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Jan. 14 (Bloomberg) -- Just because oil trades above $100 a barrel, gold fetches more than $900 an ounce and U.S. consumer prices climb at the fastest rate in two years, now is not the time to buy U.S. government securities protected from inflation.
Just because the sky is dark, the clouds have formed and thunder is heard in the distance, now is not the time to seek shelter.
``There's a distinct possibility we could encounter a severe recession,'' said Seamus Brown, a bond fund manager who helps oversee $8 billion at JPMorgan in New York. ``You would expect inflation to slow and as a result TIPS would probably underperform nominal securities.''
"Probably" and "you would expect" are the keys here. There was a severe recession in 1974. The short-term disinflation was swamped by the inflationary aftermath. It slaughtered nominal securities over the next few years.
TIPS outperformed Treasuries last year amid ``a perfect storm'' that's likely to continue, said John Brynjolfsson, a managing director at Pacific Investment Management Co. The financial crisis stemming from losses on securities tied to subprime mortgages lingers and there's still ``explosive growth'' in emerging markets such as China to drive up commodity prices, he said.
I'm a believer in "perfect storms" these days. Let's not forget the U.S. Dollar losing its purchasing power through a massive trade deficit. There's only so many we can ship in exchange for hard goods before somebody starts to question the value of the fiat paper IOUs. I'm also with Volcker when he calls our current situation "dangerous and intractable."
Demand may already be faltering. The 1.655 percent yield on the Treasury Department's auction of the $8 billion in 10-year TIPS was the lowest since that type of debt was first issued in 1997. Investors submitted bids for 1.90 times the amount sold, the least since April, according to the Treasury.
The article fails to mention that the yield has dropped considerably since then though. Why do you suppose that is? The yield is now just 1.5%. Those who participated (such as myself) in the auction are quite happy as investors rushed in behind them. TIPS also outperformed nominal treasuries today by a wide margin AND did very well despite the stock market rally, for what that's worth. In my book, that's worth quite a lot. That's not exepcted behavior. TIPS have generally been moving counter to the stock market.
In general, I'm especially skeptical of "traders" telling me to "forget" what to do. Why would a trader be looking to protect MY money? While I do not have great expectations for TIPS continuing to reward as they did in 2007, on a relative basis I think they will cause less pain than most (which amounts to the same thing). I could be wrong of course and this is most certainly not investment advice. However, I will say that I am participating in the 20-Year TIPS auction which should be announced later this week. I'll be buying and holding for the full 20-Years. I'm clearly not a short-term trader. It is the long-term future that concerns me most.
As long-term holders of TIPS, we need only suspect that the long-term direction of future real yields is down (that's the most important thing that determines what TIPS are worth). I not only strongly suspect that real yields will fall, but I'm actively betting on it. Real yields were actually negative in the 1970s. Few seem to know/remember that.
Death of Real Yields Perfect Storm
- Guns AND Butter Governmental Policies
- Forever War
- Banana Republic Trade Deficit
- Banana Republic Rising Income Inequality
- Banks "Too Big to Fail"
- Credit Crisis Flight to Quality
- Slowing Economic Growth Flight to Quality
- Retiring Baby Boomer Flight To Quality
Further, since I am holding until maturity I will actually do better if I am wrong. It would more than likely mean inflation was not as bad as I feared and/or the economy is doing better than I expected (and those would be VERY good things). I just won't be doing as well as the next person over the next 20 years (who was not buying insurance for inflation protection).
19 comments:
How much scope has the Treasury to fiddle with the definition of inflation that TPIS yields are based on? I ask because here in the UK our Treasury has the right, on some of our equivalent "Index-Linked Gilts", to alter the definition.
dearieme,
I'm confident that they can and will alter the definition all they like. :(
Some would argue that it has already been altered too much. I'm not in that camp but clearly any altering of the index is not just going to be out of the goodness of their hearts.
That being said, real yields tanked today as investors rushed into nominal treasuries and TIPS (thanks to the poor retail sales and Citigroup). The real yield on the 5-Year TIPS is a mere 0.74%, the 10-Year is 1.42%, and the 20-Year is down to 1.75%.
The 20-Year TIPS auction should be announced the day after tomorrow. I really hoped the economy would hold together a bit longer. The yield I will be getting is well less than what I would have gotten last month (and MUCH further below what I would have gotten in June, before the wheels started falling off this economy).
The real yield on TIPS cannot fall below 0%. However, at 0% we are almost guaranteed to hoard certain goods. It is almost laughable to buy TIPS with a 0% real yield only to be taxed on the amount they rise with inflation. Hoarding almost anything you use (that merely rises with inflation) would be a better choice.
Is it any wonder gold is over $900 an ounce?
For those in the 30% tax bracket (and assuming you actually trust the current and future CPI for its absolute accuracy ;)), the inflation breakeven point on the 5-Year TIPS (earning 0.74% above inflation) is a mere 1.73%.
(0.74% + 1.73%) * 0.7 = 1.73%
If the CPI rises more than 1.73% you will lose money after taxes on the 5-Year TIPS investment.
The inflation tapeworm (as Warren Buffett puts it) is active and is seeking hosts (even if inflation remains tame). The jury is out on whether the tapeworm is growing larger or smaller though (inflation vs. deflation debate continues).
Stag,
http://www.safehaven.com/article-9237.htm
Another stagflationist.
Stag,
Heres my math based on reported 2007 inflation of 4.1%.
Current 3mo treasury yield = 3.08%
3mo treasury yield = 2.16% (after 30% taxes)
Real after tax yield on 3mo treasury = 2.16% - 4.16% = -1.94%
Oh yeah, I forgot to mention that real hourly wages for 2007 were negative 0.9%. Worse yet, fed fund futures are predicting drastically lower short term rates.
Wages for work are negative. Yields on savings are negative. Looks like housing is contained to the pocket books of workers and savers.
What a disgrace.
MAB,
From your link:
For decades, no one has understood it. But it is plain and simple.
Great article. It does fail to mention the risk of owning gold at $900 vs. the risk at $250 though. No mention of the merits of toilet paper (which has yet to rise much ;)). Apparently gold is good at any price (the same was said of real estate until recently if memory serves). There's also no mention of TIPS and I-Bonds.
As for the real yields you mention in your next comment, TIPS had an outstanding year in 2007 (my TIP fund was up ~11%, for safety, go figure). The 20-Year TIPS has a 1.83% real yield on it as of right now. That's low by historical standards. However, historical standards only go back 11 years (since TIPS were introduced 11 years ago). If one includes stagflationary eras the historical standards criteria might change substantially. 1.83% might seem more like an average, or dare I say it even a bargain (assuming you buy TIPS for stagflation insurance and stagflation actually appears). The auction should be announced tomorrow. The auction itself should be on the 24th. I'm hoping the yield holds. I'll be backing up the truck regardless (~10% of my investable net worth). I'll also be buying more I-Bonds this month (which I prefer, but there's a limit on how much I can buy).
Unlike the conclusion of the article in your first link, I'm seeing a very long-term stagflation problem. I'd argue we have at least five years worth of stagflation once people actually believe it is here. In the short-term (next year or so), I think stagflation may give way to recession (which should push the thoughts of stagflation temporarily to the sidelines, perhaps).
The TIPS spread between the 20-Year nominal treasury (4.34%) and the 20-Year TIPS treasury (1.83%) implies a CPI inflation of 2.51% over the next 20 years. In the 20% tax bracket, I'll be earning ~1% after taxes and inflation (using the market's own math and expectations).
For each 1% inflation is higher than that, I'll be earning ~0.2% less after taxes (and at some point be moving to a higher tax bracket which would hurt me more). However, for each 1% inflation is higher than that, those in nominal treasuries will be earning the full 1% less. In my opinion, the insurance of TIPS is SO worth what little is paid these days. And what's the upside for those in nominal treasuries? 2.51% expected inflation going even lower over the next 20 years? To what? 1.5%? I find that VERY hard to believe if we continue down the path we are on.
Thank goodness there aren't many stagflationists among us. We seem to have a glut of short-term traders looking for "fast money" and "mad money" though. We also seem to have a glut of deflationists (who somehow continue to believe that the value of all that paper fiat money printed "at essentially no cost" will continue to become worth more and more in the coming years). Whew!
There's some short-term deflationist in me too (just like there would have been heading into the 1974 disinflationary recession in a sea of inflationary long-term pain). I just refuse to invest for the short-term. If nothing else, the long-term picture is easier to digest (if you can stomach our long-term picture that is).
Stag,
You've probably read this, but it might be useful to your other readers.
Good info imo.
http://www.clevelandfed.org/research/inflation/TIpS/index.cfm?state1=1&state2=2&state3=&state4=&startDate=01/01/2005&endDate=01/17/2008&freq=daily
Its interesting that TIP investors pay a premium of about 50 basis points. If this reverses, it could be an indicator of a top.
MAB,
Its interesting that TIP investors pay a premium of about 50 basis points.
That's one way of looking at it (at least if you try to resell them instead of holding them to maturity). They are less liquid and are therefore more difficult to resell. However, that same mechanism allows us to buy them cheaper.
The TIPS-derived measure of inflation expectations underestimates SPF expected inflation and on average actual expected inflation by 50 basis points.
In my book we're actually getting a discount when we buy (if held to maturity).
As TIPS investors we clearly underestimate inflation. That means if inflation comes in as others expect we will earn MORE than we expect. That's a good thing for us (and a not so good thing for the nominal treasury holders).
I would offer up one reason of my own that seems to be missing from their analysis. Those SERIOUSLY worried about inflation do not buy TIPS. They buy gold. TIPS investors are therefore just a subset of inflationists (and therefore would have lower inflation expectations than the average inflationists).
Stag,
I agree with all of your points.
What I meant by "interesting" is that I don't agree with the Cleveland Fed's conclusions.
Their conclusions are based on a period of declining inflation with well anchored inflation expectations.
My view is that the future will bring increasing inflation combined with increasing inflation expectations.
The Clevland Fed's next research paper will have a different perspective, imvho.
Stag,
Do you or any others here sense that we heading for a "well anchored" distrust of wall street.
Outside of the early adopters on this and other blogs, I sense that mainstreet is getting fed (pun intended) up of getting fleeced.
The return on canned goods and toilet paper is looking better and better compared to the 1970's style junk wall paper the financial services community is selling.
MAB,
Do you or any others here sense that we heading for a "well anchored" distrust of wall street.
Well anchored since 2000!
I know I'm not alone. Wall Street attempts to remain bullish based on how much money is sitting on the sidelines (a lot!). However, I think Wall Street is underestimating how much money has permanently moved to the sidelines.
What are the odds the money I'm putting into this month's 20-Year TIPS auction will ever make its way back to Wall Street? ZERO. In 20 years I'll be even more risk averse than I am now (which seems SO hard to believe, lol).
What are the odds the money I put into 30-Year I-Bonds will ever make it back to Wall Street? ZERO. I've got I-Bonds that I bought in 2000 that are up 61% (paying 3.4% above inflation and tax deferred). They still have 22 more years to compound.
Heck, I won't even buy annuities. I'd be too concerned that a currently financially sound insurer wouldn't be by the time I started withdrawing the money.
http://finance.yahoo.com/q/bc?s=abk&t=my
Clearly 20+ years of financial stability can disappear in a heartbeat, if the above bond insurer's chart is any indicator.
It seems that long-term prosperity was merely an illusion. Go figure.
Stag,
What about the ROUS's?
Shttp://animals.about.com/b/2003/09/22/giant-rodent-fossil-unearthed-in-venezuela.htmtag,
Rodents Of Unusual Size? I don't think they exist.
DUDE!
Times are getting exciting, and we're missing you over at CR's place.
tj& the bear,
Thanks for the kind words. I feel the need to avert my eyes at the moment of impact though, lol. (Gallows humor.)
Good grief!
DJIA futures: -451.00
S&P futures: -53.80
Nasdaq 100 Futures: -70.00
It looks like I named my blog the wrong thing. I suspect "Illusions of Airbags Being Deployed" might have been better, at least in this environment.
I meant to offer a link.
http://www.bloomberg.com/markets/stocks/futures.html
I see tj & bear beat me to it. Wassup?
Hi Rob,
I offer an analogy.
My site was like the guy in the passenger seat screaming at the driver to hit the brakes.
I see little need to continue to scream, now that the collision is underway. It isn't like the driver has much control of the car at this point. D'oh!
Well, I'm hoping it's a mild bout of SAD (seasonal affective disorder?) and you'll be in good form say springtime. BTW, noted the Year of the Rat posting (my daughter is half chinese, her mom isn't) and I have a clock on the wall with the Chinese zodiac characters to remind me of my ethnic background. But for all of that I'm as white on the inside as a banana. See you at CR sometime.
David,
Perhaps I'm suffering from eSad (economic seasonal affective disorder). ;)
As can be seen in my posting activity, much of the drop off came just as the you know what started seriously meeting up with the fan.
On the one hand, I suppose I should be happy that real yields have continued to drop. That "bet" made me a decent chunk of money in 2007 (my TIP fund was up 11.93%).
On the other hand, falling real yields means it is going to be very difficult to make money for the rest of my life. It also doesn't help that my girlfriend is having a difficult time finding work.
Maybe I just need a pick me up song to get my spirits back on track and clear me of this seasonal funk.
The sun'll come out
Tomorrow
Bet your bottom dollar...
Oh wait, that's a 1970s song! Nevermind!
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