Exchme wrote: ↑Tue Jan 25, 2022 9:18 am
I think a key point is that markets respond to external events, not just their own rhythms and excesses. Bad events can and do occur at any time, even back to back. So regardless of how a bond tent behaved in historical outcomes, the bond tent hurts in the general case of randomly occurring bad events as illustrated by vineviz 's Monte Carlo simulations.
For every sequence of returns that the bond tent fixes by lowering stock exposure early, there is another possible outcome where the bond tent's slower initial growth and eventual higher stock allocation gives you more risk later. When you face that later storm, the bond tent means you have fewer assets at the start of the storm and more stock exposure, so can end up worse than just keeping everything at your average allocation and sailing the stormy seas as best you can.
Maybe another way to view it is via the willingness, ability and need to take risk viewpoint. The early low stock allocation may increase your need to take risk later, which may leave you needing to take more risk than you are willing and able to emotionally withstand.
This is all true, and is a good point. Whether fixed AA, "age in bonds" or bond tent is better depends on market dynamics, and how they respond to external events. Under the
Random Walk Hypothesis, bond tent might have worse outcomes than fixed AA or age in bonds.
The bond tent is premised on the idea that, while stock prices have a speculative component which may dominate day to day and perhaps even year to year performance, that over the course of 20 years or more, the bigger dynamic is the inherent value of the stock market, because owning part of a company gives you a right to part of its profits. Since people will need food, shelter, transportation, clothing, entertainment, etc., the bet is that as stock prices get lower, they become more attractive. As an extreme example, if the price of a stock were equal to one year's dividends, then you could buy the stock, make your money back in a year, then keep getting more money every year. If you buy and hold in this scenario, then not even assuming global GDP rises but just that it stays the same, on average, for 20 years, you'd have a 20x return on your investment.
Under the random walk hypothesis used in Monte Carlo, the price of stocks are as likely to go down in this scenario as they are to go up. Personally, I think that's wrong, and that on the scale of the business cycle and beyond (i.e. decades), the random walk hypothesis is wrong, and in the above scenario, stocks are much more likely to go up than down.
There are other reasons to believe markets have memory on the scale of decades. For example, everyone is "fighting the last war." During the 1970s, the common wisdom was that the Fed's rate didn't affect inflation much, so there wasn't anything they could do about it. Finally, in 1982, Paul Vlocker raised rates, threw the country into recession, put a lot of people out of work which caused a lot of misery, but got inflation under control, which in the long term created a lot more happiness. After that, the Fed was full of "inflation hawks," and the accepted wisdom became the opposite: the Fed can and should keep inflation low.
The point is, the chance of a second bout of stagflation after the first one is small, because institutions have memory and are ready to address it.
Similarly, after a world war, it's unlikely to have another world war in the next decade or two, as everyone has scars and wants to prevent it at all costs.
So, I believe that the data shows that the memoryless assumption is wrong, and e.g. that
the CAPE10 is not a random walk, and that therefore the bond tent is the safer approach than a fixed or declining AA. You're certainly welcome to take the random walk hypothesis as a better model, and therefore listen to the Monte Carlo over historical analysis.