"The fundamental reason that a repeated-play cooperative strategy doesn’t work in a game of Chicken is that the meaning of cooperation is different in this class of games. You see it in the title of the game itself. If you cooperate in a game of Chicken — i.e., you’re driving your tractor straight on at Kevin Bacon’s pick-up truck and you veer off from the looming crash, or you and James Dean are racing towards a cliff and you put on your brakes first — you are the LOSER. You are the COWARD. That becomes your identity and your reputation, which means that others will now treat you like a loser and a coward in the games that they play with you in the future. Compare that to the meaning of cooperation in a game of Prisoner’s Dilemma, where cooperation — i.e., you refuse to rat out your partner and cut a deal for yourself at his expense — means that you are STRONG and LOYAL. The words and the examples used to illustrate bloodless, mathematical game theoretic matrices are not accidental! If we believe that our identity is at risk in a repeated-play competitive game, we behave very differently than if it’s not. More to the point, we should behave differently if our identity is at stake. It’s the rational thing to do. If Trump inspires you like a dog inspires a rabbit, then you should never cooperate if it’s a game of Chicken with his tribe and you should always cooperate if it’s a Prisoner’s Dilemma game with your tribe. Maybe you’ll crash the car in this particular game of Chicken and maybe your partner will rat you out in this particular game of Prisoner’s Dilemma. But your identity and reputation will be strengthened, not damaged, for the next game you play with the other tribe or within your own tribe. And there’s always another game." http://www.zerohedge.com/news/2017-02-09/game-theory-trump-not-every-tweet-constitutional-crisis "And there’s always another game", that's what the new age flax seed eating hipsters don't get
I have been making some interesting discoveries in my portfolio research. I just read this paper https://faculty.fuqua.duke.edu/~charvey/Teaching/IntesaBci_2001/GJ_Global.pdf And it talks about how looking at equity returns from a US point of view creates suvivorship bias because the US has been the most sucessful country in the past century. It grew the most, it won all the wars that mattered and it avoided significant risks that played out in other countries (socialistic revolutions) The paper attempts to solve that by looking at global equity returns. What the paper found in terms of global stock returns was quite interesting US equity returns are much better than a global index that they built. But whats noticeble is that there was so many stock markets that completetly dissapeared or got halted for a really long-time. That were so many markets that effectively lost all the capital for all investors. If you get halted for several years and lose 80-90%+ (real) when the market reopens, that's pretty much a wipeout. Overall, they found a positive return from a global index of stock markets But that got me thinking about something else, which is what would it happen if one were to run a bond study of similar nature. According to my studies, UK bonds were not as good as US bonds. Yet, UK long-term EQUITY nominal returns were quite a bit better (according to that paper) than the median country long-term equity nominal return (2.35% vs 0.75%), so by that metric, the UK was a pretty good economy to invest in. And yet, despite all that, UK gilts were shit as a hedge. At least when compared to gold, or even (to a much smaller extent) UK short-term bills. This tells me that (although I will confirm by researching global returns from bonds over the last 100 years) using long-term government bonds is indeed, a very "risky hedge". It only works if the country is very stable. The country has to -Be disciplined in its fiscal and monetary policies -Avoid wars and if they get in wars, win the important ones (the ones that if you lose, you get invaded) -Respect private property. (ie: dont halt markets and confiscate assets, don't default on obligations, don't suffer from a socialism/communist revolution) That's a pretty high wire act. Bonds are a lot more sensitive to uncertainty than stocks (although US investors seem to think otherwise because they are looking from a suvivorship biased perspective). Here are the return in German stocks One can see that despite the hyperinflation and losing 2 major wars, stocks usually (albiet with a lot of volatility) kept the purchasing power of investors, and even delivered returns. Bonds on the other hand, got wiped out in the 20s (I'm seeing figures talking about a 2.5% of face value recovery after hyperinflation was controlled). The more data I look at the more I see that cash and bonds are a lot easier to deliver gigantic losses (that don't come back, not in the mean reverting sense) as compared to stocks which are quite resilient (as is real estate) Therefore, in my Brazilian balanced portfolio design, using a typical risk parity formulaic approach of 'load up in local government bonds and put some equities and gold' is a mistake. In pretty much any emerging economy that's a mistake but even in developed economies that's a mistake. In fact, it wouldn't surprise me to see that only in the US, perhaps Switzerland and 1 or 2 countries that was not a mistake.
One could even consider US bonds as a form of 'gold'. In the last 100 years, it was pretty much like gold except it paid a higher turn (of roughly 3% real a year). So in that sense, it was better than gold. Its no wonder when there are global crisis, US bonds rise. The world deals with local uncertainties through global diversification. The best assets for storing value under uncertain enviroments are gold and gold-like instruments. Given the sucesses of the US as a country/economy, US bonds has been gold-like except it has more carry. Its insurance where you get paid to hold and historically, it has paid quite well. Of course, questions remains if the next 100 years will be different from the last
I'm getting to the conclusion that separating bond allocations between 'developed market bonds' and 'emerging market bonds' could be a flawled approach. That's because the amount of 'developed markets' out there is large but perhaps MOST of them will not serve as good hedges (like the UK didn't). Not over long periods of time anyway I suppose I need to seperate a portfolio allocation in really, only 2 buckets: -Hedge assets (gold and gold-like instruments like US bonds, safe haven currencies like CHF, etc) -Volatile assets (equities, local government bonds, real estate, certain developed market bonds etc) Any futher derivation from those 2 is only likely to confuse things rather than clarify. Hedge assets are good at keeping short-term values stable, whereas volatile assets are unstable short-term but usually, quite reliable long-term sources of capital growth. Its the relationship between how much to own in hedge vs volatile assets that matter and that's what I need to solve for when building a balanced portfolio for emerging markets. But its difficult, the more I research the more I find the need to research even more
For long-term bond returns in many countries I was able to find this so far: http://www.investopedia.com/walkthr...e/4/capital-markets/history-stocks-bonds.aspx Crude Sharpe is return/SD (no adjustment for the risk free rate) Looking at this one can pretty much conclude that even though most of these countries were 'developed markets' the bond markets were mostly garbage. Italy, Germany, Japan, France and Belgium produced negative returns. Germany, Italy and Japan pretty much wiped out investors. The UK was a decent middle of the pack bond market, and their bond market was inferior to gold in risk adjusted terms (and inferior to UK cash). Looking at the list, you see a decent jump from the UK level perhaps starting with the US (double the Sharpe of the UK). So pretty much only 5 bond markets had a real shot at being better risk adjusted additions to a portfolio as compared to gold I can draw from this that bond markets are like a mine field, only in finance textbooks one can consider government bonds "risk free" returns. In the real world, the majority of the time there are significant risks and odds favor at you being wiped out or suffer a huge drawdown at some point. Given enough time, its almost a certainty that it's going to happen
One thing is for sure, I will have to change my goal from building a 'balanced portfolio' for emerging markets to building a 'resilient' or 'smart' portfolio. I no longer think balanced portfolios for emerging markets make any sense. An "all weather" strategy makes sense in the US. There it makes sense to hedge against disinflation/deflation and well was inflation. In Argentina/Brazil/Other EMs, we don't know what the chance of deflation or persistent disinflation is but we know what is it not and its not the same as the chance of inflation:. its magnitudes lower. The Dalio portfolio applied outside the US (and the select few countries with sucessful bond markets from the previous list) are places where the domestic bond market is better than gold. But that's so rare. Furthermore its likely to be unstable long-term (as governments take advantage of the ability to borrow at low rates to accumulate debt/liabilities as its going on in the US), so just pilling those countries could be fighting the last war. In EMs and certain developed markets, one has to weight the portfolio in a way that its biased for inflation and fiscal problems, because the history of those countries and similar countries all point out for that being a much greater risk. As a result, there is not such thing as an 'all weather' portfolio for Argentina. I mean, there is, but the weather is dominated by rising inflation not disinflation/deflation. I guess what I'm trying solve for is how much of domestic risk to take (in equities, local bond markets, real estate) vs how much to put away in safe stores of value like gold, hard currencies (like CHF, USD and others). This is similar situation that Taleb dealt with by coming up with his barbell of 90/10 storeofvalue/risk balance. I suppose what I need to test and research is what specific %s make sense (why not 60/40 or 50/50?) and which level of balance makes the most sense from a risk adjusted perspective
" When we focus, however, on only “Valuation Expansion,” the top five changes to: February 2003 to October 2007 (36%) December 1987 to August 2000 (30%) June 1962 to December 1968 (30%) August 1921 to September 1929 (27%) March 2009 to December 2016 (25%)"
Right now I own about a ~7.5% position in Brazil USD bonds yielding something like 4.5%-5%. But I was thinking about doing some 'investment alchemy' and switching this position to a cash+EEM (emerging markets stock ETF) position. It's similar to what Dalio teaches and Taleb implies through his barbell strategy. If I mix enough USD cash with EEM (at the correct ratio) I will emulate the 5% expected return but with a much better liquidity profile (those BR bonds are quite illiquid and it will get much more illiquid when markets goes into risk off mode like after the Trump election) plus some diversification. I'm planning to do that soon and also, I plan to think of futher ways to implement 'investment alchemy' to improve my portfolio in a way that makes sense (from a risk, return and liquidity perspective) I think investment alchemy is something that is not talked about but I think its some sort of quasi-free lunch that people miss