YES, I’M STILL HOLDING ONTO MY TIPS…UPDATED EDITION

11/21/13

Today’s (Thursday, 11/21/13’s, page C1) Wall Street Journal featured a front page article in the Money and Finance section entitled “Inflation Linked Bonds Take a Hit.”   The paper reports, accurately, that Treasury Inflation Protected Securities (“TIPS”) have taken something a beating, in bond terms, this year, with a total return of negative 7%.  (While the article doesn’t specify where this number for “TIPS” came from, I’m assuming that it is measuring return based on the exchange traded fund (“ETF”) TIP; the ETF’s year to date return matches that negative 7% number.)   This miserable, by bond standards, performance has been the obvious result of two distinctly anti-TIP developments in the economy and the financial markets.  First, all bonds, or at least all treasury bonds, have had a bad year as the economy improves and the Fed hints at tapering (Oh, how I’ve come to hate this latest term from which one cannot seem to escape!  But I digress.) its bond buying program.  Second, there is no measurable inflation in the economy.   The CPI is increasing at a 1% annual.  Whether that number jibes with one’s experience is another issue; the inflation compensating increments to TIPS are based on the CPI, so that is the measure with which we are forced to live in this circumstance.

As regular readers know, I’m a big (for me; by most standards, I’m not a big holder of anything) holder of TIPS in my own accounts, and have been for years.  I have counseled friends and consultees to own TIPS for just as long.  I continue to both hold TIPS and advise people to hold TIPS despite some misgivings and hand wringing near the top of the TIP market; see 6/26/13’s TREASURY INFLATION PROTECTED SECURITIES (“TIPS”):  REPLACING PANIC WITH CALM PERSPECTIVE and 2/2/13’s YES, I’M STILL HOLDING ONTO MY TIPS.

Am I displeased, sullen and down in the mouth, about my large TIP holdings?   No.  The same Wall Street Journal article points out that, before this year’s debacle, in the three years from 2009 to 2012, TIPS returned 44%, which works out to an annual return of 12.9%, which, in bond terms, if a terrific performance.  Even after this year’s 7% hit, TIPS are up 34% over the last three years, which works out to an annual return of 7.6%.  This remains an outstanding return for a  credit instrument with no real default risk.   I’m happy, bordering on the ecstatic, with the four year return on TIPS and, if you’ve been holding them, you should be, too; this is investing, not trading!

Note also, in one of those “not for nothing” observations, that since I wrote the aforementioned 6/26/13 piece, TIPS are up a touch.  The ETF was trading at 110.72 then and it is at 111.23 as I write this, plus they’ve paid five dividends.

Why do I insist on holding onto my TIPS?   Aren’t we experiencing conditions that continue to argue against TIPS?   If I were inclined to trade major portions of my portfolio, I might, and only might, be tempted to get out of TIPS with the hopes of getting in again at a lower price.  But I’m not trading my TIPS because I decided long ago that TIPS make sense in our economic environment for long term investors who are either very risk averse or who simply want a buffer against several nasty possibilities in the financial markets. 

I agree that, at this juncture, those horribles, such as inflation or a plunge in the stock markets, do not look imminent, though I am starting to think the probability of the latter is increasing.   However, unlike those who pretend to be for a living, I realize that I am not clairvoyant.  The older I get, the more I realize I don’t know, especially about the short term movements of the financial markets.   I am about as likely to be right as I am to be wrong on any short to intermediate term call in markets, as are those who pretend they can see the future, and I am not willing to bet my long term investment results on such fuzzy odds.  If I were inclined to trade these things, I would be about as likely to get out at a bottom and in at a top as I would be to get out at a top and in at a bottom.

So, yes, I continue to hold my TIPS.   They have delivered a near spectacular risk adjusted return over the long period I have held them and I expect them to do nearly as well over the similarly long anticipated remainder of my holding period.   While economic and financial conditions right now do not favor TIPS, things change fast.  And, despite their high opinions of their own prognosticatory skills, the “experts” rarely can tell you, with any degree of consistency, when those changes will come.

TREASURY INFLATION PROTECTED SECURITIES (“TIPS”): REPLACING PANIC WITH CALM PERSPECTIVE

6/26/13

As anyone with a pulse who has been able to somehow tear himself or herself away from the “All Blackhawks, All the Time Because, After All, What Could Possibly Be Nearly As Important” coverage here in Chicago knows, bonds have taken a terrific beating of late.  Treasury Inflation Protected Securities (“TIPS”) of which I have been so enamored, and of which I own so many (as a proportion of our total holdings) have been beaten up at least as badly as conventional bonds.  

Some numbers can best convey the carnage in TIPS.   I am using the “closing” 10 year TIP yield (I had to be approximate for 12/10/12 and 6/24/13 on the yields; I’m an investor in TIPs, not a trader of TIPs, and so don’t necessarily follow the yield on a daily basis.) and the closing price of the exchange traded fund (“ETF”) TIP as indicators of levels:

Date                             10 Year TIP yield                     TIP Price

12/10/12 (High)            -1.00% (App)                          123.30

4/5/13 (2013 High)       -0.78%                                     122.57

6/24/13 (2013 Low)     0.60% (App)                            110.02

6/26/13 (Today)           0.54%                                      110.72

Note how tough the last few months have been.   Obviously, I had some doubts about my loyalty to TIPS, especially given the misgivings I expressed in my last post on TIPS, 2/2/13’s YES, I’M STILL HOLDING ONTO MY TIPS and the posts to which it referred my readers. 

But, as I indicated on 6/20/13 (INVESTORS:   HERE’S WHAT TO DO WHEN THERE’S NOWHERE TO GO or…GIMME THAT OLD TIME RELIGION), I have taken no action on my TIPS, or on any of my investment positions, in response to the market turmoil of the last several weeks.  Full disclosure, though…I do have a rebalancing date on Friday and may sell or buy TIPS as part of that rebalancing, but rebalancing has nothing to do with one’s perceptions of the market; it is, instead, the sine qua non of rational investing and must be done religiously regardless of one’s feelings about the market, as I have said and written ad nauseam in the past and will say and write until the day I die.

Besides my aversion to getting emotional and consequently doing dumb things in response to market gyrations, there is another reason I have done nothing on TIPS, or anything else in my portfolios, and do not, on reflection, feel bad about not lightening up on TIP position.  That reason is PERSPECTIVE.

Let’s use the price of the ETF TIP as a surrogate for TIP performance.  I purchased my largest TIP position in three bites…in June, 2004, July, 2005, and June, 2006, coinciding, not at all coincidentally, if you will, with one of my rebalance dates and with my gradualist approach to investing.  I have reinvested all interest payments or, technically, dividends since TIP is an exchange traded fund.   My average price on my TIP position is 104.738, which is, of course, inflated by the reinvestment of dividends at higher TIP prices.   Those 2004, 2005, and 2006 purchases were made at the prices of 102.44, 107.23, and 100.56, respectively.

As can be seen in the numerical array above, TIP closed today at 110.72, considerably above my average price and, more importantly, since these are bonds, I have been collecting, and reinvesting, interest payments along the way.   Further, when I bought those bonds, I didn’t have the expectation that TIP would trade as high as 123.30, at least not as quickly as it did; such price appreciation, when added to the dividends collected and reinvested, would result in an unusually high return a bond investment, or at least for a bond investment in which credit was and is not a consideration.  As loyal readers know, I knew at or about the time of the high that TIPS, like conventional bonds, had run too far, too fast, courtesy of the Fed, and real rates were bound to increase, bringing both conventionals and TIPS down.

So do I wish I had sold my TIPs at or near the high?  Of course, one always wishes one could sell at a high, but, perhaps strangely, I don’t feel bad that I didn’t sell 12 points or so higher. 

Am I crazy?  Why wouldn’t I have liked to have sold something around 123 that is currently trading at 110.72?  The answer is simple:  I am not smart enough to pick the high on anything.   Further, even assuming I got lucky and  picked and sold at the high, I am not smart enough to get back in at a decent entry point.  If I were so “smart” as to think I could trade TIPS, I might have gotten out at 110, a high price relative to my average cost, and gotten back in at 123 rather than the opposite.   So rather than try to do things that I am, and most people are, incapable of doing, I simply held my TIPS position.  In so doing, I have enjoyed a pretty decent return…judging from my 104.74 average price, the 110.72 average price, the coupons, if you will, that I have clipped and reinvested in the intervening years, and the inherent safety of a government issued bond with built-in inflation protection.

Further, at the prevailing yields of 2.54% on the conventional 10 year and 54 basis points (“bps”) on the 10 year TIP, the implied projected inflation rate is 2% for the next ten years.   A lot of people believe that inflation will average less than 2% over the last ten years.  I am not one of them.   On a relative basis, then, I would be a big buyer of TIPS at these levels…if I were inclined to be a trader of, rather than an investor in, TIPS.

YES, I’M STILL HOLDING ONTO MY TIPS

2/2/13

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:

1/8/13              TIPS:  STILL WARY, BUT STAYING, AFTER ALL THESE YEARS

10/3/12            WARY OF TIPS AT THESE LEVELS?  A LITTLE, BUT…I’M STAYING

7/19/12            10 YEAR TIPS AUCTIONED AT A RECORD LOW YIELD—NEGATIVE 63.7 BPS—WHAT, ME WORRY?

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

1/8/13

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. government are merely one range of mountains the world economy must surmount, and even those problems were not solved by this poor excuse for a deal.   While the rally could be justified for a trade, largely on the greater fool theory, which tends to work well in the world of short run trading, it is utterly baffling from an investment standpoint.   And if one believes the stock market rally has no legs, as the last few days seem to be indicating, it’s hard to think that treasuries and, by extension, TIPS, are in serious peril at this juncture.

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.