Tuesday , 22 October 2019


“Black Hole” Investing Or “Dumbbell” Investing – Your Choice

…Many financial advisors…continue to recommend old solutions like the “60/40” portfolio…Those who adopted that strategy and…stuck with it…had several good decades…starting in the late 40s and up until 2000 [but] that doesn’t guarantee them several more, though. I believe times have changed.

…The “logic” of 60/40 is that it gives you diversification. The bonds should perform well when the stocks run into difficulty, and vice versa. You might even get lucky and have both components rise together but you can also be unlucky and see them both fall, an outcome I think increasingly likely.

Louis Gave wrote about this last week [saying;] Historically, the optimized portfolio of choice, and the one beloved of quant analysts everywhere, has been a balanced portfolio comprising 60% growth stocks and 40% long-dated bonds. Recently, [however,] this has come to look less and less like an optimized portfolio, and more and more like a “dumbbell portfolio,” in which investors hedge overvalued growth stocks with overvalued bonds.

At current valuations, such a portfolio no longer offers diversification. Instead, it is a portfolio betting outright on continued central bank intervention and ever-lower interest rates. Given some of the rhetoric coming from central bankers recently, this is a bet which could now be getting increasingly dangerous.

We are rapidly approaching the event horizon where central bank intervention and ever-lower interest rates will not help your bond portfolio. That is already the case in Europe and Japan. Stocks are at historically high valuations and subject to a severe bear market brought on by a recession.

“Diversification” is not simply owning different asset classes. They have to be uncorrelated to each other and, more important[ly], stay uncorrelated. That was a problem in 2008 when lots of previously disconnected categories suddenly started moving in lockstep.

For the moment, I still think long-term yields will keep falling, helping the bond side of a 60/40 portfolio. Meanwhile, negative or nearly negative yields will push more money into stocks, driving up that side of the ledger so 60/40 could keep firing on all cylinders for a while but it won’t do so forever, and the ending will probably be sudden and spectacular.

Which brings us to my final point. The primary investment goal as we approach the black hole should be…capital preservation…[and] capital preservation can be better than growth, if the growth comes with too much risk.

Here’s the math:

  • Recovering from a 20% loss requires a 25% gain
  • Recovering from a 30% loss requires a 43% gain
  • Recovering from a 40% loss requires a 67% gain
  • Recovering from a 50% loss requires a 100% gain
  • Recovering from a 60% loss requires a 150% gain

If you fall in one of these deep holes you will spend valuable time just getting out of it before you can even start booking any gains. Once you start to fall, the black hole won’t let go. Far better not to get too close.

Friends don’t let friends buy and hold.

I can’t say that strongly enough. You must have a well thought out hedging strategy if you’re going to be long the stock market. If your investment advisor simply has you in a 60/40 portfolio and tells you that “we are invested for the long term and the market will come back,” pick up your capital and walk away. I can’t be any more blunt than that.

Every investment advisor, including me, uses these words in their disclosure documents: Past Performance Is Not Indicative of Future Results. I think that has never been more true than for the coming decade. The 2020s will be more volatile and difficult for the typical buy-and-hold index fund investor than anything we have seen in my lifetime.

Active investment management is not particularly popular right now since passive strategies have outperformed but I think that is getting ready to change. You should start, if you’re not already, investigating active management and more proactive investment styles. You will be much happier if you do….

Editor’s Note: The above excerpts from the original article by John Mauldin have been edited ([ ]) and abridged (…) for the sake of clarity and brevity. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

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(The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.)

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