Occasionally, I will write purely financial pieces on Mighty Quinn on Politics and Money; this is one of those occasions.
In this weekend’s (i.e., 2/2/-2/3/13’s) Wall Street Journal (“Looking for Inflation Protection? Take TIPS off Your List,” page B7), Brett Arends argues against holding Treasury Inflation Protected Securities (“TIPS”), which comprise an astronomical proportion of my portfolio and large proportions of the portfolios of those I informally advise. Naturally, Mr. Arends’ comments merit a response, if only to clarify my thinking.
Mr. Arends’ main argument is that TIPS, with their negative real yield, are “a lock to lose money in real, inflation-adjusted terms.” But this is not news to my readers; I’ve written extensively on this point at the now defunct Rant Finance:
In the interest of space, only the most recent of these has been reproduced below.
While Mr. Arends reiterates my, and most people’s, primary objection to TIPS, he fails to
Answer a question I’ve asked in all the above posts: What’s the alternative? Yes, it seems crazy to hold an investment with a negative real yield, but, in an environment characterized by investments with negative real yields, TIPS make sense on a relative basis.
With the conventional ten year treasury yielding 2.01% and the ten year TIP yielding a negative -0.57%, if one holds ten year treasuries, one would be betting that inflation will average less than 2.58% over the next ten years. I, for one, would take the other side of that bet all day. If one were to hold cash at 0%, one would be betting that inflation will average less than 0.57% for the next ten years or that short rates will turn up quickly and decisively. While I might consider taking the latter bet, would anyone care to take the former?
Mr. Arends did suggest going from long TIPS to shorter maturity TIPS (So how much can he really hate TIPS? But I digress.) This might be a good idea, primarily because TIP yields get less negative as one moves in the treasury curve (shortens maturities) and because short TIPS are less exposed to increases in real rates than long TIPS. But to take one’s capital gains (As Mr. Arends points out, the February, 2040 TIP is up 40% in price since its issuance three years ago.) and pay the attendant taxes (even at the lower capital gains rate, as Mr. Arends also points out) for such a small change in positioning seems a little silly. And those of us who hold our TIPS in funds (the exchange traded fund (“ETF”) TIP or a TIP fund from a major mutual fund family) don’t have that option, though Vanguard has now come out with a short maturity TIP ETF, and I’m sure Vanguard isn’t alone. Still, moving out of TIP into the short term TIP ETF involves a lot of taxes for not much of a change in one’s portfolio.
Mr. Arends suggests that those who are buying TIPS for inflation protection go into real estate and commodities. I, and those I advise, have plenty of gold and silver exposure, primarily through the ETFs GLD and SLV. But one has to understand that TIPs and, say, gold, display profoundly different risk profiles and therefore are not ready or obvious substitutions for each other.
Mr. Arends did not suggest common stocks, and especially big dividend payers, as an inflation hedge. There would have would been some merit to this suggestion, but stocks, while providing a good inflation hedge in the long run don’t do so well in the short run when inflation starts to pick up. Further, increasing one’s equity exposure because one no longer likes his or her TIP position seems to be making an asset allocation decision with too many other variables swirling around it.
Mr. Arends makes some good points and I thank him for causing me to reexamine my assumptions, but I will continue to hold my TIPS…and will let my readers, and those I advise, however informally, know quickly should I change my minds.
PROMISED 1/8/13 POST REPRODUCTION:
TIPS: STILL WARY, BUT STAYING, AFTER ALL THESE YEARS
Treasury Inflation Protected Securities, or TIPS, have taken a beating over the last month or so. The yield on the ten year TIP has increased from a record low negative 93 basis points (“bps”) on 12/6/12 to a negative 67 basis points as I write this. The ETF TIP has fallen from a high of 123.30 on 12/6/12 to 121.07 as I write this. As loyal readers know, I have been long TIPS in one form or another in a big (for me) way for a long time. This investment has worked out very well for yours truly, so, naturally, I am nervous about it, as any prudent investor should be after a prolonged pleasant experience; complacency is dangerous in investing, as it is in most aspects of life. So I have been watching TIPS closely and have curbed, but not abandoned, my enthusiasm for them. See my 10/3/12 post, WARY OF TIPS AT THESE LEVELS? A LITTLE, BUT…I’M STAYING.
The recent drop in TIPS is entirely attributable to the drop in treasuries in the wake of anticipated and actual “progress” in the fiscal cliff negotiations (See, inter alia, my 1/2/13 post at Rant Political, FISCAL CLIFF REVISITED for some thoughts on the so-called fiscal cliff.); note that the implied inflation rate in the 10 year TIP has increased, albeit by only 2 bps to 2.54%, since 12/6/12, indicating a very slight outperformance of the conventional 10 year by the 10 year TIP. Therefore, a logical conclusion would be that if one really believes that the fiscal cliff deal was sufficiently salubrious for the economy and the market to justify the post January 2 rally in stocks, one should be abandoning both conventional treasuries and TIPS and doing so with enthusiasm.
Yours truly, for one, is not yet ready to declare that the patchwork excuse for a deal that the eminences in Washington managed to barf out after their deadline has removed the obstacles the economy and the stock markets faced in seeking their true, and much higher, levels. Indeed, the fiscal problems of the U.S.
However…
We are not dealing with conventional times or conventional markets. The reason that the conventional ten year treasury is yielding 187 basis points, a yield still laughably paltry though way up from its low of 138 bps in July, is because the Fed is buying the lion’s share (about ¾) of treasury issuance. If the Fed were to back off, conventional rates would increase, if not soar. And if the Fed were to back off, it would, necessarily, stop creating the money it uses to monetize the debt (Let’s call a spade a spade.). That would presumably tamp down inflation expectations, which would cause TIPS to underperform a poorly performing conventional treasury market as real rates increase and inflation expectations decrease. This is a bad, if not a nightmare, scenario for TIPS.
So if one believes that the economy is improving sufficiently for the Fed to back off its aggressive bond purchasing programs, or the fiscal cliff deal impresses Obsequious Ben and His Merry Men to the point at which they no longer feel that their wise beneficence, and prodigious money creation, is necessary, then, yes, one should get out of TIPS with alacrity. But yours truly believes neither that the economic roads have been made smooth nor that the fiscal cliff deal solves much of anything. So I will continue to hold TIPS.
Admittedly, part of my reason for being tenacious, or stubborn, on TIPS, as it was on 10/3/12 , is that I can’t think of anywhere else to go with the money. While that is not generally a good reason to hold anything (There is always cash at a few basis points.), my October 3 theory on the dearth of alternatives seems to have held; the stock market has been essentially flat since then. And I suspect it continues to hold. Stocks are scary in the wake of this rally and just about any scenario that would make cash attractive would make TIPS more attractive. I have liked, and profited from, gold for the last several years, and I like it more after its recent defenestration, but to commit TIPS money to gold would be to move into an entirely different risk universe.
So, yes, I am staying with TIPS.
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