30 Year TIPS Thought Experiment
So the real question becomes...
Is it better to lock in today's rate of 1.07% or is it better to hope that making money off of money will become easier in the future?
Is it better to lock in today's rate of 1.07% or is it better to hope that making money off of money will become easier in the future?
In hindsight (at least so far), it was much better to assume that it would be more difficult to make money off of money in the future and therefore lock in the 1.07% rate.
The data has changed. It's time for a new thought experiment.
I once again present 5 options that are roughly equivalent.
Option 1
Buy the 30-Year TIPS. Lock in 0.50%. Done deal.
1.0050^30 = 1.161
Note that this is a 16% smaller overall real return than the last time I did this thought experiment. Ouch.
Option 2
Buy the 20-Year TIPS. Earn 0.09% for 20 years and earn 1.32% for the following 10 years.
(1.0009^20)*(1.0132^10) = 1.161
Option 3
Buy the 10-Year TIPS. Earn -0.54% for 10 years and earn 1.02% for the following 20 years.
(0.9946^10)*(1.0102^20) = 1.160
Option 4
Buy the 7-Year TIPS. Earn -0.91% for 7 years and earn 0.93% for the following 23 years.
(0.9909^7)*(1.0093^23) = 1.161
Option 5
Buy the 5-Year TIPS. Earn -1.18% for 5 years and earn 0.84% for the following 25 years.
(0.9882^5)*(1.0084^25) = 1.162
The new real question has become...
Is it better to lock in today's rate of 0.50% or is it better to hope that making money off of money will become easier in the future?
I once again think it is a tough call. On the one hand, 0.50% is extremely low. It's enough to make one gasp in disbelief. On the other hand, I strongly believe that real long-term GDP growth will be extremely low. I can certainly understand why some might gasp in disbelief over that too.
In any event, the bond market clearly believes that we're no longer in 1980s and 1990s biscuits and gravy mode. In sharp contrast to Jeremy Siegel, I'd be the last person to argue differently.
This economy has a nearly infinite supply of long-term "gasp in disbelief" potential. I've been a permabear for 8 years. That's a long time. It hasn't exactly hurt me either. I'm at least as bearish long-term now as I was in 2004. Why? That's an easy one. Name one thing that's changed for the better.
Put another way, I turned bearish in 2004 based on what I thought excessive debt would do to our economy. There is now roughly $18 trillion more. So yeah, I'm still a permabear.
This is not investment advice.
Source Data:
U.S. Treasury: Daily Yield Curve
At 1%, I was on board with long term TIPS. At 0.5%, it was the final gasp in disbelief for me and I got out.
ReplyDeleteIt may very well outperform everything else over 30 years, but I think the risk to reward no longer makes sense. I am slightly more inclined to believe that the US will run out of credit in less than 30 years at the current pace.
That might lead to a spike in interest rates and a reset of the system. Of course, after G-20 summits, international accords, and all kinds of gnashing of teeth, maybe a world war.
Mr Slippery,
ReplyDeleteI certainly can't blame you. Hindsight may be kind to your prediction (and very unkind to most investors).
That said, it was never my belief that TIPS would outperform "everything else". Not even close.
My concern is and was that TIPS could outperform the "average" alternative (t-bills, nominal bonds, stocks).
It is my belief that the justifiable fear of running out of credit will hurt all long-term yields in the future.
And lastly, wars very much tend to send real yields lower (if WW2, Vietnam, and Iraq are any indicators). Real yields can easily slide into seriously negative territory and stay there. Sigh.
I think there will be a system reset someday. I just don't think it will be in my lifetime. That's how I could be wrong. In other words, as bearish as I am, hindsight may show that I was not bearish enough. In that event, at least I'll have plenty of hoarded toilet paper. Sigh.
"Name one thing that's changed for the better."
ReplyDeletenatural gas glut, which will aid the cracking of Alberta's bitumen, too, so $100 oil might be available for a good long while.
solar power has also become cost-performant lo these 8 years, assuming you live outside the PNW's sun gap.
But these are minor boons compared to the freight train of troubles we keep loading.
http://research.stlouisfed.org/fred2/graph/?g=84e
I call this graph, hmm
ReplyDeleteTroy,
ReplyDelete"Name one thing that's changed for the better."
I should have qualified that. There are many minor things that are better. I cannot argue otherwise.
For example, for those who absolutely had to have Facebook stock at any price, their wish was ultimately granted. ;)
I'm of the opinion that real growth and real yields have become disconnected.
ReplyDeleteIt's not a free market. Interest rates can float or be manipulated, this is what CONfuses so many people.
At present, interest rates are being repressed by the Fed (with the help of CONgress) to accomodate trillions in fraudulent and counter-productive credit.
I see the financial repression continuing well into the future - all for the greater glory of Wall Street! What a system.
mab,
ReplyDeleteI'm of the opinion that real growth and real yields have become disconnected.
In my opinion, it depends on what we consider real growth to be.
At present, interest rates are being repressed by the Fed (with the help of CONgress) to accomodate trillions in fraudulent and counter-productive credit.
Is that real growth? Would interest rates be high if the Fed had done nothing? Or would we be in a Great Depression? Will we in one anyway at some point?
I see the financial repression continuing well into the future - all for the greater glory of Wall Street! What a system.
That does seem to be one of our top growth industries. Sigh.