By Dale Roberts

Special to the Financial Independence Hub

The traditional balanced portfolio is built for the current economic environment. It is built upon the premise, or guess, that we will remain in a disinflationary environment. It is all that today’s investor has known. In a disinflationary environment US and Canadian stocks and other developed markets perform well. US and Canadian bonds perform well. As you will have noticed, if you have a sensible balanced portfolio or even a portfolio that is heavily weighted to stocks – you’ve done very well. But things could change. The economic conditions could change. For that possibility you might consider a portfolio that is built for any economic condition – the Permanent Portfolio.

The portfolio blind spot

I “got” the portfolio blind spot framing from a Canadian financial planner. The planner stated that for them, inflation was a blind spot. It was not something that the planner understood or knew how to address.

So if many portfolio managers and financial planners don’t consider serious inflation or the possibility for a change in economic conditions (economic regimes) it’s not surprising that the everyday retail investor would not ‘get it’.

And by the way, I am told that advisors and planners are not trained ‘on this.’ They are not trained to protect your wealth in all economic conditions. The word “stagflation” does not show up in their training materials.

And for the record, here are the economic possibilities and what works best in each regime. The chart is courtesy of ReSolve Asset Management.

When you have a blind spot you could get side swiped.

As I detailed in the lost decade for US stocks, there are periods (long periods) when stocks simply don’t work. They deliver no returns, or no real returns (when we factor in inflation) for extended periods – even a decade or more.

For example, US stocks delivered no real returns for a 15 year period from 1968 through 1982. You can thank inflation for that.

Each stock market is different (that is US vs Canada vs other International) but that trend and fact remains. Stocks don’t always work.

All positive US stock gains over the last 130 years have occurred in disinflationary periods.

Not only that, the traditional balanced portfolio can also deliver no real returns for extended periods. The chart is for US stocks and bonds, but the conditions would not change change materially when we substitute or add in other developed market stocks and bonds.

Where stock diversification would have helped (marginally) is in the early 2000’s period. Canadian and International developed markets did not suffer to the same degree, as did US stocks in the dotcom crash. It was the US stock market that suffered from greater euphoria and greater over-valuation “issues”. You mean, like today? You might ask.

So how do you build a simple portfolio to protect and prosper through all economic conditions?

The Permanent Portfolio

There are four economic conditions that can exist. The economy can grow or the economy can shrink – economic contraction. We can have inflation and we can have deflation.

And yes we can have periods of stagnation or muted movements for each of the above.

With inflation prices are increasing and so is your cost of living.

With deflation prices are falling and the cost of living is decreasing.

Putting it all together, we can have four quadrants or economic conditions.

• Inflation in a period of economic growth.
• Inflation in a period of economic contraction.
• Deflation in a period of economic growth.
• Deflation in a period of economic contraction.

Have another look that chart from ReSolve and you’ll see the economic conditions of the last 120 years and more.

Something is always working

The Permanent Portfolio is designed to hold assets that will perform in each economic environment. Something is always working. Continue Reading…