The Permanent Portfolio Approach

Includes: GLD, SHY, TLT, VTI
by: Lowell Herr

The following comment generated this response. The question is quoted so readers will follow the context of my post. This is likely to be a long post, so prepare yourself for some detailed information.

"I would appreciate your comments on the following:
I've been thinking about the Permanent Portfolio approach, and the Feynman studies; and possibly how to meld them together.
First, about the Perm Port:
It is not built around the idea of asset class correlations. It is built around the idea of looking at the changing seasons of the economy:
1) Prosperity
2) Deflation
3) Inflation
4) Recession
Bonds don't move up sharply in price because stocks moved down. Bonds move up because deflationary forces make it a good investment. Gold doesn't move up because bond prices are falling. Gold moves up when people think inflation is becoming a threat. Stocks don't move up because gold prices have come down. Stocks move up in price when people think the economy is going to be prosperous.
This is the difference between the Permanent Portfolio allocation and others. The assets chosen respond the best to the four conditions of the economy outlined above. Those assets are (for US Investors) Stocks, Long Term Treasury Bonds, Treasury Money Market Funds and Gold. So, a 4-asset Perm Port might have VTI, TLT, SHY, and GLD.
Now for the melding idea:
Decompose VTI into the 9 subcategories (Large Cap Growth, etc.), along with TLT, SHY, and GLD, and put them in a Feynman spreadsheet.
Run the separate sheets, but focus mainly on the buy-hold sheet.
Based on momentum, one of the " four conditions of the economy" assets would rank highest.
Concentrate on that area for investing (i.e., if equities were highest, I would buy the top 4 and hold them as long as they remained in the top 8 or so. If SHY came out higher on any of the top 4 when doing a rebalancing run of the Feynman workbook, go to "cash."
What do you think? Is there any merit to the idea?"

Dick et. al.,

Here is my response to very good questions.

Let me begin by stating that I have reservations about the Permanent Portfolio, particularly in this environment. Begin with Bonds. To hold 25% in an asset class that seems prone to decline over the next five to ten years does not make a lot of sense. Yes, the MOM plan will steer investors away from bonds. More on bonds below. Next is Cash. With interest rates as low as they are, holding 25% of the portfolio in cash means one will automatically lose ground to inflation. Gold had a great run during the golden era of the Permanent Portfolio, but will that be duplicated. Remember the Harry Browne PP took advantage of a great bull market in bonds and stocks from the late 1970s through 2000.

Some of you will remember Michael O'Higgins "Beating the Dow" which became known as Dogs of the Dow. This was a look back into history or somewhat like looking back at the performance of the Permanent Portfolio. The O'Higgins book was flawed and exposure of the curve fitting and data mining was brought into the open by a university professor who went by the pseudonym Datasnooper and later Repoonsatad (Datasnooper spelled backward). A multi-year debate raged on the Motley Fools' website until the Fools finally cried UNCLE. The Motley Fools launched their careers with "The Motley Fool Investment Guide," using a tweaked version of the Dogs of the Dow. I bring this Dogs of the Dow subject up as O'Higgins wrote another book "Beating the Dow with Bonds." I see my 1999 review of this book is still available on Amazon. Check it out. This book was bogus and that is putting it kindly.

Now to focus more precisely on your attempt to meld the PP and MOM methods into a portfolio modeling plan. My first response is that I don't want to remove any of my basic asset class arrows from my investment quiver. While I cannot analyze thousands of securities, I am able to conduct runs that will likely have potential winners that lie outside the "Big Nine" plus the key securities that make up the Permanent Portfolio. Yes, one could use MOM with an emphasis on VTI, SHY, GLD, and TLT, but I recommend also including international markets and commodities. There is nothing to lose as the MOM plan will not include these investments in a portfolio unless called for by the model itself. The advantage of what you are suggesting is that it is a little simpler, but not that much that merits elevating it to a better plan of portfolio construction.

This is a long answer to a good question or point of view. I eagerly await results from HedgeHunter on the momentum test where 17 ETFs are used to maintain a portfolio. This study should provide data as to whether or not to continue using the Momentum-Optimization Model. So far the results point toward continued use.