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With TIPS Like These, Investors Need Advice
The bidding frenzy has sent TIPS prices soaring. The bonds have become wildly overvalued and now offer a terrible long-term bet.
Don't blame the TIPS. Blame the inflation! What isn't wildly overvalued at this point? Perhaps you'd rather stuff the dollars under your mattress as more is flung from the helicopters? Would you rather buy gold at nearly four times what it cost just a few years ago?
Imagine what is left for investors in a regular bond or balanced mutual fund that puts money in TIPS. Most do. And they charge fees of 1% a year or more.
Don't blame the TIPS. Blame the excessive fees! I can't help people who wish to pay 1% fees or more on an investment only expected to earn ~4%. Further, it is an investment you can buy from the government for free. That's certainly absurd.
And right now, those real yields are terrible. They recently touched record lows.
Record lows? He's kidding me, right? TIPS have only existed during this era of tame inflation (introduced in 1997). Too bad he can't go back in time (or apparently even imagine it) and see how TIPS would have done in the 1970s. If inflation truly picks up as he describes in the following example, I'd not be predicting higher real yields. Contrary to popular opinion it seems, we're not going to all be making out like bandits if inflation continues to rise. No sir, the only bandits will be the government as they dilute the value of our savings. Is this really rocket science?
An illustration: Imagine inflation rises to 5%. Your 10-year TIPS, with its 1.56% "real" yield, will therefore pay 6.56%.
Don't blame the TIPS. Blame the inflation! Further, if TIPS really do start paying 6.56% on a regular basis AND he expects to be making more money elsewhere (presumably through even higher real interest rates as he implies) we'll be watching the housing bust turn into a housing apocalypse.
As a general rule of thumb, TIPS are usually worth looking at only when the real yield on the 10-year rises well above 2%.
He means as a general rule of thumb since 1997, since TIPS didn't even exist before then. Here's a thought. As a general rule of thumb, real interest rates were decidedly negative during nearly the ENTIRE 1970s. Good luck holding out for this mythical 2% real interest rates in this environment. Get out the disco balls!
As a long-term investment for serious individuals, TIPS right now look absurd.
Absurd? Really? I'm certainly dead serious. I'm not going to pump my money into the stock market instead if he's right about where inflation is headed. We'll see how well the stock market will do if TIPS start paying 6.56% or more on a regular basis as he suggests. We'll see how well the consumer can hold up as inflation continues to rise. We'll also see how well the real estate market will do as mortgage rates rise to compensate for that inflation. Woohoo! It will be quite the party. Leverage baby! Buckle up and hold on!
This is not investment advice. I could be wrong of course. I just find it all very amusing that he can say TIPS are absurd. It is the INFLATION that is absurd. Maybe he's got some sort of magical device that protects himself from it though. I'd really like to know. If we truly are entering a serious bear market (with the rising inflation he uses in his anti-TIPS example), the goal is to lose less than the next person. That's the best we can hope to do. What we don't want to do is flop naked around on the beach once the tide goes out though, or back up the truck into the soft sand. That's my thinking anyway.
The article is silly. If you really want to scare me out of TIPS, tell me the economy is going to be incredibly strong soon and we'll be seeing huge increases in the number of productivity miracles. Now THAT could scare me out of TIPS. Using higher inflation as the reason to avoid inflation protection is silly though. Very silly. Damn our economy must be in bad shape to use such silly scare tactics. Just my opinion of course.
Real Estate Newsletter Articles this Week: Existing-Home Sales Increased to
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At the Calculated Risk Real Estate Newsletter this week:
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11 hours ago
17 comments:
Oh shinnola! The WSJ is trying to steer retail investors away from TIPS? Now I'm scared.
AllanF,
Oh shinnola! The WSJ is trying to steer retail investors away from TIPS? Now I'm scared.
Not that I consider the Wall Street Journal my enemy but...
You can discover what your enemy fears most by observing the means he uses to frighten you. - Eric Hoffer
Think about it. He's using inflation to scare me away from inflation protected treasuries. The scare tactic is not going to work, lol.
Keep in mind that if I own TIPS directly and for the long run (which I do for the most part) I should actually hope he is right about real yields rising from here. As my TIPS mature (mine are somewhat laddered and therefore mature rather frequently in the grand scheme of things), I'll be able to reinvest them at higher yields. I just don't think I'll be anywhere near that lucky. That being said, maybe I will be that lucky as long as investors are told to avoid them, lol.
Further, Warren Buffett approved of TIPS in 2004 ("TIPS are not a bad investment for people worried about inflation heating up, which we're seeing signs of") when the real yield was only 0.6% higher on the 10-Year TIPS. I doubt very much a mere 0.6% yield differential would make him think TIPS were currently "wildly overvalued." I'd be the first to say they aren't a screaming bargain, but what is these days for those who wishing to minimize risk?
How much risk are we really talking anyway? Let's say real yields did rise by 0.6%. What would that mean? With an average duration of about six years, my TIP fund would therefore drop about 3.6%. Yeah, that's some "wildly overvalued" risk I'm taking on. Further, after six years I'd be getting that 3.6% back anyway thanks to the 0.6% higher real yield. Big frickin' deal! Not going to lose sleep over that I assure you. I'm much more likely to lose sleep should real yields continue to drop though. That would mean it will be much harder to make inflation adjusted money off of money in the future (which is something I'm betting on big time by owning TIPS).
But hey, maybe the "absurd" Warren Buffett isn't a "serious individual" though. Maybe I'm not either. Who knows!
Um, may be should have labelled my post sarcasm. :-)
My point was, if WSJ is lampooning TIPS it's probably because Big Money wants TIPS. And Big Money wants TIPS because inflation is increasing while growth is stagnating.
In any case, I completely agree using the dire prospect of 5% inflation as reason not to buy TIPS is the stupidest thing I've ever heard. The guy sounds like one of those 28 y.o. certified financial planners Human Resources brings in to explain how my 401k will make me a millionaire in 30 years for just $5 a day.
AllanF,
I was attempting to agree with you. Had you seen my hand gestures and heard my tone you'd have seen just how much pent up "you've got to be kidding me" was left in me apparently. It was not intended to be a sermon. I KNOW I'm just preaching to the choir around here anyway, lol.
I've either brainwashed the regular readers here, or they've brainwashed me! I've yet to have even one comment left for me from the Larry Kudlows of the world saying I'm full of @#$%. I'd certainly welcome the debate. The last serious debate I had was several years ago on Yahoo's Capital One Financial message board. In hindsight, I should have shorted the heck out of the stock at the time.
I guess that's another reason I don't post as often. What's the point attempting to warn people of what I think is coming, when the only people reading what I think I see already seem to see it too?
Me: The sky is falling! Take shelter!
Readers: We know! We can see it too!
Me: So why am I warning?
Readers: Beats us! We're off stocking our pantries!
Hahaha! *cough* *sputter*
Stag,
People just can't let go of the last 25 years. It's no wonder though. Two plus decades is a whole lot of conditioning for herd (investor) behavior and expectations. Amazingly, the starting points of 1982 vs. today are not even part of the discussion. That is amazingly amazing to me.
Ironically, people are not even saying "its different this time." More like "its the same this time." What other view should people have? They've staked their futures on outsized real investment returns. More of the entitlement mentality I suppose.
I just don't see how historically high valuations can result in historically high real returns. For me, that's the crux of the issue. The rest is just noise.
We really need a productivity miracle.
RE: Attempting to agree
I re-read, my bad. Yeah, it was a lot of words to respond to a guy who was trying to make a sarcastic funny in agreement. Um, kind of like agreeing with a street preacher. You can't do it. They'll agrue with no matter what you say. Of course they're nuts. :-)
RE: Preaching to the choir
Well, for what it's worth, I once was somewhat skeptical and challenged your simple TIP & hoarde strategy as fine ONLY for a 7 figure millionaire looking ONLY to maintain a modest standard of living for his indefinite future. Remember? :-)
But it's true I reckon I've since been converted. I remember what converted me too. It was those charts of real returns of 3 month treasuries through the 70's. That's when I realized your strategy was a relatively cheap insurance policy.
By the same token I don't think it's right for all people in all circumstances. Keeping the analogy, insurance is only useful if you have something to insure. And even then, I think it is an incomplete strategy for most folks since most folks are not Zen enough about their wealth to be content with exactly what they have for their indefinite future.
Beyond that, I will say the problem with hoarding is while the percentages are fabulous, the absolute amounts are trivial. If you hoard perfectly what's it worth? An extra $2000 in spending power per year for the next 3 years? An extra $4000? And what's that Public Storage unit run a month? That's gotta cut into your returns! ;-)
I'm 35 and have been married for 12 years, I can think hard enough and actually count the sets of bed linens we've gone through in those 12 years: 8. Actually that's not quite right. We've bought 8. But have only gone through (as in no longer have) 4.
I will say early on we bought expensive (well expensive at full retail, we bought 'em clearanced close-out from Lands End catelog) high-quality stuff and they lasted a long time. Last winter my wife bought 1 set of cheap Fred Meijier then this winter one set of cheap Target flannel sheets and they both relatively suck. They aren't going to last like the Lands End flannels we bought 12 years ago which lasted 7 or 8. These I can tell will only last 3, maybe 4 years. But I digress. :-)
*For me* I'm willing to take more risk on speculative plays (shorting builders and banks) and watch 'em more closely because I'm not to the point where I could maintain my desired standard of living on the wealth I already have. I'm also buying high yielding stocks and closed-end bond funds that have been beat-up since last summer. With yields at 6-9%, I think they are paying worth the risk I'm taking if I have to move to a different investment should inflation really get roaring. I don't mention it, or use them to counter-argue with you because I don't think you are interested in the increased risk.
Plus I think our time frames may also be different. It's kind of like I've taken a 5 year ARM while my brother went 30 year fixed. He's hoping to see his decision pay-off having a relatively cheap rate 5-10 years from now. Me, I bought a smaller house; I'm paying down the principle, and wanted the cheap rate now. My loan will be paid off completely 5-10 years from now.
Similarly, I'm speculating/investing now to buy a boat to go live-aboard 3-4 years from now. This may be 1973 and 10 years of crap are in store, but hopefully I'll be out cruising with the wife and kids for the really miserable part. In some senses, I guess I'm in your shoes back when you loaded up on gold. That's paid off for you and your looking to coast now. I loaded up on homebuilder and bank shorts and those have paid off handsomely, but not enough for me to coast. I worry all the time whether I should just cash out and be done, but I've not see anything to indicate banks and homebuilders are going to suddenly be solvent. (Maybe the Feds will rescue the banks, and I'm watching for that to happen. But homebuilders are still toast.)
Well anyway, I'm rambling. But it's Sunday so it's all good. I enjoy your blog and the humor it has. I appreciate your doing the hard work tracking economic data so I don't have to. ;-) 1-3 posts a week are plenty for that purpose, so I'm happy as a clam. Don't change. I'd be crushed. :-)
Best.
-Allan
MAB,
We really need a productivity miracle.
I purchased an anti-productivity miracle this past weekend. The Playstation 3 and the game Rock Band isn't improving my productivity one bit! Of that I can assure you. ;)
AlanF,
Similarly, I'm speculating/investing now to buy a boat to go live-aboard 3-4 years from now.
I had my name on a waiting list at a local marina to do exactly the same thing at one point in my life. It cost me $25 to do it. I had no boat (still don't, unless you count a relatively cheap raft). I think that dream is over though. That was before the economy imploded during the dotcom bust (and I would argue its aftermath, but that remains to be seen of course).
If we stay on the path we're on, perhaps my next dream will be living in a van down by the river. D'oh!
Stag,
I'm seeing more and more red flags in the press about rising inflation. Was never an issue until asset prices started falling.
http://www.iht.com/articles/2008/02/24/business/rtrmarkets25.php
BTW, I've embarrassed myself many times since Chistmas on rock band. Dani California is a personal favorite.
MAB,
Dani California is a really fun one to play. My favorite is probably "I Think I'm Paranoid" by Garbage. It probably just means I need therapy though, lol.
I keep hearing on the TV that inflation is a lagging indicator. I feel like shouting, "Yeah, all that inflation we sent China in the form of freshly printed trade deficit dollars takes a LONG time to come back to us! So what's actually going to stop it?"
Stag,
Is it possible to be paranoid of being paranoid?
That rock band game likely cost me a potential fortune. I was planning on writing a self help book titled "Air Guitar for Dummies." Doesn't make much sense now though.
CPI & PPI were just awful. I might have to take a second job. Maybe as a roadie or a grip. Off-hours work that can't be outsourced. Woohoo!
MAB,
Is it possible to be paranoid of being paranoid?
Time for a video!
Stag,
Did you ever see the movie Wayne's World?
The band name "Garbage" reminded me of the scene where Wayne & Garth are going into a club and Wayne asks the bouncer what bands are playing.
who's playing tonight? Jolly Green Giant, Crew deTante and the Shitty Beatles. The Shitty Beatles - are they any good? Nah, they suck. So, its not just a clever name. (paraphrased from memory)
I'm laughing out loud here - at the band name, not their music.
MAB,
The band's greatest hits album is titled Absolute Garbage, lol.
Garbage also performed the title track to The World Is Not Enough. It is one of the best Bond themes in my opinion.
http://www.youtube.com/watch?v=tYbLR67_F9E
Stag,
Something to keep in mind is that all these bands with greatest hits albums need "farewell" tours in order to have "reunion" tours. One follows the other, just like booms and busts.
I saw the Police last summer. I was never a huge fan, but it was a good show. I missed Van Halen. Again. Bummer.
Sometimes I feel mankind is stuck in a rut with the wheel. Same with baby boomer music. Perhaps not so strangely, numerous contestants on American Idol this season are perfroming 1970s songs. Heart, Air Supply, Foreigner, the BeeGees and a few others so far.
I don't know whats going on. I just can't stop this feeing, deep inside of me. You might say, I'm hooked on a feeling - ooogachaka (the Blue Suede version). If I hear any songs from Bread or ABBA, stagflation is a lock and I'm buying gold.
Well, let's just hope that people don't suddenly become interested in TV shows from the 1970s. That could get very ugly!
Hi Mark... A few websites are pointing out that TIPS are in negative real yield territory now (as of March 7th, 2008). I don't understand how it's even possible. Care to comment?
Anonymous,
I believe they can be in negative territory because there are only so many TIPS offered. Although you can't get lower than a 0% rate during an actual auction, there is no limit to how much you can bid for them (and therefore no limit on how low the yields can go) in the secondary market.
That's just a guess though.
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