StreetEYE Blog

Are long term asset class relationships stable?

Last week, we looked at gold as part of a long-term asset allocation.

I was curious about how stable those relationships would be over time, so I ran the same plots, starting from different inflection points.

Portfolio Optimization and Efficient Frontiers in R

If you want to frustrate someone for a day, give them a program. If you want to frustrate them for a lifetime, teach them how to program.

A brief overview of how to use R to generate the analysis and plots in the most recent post, Gold as Part of a Long-Run Asset Allocation, using R, and code shared at Systematic Investor.

Gold as Part of a Long-Run Asset Allocation

What does an efficient long-run portfolio look like for major US asset classes, and where does gold fit in?

Let’s take US annual stock, bond, T-bill, and gold returns for 1928-2010, and subtract CPI inflation to get real returns.

  Real Return   Real Risk
Stocks   8.1%   20.1%
Bonds   2.1%   9.1%
Bills   0.5%   4.1%
Gold   1.7%   15.8%


Let’s plot an efficient frontier. This shows the highest return you could achieve with those four assets over those 83 years at different levels of risk.

Efficient Frontier

  Real Return   Real Risk
4% real return portfolio
(34% stocks, 44% bonds, 22% gold)
  4.1%   8.4%
5% real return portfolio
(49% stocks, 32% bonds, 19% gold)
  5.0%   10.7%


Let’s plot a transition map. As you move from low risk to high risk left to right, it shows you the composition of the best-performing portfolio at that risk level, how much would be in each asset.

Transition Map

What does this tell us?

  • For minimum real return risk, the best portfolio was mostly cash (bills), with a small amount of gold (and a smidgeon of stocks). This would have given a modest real return of 0.8%.
  • For maximum real return, stocks were big winners.
  • Gold had a modest real return in this period, which ended in 2010 with gold at 1225. In real terms gold performed better than bills and just behind bonds, and added value as a modest fraction of most optimal portfolios. Gold’s volatility was high, and is also understated since its price was pegged for more than half of this period (and Americans couldn’t legally hold it).
  • TIPS only became available recently, so there isn’t enough history for this analysis, and they also have their place. (But with rates at and sometimes below zero, CPI basis risk, fees, taxes, they will only shine if there is inflation.)

While returns are adjusted for CPI inflation, they don’t reflect fees and taxes.

The analysis is based on this post at Systematic Investor, and the gold mine of R code generously shared there. Will post more technical details, code, and some drill down analysis in coming days/weeks.


(A 2015 update also looking at how stable this relationship was over time.)

Over-The-Top Speculations

Case study #1. Megatrends: migration from wired to mobile unwired; broadcast & circuit switched to packet-switched Internet.

Verizon cut a blockbuster deal with Time Warner Cable and Comcast, essentially sacrificing the declining fixed-line residential business to try to gain a big edge in mobile.

  • Verizon bought out the spectrum the cable companies had warehoused to compete in wireless.
  • The cable companies agreed to resell Verizon Wireless as part of quadruple play TV, Internet, phone and cellular deals.
  • Verizon unceremoniously dumped its partnerships with DirecTV, which it used to compete with cable quadruple plays in areas where it didn’t have a TV offering.
  • Verizon stated they will not ramp up FiOS beyond its 18m-customer current buildout

Why did they strike a truce?

  • Verizon loses the massive capital drain of FiOS rollout
  • The high cost of the rollout, coupled with commoditization of Internet connectivity, increasing competition from over-the-top-services like Netflix may mean cable TV will not be as attractive as it was.
  • Verizon may gain a significant advantage in mobile network footprint. Their biggest competitor, AT&T, has a slightly older technology (3.5G GSM), a perceived network disadvantage with coverage/speed/dropped calls, and was just dealt a stinging defeat in the T-Mobile bid. T-Mobile and Sprint look increasingly like also-rans.

If it goes as planned, Verizon could be in an emerging duopoly with AT&T in mobile, with a network edge in footprint, bandwidth, and LTE 4G technology, and a distribution edge through the cable tie-up.

Case study #2. Megatrends: PC and client/server migration to tablet/mobile device/cloud.

In the future, we are going to do everything on mobile devices like tablets: communicate, read books, listen to music, watch movies, run productivity apps.

Who do you like in this world?

  • Apple is killing it. Apple’s edge is complex technology that is not just easy to use, but delights the wealthy, hip, tech-savvy, and those who aspire to be. But their control, and ability to extract all the profits, leads to no small degree of fear and loathing from carriers and business partners. Their moat is the brand connection with consumers, seeming ability to constantly raise the bar, significant technological lock-in through the App Store and network effects.
  • Google’s DNA is to digitize the world’s information, get a vig for access to information and consumers. They could ill afford to stand by and let Apple lock up the platform and charge Google a tax on every search. Android is catching up to Apple’s iOS. A Samsung Galaxy 2 is, for the first time, ahead in some areas (size/weight/screen, geeky features) and behind in others (Siri voice recognition, tablet form factor, number of apps, overall slickness and emotional connection, carrier crippleware). Google is activating more devices than Apple, especially in emerging markets. Google’s moat is the incredible amount of information they have, particularly about their users; incredible infrastructure; relationships with the advertising community.
  • Amazon’s DNA is the retail SaaS platform. They are trying to extend it into a media platform, with a big success in ebooks, more limited success in music and video. (Also stunning success in the cloud IaaS, PaaS space.) The Kindle Fire is, so far, looking like a defensive play to prevent Apple’s dominance (and margins) getting out of hand, and allowing them to seize the ebook space. The initial Fire doesn’t seem up to the task of a successful broad-front offensive in tablets and phones. Amazon is a dark horse, currently playing in a narrow-moat, low-margin ghetto, and trying to leverage ebooks, infrastructure, and consumer relationships to jump to the big time.

So you have a battle for the post-desktop (the lap?). Three different strategies, and three different business models. Apple makes money the old-fashioned way, by selling high-margin hardware, with an assist from media and software through iTunes. Google gives an incredible mobile/cloud platform to hardware manufacturers for free and sells access to the users. Amazon wants to own media distribution and retail on the device. They are basically a software as a service platform for retail and media distribution (and any online business through the cloud platform).

It’s far easier to see a 20-something without a landline and cable TV and PC, than without a mobile device. YouTube and Netflix are available over Internet, live sports are the only exclusive broadcast offering, and Internet sports packages seem like a foregone conclusion (e.g. Apple’s rumored-but-denied bid for Premier League).

  • Google and Apple: well positioned.
  • Amazon, Facebook: dark horses, not necessarily cheap.
  • Microsoft – profitable has-been. No company that dominated one computing paradigm has been able to dominate the next one.
  • Intel: chips power the cloud servers, but lost the mobile client to ARM, which is a year or two away from possibly disrupting servers.
  • Cisco: interesting value, possibly lumped in with large-cap declining franchises. Yet mobile/cloud still needs network infrastructure and they have catalysts like VoIP, video, IPv6, etc.
  • Do not like: second-tier cable content networks that aren’t going to have success in view-on-demand and depend on cable per-subscriber fees.

It will be interesting to see what Apple has up its sleeve with iTV, and if one of these platform companies makes a strong play for Netflix, which seems wedged between strong upstream content providers and downstream cable networks, that both wish it would die.

Tech winds of change shift. Unfurl the sails, and try ride them to blue ocean, uncontested market space.

2012: Toilet bowl or takeoff?

Some drive-by thoughts on Europe:

While the LTRO takeup was larger than anticipated, the consensus seems to be the new ECB funding largely replaces old ECB funding, bank deposits that are fleeing, interbank credit and money market funding that has dried up.

To the extent it signals the ECB will do everything necessary to prevent a bank failure, and potentially takes a Lehman scenario off the table for now, it is a positive development.

It’s the turning point in the crisis, only if it’s a signal that the Great Pumpkin is coming next year in the form of more QE, orderly equity raises for the solvent banks, bailouts/mergers of the insolvent ones, and above all, resumption of economic growth.

Once Again, Britain stands alone

Two differing views on UK and the EC.

Unstoppable Forces, part deux

BERLIN, GERMANY - JUNE 17:  In this photo prov...

Image by Getty Images via @daylife

A followup to the most recent post following the latest solution from Merkozy.

Unstoppable Forces vs. Immovable Objects

Titanic (1943 film)

Image via Wikipedia

Europe is heading into yet another moment of truth this week, with a Merkozy summit and a new plan, an ECB meeting and likely interest rate cut, and a full EU summit starting Friday.

Why only millionaires should play Powerball

ROCKY HILL, Conn. — Three asset managers from Connecticut’s affluent New York suburbs claimed a $254 million Powerball jackpot on Monday off a $1 ticket.

The Lotto Powerball logo

Image via Wikipedia

Lottery tickets are generally a terrible deal in terms of expected value – the lottery pays out far less in winnings than it receives in ticket sales. It has to pay expenses and show a profit. Then the winner has to pay a big income tax bill.

But occasionally, after no one wins the big prize several drawings in a row, the jackpot gets so big that the expected value is positive.

[Edit 1/7/2016: This is rare unrealistic. For instance the current record jackpot is quoted as $800m. The lump-sum payout would be only $496m. The odds of winning a single bet is 1/292,201,338. So a $2 bet is only worth $1.69. This disregards the possibility of a split pot, which is significant. If you pay the top Federal tax rate of 39.6%, that $1.69 is only worth $1.02. NYC rate maxes out at 12.7%, bringing the top combined income tax rate to 52.3%, leaving $0.81 per $2 bet.]

You might think that when there’s positive expected value, it’s a good time to buy a ticket. Actually, it turns out that’s still a losing strategy. Why? Because unless you’re a millionaire, the correct amount to bet is very small. And if you’re not a millionaire, a single ticket is an overbet. You almost always go broke before you hit the jackpot. Paradoxically, even though each individual bet has positive expected value, your expected long-run profit if you bet every week is less than zero.

What’s the right amount to bet on a risky, but profitable proposition?

Margin Call – A Big Sell Out

Watched Margin Call last night on iTunes and woke up cranky. Here is a short list of things that it gets wrong about Wall Street. (more…)

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