Ever since the public became interested in stocks, the concept of safe havens have been touted during every equity bear market. Here we’ll examine three such safe haven assets and their performance during the most recent equity market meltdowns in 2008 and 2015. Finally we’ll discuss if Bitcoin can provide a better safe haven than its traditional competitors. The classical safe haven assets are:
- Defensive stocks
Defensive stocks have become the equivalent of low beta stocks. Simplified, these are stocks that “move less” than the general market. However, defensive stocks used to be defined as stocks in companies acting in non-cyclical industries. Examples of such industries are consumer staples, defense, health care, and utilities. Companies in these industries have the ability to maintain earnings even during recessions (people still need electricity and medicine), giving birth to the notion that the share prices of these companies fall less during bear markets.
Having some experience in the art of short selling, we’ve never understood the point of owning something that falls “less” than the general market. Proponents of the defensive strategy would of course counter that the generous dividend granted by many of these companies, would make up for the capital depreciation during bear markets. But, this is simply not the case. No dividend policy, however generous, would make up for the 40-50 percent drawdowns that consumer staples companies such as Procter & Gamble suffered during the great recession. Instead, the strategy of rotating into defensive stocks is probably something invented by brokers in order to earn commissions during bear markets.
Although the gold standard was dropped long ago, gold is often seen as the money that doesn’t lose value. It’s widely believed that gold buys the same amount of bread today, as in the times of King Nebuchadnezzar of Babylon, during the 6th century B.C. But that’s not all, financial legends such as Ray Dalio suggests that gold should be a part of any long term portfolio. Does this mean gold is a good place to park your your cash during equity bear markets?
Perhaps, but not immediately. As witnessed during both bear markets of 2008 and 2015, gold could not withstand the liquidation that occurred on these occasions. We’ll talk more about liquidation when we get to bonds, but let’s get back to the price movements of gold in response to equity market drawdowns. As seen in both years, gold tends to fall together with other risk assets. However, gold has a tendency to rebound faster in appreciation of monetary stimulus from central banks. The printing of money sends investors to gold, most likely because of its ability to
buy bread retain its purchasing power while paper currency is printed en masse.
The bear market of 2015 is a peculiar event in modern financial history as the S&P 500 — the most widely followed U.S. index — never reached bear market territory, while european markets as measured by the STOXX 50 index fell by more than 30 percent.1 Initially, gold fell together with equities, but rebounded more quickly in what was most likely anticipation of monetary stimulus. The script was similar during the 2008 financial crisis: gold started its rebound in October while it would take another 5 months for equities to turn.2
As equity markets peaked in October of 2007, bonds started rallying in earnest. The U.S. 30-year bond had been rising in anticipation of Bernanke softening rates during the second half of 2008. As the crisis exploded, additional investors fled to bonds.
The aforementioned manifests the difference between gold and bonds. While bonds provide yield to investors during times of panic, gold is seen as a risk asset until central banks provide stimulus. However, if the stimulus is seen as getting out of hand, the roles are reversed and gold continues to rise as inflationary pressures starts eating into the yield of fixed income assets.
But all of this is history, and we have yet to see if the structure holds as so called risk parity funds have increased their leverage to bonds in the hunt for alpha.3 Pioneers such as Dalio and his firm Bridgewater, and competitors such as AQR, are no longer alone in this space. Massive amounts of money have been employed in risk parity and volatility targeting strategies. While traditional investors may flock to bonds in the event of a crisis, a liquidation event may force risk parity funds sell bonds, re-categorizing bonds as a risk asset with similar characteristics as gold and equities.
It should be noted, that it’s unlikely that the pioneers in the space, i.e. Bridgewater and AQR, employ massive amounts of leverage to increase the yield on bond holdings. But there are undoubtedly a large amount of less experienced funds utilizing far simpler, riskier strategies.
But although bond leverage may not be an issue per se, volatility targeting may lead to the same end result. As equity volatility has decreased in the latter years, many risk parity funds have concluded that equities should constitute a larger portion of their portfolios. If equity volatility explodes, these funde may have to cover losses in equities by selling bonds.
Whether bonds will act like equities in the next crisis is a known unknown. This is because a mass liquidation from risk parity funds may be met by institutional investors flocking to the safety of bonds, thereby offsetting the potential damage inflicted by risk parity strategies.
Bitcoin and other crypto assets
Finally we arrive at Bitcoin. Many die-hard maximalists would like to see Bitcoin as the ultimate safe haven asset. However, this is unlikely. As institutional investors, retail investors, and funds have entered the picture, Bitcoin is most likely another risk asset. This means Bitcoin is doomed to be affected by the whims of aforementioned market participants who may dump their holdings because of losses suffered in other asset classes.
Reflect on the past couple of years and the vision espoused by Satoshi in the genesis block.4 Bitcoin was invented in opposition of the current fractional reserve banking system where central banks can “print” money out of thin air, thereby debasing the value of fiat currencies. Lately however, central banks led by the Federal Reserve have started going in the opposite direction. Under such circumstances, Bitcoin, like gold, is no safe haven.5
Does this mean we are bearish on Bitcoin long term? On the contrary, when the “everything bubble” eventually pops, central bankers around the world will yet again launch stimulus packages to save overindebted consumers and underfunded pension plans. Then, the mighty dollar will fall and Bitcoin, a.k.a. the anti-dollar, will yet again shine.
Update on bitcoin as a safe haven
Later research now leads us to believe that the above only applies when bitcoin adoption has increased somewhat. Right now, however, bitcoin’s popularity has fallen among retail investors and institutional investors. After the bubble burst in early 2018, the asset has failed to keep up with risk assets such as U.S. equities.
However, we now feel that sentiment is so low, that bulls may try to, for a lack of a better word, front-run accommodative actions by the Fed. As of this writing, no one is expecting such actions. But these are highly likely in a sharp equity market sell-off. This even though the current Fed composition is much more hawkish than the former. When the facts change, change your mind.
- Traditionally measured as a peak-to-trough drawdown of 20 percent or more. ↑
- Those active during the crisis remember the Fed’s accomodative stance during this period. ↑
- A gross simplification of a risk parity strategy would be to start with a portfolio consisting of 60 percent equities, and 40 percent bonds. Then, assuming equities are three times riskier (based on the not so perfect measure known as volatility), decreasing the ratio to 25 percent equities and 75 percent bonds. Let’s then assume that the historical annual return of equities are 6 percent, and bonds 3 percent. A portfolio consisting solely of equities would then generate a 6 percent annual return, whilst our portfolio would generate only 3.75 percent. But, since bonds are less risky than equities, we can use leverage on our bond size to reach an expected annual return that matches that of the 100 percent equity portfolio—without taking on more risk. Well, in theory that is. ↑
- In the first block of the bitcoin blockchain, i.e. the “genesis block”, Satoshi Nakamoto encoded the following message: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. ↑
- It should be added however, that we do not know if the tipping point has been reached yet. ↑