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0.00% is the absolute floor. There's just 0.16% left to go.
The maximum possible upside reward is now just 0.80% (0.16% x 5 years).
In my opinion, that's one of the wimpiest maximum possible upside rewards (adjusted for inflation) in the history of investing, especially considering that the maximum possible downside loss is much, much higher.
It will be interesting to see what happens if indeed the rate does hit 0.00% again. I find it hard to believe it will just permanently hover there. It didn't last time. Take a look back in time to 2007-2008.
I would also point out that a 0.00% floor is a momentum trade killer. You can see it in the chart above. It's just like hitting a brick wall. I can't think of a single other investment where momentum trading can be killed off that easily. Can you? That's no coincidence that it bounced at 0.00% in my opinion.
That said, I'm certainly taking some risk being out of TIP. It's up nearly 1% since I took profits last week. Investors continue to flood in. On the other hand, my gut says I should probably be selling the TIP in my IRA too at this point. I'm certainly thinking about it.
It isn't just deflation that can hurt TIP. It could be that there's more supply of US Debt than demand at some point. It could be a hint that the government may default on its Debt at some point. It could be that the stock market euphoria continues to the point that everyone wants stocks again. There are lots of reasons real yields could rise again, and any one of them would be bad for TIP.
Just opinions. Please don't think of this as investment advice. It isn't.
26 comments:
U.S. will be out of Afghanistan by 2017: White House
http://tinyurl.com/yh7fnef
Tips won't save you.
Looks like it will be full speed ahead untill the dollar and the bonds are totaly worthless.
Kevin
Kevin,
You are such a pessimist. I see the glass as half full.
"VERY, VERY, VERY EXPENSIVE"
Oops. I quoted the wrong part. Let me try again.
"It is very, very, very expensive," Gibbs said.
Nope. That's not it either.
Two veteran Democratic lawmakers have already called for imposing a "war tax" to pay for the troop increase.
What was my point again? I forgot.
I am no chart expert, but I would venture that 0% is an absolute fibonacci ultra 5th wave over the inverse shoulder boulder holder bottom for TIPS. Thats just how I see it though.
GYSC,
LOL!
Hey Mark,
"Two veteran Democratic lawmakers have already called for imposing a "war tax" to pay for the troop increase."
Mark,
That's why there isn't any sense in working from what I can tell, and and the way I look at it is you may ass well just get on the government tit rather then work.
They raise taxes and the whole eCONomy collapses, they try to inflate their way out the eCONomy collapses. Either way everyone is going to get screwed.
It will be the choice of freezing to death or burning to death.
Kevin
Kevin,
I prefer heat, everything just hurts more in the cold!
Happy thanksgiving old friend.
That's why there isn't any sense in working from what I can tell,
Kevin,
It makes me sad, but that's the way I see it too. I just can't stand the thought of working to bailout and/or preserve the value of trillions in fraud.
I refuse.
Mab,
Makes me sad too but I have never seen a government more hell bent on destroying it own economy and impoverishing it's citizens then ours.
Health-care, Cap and trade, an insolvent banking system, endless wars, unfunded liablilities, aging baby boomer's. corruption at every level of government, there is no happy ending here for most of us.
Kevin
"The Short Victorious War"
http://en.wikipedia.org/wiki/The_Short_Victorious_War
The People's Republic of Haven finds itself teetering at the edge of economic disaster. Unable to maintain its massive welfare state in the face of inflation and deficit and with opposition to the government getting bolder, the leaders of the People's Republic decide to resort to war against Manticore. A short, victorious war, they believe, will both distract the proles from their current economic problems and allow them to use the riches of the Manticore system to prop up their wellfare state.
It's a work of fiction. It was published in 1994. It has nothing to do with our current situation. I don't even know why I bring it up.
Why sell TIP yet?
Why not simply track the price and maintain a sell-stop strategy, protecting yourself from the downside risk?
After all, it's only an ETF.
G.H.
Why not simply track the price and maintain a sell-stop strategy, protecting yourself from the downside risk? - G.H.
That's a good point. However, stops are not without risk in an unstable and jittery market. I've personally had trades blow right through stops when a panic hits. The first time it happened to me was several decades ago. I thought my brokerage should have been responsible for not hitting my stop. Not so. I was S.O.L.
When the upside becomes so limited, I'd rather be early than greedy. Trying to be the first fool to the exits is not as easy as it looks.
Stops can be crowded trades too!
Stag,
Deflation continues in Japan:
http://www.bloomberg.com/apps/news?pid=20601087&sid=abCQqGhGht4M
I still can't get over how the MSM frames falling consumer prices as a negative occurrence. You'd think that after the disastrous effects of pushing unaffordable housing that people would start to question the notion that falling prices are bad. It's mind boggling.
Wall st. is a giant skimming operation. Pushing trillions in non-economic debt and skimming off the top is the biggest financial sham the world has ever seen. Just one problem though - eventually, the debts come due!
G.H.,
It is a good question. I just don't like paying for insurance when I don't have to though. I have never used a stop and I doubt very much I ever will.
1. I either like an investment or I don't.
2. Stops aren't an investment to me. I consider them to be a gambling strategy. Derivatives are a zero sum game. I'd pay to play and yet for every winner ther must be a loser. Over time, the only one who truly benefits is the broker (casino).
I'm reminded of a comic/cartoon. It went something like this. It showed a financial advisor describing a high risk investment that used derivatives to protect against all the downside risk. The client asked, "So it now should just track safer Treasuries and I'll be paying excessive fees too?" The answer, "Yeah, pretty much."
I should have written "...it's only a bond ETF."
I can't imagine a scenario where it will move down with such velocity that you'll be unable to protect yourself.
Also, maybe I should have clarified something else, that is, that I don't use the broker supplied sell-stop tools either. I only work with near close of day prices and execute my own trades based on % drops from current buy highs.
This is not gambling. It pulled me out of equities between Nov. 07 and Jan. 08 and I don't need to tell you how well that worked out.
I also own VIPSX and CREF IPS's in IRAs and I'm frankly not scared of dramatic moves catching me out.
Should I be?
G.H.
G.H.,
We just have a difference in investment styles it seems.
The higher the price, the less I like it. The lower the price, the more I like it. It's just a value play to me.
That pretty much makes me an anti-momentum investor. In other words, I'm never trying to ride the market's wave. An investment is either good at a given price or it isn't.
The 5-Year TIP was not a good investment to me when I sold. The market currently disagrees with me. Time will tell.
I can say that in a 30% tax bracket and assuming just 2% inflation over the next 5 years, today's 5 Year TIPS are guaranteed to lose purchasing power. That's not even factoring in fund expenses.
That's not gambling either. It's a sure thing (loss). The loss will be even higher if inflation fears become a reality.
So why are investors doing it? Here are two theories.
1. TIP shows a 7% YTD return in Yahoo.
2. TIP has been going up in price and investors are betting on further capital appreciation.
The first is rear view mirror investing. The second would be a lack of understanding that TIP's price is constrained by the 0% floor on TIPS yields.
Just theories though. I don't really know why investors are flooding into TIPS now that the value is mostly gone. I know why I bought TIP when I did though. I also know why I sold when I did.
A few more thoughts...
My investment style pulled me out of equities in 2004 when the DJIA was about 10,150. It prevented me from getting back in at 11,000, 12,000, 13,000, and even 14,000. Hindsight is hardly beating me up.
In theory, I should have been buying the DJIA at 7,000 recently it seems. I just have no idea what the stock market is worth any longer (not that anyone truly knows or has known), and the thought of buying blind doesn't appeal to me.
At least with TIPS, I can at least attempt to determine their worth to me. The risks are pretty much known (and not all are trivial). If I buy directly from the government and hold until maturity I can avoid one significant risk. While hindsight may show that I was a fool to do so, at least I won't be a greater fool. That should be reserved for buying investments on the hopes that they can be sold to others for a profit (dotcom, real estate, ...) without actually caring if the investment is a decent value.
I think 5 Year TIPS yielding 0.16% have little value but 20 Year TIPS yielding 1.75% still have some, especially if I'm right to be a long-term bear.
Just opinions of course.
G.H.,
You said you own VIPSX, which is a fund very similar to TIP. I was curious what the differences are. I stumbled upon one today.
This is from VIPSX's prospectus.
"Futures, options, and other derivatives. The fund may invest up to 20% of its total assets in bond futures contracts, options, credit swaps, interest rate swaps, and other types of derivatives. These contracts may be used to keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in bonds, to reduce transaction costs, for hedging purposes, or to add value when these instruments are favorably priced. Losses (or gains) involving futures can be substantial—in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for the fund. Similar risks exist for other types of derivatives. For this reason, the fund will not use derivatives for speculative purposes or as leveraged investments that magnify the gains or losses of an investment."
There is no mention of futures, options, or derivatives within TIP's prospectus.
Just pointing it in case you weren't aware. I certainly wasn't until I looked.
At the risk of taking up excessive space on this blog I'd like to offer further discussion and maybe learn something at the same time.
"The 5-Year TIP was not a good investment to me when I sold. The market currently disagrees with me. Time will tell."
Why not listen to Mr. Market and follow his direction rather than guess his moves in advance. He will always be honest with you, he knows no other way.
"I can say that in a 30% tax bracket and assuming just 2% inflation over the next 5 years, today's 5 Year TIPS are guaranteed to lose purchasing power. That's not even factoring in fund expenses.
That's not gambling either. It's a sure thing (loss). The loss will be even higher if inflation fears become a reality."
All that you say here may be true but Mr. Market could care less about all the rational intelligence in the world. He's going to go wherever he wants.
"So why are investors doing it? Here are two theories.
1. TIP shows a 7% YTD return in Yahoo.
2. TIP has been going up in price and investors are betting on further capital appreciation.
The first is rear view mirror investing. The second would be a lack of understanding that TIP's price is constrained by the 0% floor on TIPS yields."
This makes perfect sense to me, and should to everyone. Do I fall into either category? I'd say yes, to both.
1. If I invested in VEIEX (emerging markets) on July 13 I missed an enormous run-up from the early March bottom. And if I got stopped out on Oct. 30 I left a near 10% drop on the table. Rear view mirror? What do I care, I netted 23.5%.
2. I don't understand the first thing about emerging markets. And I don't know diddly-squat about GNMA's but I exchanged my father's IRA from equities to VFIIX in Oct. 2000 and he's enjoyed an average annual return after expenses of 8% (I sold this position in Jan. last year and reentered May of this year.) While the S&P has returned nothing.
Lack of understanding? You betcha. Should I care? I don't think so.
"I just have no idea what the stock market is worth any longer (not that anyone truly knows or has known), and the thought of buying blind doesn't appeal to me."
Why should you or I care what it's worth? Mr. Market will send clear signals telling us what to do. In my view, it's not a matter of buying blind, it's a matter of protecting oneself from bear markets. Self directed sell-stops do this, always.
All of the above is only my opinion of course. Now on to, hopefully, some learning. What follows is not opinion, it's generally lack of understanding looking for some answers.
"...today's 5 Year TIPS are guaranteed to lose purchasing power. That's not even factoring in fund expenses."
I'm somewhat miffed by the notion of 5 year TIPS behavior and their connection to the ETF TIP. Doesn't the ETF contain varying maturities that will diversify out some of the losses from 5 year that you refer to?
I'm assuming some things here because I don't know but from what you're saying I think you are trying to tell me that as the chart reaches the zero mark the TIP will be paying zero dividend yield, right?
And in addition, I think you're saying that if the chart starts to move back up that the principle value drops, right?
And lastly, should the yield go to zero and hover in that range, the TIP investor ("investor" used lightly :-) could expect little to no price movement and paltry dividends, right?
And it's these indicators that have caused you to take the action you have?
G.H., the pupil
Mark, I was not aware of the diffs between the two, my reason for using VIPSX is performance. Since becoming interested in TIPs approx. two years ago the Vanguard fund has slightly outperformed TIP.
And a quick look at comparison charts would indicate to me that an investor has little to fear in those futures within VIPSX. They track each other very tight, even during the '08 meltdown.
G.H.
G.H.,
We have such a different approach to investing. If you can make money doing what you do then more power to you. Honest. Most people cannot make money trading like you do though and you'd therefore be the exception. Put another way, if everyone could trade as smart as you are then nobody would ever lose money. Yet we know that investors lose money. They lose a lot of money.
Pretty much every investment I have ever made has been based on the idea that it was good for me, not what Mr. Market says it is worth or what someone else might someday pay to buy it from me. This allowed me to retire at age 35 and avoid much if not all of the pain of the dotcom and real estate bubbles. Must have done something right, even if it was only luck.
Why are you miffed by the notion that the 5 Year TIPS yield matters? I'm simply offering my thoughts. You don't have to agree with me. :)
The TIP fund has an effective duration of just 4.33 years and a weighted average maturity of 8.91 years. The 5-Year TIPS isn't all that bad of a proxy for that, although the 10-Year isn't either.
Here's my point in a nutshell. As TIPS of ANY duration hit the 0% floor, they can no longer go up in price through any other mechanism than inflation. This is unlike every other investment that most investors understand. Real estate has no upper bound. Stocks have no upper bound. TIPS do.
Here is why this is true.
When you participate in a TIPS auction directly from the government you are guaranteed to get at least a 0% rate on your TIPS purchase. No matter how the bidding goes, you can get that. So why would anyone want to buy a 5-Year TIPS in the secondary market that pays much less than 0%? Simple answer, they won't.
Once a TIPS bond hits 0% in yield, further price appreciation from falling yields is impossible. All further gains must be through inflation alone.
Now imagine a hypothetical TIPS fund holding only 5-Year TIPS with a yield of 0%. It pays out all inflationary distributions each month. It's price cannot go higher no matter what inflation does. Further, the 5-Year TIPS bought directly from the government are MUCH safer than the secondary market's 5-Year TIPS. You are always guaranteed to get your original principal back at maturity. A 5-Year TIPS that has appreciated due to inflation can deflate back down though. Given the risks of deflation there would be NO rational reason to invest in this hypothetical TIPS fund at this point. Right?
Inflation does not drive the price of TIP. Investors do. TIP pays out ALL interest and inflationary gains each year to its investors. That's one thing that made it such a decent bargain in recent years. People would look at the chart and see something rather boring. Meanwhile, those of us who were investing were getting decent payouts. Anyone who thinks TIP will be trading at $120 in the coming years will be sorely disappointed. $110 maybe. $120 is virtually impossible though. That's true even if inflation hits 20%. Once again, the reason is that it would require negative real rates on TIPS (which can't happen through auctions). Can the payouts be big? Of course they can. Will they keep up with inflation and taxes? Not likely if the average TIPS bond in the fund pays just 0% over inflation at some point. Most rational people will start to question their investments once the pain becomes apparent.
Your VIPSX fund hasn't been tracking TIP all that well lately. It has done much better. The two are diverging. Any explanations for that? Will they continue to diverge or will they revert to the mean? I could not find information on whether or not VIPSX is trading at a premium to assets. I could also not even find the individual bonds in VIPSX. As an investor, I'd want to see that. The bond fund is only as good as its contents.
http://finance.yahoo.com/q/bc?s=VIPSX&t=2y&l=on&z=m&q=l&c=tip
And lastly, we're all pupils here! :)
G.H.,
"At the risk of taking up excessive space on this blog I'd like to offer further discussion and maybe learn something at the same time."
You are at ZERO risk of this. I VERY much welcome your thoughts and would encourage you to write a large novel here if you so desire.
I'm always looking for any excuse to become amazingly chatty, lol. That's especially true in the comment section.
You'll never see me wave the "off topic" flag either, as long as it is related to anything even remotely interesting to me or others. The only comments I have ever deleted or thought of deleting were for-profit SPAM and offensive material.
G.H.,
I also want to point out what could happen to TIP if inflation really did hit 20%. I went down this path a bit but didn't finish it off.
Let's say the 5-Year TIPS pays 0% over inflation. What happens when inflation hits 20% to the person in a 30% tax bracket?
At the end of one year, your $100 investment pays you $20. You pay tax of $6. That leaves you $114. In order to keep up with 20% inflation you needed to have $120. You only have $114. 5% of your money vanished.
You might accept that for one year. You might accept that for two years. Eventually you and the investors around you will start demanding a higher real yield to compensate you AND/OR you and the investors around you will give up and hoard bed pans and anything else you can think of. Either way, real yields on TIPS would rise.
I once believed that the negative real yields in the 1970s could force real yields on TIPS down to zero and keep them there. Even 0% on TIPS in the 1970s would have been better than the alternatives. I've since changed my mind.
I suspect that investors in the 1970s did not knowingly accept negative returns on their investments. I don't think they imagined themselves losing money. It surprised them.
That's not the same thing as today.
If you lock in a 0% return (after inflation) on TIPS right now and hold until maturity on the belief that inflation will rise, then you are knowingly accepting a negative inflation adjusted return after taxes.
One of the most dangerous things to say in all of investing is to say that it is different this time.
That said, I do think it is different this time. At what point in investing history, have investors ever knowingly invested in something long-term (5 years or more) that was virtually guaranteed to lose them money?
The only thing I can come up with that's even close is the 0% real yield that the 5-Year TIPS had just last year, and we know how that worked out. The yields shot up. Investors are dipping back in for another pass in my opinion.
Any investor buying the 5-Year TIPS paying 0.16% without first buying the I-Bonds paying 0.3% really needs a wake-up call. The I-Bonds offer full deflation protection AND a better rate.
So much to ponder, so little time. I'll have to absorb all of this over time but for now just a few things:
"...Yet we know that investors lose money. They lose a lot of money."
I cut my investing teeth during the dot-com collapse, and I lost money. That led me to find a better way and truth is I'll still lose a little but more importantly Wall Street will never steal any of my money again.
A man has got to know his limitations. I'm not trying to outwit the market but I do utilize one particular talent that has served me well, namely being able to distinguish between who is full of s__t and who isn't. Roubini and Schiff were staples in my diet as I was preparing to exit markets in 2007. And Rick Santelli is an oasis in an otherwise barren desert of useless information, a.k.a. CNBC
"Why are you miffed by the notion that the 5 Year TIPS yield matters? I'm simply offering my thoughts. You don't have to agree with me."
I'm not so good of a writer sometimes. I wasn't disagreeing, I was genuinely asking because I truly didn't understand. We're on the same team so to speak. I appreciate all the information.
"Inflation does not drive the price of TIP. Investors do."
Yeah, this is precisely why I believe it fits the methods I employ to follow the trends until they say otherwise. However, after reviewing your discussion of why TIP cannot approach or exceed $120 I now have a piece of information that I'm sure alot of TIP investors (speculators) do not.
"I could also not even find the individual bonds in VIPSX. As an investor, I'd want to see that."
I do not have the semi-annual report handy but I'll take a look at it when I get a chance and compare to TIP. Vanguard used to have this information under the "Portfolio and Management" tab on their fund page but I see they've dumbed it down a little.
That's all for this evening, as Blofeld said in "Diamonds are Forever", "It's late, I'm tired, and there's so much left to do."
G.H.
G.H.,
We are definitely on the same team. No doubt about it.
"And Rick Santelli is an oasis in an otherwise barren desert of useless information, a.k.a. CNBC..."
I am glued to the TV every time he speaks. He's not always right (nobody is), but when he's wrong at least you know he wasn't wrong out of ignorance. That man sure is smart.
As for TIP going to $120, it is still theoretically possible I suppose. As an individual investor I know I can get 0% TIPS in an auction. People can bid them to whatever they like in the secondary markets. They tend not to though, as seen in the chart I provided in this post.
The "momentum trade" died utterly at 0%. There was nowhere left to go. Keep in mind that oil was about $107 a barrel that day and rising. Oil didn't peak until $145 or so a few months later. It therefore seems very unlikely to me that the lack of inflation fear killed 5 Year TIPS last time. It was the 0% brick wall. Just an opinion of course.
Stag, G.H.,
Here are the holdings for the Vanguard TIP fund as of 9/30/09:
https://personal.vanguard.com/us/FundsAllHoldings?FundId=0119&FundIntExt=INT&tableName=Bond&tableIndex=0&sort=HOLDINGS_NAME&sortOrder=web.funds.profile.view.FundsAllHoldingsSort$SortOrder@4be8fc
Looking at the listed coupons and comparing them to today's yields, it doesn't look like there is a lot room left for price appreciation. I sold this very fund recently in part for that reason as well. My other reason for selling was a fear of a deflationary panic and the likely abrubt drop in the fund's price that would ensue. Hey, it happened last year and gave me a great buying opportunity.
Even if I am wrong on the deflation panic part (I likely am) the recent five year after tax annualized returns were 2.92% before state taxes. Going forward, one can expect a much lower real yield and I believe a much lower inflationary yield. If I am right on inflation, this is a loser going forward in a non-tax sheltered account.
Given the low upside potential and the increased downside potential, I just couldn't justify holding this as an investment. And mind you, I was holding it in a tax deferred account.
Rightly or wrongly, I'd rather hold near cash equivalents than low return, potentially high volatility instruments. The combination of low return and potentially high volatility is an accident waiting to happen imo. Stocks at high prices/low dividend yields and high yield bonds at high prices/low yields com to mind.
mab,
They sure don't make it easy to find out what the real value of those bonds are. The coupon rates look great, but then when you look at the "Market Value" vs. "Face Amount" it is clear that you really need to discount a lot of those coupon rates to something closer to zero. The iShares TIP sight offers a lot more information by comparison.
I also find it interesting that the first TIPS bond mentioned in that link looks to be my oldest TIPS bond. I bought it in 2001 and it also matures on 1/15/2011 and has a 3.5% coupon rate. I can safely say this. Nobody is going to buy that bond of mine from me and expect to earn 3.5% (over inflation) to maturity. I clearly wouldn't sell it that cheap. They should expect to earn roughly 0% over inflation, since that's what the treasury market now thinks short-term TIPS should pay.
"Rightly or wrongly, I'd rather hold near cash equivalents than low return, potentially high volatility instruments."
From Richard Russell's "Rich Man, Poor Man (The Power of Compounding)" article.
"RULE 4: VALUES: The only time the average investor should stray outside the basic compounding system is when a given market offers outstanding value. I judge an investment to be a great value when it offers (a) safety; (b) an attractive return; and (c) a good chance of appreciating in price. At all other times, the compounding route is safer and probably a lot more profitable, at least in the long run."
(a) The 5-Year TIPS is only "safe" if real yields permanently hover at 0%. That doesn't sound safe to me. 5 years is a long time to be betting on lack of change.
(b) The 5-Year TIPS does not offer an attractive return. 0% over inflation virtually guarantees you lose money once taxes are factored in.
(c) The 5-Year TIPS is very unlikely to appreciate in price through any other mechanism than inflation. Momentum investors will have a much harder time pushing up its price once it hits the 0% floor. There are a variety of ways it can depreciate in price though. In a bearish world, deflation could do it, too much debt supply vs. demand could do it, and questions over the USA's ability to ultimately pay its debts could do it. In a bullish world, productivity miracles and growth could do it (either real or imagined, think dotcom bubble).
In my opinion, it fails all three of his tests for great value. Any one failure should be a reason for concern, but failing all three? I'll pass.
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