The Lemon Fool

Anew Vanguard article: "Inflation won't come down magically":

https://www.vanguardinvestor.co.uk/arti ... -magically

As I read somewhere, "The only thing 'transitory' about current inflation is the Fed's use of the word transitory to describe it......."

And then they bang on about how good higher interest rates would be for your portfolio... If you have bonds.
I see bonds aren't a very good 'shock absorber' at the moment. Or indeed ever.

absolutezero wrote:And then they bang on about how good higher interest rates would be for your portfolio... If you have bonds.
I see bonds aren't a very good 'shock absorber' at the moment. Or indeed ever.

Vanguard disagrees:

https://www.vanguardinvestor.co.uk/arti ... sification

If equities crash, you will always be better off if you hold bonds, rather than 100% of the stuff that has crashed.

GeoffF100 wrote:

absolutezero wrote:And then they bang on about how good higher interest rates would be for your portfolio... If you have bonds.
I see bonds aren't a very good 'shock absorber' at the moment. Or indeed ever.

Vanguard disagrees:

https://www.vanguardinvestor.co.uk/arti ... sification

If equities crash, you will always be better off if you hold bonds, rather than 100% of the stuff that has crashed.

Always?
Even if bonds also crash?

In a situation where interest rates rise substantially, then the theory (for what that's worth) says that bond yields will rise and the bond prices will fall. Great if you are going to buy them. Not so great if you already own them.
If your equities are also falling due to raising interest rates and the effect of those on the wider economy and company debt, then bonds don't sound like a good shock absorber to me.

Vanguard can agree or disagree as much as they like. They know no more than anyone else. You, me and everyone else included.

absolutezero wrote:Always?
Even if bonds also crash?

Bond markets generally do not crash, but equity markets do. Bonds can suffer slow attrition due to gradual increases in interest rates, but that is another matter. The numbers that I posted above clearly show that Vanguard was right for the recent dip, despite 7.5% inflation. Bonds did greatly soften the fall.

absolutezero wrote:In a situation where interest rates rise substantially, then the theory (for what that's worth) says that bond yields will rise and the bond prices will fall.

Yes, but equity prices will fall harder. If the interest rates were to stay high for decades, equities may eventually triumph, but the market does not believe that will happen.

absolutezero wrote:If your equities are also falling due to raising interest rates and the effect of those on the wider economy and company debt, then bonds don't sound like a good shock absorber to me.

Both equities and bonds are overpriced, but they are fairly priced relative to each other in the market's assessment. If prices eventually return to what used to be normal, you will lose a lot of money irrespective of whether you hold equities or bonds. There is no way out of that. The market does not believe that will happen. It believes that the Central Banks will bring inflation back under control.

absolutezero wrote:Vanguard can agree or disagree as much as they like. They know no more than anyone else.

The market agrees with Vanguard.

GeoffF100 wrote:

absolutezero wrote:If your equities are also falling due to raising interest rates and the effect of those on the wider economy and company debt, then bonds don't sound like a good shock absorber to me.

Both equities and bonds are overpriced, but they are fairly priced relative to each other in the market's assessment. If prices eventually return to what used to be normal, you will lose a lot of money irrespective of whether you hold equities or bonds. There is no way out of that. The market does not believe that will happen. It believes that the Central Banks will bring inflation back under control.

As a example, FT250 dividend values are down around 30% from former pre-lockdown levels. With the economy opening up again along with higher prices (potential for greater profits) dividend values could rise to in excess of former levels, perhaps a 50%+ increase from end of 2021 levels. That's a considerable potential offset against rising interest rates such that whilst bonds may decline in price, stocks could rise in price. Stocks are fairly priced according to the collective market wisdom and assuming bonds are also fairly priced relative to stocks then the market is fairly priced. As most usually, equal probability of a gain or loss.

The practical outcome of this is that the investor does not need to worry about the relative pricing of equities and bonds. The market does that for him. All he needs to do is decide his risk tolerance and capacity to absorb risk, and set his bond percentage according to the amount of money he is prepared to lose in a crash. After that, all he needs to do is rebalance periodically. That may or may not work out well, but there is nothing better, unless he knows more than the market.

GeoffF100 wrote:Bond markets generally do not crash

Really? Tell that to many holders of fixed rate instruments in the 2007-8 financial crash.

You might also argue they don't generally rally. Odd then to see such a dramatic bull market in bonds over the last 30 years (largely absent from inflation above Central Bank targets). Is it not possible they could move down too, especially in an inflation scenario you are referring to?

dealtn wrote:

GeoffF100 wrote:Bond markets generally do not crash

Really? Tell that to many holders of fixed rate instruments in the 2007-8 financial crash.

You might also argue they don't generally rally. Odd then to see such a dramatic bull market in bonds over the last 30 years (largely absent from inflation above Central Bank targets). Is it not possible they could move down too, especially in an inflation scenario you are referring to?

Here is the first Google hit:

https://darrowwealthmanagement.com/blog ... t-is-down/

Bloomberg Barclays US Treasury + 11.6%
S&P 500 -36.49%

Bonds evidently did work, but if you want to hedge equities, you have to use high quality bonds. It is no good buying junk for that purpose.

GeoffF100 wrote:

dealtn wrote:

GeoffF100 wrote:Bond markets generally do not crash

Really? Tell that to many holders of fixed rate instruments in the 2007-8 financial crash.

You might also argue they don't generally rally. Odd then to see such a dramatic bull market in bonds over the last 30 years (largely absent from inflation above Central Bank targets). Is it not possible they could move down too, especially in an inflation scenario you are referring to?

Here is the first Google hit:

https://darrowwealthmanagement.com/blog ... t-is-down/

Bloomberg Barclays US Treasury + 11.6%
S&P 500 -36.49%

Bonds evidently did work, but if you want to hedge equities, you have to use high quality bonds. It is no good buying junk for that purpose.

So with 4 of the 6 bond lines falling in 2008 you are now ready to concede it is possible they can crash, or at least fall?

Try using some that aren't US based, or don't they count?

Remind me what was the inflation rate in 2008, seeing is this is premised on an inflationary environment?

dealtn wrote:

GeoffF100 wrote:

dealtn wrote:

GeoffF100 wrote:Bond markets generally do not crash

Really? Tell that to many holders of fixed rate instruments in the 2007-8 financial crash.

You might also argue they don't generally rally. Odd then to see such a dramatic bull market in bonds over the last 30 years (largely absent from inflation above Central Bank targets). Is it not possible they could move down too, especially in an inflation scenario you are referring to?

Here is the first Google hit:

https://darrowwealthmanagement.com/blog ... t-is-down/

Bloomberg Barclays US Treasury + 11.6%
S&P 500 -36.49%

Bonds evidently did work, but if you want to hedge equities, you have to use high quality bonds. It is no good buying junk for that purpose.

So with 4 of the 6 bond lines falling in 2008 you are now ready to concede it is possible they can crash, or at least fall?

Try using some that aren't US based, or don't they count?

Remind me what was the inflation rate in 2008, seeing is this is premised on an inflationary environment?

Yes, of course bonds can crash. Junk bonds behave very much like equities when the equity market crashes. The context here is bonds that are suitable for hedging equities. Junk bonds should be counted as part of the equity allocation. Long dated Treasury bonds are generally considered to be best for crash protection, but the longer the duration, the greater the interest rate risk (but see the Vanguard article).

British data would be welcome. Better still global equities in sterling terms and global bonds hedged into sterling. Nonetheless, the US data will do.

The US inflation rate was 3.84%.

dealtn wrote:

GeoffF100 wrote:Bond markets generally do not crash

Really? Tell that to many holders of fixed rate instruments in the 2007-8 financial crash.

You might also argue they don't generally rally. Odd then to see such a dramatic bull market in bonds over the last 30 years (largely absent from inflation above Central Bank targets). Is it not possible they could move down too, especially in an inflation scenario you are referring to?

A 10 year rolling ladder of 10 year Gilts not marked to market has each years gain as the approximate average of the current and past nine years 10-year-gilt maturity yields, that will tend to be relatively smooth and always positive and has around 10% of the value maturing into cash each year. Shorten that down to a 3 year ladder and that's a third maturing into cash each year. 50/50 stock/3 year gilt ladder and rebalancing as/when a gilt matures and that supports a -66% stock decline assuming bonds paid no interest (all of the maturing gilts proceeds going into buying more stock shares, where bonds had lost nothing, typically gained).

But that is nominal, factor in inflation and multi-year crashes can/have occurred, such as losing -50% in real terms. Or if you mark to market the paper value can dip. To be more inclined to hedge equities you have to move to longer dated gilts and mark to market which increases volatility - which might be considered as being risk. Buffett prefers to shift bond risk over to the stock side, he might suggest holding 80/20 stock/3 year gilt ladder instead of 60/40 stock/bonds. The combination of one asset that doesn't lose nominal value that permits more stocks to be purchased after declines might be considered a form of inflation hedge. In the present low yield era that is perhaps a better choice than looking to longer dated gilts as the stock hedge.

I have done my best to explain the theory. What do I do in practice?

I can tax shelter about a third of my portfolio. I have chosen to shelter mostly equities. (That will be good if equities appreciate in value, because it will increase my tax free allowance, but less good if they do not.) Another third of my portfolio is in (mostly 5 year) savings accounts, with some index linked gilts and National Savings Certificates. The final third is in equities. I have accumulated some VAGP in my ISA as a result of rebalancing.

I am not particularly exposed to inflation. My cash/bond allocation is not likely to appreciate in an equity crash, but it will dilute the loss, and enable me to buy equities at a lower price.

The van guards have published another article:

https://www.vanguardinvestor.co.uk/arti ... ets-better

Of course, good little passive investors should just be sleeping through all of this, but be that as it may.

Geoff: Thanks for the link. I think it’s a bit motherhood and apple pie but I found this note interesting “ 3 Based on Vanguard's modelling, we think UK investors can expect 10-year annualised returns ranging from 4.6% to 6.6% in the case of UK shares and 2.8% to 4.8% for those elsewhere in the world.”

Best wishes, Steve

Steveam wrote:Geoff: Thanks for the link. I think it’s a bit motherhood and apple pie but I found this note interesting “ 3 Based on Vanguard's modelling, we think UK investors can expect 10-year annualised returns ranging from 4.6% to 6.6% in the case of UK shares and 2.8% to 4.8% for those elsewhere in the world.”

Best wishes, Steve

[grump]

I do find this sort of fake accuracy disingenuous. How can such a woolly term as "in the case of UK shares" be forecast by their modelling to fall within a range accurate to tenths of a percent? I mean, I'm amazed it came out at "4.6% to 6.6%" and not 4.6% to 6.5%. It all seems false and designed to give the impression they actually know something the rest of us don't.

It would seem more honest to me to say "We expect annualised returns from UK shares over the next decade to be somewhere around 5% to 6%". Or even 4% to 7%. I hold that like the rest of us, they Just Don't Know.

[/grump]

Mike4 wrote:I do find this sort of fake accuracy disingenuous. How can such a woolly term as "in the case of UK shares" be forecast by their modelling to fall within a range accurate to tenths of a percent? I mean, I'm amazed it came out at "4.6% to 6.6%" and not 4.6% to 6.5%. It all seems false and designed to give the impression they actually know something the rest of us don't.

It would seem more honest to me to say "We expect annualised returns from UK shares over the next decade to be somewhere around 5% to 6%". Or even 4% to 7%. I hold that like the rest of us, they Just Don't Know.

I agree that the second significant figure is not significant here, nonetheless they are just reporting the results. Those expectations are based on the present values of some macro-economic variables. Those values will change over the course of the next ten years. More importantly, the actual outcome will depend on unpredictable future events. Nonetheless, Shiller CAPE has a lot of predictive power for 10 year returns. Vanguard is trying to improve on that.

Steveam wrote:Geoff: Thanks for the link. I think it’s a bit motherhood and apple pie but I found this note interesting “ 3 Based on Vanguard's modelling, we think UK investors can expect 10-year annualised returns ranging from 4.6% to 6.6% in the case of UK shares and 2.8% to 4.8% for those elsewhere in the world.”

Best wishes, Steve

Is this in real terms?

TUK020 wrote:

Steveam wrote:Geoff: Thanks for the link. I think it’s a bit motherhood and apple pie but I found this note interesting “ 3 Based on Vanguard's modelling, we think UK investors can expect 10-year annualised returns ranging from 4.6% to 6.6% in the case of UK shares and 2.8% to 4.8% for those elsewhere in the world.”

Is this in real terms?

No, it is in nominal terms, before costs and taxes. Inflation? The BOE target is 2%, but they are not good at keeping to that. 3% average over the next 10 years perhaps?