TIPS News

TIPS Gain in Market’s Worst Year; Validation of Pimco (Update3)

Here is the FOR case.

“The deflation scare has pretty much been taken out of the market,” said Kenneth Volpert, who oversees $180 billion as head of taxable fixed-income at Vanguard Group Inc. in Valley Forge, Pennsylvania. “The inflation scare has not been priced in yet, and we think that’s still to come.”

TIPS are the only long-term U.S. government debt to post gains in what is the worst year for U.S. securities since at least 1978. TIPS have returned 2.98 percent since December, including reinvested interest, while Merrill Lynch & Co.’s U.S. Treasury Master index slumped 5.7 percent.

Here is the AGAINST case.

“I’m in the camp that says this is overdone,” said Wan- Chong Kung, who helps oversee $89 billion in Minneapolis at FAF Advisors, the asset-management arm of U.S. Bancorp. “What we see is a really healthy rise in inflation premium with not much realized inflation behind it. At some point you have to have realized inflation be part of the story to continue to see breakevens perform from here.”

As usual, I am right in the middle. That's much like I am in the inflation vs. deflation debate overall. That being said, I have almost my entire nest egg in TIPS. I'm a believer in the long-term bull market in "safer" havens, and there's really nothing much safer than US Government backed debt that's also inflation protected. Note that I didn't say it was safe. I'm just saying it is safer.

Let's look back nine years. That's when the bull market in safer havens began.

Considering how much pain has been inflicted in both the stock market (twice!) and the housing market (once!), there really hasn't been a whole lot of deflation so far. We're looking at $70 oil even during one of the biggest downturns this country has ever faced. I am sympathetic to the deflationist arguments though. Don't get me wrong. I could easily see the price of oil drop by half. It would still be more expensive than it was in 2000 though.



As seen in the chart, the CPI ended at roughly the same point it started during the 2001 recession. It flat-lined. Note that while volatile, the CPI is also at roughly the same point it started during this current recession. That's not exactly the sort of deflation that the deflationists would point to as an overwhelming confirmation of their theories, at least so far.

Here's why I think TIPS is much better than buried cash, even if the deflationists seem right. It's certainly possible.

1. No matter how bad deflation gets, if we buy TIPS we still get the face value at maturity. If we buy $1000 worth of 10-Year TIPS during the next auction and hold the full 10 years then we are guaranteed to get at least $1000 in 10 years. That is absolutely no different than burying cash in our backyards for 10 years.

2. Unlike buried cash, TIPS pay interest. Therefore, if we are a believer in the long-term bull market in "safer" havens and we are absolutely convinced massive deflation will be upon us, then TIPS is still a better long-term play than buried cash.

3. What if we are wrong about deflation? What if we enter a stagflationary nightmare instead? That buried cash would be dug up so fast it would make our heads spin. What might we buy with it? I don't know. Maybe something with inflation protection that's reasonably safe. Perhaps TIPS. Of course, if we are digging up our cash to buy inflation protection at that time, chances are we won't be first. That means it will cost us more.

4. Some might argue that cash is safer than TIPS because the government might not pay us the interest it owes us and will quite possibly default on the principal too. I'm not in that camp. We would be owed little pieces of faith based paper (dollars). That's it. Ben Bernanke has a monetary printing press that can print them at "essentially no cost". We'd need brave politicians to explain to us why the government can't print us what it owes us at essentially no cost. There is no promise that the pieces of paper will be worth anything of course. The less they are worth, the easier it will be to print them. And lastly, just exactly where will we find these mythical brave politicians? I sure haven't seen many.

So yeah, I like TIPS. Deflation? Inflation? Stagflation? Whatever! If I am wrong to like them, then the "riskier" havens are going to be absolutely devastated. There's very little I can do to protect myself in that world though, so why even bother trying?

This isn't investment advice of course. It's just the rantings of what would best be described as a permabear I guess. We find ourselves in a hole (debts and deficits) we can't quite get out of. Our solution? Dig deeper.