2/21 Permanent Portfolio Update

Not much to report this month (performance as of intraday Monday).

Current allocation is roughly:

32% S&P 500 futures

21% Laddered Treasury futures

32% Gold

30% ex-US equity

115% gross exposure

A Brief Aside About Portfolios & Inflationary Regimes

Lately at work I have been helping a few people (and their clients) think about building portfolios to better withstand inflationary economic regimes. A recurring theme I come across is clients concerned about the potential impact of high inflation on their portfolios, whose first impulse is to cut or eliminate their equity exposure.

If anything, it is the bonds and cash they should be cutting. This is not to say that equities will do super well in an inflationary environment, but they are, at least in theory, capable of passing some inflation through to customers via price increases (what you really want to own in a high inflation period are companies with pricing power). Setting aside TIPS for the moment, bonds and cash are what are going to suffer badly in a highly inflationary environment.

What I think is happening here is that folks are thinking of high inflation as a Bad Thing and then thinking of Bad Things in deflationary terms. It is natural to think that if a Bad Thing is happening you ought to cut equity risk. Don’t do this! It may indeed be worthwhile to cut some risk. Just make sure you are cutting the right risk.

Again, this is not to say that equities will not suffer in an inflationary regime. It is important to disaggregate equities here. Equities I would be most worried about in an inflationary regime would be high multiple stocks with questionable pricing power and little to no free cash flow. These companies are going to be the most sensitive to substantial changes in the cost of capital/”discount rate.” They are the zero coupon bonds of the equity world.

I try to discourage people from positioning portfolios specifically for extremely high inflation or hyperinflation. Doing so requires them to dump their deflation allocation. We just don’t know whether/when significantly higher inflation is going to show up, and how many more deflationary episodes we might endure in the meantime. The basic intuition underlying the permanent portfolio concept is that we are bad at predicting things. Better to strive for a balanced portfolio capable of surviving many different regimes, even if it is not the best performer in any given regime.

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