The Sarcasm Report v.112

Forbes must hate math. It's the only thing that makes sense.

If I buy a 30 year TIPS and hold it until maturity and you tell me what the CPI and taxes will do over the period then I can use math to determine exactly what I will get as a return (right down to the last penny). How can I do this? TIPS are directly to the CPI (100% correlation) and I kind of like math.

So imagine my surprise when I read the following.

July 13, 2011
Forbes: Worried About Inflation? TIPS Aren’t The Answer

The problem is, Cutwater’s research shows that TIPS have zero correlation to inflation.

Fascinating. Forbes is claiming that inflation linked treasuries have no correlation to inflation. I'm having the same reaction one would have if Forbes declared that gravity has zero correlation to falling objects.

I'm not done yet though. There's much more to be sarcastic about.

Corso figures a 10-year TIPS could lose 10% or more of its value if real rates double to their historical norm of about 3%. Until recently, real rates tended to track overall growth in Gross Domestic Product.

First of all, if I buy a 10-year TIPS and hold it until maturity then I will not lose so much as a penny if real rates double. I will have simply lost the opportunity to do better. That's all. No big deal. Not only that, but I even root for that outcome. It would mean that when the TIPS in my bond ladder mature then I could reinvest them at a higher rate. What's not to like?

Secondly, what if I don't expect real GDP to grow like it has historically? Knowing that real rates tend to track the real growth of GDP, the real growth of GDP tends to track employment growth, and I can prove that employment growth will not rise like it has historically, then what might I expect real rates to do in the future?

You'd think I'd be done heckling but you'd be wrong. The sarcasm was just getting warmed up for the grand finale.

One remaining rule: Under no circumstances go beyond 10 years.

Yes. By all means sit in short-term investments to meet your long-term needs. Do not take advantage of the steep yield curve to lock in higher long-term rates. Don't worry about the long-term future. Things are bound to get miraculously better once we get through this soft patch (of quicksand).

I've been betting on falling real yields for a decade under the assumption that it would become increasingly difficult to make money off of money. It was just over a decade ago that I first embraced TIPS and I-Bonds. For what it is worth, I continue to do so. Growth has been lousy over the last decade. Real rates are therefore justifiably low. I don't expect the next decade to be much (if any) better. In fact, it could easily be worse.

We're told over and over again to avoid long-term TIPS. I have avoided that advice each year and have been rewarded for doing so. That was especially true this year. Thanks Jeremy Siegel! Not one of the TIPS in my bond ladder is currently underwater, not that it matters. I only track the inflation adjusted principal. I do not track what the market claims they are worth. I know what they are worth to me.

Perhaps I am wrong. Perhaps this economy is about to generate enormous "real" prosperity for the typical middle class American worker. I put the odds of that happening slightly higher than a snowball's chance in hell though. Barring that I tend to place my long-term bets on the combination of inflationary World War II, the inflationary 1970s, and deflationary Japan though. That's why I like long-term TIPS. It's the same reason I hoard toilet paper (and why I once hoarded gold and silver). It is my way of locking in a current standard of living for what I see coming.

And lastly, if you are willing to lock in a current standard of living then even 0.0% real rates on I-Bonds don't look so bad. At the very least, it's a better rate than most short-term investments.