Chris Cole's “Mysterious Dragon Portfolio” turns the myth of dragon powers into reality to help you protect your financial future.
Interested in how to set up time-proof economic stability?
Then this article is for you. Relax, take a seat, and enjoy.
Basics of “the Allegory of the Hawk and the Serpent”
This title may sound a little complex and philosophical, but you need to trust me on this one: It is amazing and pretty straightforward!
The chart below displays U.S. treasuries and stocks from 1929 to 2020. On the treasuries left side you can appreciate a dollar amount that goes from $1 up to $21. On the stock side, it goes from zero to $10. This represents the dollar gain that you would have in your portfolio.
Chris Cole, the author of the Allegory of The Hawk and The Serpent, breaks things down into two cycles of about 20 years. One is the Serpent and the other the Hawk.
In 1929, during the Hawk period from '29 to '46, treasuries didn't do much at all. And during the same time frame, equities went down in value.
Then, from '47 to '63, we had a serpent period. Treasuries didn't do much, but stocks went up tremendously. Please keep in mind the charts are in nominal terms.
They are not adjusted for inflation. From '64 to '83, there was a hawk period again. Treasuries didn’t do much and stocks went up a little.
After this, we got to a massive serpent period from 1984 to 2007. Treasuries went up so high, that if you started with $1, you would end up with almost $22. That was just in treasuries.
But, if you also had stocks in your portfolio, they went from zero up to $11 or $12. Tremendous gains.
If you took the entire gain from an average portfolio, I am referring to about 60% stocks, 40% bonds, and you went back over the last 90 years, 91% of the gain came from 1984 to 2007. Just that serpent period, 91% of the gain.
That means in the other 70 years, there was only a 9% gain in a person’s portfolio. Then in 2008, we went into the next hawk period.
Treasuries haven't done much. Stocks have gone up substantially, but remember: We are only 10 or 12 years into the cycle. We have another decade to go.
To dive into greater detail, here is an extract of Chris Cole's paper, Allegory of the Hawk and the Serpent:
The serpent represents a period of secular growth, secular is long-term, fueled by the virtuous cycle of value creation and rising asset prices. The growth cycle begins naturally through some combination of favorable demographics, technology, globalization, and economic prosperity. As the secular boom matures, it's corrupted by greed as fiat devaluation and debt expansion replace fundamentals as critical drivers of asset price gains, not unlike a serpent devouring, its tail into oblivion. Greed fiat devaluation and expansion of debt replace fundamentals.
How much does that remind you of exactly what's happening today?
The hawk signifies the forces of secular change that will challenge and ultimately destroy the corrupted growth cycle of the serpent. The left-wing of the hawk is a deflationary path, whereby an aging population leads to low inflation, faltering growth, financial crash, and then debt default. The right-wing of the hawk represents inflation, fiat default, and helicopter money. The pattern is as old as money itself.
Now, with a better understanding of the two cycles, the hawk and the serpent, I will take a deep dive into what happened.
How did we have such massive growth in the timeframe between 1984 and 2007?
It starts with demographics. We had a huge glut of the population. The baby boomers went into some of their peak spending years in the early 1980s. And this was combined with a dramatic cycle of falling interest rates the entire time, going from almost 20% down to 0%.
This created an environment of continually rising asset prices. Next, we had globalization, which kept consumer prices low and an explosion of debt, of not only government debt, but corporate and consumer debt.
On the left side of the graphic, you can see we had the real economy and all the people coming into their peak spending time. They were making money so they wanted to buy houses, cars, and go on vacation. They wanted to spend money.
So the fed said: “We have your back. We will lower interest rates and we'll print up funny money. There will be a Fed put so don't you worry about it.” The banking system also came in and said: “Yes, we'll do the same thing. We'll get aggressive. We'll shower you with as much debt as you're willing to take on.”
As you could imagine, home prices went up. The same happened to vehicles, and the 401k went to infinity and beyond.
The bottom line is we had a huge population with unprecedented purchasing power. Remember what Ray Dalio has taught us:
One person's spending is another other person's income.
We had huge increases in spending and incomes, which led to a booming economy and booming asset prices. Unfortunately, as you know, there is no free lunch. It also created an even bigger doom vortex.
So what time is it now?
I think you know. It's a stiff drink time.
Recency Bias And The Risk Parity Portfolio
This is in essence a 60-40 stock-bond split. The recency bias goes back to every single financial advisor you have ever heard telling you to buy the dip. But…
How does buying the dip work?
Chris Cole's charts should shine a light here
1929 is our start today, and moving forward because we are still in the next cycle. It goes from $0 on the left up to $3.
This represents the value of your portfolio. 1929 started off at a dollar, but then it came crashing down to 1946.
If you would've had the buy the dip approach during this timeframe, and a 60-40 split between stocks and bonds, you would have gotten crushed. Same thing between '47 to '63 and '63 to '84.
It has only been recently, and just in the United States, I might add, where this buy the dip risk parity portfolio approach has worked well. I would like to remind you that markets -and the world for that matter- operate in cycles. What goes up, comes down. What goes down, goes back up.
Just because something happened in the recent past doesn't mean that it's going to happen indefinitely into the future.
I'd also like to point out that if you look at the timeframe between the late 1990s and today, it represents almost 100% of the gains in the housing market, going back to 1900 when you adjust for inflation.
You also need to remember the graphic above doesn't include what has happened recently with Covid-19.
So how is this 60-40 risk parity portfolio, and buy the dip approach going to work out in the next cycle?
Well, to get some insights on that, I included a short transcript from my full-length interview with the legendary hedge fund manager, Hugh Hendry.
Every expert like me, or every pro looks like a dumb ass when you consider the investment strategy of the permanent portfolio. I'm sure at some point it's going to be on your whiteboard. You're going to explain the concept of disparity. You're the biggest hedge fund in the world. You do it adjusting for risk, but you sit there with 25% of your portfolio of precious metals, gold, and maybe a bit of silver. You sit there for 25% in the S& P, or maybe you have a bit of NASDAQ or whatever. You sit there with 25% in government bonds. You might have a little bit at the short end, you might have a little bit long end. You might even have a bit of commercial. Then you sit there with kind of cash and looking for opportunities, you sit there. That strategy for the last 40 years has just wiped everyone. It's the leader. It's the Olympics. It's the Usain Bolt or whatever. I don't know the American sporting analogies to make but it has hit the ball out of the park time after time after time. It's finished. This is the time to preserve the account.
So as Jim Rogers always likes to say:
This risk parity portfolio, buy the dip strategy is going to be a fast way right to the poor house.
It makes sense when you go back and look at Chris's chart. From 1929 to '46, this approach would have gone bust. '47 to '63, bust. '64, '83, bust again.
The main point is people who advise taking this approach are suffering from the recency bias I always talk about in my articles. Chris Cole outlines this beautifully in his paper.
How did we have this huge boom between '84 and '07?
Demographics, falling rates, rising assets, globalization, and a massive expansion in debt. However, in the next cycle, that most likely won't continue.
We're going into a period of bad demographics, rising interest rates, falling asset prices, de-globalization, #Covid19, face masks, pharmaceuticals, and debt contraction.
This takes us straight over to the doom vortex, the largest percentage of the US population, the baby boomers are going from the peak down to weak.
I don’t mean they just walk around with canes or in wheelchairs. I'm not implying that if you're a baby boomer. I'm just saying they're going from peak spending down to very weak spending.
If we combine the Baby Boomer doom vortex, and the reversal of the cycle we had from '84 to '07, this leads to less spending and less income, which means lower GDP.
The worst the economy gets, the quicker we go right back to the baby boomer generation, which have a lower propensity to spend and consume. This takes us straight into a depression, which Jeff Snyder calls GFC 2.0.
The big question is whether the depression is going to be deflationary or inflationary.
To give you some food for thought I wanted to throw in another bonus from Chris Cole's paper. It is a quote from Bill Gross, the bond king himself.
Let me admit something, Bill Gross says: “There isn't a bond king or a stock king or an InvestorSovereign alive that can claim title to a throne. All of us, even though old guys like Buffett, Soros, Fuss, yeah, and even me, have cut our teeth during perhaps the most advantageous time an investor could experience. An investor that took a marginal risk, levered it wisely, and was conveniently sheltered from periodic bouts of de-leveraging or asset withdrawals could, and in some cases, was rewarded with the crown of greatness. Perhaps, however, it was the epoch that made the man as opposed to the man that made the epoch.
In other words…
Were the greats that 99% of the investing public try to emulate great?
Or were they just at the right place at the right time?
I'll let you be the judge.
A Look At Chris Cole's Dragon Portfolio
The pie charts below show the typical portfolio structure that all the normies out there have, just like your friend and family member, Fred. It comprises 73% stocks, 21% bonds, and 7% cash.
The exact portfolio Hugh Hendry was just referring to, but the dragon portfolio is much, much different. Just a warning, if you like this type of portfolio, I can guarantee you, they're going to call you a tin foil hatter for sure.
It only has 24% stocks, 18% bonds, 19% physical gold, 18% commodity trend, and this is a type of trading or a type of investing where you follow trends in commodities. Also, 21% long volatility.
When we check out the charts…
How did the two strategies perform over time?
Start in 1928, and go all the way to 2018. With the Dragon portfolio, if you started with $1 in 1928, by the time you got to 2018, you would have over $100,000.
What is even more incredible is, if you look at the timeframes I discussed earlier in Recency Bias And The Risk Parity Portfolio section, the dragon portfolio does exceptionally well regardless of whether or not we're in a serpent cycle or a hawk cycle.
To take it a step further, the Hawk cycle can be inflationary or deflationary, the complete opposite of one another, and the Dragon portfolio still crushes it.
What would happen if you would have taken the advice of every single financial guru on YouTube and just bought the dip?
Whenever stocks go down, you are buying because you know the stock market always goes up over time. You would have started with a dollar at the end of 2018, you'd have right around 4 cents and that doesn't even include inflation.
Excluding inflation, you still would have lost about 96%. Then, your friend and family member, Fred -who is telling you that you are wearing a tinfoil hat because you don't want to buy the dip- gets crushed.
While you the tin foil hatter, who dares to go against the grain and challenge the mainstream narrative does quite good and get rich.
Now, what I am sure you are saying to yourself is, “Yes, George, I'm a tin foil hatter. I agree. I'll raise my hand. I admit. I'm coming out of the closet, a tinfoil hatter.”
But how do I set up this dragon portfolio?
Or maybe even better yet, how do I set up a hawk portfolio?
Because I think the cycle of the serpent has come to an end…”
I defy you to take off the tinfoil hat and check this article where your questions regarding the Dragon portfolio will be solved.