactures in the world, the foundations of the consumer staples category. What’s made FDSAX so successful is that incredible difference in performance between the different sectors of the market with a spread of nearly 800 bps between utilities (the Utilities Select Sector SPDR ETF ( XLU) – up 4.07%) and financials (the Financial Select Sector SPDR ETF ( XLF) – down 3.88%) in 2015. For the same period of 16 trade days at the start of 2014, the spread between healthcare and consumer cyclicals was only 594 bps. If the trend continues, 2015 is shaping up to be another year that separates the true active managers from the closer indexers. Let’s start by taking a look at the broader market to see what we can make of the situation. Starting with a daily chart, the S&P 500 was pulled back into the late 2014 ascending wedge on the promise of the new ECB QE program along with a spate of negative economic reports here at home that lite the hope that the Fed’s anticipated rate hike program is on hold. (click to enlarge) While Thursday’s price action was a welcome change, all things considered the weekly action was unimpressive. The volume heading into Thursday was steadily diminishing and Friday’s close just off the lows failed to confirm the move higher. Today’s election of a new leftist government in Greece probably won’t help the open on Monday. As of press time (10:30), the VIX futures had jumped although we backing off the highs. On a weekly basis, you can see the S&P bounced off the first potential stopping out point, but we’ll need to see follow through this week to confirm whether this is just a bounce off one day’s positive news. The fact that the news that lifted the market originated overseas rather than here doesn’t strike me as particularly positive. (click to enlarge) What’s more worrying for trying to separate the closet cases from the true active managers is that the internal make-up of the market doesn’t show any signs of improving although the recent trend towards defensive sectors might be running out of steam. First let’s start with this chart showing the percentage of stocks above their 200 day moving average. You can see that the percentage is way off, even after Thursday’s big one day spike but you have to consider what did well versus what lagged last week. (click to enlarge) Sector wise, Healthcare and Financials make up nearly 30% of the S&P 500 and both lagged noticeably; the financials have been hit hard on weak earnings and healthcare stocks are showing signs that they’re running on fumes after so many years of strong performance. That strong performance is probably the biggest detractor to stronger returns going forward as long term investors have serious gains to protect. Consumer defensive’s and healthcare stocks also underperformed for the week although they make up a much smaller portion of the index at a little more than 12% while high flying REIT’s make up only around 2%. (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) For the S&P 500 to really breadth stabilize and give the market a fighting chance to making serious gains, the last need to become the first. Consumer cyclicals and industrials make up over 22% of the S&P 500 and have had…well mixed performance following tough 2014’s. And the best that can be said about energy stocks is that they haven’t gotten lot worse. This is why market prognosticators always say defensive-led rallies are doomed to failure in the long run. They make up such a relatively small part of the market that as long as they’re pulling the market higher, the advance will be tepid and unstable. Goldbugs Take Heart: What about the Yinzer Analyst’s favorite wager of 2015, European equities? Well you can see that the unhedged iShares MSCI EMU ETF ( EZU) managed a decent advance for the week although it underperformed SPY, up 1.36% to 1.66%. On a daily chart basis, the advance off a retesting of the downtrend line was confirmed by a shift in momentum and the sharp rise in the CMF (20) score although the failure to break above the 50 day moving average was disheartening. (click to enlarge) On a weekly basis, the sharp uptick in volume was offset by a middling CMF score for the week leading to a decline in the CMF 20 and failing to confirm the breakout. With Sunday’s election in Greece, the most likely direction will be lower to retest the downtrend line. (click to enlarge) Who has enjoyed a seriously strong and undeniably positive start to 2015 are the gold miners. After so many bad years, could the global uncertainty over deflation and equity weakness here at home be ready to push the miners back towards their 2014 highs? Take a look at the daily chart below, you can see the Market Vectors Gold Miners ETF ( GDX) managed to push back into its 2014 trading range before getting stuck at the 200 day moving average, but the real handicap for the week wasn’t profit taking (we hope) or covering old losses, but a positive week for the S&P 500. Despite the best efforts of the Permanent Portfolio Fund (MUTF: PRPFX ) which is killing it in 2015, gold has lost its luster for most investors and the miners especially aren’t playing a big role in their portfolios anytime soon. But hey, room to grow right? (click to enlarge) Longer term, the miners are still stuck in the falling wedge pattern that has been guiding its destiny ever downwards since 2012. This week GDX ran smack into the upper boundary and managed to push through it before running out of steam and closing below the trend line. For those gold bugs out there, take heart. Volume was lower on the week and didn’t damage the uptrend line while the MACD seems to be in the early stages of rolling over to turn positive. Even if the move turns out to be another false rally, take heart goldbugs, the pattern continues to narrow indicating a breakout could be in the cards later in 2015. (click to enlarge) That’s it for the Yinzer Analyst tonight; he’s going to need his rack time before getting up to clear some snow. But tomorrow is a new day and another change to make some money, make sure you’re ready for whichever way the market bends.