And I think it's going to be a long long time...
This is going to take a long long time. No quick fixes, no rabbits in the hat, no Mars to the rescue, no easy way out. "Mars ain't the kind of place to raise your kids, in fact it's cold as hell."
Our problem started in earnest in 1971, when the US and the world abandoned the gold standard and adopted a debt-based credit standard. Some call it the dollar standard, but it is really a credit standard based on dollars. For the next 30+ years countries around the world learned how to grow through the expansion of credit. The creation of credit grew so rapidly that it significantly overtook the creation of real goods. Money has been printed, interest rates lowered to zero, assets have been securitized to the point of no return, but finally in 2008 the wheels began to fall off. The worlds central banks rode to the rescue with even more credit, substituting sovereign credit for private credit. Now it appears that this trend may also be nearing its end, at least in Europe. The financial markets are slowly imploding (delevering), because there is simply too much paper and very little trust.
Some say the US will be OK because we have already started down this delevering path, unfortunately that couldn't be further from the truth. Sure corporate America has delevered, and US households have cut back a bit, but the US government is actually banging on the debt ceiling again. The following chart shows how debt exploded after 1970, and how recently the government has simply taken over the credit expansion reigns:
After 30 years of credit exploding, and with our built in entitlement promises, it is hard to see a rapid delevering ensuing. Not that a rapid delevering is something to wish for. Rapid delevering happens in depressions. No, this process we are entering will take time, a long long time. Economic growth will be muted at best, and interest rates will be held at extremely low levels. These facts have caused us to make some rather substantial changes to our Global Tactical Asset Allocation model. The first such changes we've made in two years.
First, when it comes to fixed income investing, investors need to worry about credit risk (will I get my principal back) and interest rate risk (will interest rates change dramatically by maturity). In the old days we could check our credit risk worries at the door when buying sovereign bonds (developed nations don't default, they don't even get downgraded), that's not the case any longer. No, today we have to worry about both credit risk and interest rate risk. Just look at those wonderful Greek government bonds that were trading near parity with German bonds just a few years ago, now they are 80% lower. The same scenario is unfolding in Italy, Spain, Portugal, and even France, credit risk is front and center. It's one thing to loan money to a relative and not expect to get paid back, it's entirely different thing to loan money to a government and worry about getting paid back. The perverse part of ZIRP is that with rates at zero there is no incentive to loan governments money and take on the credit risk. Liquidity dries up.
That being the case we see no reason to allocate assets to European or Japanese government bonds, and are therefore eliminating our exposure to International Government bonds (IGOV). We still have some exposure to emerging market fixed income since their balance sheets are much better than the developed worlds. Those holdings were reallocated to our other fixed income holdings.
The second big change we made was to eliminate our US Total Bond market exposure (BND), which buys bonds all along the yield curve, and replace it with a purely Long-Term US Government Bond holding (BLV). If deflation continues to be a risk then these bonds should continue to do well. Alternatively, if inflation becomes a risk our holdings in TIPS and higher yielding bonds should do well. This is much more of a barbell strategy, to take advantage of what appears to be fatter and fatter tail risk.
Finally, we did a little house cleaning by eliminating one of our redundant commodity holdings (CRBQ), and reallocating the proceeds between (DBC) & (MOO). Overall we are still fairly defensively positioned with 37.5% in cash equivalents, and a total portfolio correlation to the S&P 500 of 0.38.
Investing is not rocket science, its about understanding and managing risk, "It's my job five days a week. A rocket man, a rocket man."