The all-weather portfolio. Ready for most anything.

I recently posted a portfolio concept for the all-weather portfolio for 2022. The idea behind an all-weather portfolio is that it can prosper during periods of sun, rain, storms, hurricanes, earthquakes and tsunamis. Of course, in the above analogy weather serves as a proxy for the economic conditions that might arrive. The all-weather portfolio is ready for most anything.

On Seeking alpha I posted the all-weather portfolio for 2022. The portfolio is designed for U.S. investors, though Canadians can certainly mimic the approach or apply the greater concepts. The big idea of the all-weather portfolio is to hold assets in four buckets. It is an extension of the Permanent Portfolio.

There is a bucket of investment assets ready to thrive no matter what the weather offers (economic conditions). For example, for the last 40 years or so we’ve had favourable weather. Inflation has been low and economic growth has been modest, but positive. We’ve been in a disinflationary environment. Inflation has been low and mostly falling.

The weather has been nice

Stock markets and bond markets perform quite well during these disinflarionary periods. What they don’t like is unexpected inflation or deflation.

Stocks have performed quite well over time as we’ve mostly been in a low inflation or disinflationary environment. That said, investors needed to be armed with some very impressive umbrellas (and risk tolerance) to withstand the Great Financial Crisis (2008-2009) and the dot-com crash of the early 2000’s. Stock markets declined in spectacular fashion in both of these events.

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Given that we were still in the midst of a mostly disinflationary period, bonds did the trick in lowering the volatility of the typical balanced portfolio. Bonds will mostly go up when stocks go down, offering that useful inverse relationship. We can think of bonds as portfolio shock absorbers.

These two major stock market corrections came and went, and we returned to our mostly fair-weather disinflationary times. Modest economic growth returned as well.

And now for something completely different

Yes, the above subhead is referencing a catch phrase made famous by Monty Python’s Flying Circus.

The comedy troupe was certainly different. And so is today’s economic environment. We have inflation, real inflation. It might even turn into stagflation when most everything fails for the investor. Stagflation is a period of persistent inflation that is accompanied by economic decline. The worst of all worlds you might say. Some nasty weather.

What works during stagflation or unexpected inflation (persistent inflation above those central bank 2-3% targets)? It’s not stock markets; it’s certainly not bonds. Oooops. That’s the traditional balanced portfolio.

Commodities and energy stocks work. Gold mostly works. And a select few other types of stocks can work as well in inflationary or stagflation periods.

In 2022 a balanced portfolio was down in surprising fashion. Stock fell, bonds fell. That can happen during an inflationary regime. iShares XBAL was down over 11% in 2022.

XBAL from iShares is a traditional 60% stock to 40% bond mix.

Today’s investor is not used to seeing bonds being down more than stocks. Given that we are in an inflationary environment, central banks are raising rates to combat inflation. As rates increase, bond prices (and bond values) go down accordingly. A rising rate environment by design will put the brakes on economic growth, and eventually curb inflation.

Commodities are King!

Commodities are reliable (they show up in every inflationary period) and they are explosive. Offering gains that are many times the rate of inflation. In the chart below, we see gold as the most helpful in the 1970s stagflation environment. Gold did not show up in the other periods of more muted but unexpected inflation. Gold appears to save its usefulness for when inflation is more ‘out of control’.

We see commodities with consistent real returns in all periods of this evaluation.

Oil is ‘pretty good’ as well. We see that U.S. stocks delivered negative returns for the period. Canadian stocks offered better returns for the period, but were still not able to muster real returns above the rate of inflation (my calculation as per data from BlackRock).

We see that bonds (Treasuries) were the laggard.

So yes, it’s commodities, gold and energy stocks to battle inflation and stagflation.

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Here’s the Purpose Real Asset ETF that holds gold, REITs, commodities and commodity stocks. Year to date, the ETF is up over 20%. You might look to Invesco (DBC) for U.S. dollar accounts. I hold both, along with energy stocks and other materials ETFs.

Canadian energy stocks said ‘hold my beer’.

In the current bought of inflation, commodities, energy and commodity stocks are doing their thing.

What’s next?

Will inflation stick around? Will rising rates or inflation or the ongoing pandemic cause a recession or rolling recessions? Is it possible that we will return to a disinflaionary environment? Most investors and advisors should hope so. Perhaps a period of deflation is on the way. Any of the above are possible, and it’s safe to say we don’t know the future.

Is your portfolio prepared for ‘don’t know’? Likely not.

If we look at mutual fund and ETF holdings, gold and commodities exposure is limited. Advisors mostly laugh at me when I mention gold, commodities or energy stocks. Ditto for most retail investors.

If we get periods of rolling recessions or deflation, the investor with an all-equity or equity-heavy period is most likely not well-positioned. There is more than inflation to consider.

That said, if you are in the accumulation stage, and not within the retirement risk zone, you might consider ignoring all of the above. Stock markets have historically been the most superior growth asset. Over much longer periods, stocks have (mostly) delivered returns well above inflation. Here’s a look at the 20-year rolling returns for U.S. stocks.

• Nominal = price returns
• Real = returns after inflation

It is the retiree that needs to protect against changes in economic conditions. Their risk becomes short term – within 5 to 10 years of retirement, and within the first few years of retirement. The retiree can’t afford heavy losses.

The U.S. all-weather portfolio

Let’s move on to the all-weather potfolio model. Keep in mind, this is not advice. Do your own research and treat this and the entire post as ‘for informational purposes’.

The economic quadrants

Inflation: REITs, Gold, Commodities, Energy stocks, Commodities stocks

Stagflation: Gold, Commodities, Energy stocks, REITs, Short term bonds, Healthcare stocks

Deflation: Cash, Gold, Bonds, Consumer staples and Healthcare stocks

Disinflation: Stock markets, Consumer staples and Healthcare stocks, bonds

The all-weather portfolio for 2022

• REITs – (RQI) (REET) 5%
• Commodities (DBC) – 10%
• Energy equities (IYE) – 5%
• Gold (GLD) – 5% (*Bitcoin 2.5%)
• Short Term Bonds (SHY) -20%
• Long Term Bonds (TLT) – 15%

*you may decide to bolt-on a bitcoin allocation, while keeping your gold allocation. I consider bitcoin to be modern, or digital gold. I’d suggest that to make room for bitcoin, you trim evenly from all of the assets. I have a 2-3% weighting in bitcoin.

Stocks @ 40% – Global equities plus defensives

1. (VT) – Global markets – 20%

2. Defensive Stocks – 20%

Consumer Staples (XLP) 10%, Healthcare (IYH) 10%.

In the above you will see that consumer staples and healthcare stocks are in the mix, and doing double or triple. duty. That will allow for greater stock (growth) exposure, but may add to the overall portfolio volatility. Given their defensive stance, staples and healthcare are traditionally less volatile sectors compared to total stock market index funds. They are good assets to hold in market corrections as well.

The defensive sectors were twice as good as a traditional balanced portfolio through the financial crisis and to date, in a retirement funding scenario. As you can see from that post, you may decide to include utilities.

Here is the U.S. stock portfolio for retirement.

The Canadian all-weather portfolio

As we know, many Canadian self-directed investors love their big-dividend-paying Canadian stocks. That can be put to work with great effect. And given the low real bond yields of the day, using some juicy dividends makes sense as bond substitutes.

Related post: The Beat The TSX Portfolio.

I will organize the stocks by economic quadrant as well and arrange strategically to cover off each economic regime.

Here is using defensive sector ETFs for the Canadian retirement portfolio. That is an all weather model that uses defensive sectors, allowing us to lighten up on the bond and cash exposure.

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