INVESTORS: HERE’S WHAT TO DO WHEN THERE’S NOWHERE TO GO or…

6/20/13

The S&P took a 2.5% dump today.   The Dow and the NASDAQ experienced similar debacles.   Commodities all took gas.  And bonds got pounded.   Rough day for the longs, indeed, especially coming after a similarly rough day yesterday.  Fortunately for the home team, I had some effective shorts (long put positions) in my trading account, but, as I have said in the past, that account is so small as to be laughable; it exists only to focus my thinking for these posts and my usual discourse with friends.   Like everybody else, I took a beating today in the real money accounts, as did everybody else; there simply was no place to go to be long.

What was especially interesting, and somewhat painful for the home team, was that emerging markets stocks performed even more poorly than “domestic’ stocks, whatever the latter might be, but that is grist for another mill.   Some have speculated, in fact, that the cause for today’s worldwide stock market debacle was not so much the Fed as troubles in the financial system of China, the uber emerging market.   I like that theory, though, as I have said in the past, opining on why a market did what it did is nearly as foolhardy as calling the direction of markets.  

Whatever the reason, emerging markets got pounded today more heavily than U.S. markets and have been having a difficult time of it for a lot longer than the last few days.  As someone who has outsized exposure to emerging market equities (roughly 30% of my equities are in emerging market indices), yours truly is especially feeling the pain of the emerging markets.  My problems are being compounded by a relatively heavy exposure to gold and other precious metals, which have also been taking on water of late.  My far greater exposure to Treasury Inflation Protected Securities (TIPS) (See my 2/2/13 post, YES, I’M STILL HOLDING ONTO MY TIPS, only the latest post in which I expressed misgivings regarding TIPS but decided to hold onto them.), which aren’t getting beaten up nearly as badly as stocks but are showing some very stock-like downside, compounds the problem.

So what am I going to do in response to the market moves of late?   Regular readers know the answer to this question:   NOTHING outside my insignificant trading account.   No one knows what the market is going to do; as I said in my 4/16/13 piece S&P YIELDS VS. BOND YIELDS:  I’M YOUR MAN WHEN IT COMES TO STATING THE OBVIOUS.

My important point regarding stocks is that no one knows where stocks are going in any run but the long run and anyone who tells you s/he knows where stocks are going hasn’t been around long enough, or been sufficiently humbled by his or her hubris, to be entrusted with your money.

That point can easily be expanded beyond stocks to bonds and commodities.  So the only way to approach investing is, as I said in my 5/9/13 post OF 10 YEAR TREASURIES AND STEAMROLLERS:  RICH MARKETS CAN, AND DO, STAY RICH.

Calling markets, especially in the short term is, as I have said many times in the past, is very difficult.  There ratio of people who can call short term markets to those who think they can call short term markets is nearly microscopic.  So, at the expense of sounding like a broken record, the best approach to investing is a balanced approach.  Hold some stocks, hold some bonds, hold some precious metals, and hold some cash.  Dollar cost average if you can.  REBALANCE REGLIGIOUSLY.   Let the market do what it’s going to do.  Leave the trading to those who can do it…and those who think they can do it.   Let them provide the liquidity you need to function as a long term investor. 

Nothing that happened today, yesterday, or in the last month or year has changed my long term risk preferences or my long term perceptions of what types of investments would best meet my long term investing goals consistent with those risk preferences.   TIPS, emerging market stocks, high dividend paying domestic stocks, the broad stock indices, precious metals, and some cash all make sense for me and thus all have a permanent, or near permanent, place in my portfolio.    So I will hold them all and REBALANCE, RELIGIOUSLY, from those that are doing well in a given period to those that are doing poorly in a given period.   I will thus achieve my long term goals and save myself a lot of anxiety, of which I have more than enough in other aspects of my life.

Investing can be difficult if one wants to make it difficult by trying to prove how smart one is.  If one is happy staying out of trouble while making decent returns on one’s money and one can display even a modicum of patience, investing is not that difficult.   Remain calm, don’t chase your tail, take a balanced approach, and REBALANCE RELIGIOUSLY.  And if one is not in the business of investing, paying little or no attention to the financial media, at least as it relates to your portfolio, would not be a bad idea, either.

WEST TEXAS TWO STEP—GOLD REMAINS THE WALLFLOWER

5/20/13

Today’s (i.e., Monday, 5/20/13’s, page C1) Wall Street Journal made much of the disparity of the performance of gold and West Texas Intermediate (“WTI”) crude oil.  By my calculations, as I write this, WTI is up 5.5% year to date while gold is down 17.5% and silver is down 12.2%.   As the Journal points out,

Skeptics say this mismatch may be a sign of trouble.

As one reads the article, one gleans that the experts must mean trouble for crude oil, as opposed to wider trouble for the markets, the economy, or Western civilization, which yours truly is always anticipating, but I digress.   People who follow these things point out that there is a mismatch between physical demand and investment demand for oil.  The former is still reflective of a sluggish economy, along with abundant supplies, while the former is being fueled by a thirst for, as the Journal puts it

higher returns than those shackled to rock-bottom interest rates.

The Journal may be right; who knows what goes on with various trading programs that react to what used to be considered miniscule moves of seemingly largely unrelated markets against each other?  

However…

The “out of bonds into crude oil futures” explanation doesn’t make much sense to old guys, like yours truly, who still embrace economic and financial fundamentals and have been trading long enough to know how perilous trading normally is. 

Two days ago (GOLD AND BONDS:   STRANGE BEDFELLOWS IN A YIELDLESS WORLD?, 5/18/13), I expostulated on my theory that the key to gold’s recent demise is not return but yield; i.e., gold may be getting hammered as part of wholesale desertion of low and no yield assets in favor of big dividend paying stocks, the risks of which are being downplayed or ignored.  If that theory is true, either gold has to trade up or crude oil has to trade down.   (Note that gold is up a little over 2% today and silver is up slightly more, but one day means nothing, at least to investors.) Investors can’t be fleeing no yield gold or low yield bonds in order to invest in no yield crude oil.  And it seems that if investors, or traders, more properly, are abandoning gold because it has no yield, they would also be abandoning crude oil.  Instead, they are bidding up crude oil, though 5.5% YTD only looks like a whopper return relative to the dismal performance of precious metals.

Again, I’ll leave the trading like a scalded dog to my younger and presumably wiser colleagues.  But it’s fun, and sometimes informative, to speculate on why commodities or markets are doing what they’re doing.   However, the only thing we can say for sure about crude oil is that there are big buyers, or a lot of little buyers, who like it for reasons we don’t know and can’t know.   We might also say, with only slightly less assurance, that any speculation as to their reasons is just that…speculation…and there is probably more going on than we know.

GOLD AND BONDS: STRANGE BEDFELLOWS IN A YIELDLESS WORLD?

5/18/13

Gold has taken a pounding of late, falling over $100 during the last seven trading; the June futures contract closed yesterday at $1364.70, a few bucks over its yearly intra-day low of $1360.90, touched on April 15.   Year to date, gold is down nearly 19%.  It’s been brutal for those of us disproportionately, a relative term in more ways than one, long gold.

As I have said numerous times and written numerous times in this and other forums, determining why an asset or a market has done what it has done is nearly as perilous as predicting what it will do.  But trying to glean meaning from market’s moves is instructive, entertaining, and (only) potentially profitable, so, against perhaps my better judgment, I have come up with a theory for gold’s problems.

One of the explanations for gold’s demise, i.e., no reported inflation (except in asset prices, grist for another mill or for later in this mill), would seem to make sense but is nothing new.  Why, then, should such explanation account for gold’s performance over the last few days?

Another theory, that traders anticipate that the Fed will begin to wind down its bond buying program (See my 5/11/13 post, THE FED’S EVOLVING APPROACH:  REDUCING UNCERTAINTY BY INCREASING UNCERTAINTY) might hold some water.   However, if you believe Mr. Bernanke and his cohorts when they argue that their objective in keeping us drenched in liquidity, and beating the living daylights out of elderly savers, is to support the economy, it doesn’t look like the Fed will take the turbochargers off the printing presses any time soon.  The economy still is only slowly recovering.  

On the other hand, believing anybody one has not known personally, and far more than casually, for at least twenty years is always a perilous proposition.   Believing a politician (And, believe me, these Fed guys are first and foremost politicians or they wouldn’t be where they are.) is perhaps the silliest, most irresponsible activity in which one can engage.  So if, as many of us have long suspected, the real object of the Fed’s money flood is to support the stock market, maybe they are going to start turning off the fire hoses. 

On the third hand (Where’s Harry Truman when we need him?), perhaps the Fed doesn’t dare slow down because the repercussions for the stock market might be disastrous as newbie risk takers decide they don’t have to own stocks to avoid a steady diet of dog food in their old age.

Despite all these hands, it really doesn’t matter.  As long as traders believe that the Fed will be winding down, there will be downward pressure on gold.   Whether those traders are right or not is of little or no consequence.  So the “Fed might unwind” argument for gold’s defenestration has some credibility.

Yours truly, however, likes another explanation for gold’s sudden unpopularity, to wit, gold has no yield in an almost suddenly yield obsessed world.   Gold has, of course, had no yield for the last 7,000 years or so that it has been trusted as a store of value, so what has changed?   The thirst for yield in the Bernanke created yield-parched desert has reached the point at which people are seeing mirages, like “safety” in overvalued high dividend yielding stocks.  (See my 4/29/13 post, YEAH, THE BIG DIVIDEND PAYERS ARE GETTING RICH, BUT…)  In such an environment, people tend to do irrational things…like suddenly feeling the near insatiable urge to toss the old standards over the side in favor of the hottest new item to come down the pike, in this case big dividend payers.  (See my 5/13/13 post, A “THIRST FOR RISK”?:  SOME BASICS ON RETURN, RISK, AND INVESTING .)

One can take this “no yield so no gold for me, thank you” argument a step further.   This disdain for assets with no, or close to no, yield transcends gold and other precious metals.  Notice how a virtually (certainly on a real basis) yieldless bond market has done of late.  The ten year treasury yield has gone from 1.67% at the end of last month to 1.95%.   The ten year reached a low yield of 1.38% last July, when gold was trading with a $1600 handle.   Could it be that gold, a yieldless asset, is trading with treasuries, which Mr. Bernanke have rendered virtually yieldless?

One might argue that of course gold will move in the opposite direction of yields, and therefore in the direction of bonds, because gold purchases are financed either by borrowing money or by foregoing yield.   But I am arguing causation here; perhaps both gold and bonds are getting pounded not for traditional reasons but because traders, and some investors, are abandoning low and no yield assets en masse in favor of big dividend paying stocks.

All this could be so much navel gazing, however, for two reasons.

First, gold is obviously getting pounded because big holders, or big shorters, are selling.   We don’t have to know why and we can’t, in most cases, know why.   So what difference does it make?   Big money people, or a lot of little people money, no longer like gold and have acted appropriately.

Second, the response of yours truly, and those I advise and would advise, will be to do…nothing.  The underlying reason for owning gold, i.e., an utter lack of confidence in the world’s, and perhaps especially, our, central bankers remains intact.   So I am staying in gold.  (See my 4/15/13 post, GOLD:  YES, I’M SCARED…BUT I’M STAYING, perhaps ironically (certainly not presciently) written on the date gold reached its (then) low.)  And when it comes time to rebalance, unless things change, I will be buying more gold and silver, just to maintain my long term allocation to that ancient object of kingly desire (gold and silver, not Zsa Zsa Gabor), not because I have any idea where gold will be going in the short to intermediate run.

THE AP TWITTER CRASH: THE VALUE OF KEEPING ONE’S COOL

4/24/13

There was much reporting, and handwringing, yesterday and this morning, including a front page article in the Wall Street Journal, regarding yesterday’s “Twitter Crash.”  In the space of about 65 minutes yesterday, the Dow lost and regained 145 points, and the markets lost and regained $200 billion of value, due to a false tweet that there had been an explosion at the White House that had resulted in President Obama’s being injured.  Yours truly was at lunch (Walker’s Charhouse in Naperville…great place.  Check it out.) at the time and missed the whole thing; had I not been a news enthusiast, I would not have noticed that anything had happened.

A group called the Syrian Electronic Army, which is allied with President Bashar Assad and wants to draw attention to what it considers false and one-sided reporting on the conflict in Syria.   (See?   As eclectic as this blog is, there is a connection, albeit often a contorted one, between the topics on which I write.  See, inter alia, my 4/11/13 piece   SYRIA:  GROUNDHOG DAY FOR AMERICAN FOREIGN POLICY.)  The group apparently hacked into AP’s Twitter account and broadcast, if that is the right verb, the offending tweet.

Don’t misunderstand me; I am not saying that this was an innocuous act, that such market manipulations are healthy, or, certainly, that the Syrian Electronic Army and its tactics are at all laudable.   But was there any harm done here to investors?   No, unless those investors were making a rebalancing move, or taking or unwinding a long term position, during that hour in which the markets took their roller coaster ride, and even then there could have been some benefit to such investors.   The whole thing started just after noon Chicago time and was over by just over 1:00 Chicago time, a miniscule window for long term investors. 

The only people who were hurt were traders.   Again, don’t misunderstand me.   Though, as most readers know, my days of trading like a scalded dog are over, I applaud those with the skill, the courage, or, in some cases, the recklessness, to be traders; our markets need them to provide the liquidity that makes the markets function.  (But do see my post, reproduced below, that originally appeared on 8/22/12 on the now defunct Rant Finance.)   However, when one decided to trade, and potentially cash in on the outsized rewards that trading can entail, one assumes the outsized risks of trading.   Among those risks are unexpected events like a group of Assad enthusiasts hacking into the AP Twitter feed.  Indeed, the very definition of risk (with which I admittedly have a problem, but that is grist for another mill) in the finance textbooks is the possibility of unexpected outcomes.

So it was not at all a good thing that a bunch of tech savvy miscreants with a political axe to grind could eliminate $200 billion of value for a few minutes and some traders got hurt in the maelstrom.   But traders are big boys and girls, or at least ought to be big boys and girls, and should realize that taking such risk is one of the costs of being in a position to reap big returns.  Genuine investors were not hurt by the market whipsaw; indeed, many, like yours truly, missed the whole thing.

Of course, there is a lesson here for investors.   As I have both intimated and said on numerous occasions both here and in other forums, the best thing to do in times of market panic, or apparent financial panic, is nothing.  Remain cool, stick to your plan, and keep your emotions in check.   See my 4/15/13 post, GOLD:  YES, I’M SCARED…BUT I’M STAYING.

PROMISED 8/22/12 RANT FINANCE POST:

HOW MUCH LIQUIDITY DO WE NEED?

8/22/12

This morning’s (i.e., Wednesday, 8/22, page A12) contained an article by Lillian Lin entitled “China’s Graduates Face Glut.”  In the article, recent college graduate Wu Xiuyan, expressing her understandable disappointment at the job market for grads in China, is quoted

“My classmates and I want to find jobs in banks or foreign trade companies, but the reality is that we can’t find positions that match our education.”

Such problems are, as many of you know from personal experience, worldwide and I sympathize with Ms. Wu and her colleagues.   But that’s not the point of this post.

Ms. Wu’s comments reminded me of something that Jack Bogle, one of the two guys for whom I always turn up the sound on CNBC; the other is Art Cashin.   Most of the time, I turn up the sound for Rick Santelli, but I digress.   Mr. Bogle, the founder of Vanguard and a true titan of the financial world, appearing on CNBC about a week ago was, as is his wont, decrying what he (and I) consider the excessive trading in securities.   As Mr. Bogle says, there is far too much trading and not enough investing going on.   Even though I write for this trading site, I wholeheartedly agree and have adjusted my financial behavior accordingly, but, again, I digress.

When Mr. Bogle made this comment, one of the trading guys who regularly appears on CNBC (It might have been Jon Najarian, but I’m not sure.) countered, reasonably, that that what Mr. Bogle looks askance at as excessive trading provides liquidity to the marketplace and thus serves a vital function.   Mr. Bogle agreed, partially, but then added something to the effect of, and I can’t quote because it was a few weeks ago, how much liquidity do we need?

Mr. Bogle’s comment is, as are most of his comments, profound.   We have put a lot of money and, more importantly, a lot of human capital into the financial industry, broadly defined, in this country.   One of the major roles of the financial industry, and virtually the sole role of the trading segment of that industry, is to provide liquidity to what otherwise would be parched markets.   This is a vital role, but is it so important that the best and brightest minds, or at least a huge portion of the best and brightest minds, go to Wall Street in this country?   Yes, markets need the capital and smart people necessary to keep them liquid and deep; that is one of our competitive edges as a nation.   But do we need as much capital, and as many bright people, committed to trading as we do?

The markets seem to be telling us that we don’t.   Note the reduction in both jobs and compensation on Wall Street in the wake of the latest financial debacle at least partially concocted by the people who have dedicated their lives to providing liquidity to our markets.  One suspects that these reductions are not cyclical, but secular; they are a signal that too much of our financial and human capital has gone into finance and not enough has gone into, say, engineering or medicine.

Now note the observations and the travails of Ms. Wu.  As China has gotten richer, more of China’s best and brightest have decided that “banks or foreign trade companies” (i.e., providing liquidity to the markets) would be a lucrative and otherwise worthwhile place to spend their careers.   But perhaps the market in China is directing these fine minds away from the Chinese equivalent of Wall Street.

There is another point here beyond the argument that too many of our resources are going into keeping our liquid markets overly saturated.  In this case, the market seems to be telling us that we have over invested in trading and under invested somewhere else.   The market works.   One hopes that the likes of Messrs. Obama, Romney, and their fellow “public servants” who deem themselves worthy of telling us all how to conduct our lives would realize that the markets work.   But one also hopes to win the lottery, I suppose.

GOLD: YES, I’M SCARED…BUT I’M STAYING

4/15/13

As one who is long gold in a substantial, for me, way, of course I’m scared by what that ancient object of kingly desire has been doing of late and for the last several months.   At $1,371.60 the ounce as I write this, gold is down 18% for the year and is so far off its high (I saw and recorded an intra-day high of $1,911.20 on 9/6/11, but the reportage pegs the high lower.) that one with less experience than yours truly might despair (or rejoice, depending on one’s position) of ever seeing that Everestian peak again.

But what am I doing in response to my fears regarding gold?   Nothing.   I suspect, but can never know, that this would be perhaps the worst time to sell gold; getting in the middle of what looks like a margin call induced unwinding of large leveraged positions is never wise.  Further, the underlying reasons yours truly owns gold, the most salient of which is a total lack of faith in the world’s central bankers as a group (See only my latest post on this topic, 4/5/13’s “(BEN BERNAKE) CAN ‘CAUSE HE MIXES IT WITH LOVE AND MAKES THE WORLD TASTE GOOD…”), remain intact.

Of course, I, like anyone else, could be wrong; what we are seeing may be an indication of a worldwide deflation, in which case we, and I, would have far more to worry about than the value of our gold positions.   But, at least for now, I am thinking that a lot of people have thrown in the towel on gold and are taking what remain huge long term gains in the metal and its cousins, such as silver and platinum.   When I rebalance I will act accordingly; if this swoon continues, or even if the prices of precious metals stabilize, I will probably be adding to my gold and silver positions as a part of the normal rebalancing process, which is a few months off at the earliest.

I do want to point out something that I said in my last defense of my Treasury Inflation Protected Securities (“TIPS”) position on 2/2/13, YES, I’M STILL HOLDING ONTO MY TIPS, when I was going over, and dismissing, the alternatives to TIPS:

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.  (Emphasis mine)

Now readers are getting a vibrant and glaring example of what I was talking about; gold and TIPS have radically different risk profiles and, even though TIPS have sometimes been referred to as “paper gold,” gold and TIPS are not ready substitutes for each other.

Speaking of TIPS…

First, they haven’t done all that poorly since my 2/2/13 post.  The 10 year TIP yield has gone down from a negative 57 basis points to a negative 73 basis points as I write this.  And the ETF TIP has gone up about a point to 122.   Yes, TIPS have underperformed conventional treasuries; the inflation assumption implied by the 10 year conventional and TIP yields has gone from 2.58% to 2.44%.  And stocks, again with a vastly different risk profile, have done far better.  But, on balance, if owning TIPS from the time I advised holding until now is the worst investment you ever make, you are indeed leading a charmed investment life.   If you’d held gold as an alternative to TIPS, you would have been licking your wounds.

Second, that TIPS are down slightly today while conventional treasuries are up, gold is down, and gold is getting pummeled lends credence to the deflationary argument.   But we are looking at one day’s trading, which is largely meaningless.  See, inter alia,  today’s other post, SO WHY HAS THE STOCK MARKET DONE SO WELL OF LATE?

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.