Thursday, November 8, 2012

20-Year TIPS Yield Hits New Record Low


Click to enlarge.

I suffered through a lousy economy for 20 years and all I got was a stinkin' -0.17% real yield.

Make the t-shirts now using cheap foreign labor. Hoard them for 20 years. Sell them then as collectors' items once their value goes up. Just an idea! Could happen, lol. Sigh.

As a side note, you will lose 3.3% of your purchasing power over the 20 years if you buy this bond today. That's in addition to any income tax the bond generates over the period.

(1-0.0017)^20 = 0.967

In order for this investment to make any sense at today's prices, the economy has to do pretty darned poorly over the next 20 years. As a permabear since 2004, I'm not exactly ruling it out.

Here's a shout out to the pension fund managers still expecting 8% returns well into the distant future.

[Expletive Deleted] YOU!

Just so I'm perfectly clear here, "THANK" is not the word. ;)

Source Data:
FRB: Selected Interest Rates
U.S. Treasury: Daily Real Yield Curve

16 comments:

Troy said...

CalPERS has $230B.
CalSTRS has $150B.

The "missed" @ 6% this last year, or ~$23B in missing interest income.

While I am not gay per se, I'm thinking the great state of WA is looking better this week!

I have promised myself to light a big fatty if & when I put together my first million, so you guys now have that!

AllanF said...

Good one. I assume you're referring to public pension plans, the ones backstopped by tax payers when their ridiculously optimistic returns aren't met?

But then, is there any other kind anymore?

Can I add myself to the angry mob? (It sure ain't a chorus.)

Stagflationary Mark said...

Can I add myself to the angry mob? (It sure ain't a chorus.)

The cost to register as a legal member of the angry mob has risen from $100 to $150.

Please contact the U.S. Department of Angry Mob Management for more details. ;)

Craig M. Brandenburg said...

8%? Could happen. How many of these retirement plans say anything about purchasing power.

Stagflationary Mark said...

I suspect most aren't expecting 8% inflation! Let's hope not anyway.

More state pension plans cutting assumed return rates

The board discussed the return rate often in recent meetings, reviewed all its assumptions and considered what peer plans were doing, but “in the end, the conclusion was that sticking at 7.75%, based on 3% inflation was clearly within the appropriate actuarial bounds,” said Nancy Kopp, state treasurer and board chairwoman.

It's only natural. Lemmings consider what peer lemmings are doing. What's the worst that could happen, lol. Sigh.

Craig M. Brandenburg said...

Hey Mark, this raises the inflation vs deflation question, which I'd like to know your thoughts on. Yes, yes, I know you have that "Inflation Mood" graphic near the top-left on your blog, but it lacks quantities so I don't understand what it's trying to say. What I'm thinking of—as are so many other people—is the likelihood that an unusually large amount of the debt currently out there in the world won't be payed back—not in real terms. What are thoughts on the likely resolutions of our debt situation?

Stagflationary Mark said...

Craig M. Brandenburg,

My inflation mood is currently comparable to the Fed's 2% annual inflation target both short-term and long-term. The long-term is iffy at best and that's why I prefer inflation protected bonds over those without it though.

What I'm thinking of—as are so many other people—is the likelihood that an unusually large amount of the debt currently out there in the world won't be payed back—not in real terms.

It's happening as we speak. No treasury bond with a maturity less than 10 years is likely to keep up with inflation from here.

The 5-year TIPS pays a real yield of -1.4% today. Over the course of 5 years that's a 6.2% real loss (not counting taxes).

0.986^5 = 0.932

The 30-year TIPS now has a 0.28% real yield. I'd say "experts" such as Jeremy Siegel managed to scare investors away from the reasonable 2%+ real yields they offered back in 2011. (Reasonable is an opinion, but hindsight is being very kind to that opinion.)

After taxes on the inflationary gains, it is very unlikely that a 0.28% real yield 30-year TIPS bond will keep up with inflation.

Those awaiting higher real yields must be extremely disappointed right about now. It could easily get worse. In my opinion, there's a great deal of money chasing way too few good investment ideas.

Craig M. Brandenburg said...

Mark, thanks for your response. One question I keep going back to when I try to get a handle on what's going on is: Is losing a percentage point or two in real terms each year going to be enough to cover current over-indebtedness? The US Federal Government's debt (ca. 16$ trillion) gets a lot of mind share when people talk about debt, but what about other forms of debt? State. Local. Corporate. Individual. Foreign. Retirement plans. And any other promise of prosperity someone has made to people in the future.

I'd like to see some estimates of how much we're over-indebted right now. Twice too much? Ten times too much? A hundred times? I realize that any answer to the question is inexact and depends upon unknowable things, such as how much the Economy will grow or shrink in the future. But I'd like to see some ballbark figures.

A real return of -1.4%/yr causes a principal to lose half its value in 50 years. So, for example, if you're two-times too much over-indebted and need to halve the principal over 50 years by inflating it away, then a -1.4% annual real rate of return would be the "right" yield. To shrink by more or in less time, a smaller—i.e., more negative—rate is needed. Otherwise, a bigger rate is needed.

What I'm getting at is: assuming we're not just a little over-indebted but instead need to get rid of a serious amount of debt, and further assuming that we don't have 50 or 100 years or whatever to wait for it to happen, then it seems like mild inflation won't do the trick. What then?

Stagflationary Mark said...

Craig M. Brandenburg,

The US Federal Government's debt (ca. 16$ trillion) gets a lot of mind share when people talk about debt, but what about other forms of debt?

The following chart shows the total credit market debt owed per civilian employed. I've also adjusted it for inflation.

Real Total Credit Market Debt Owed per Civilian Employed (September 2012 Dollars)

Over the past few years, at least we're going the right direction.

On the one hand, it will probably grow again when we enter the next recession. Contrary to the apparent opinions of many mainstream economists, I don't think the Fed has brought the recession risk down to 0%.

On the other hand, these low real yields will eventually start to whittle the real debt burden, at least in theory.

What I'm getting at is: assuming we're not just a little over-indebted but instead need to get rid of a serious amount of debt, and further assuming that we don't have 50 or 100 years or whatever to wait for it to happen, then it seems like mild inflation won't do the trick. What then?

I think the speed at which we reduce our overall real debt burden is not all that important. We could probably stay at these debt levels permanently. What we don't want to see is for it to grow from here.

Just opinions.

Craig M. Brandenburg said...

Mark, thanks again for your thoughts. And thanks for putting some numbers to my question by including that chart.

I think the speed at which we reduce our overall real debt burden is not all that important. We could probably stay at these debt levels permanently.

This is exactly the claim I'm wondering about. I agree that on a planet where the Economy stays strong and the people remain patient that over-indebtedness could be whittled away with mild inflation over several decades. But I'd like to know your opinions regarding the planet we actually live on.

The other thing I wonder about is: how much does the Total Credit Market Debt Owed stat reflect reality? To what degree does it include pension promises? If governments and financial companies have collectively promised millions of Americans plush old-age living—or at least something better than destitution—then that's money that must be coughed up in the future. It's debt. Because if it isn't coughed up then there will be consequences. One that springs to mind is the havoc of major policy changes that alter the rules of the market on the fly as policy makers reflect the volatile will of an increasingly frustrated populace. I'm not trying to make commentary here; I just see this as a major risk for destabilizing just about everything.

So that brings me back to my original question, which is to ask: To where does such destabilization likely lead to? Hyperinflation? Deflation? Some other scenario?

Stagflationary Mark said...

Craig M. Brandenburg,

If governments and financial companies have collectively promised millions of Americans plush old-age living—or at least something better than destitution—then that's money that must be coughed up in the future.

I don't believe that all of it will be coughed up. I refer you to my Social Security statement.

Your estimated payments are based on current law. Congress has made changes in the past and can do so at any time. The law governing benefit amounts may change because, by 2037, the payroll taxes collected will be enough to pay only about 76 percent of scheduled benefits.

Pension holders could fare even worse, since they are "promised" even less. A bankrupt company's promises really aren't worth all that much. It's one reason I tend to shy away from annuities. I can't trust the underlying insurance companies to remain solvent. Sigh.

So that brings me back to my original question, which is to ask: To where does such destabilization likely lead to? Hyperinflation? Deflation? Some other scenario?

If I had to guess, I'd say we kind of mimic what Detroit has done. Things just gradually get worse. It doesn't go out with a bang. It goes out with a never ending whimper.

I tend to set my expectations low though. It's possible that things don't get gradually worse. We could just stagnate. Or perhaps I'm wrong to be bearish at all.

Who can know?

All I really think I know for sure is that we won't grow like we once did. I just don't think it is mathematically possible.

Craig M. Brandenburg said...

Mark, thanks again for your reply.

I too think we're headed for a long, very long contraction with no single crisis or collapse event but rather a long grind of longer, harder recessions punctuated by shorter, softer recoveries—a.k.a. the Detroit model you mention. One step forward, two steps back, repeated ad nauseum.

However, I suspect some of the bumps on the way down will be especially unpalatable. It seems to me the breaking of retirement dreams will be one such bump. Millions of middle-class Americans, among them I, treat middle-class consumption as a right as good as any in the Bill of Rights, to be enjoyed to the grave, and I don't see this perception going away without people first trying to force all sorts of major political changes upon the System in an ironic last effort to maintain the status quo. Such changes put the "mild inflation all the way down" scenario in jeopardy.

My non-expert, non-quantitative analysis is we currently have a credit bubble that "naturally" warrants deflation, but the bubble is being propped up by a political status quo that has enough clout to sucker people into buying Treasuries, despite the increasing risks at decreasing yields. (What else are you going to buy?) Nearly everyone in power prefers long-term mild inflation to both hyperinflation and deflation, being as how the latter will cause new people to come into power with all haste. But the ability of people currently in power to maintain mild inflation will probably be disrupted during one of those bumps on the way down, at which time the system may quickly seek a temporary equilibrium involving hyperinflation or deflation.

On the other hand, some of those bumps may be other countries' hard times and further irrelevance in the global economy and global share of resources. For example, if a good chunk of Europe fell to third-world status, then countries such as the US might experience a temporary boost as markets reallocate resources formerly consumed by Greece and Spain and—er, I mean, those hypothetical European countries. Kinda like a game of musical chairs: Everyone (but one) loses eventually, but you try to stay in the game for as long as possible.

Enough with the metaphors and analogies. I'm about ready to give up trying the figure out what economic scenarios we're likely to get. It seems increasingly foolish for someone like me to try to predict what's coming, though I'm curious to hear what other people such as yourself have to say. Thanks for your thoughts.

Stagflationary Mark said...

Craig M. Brandenburg,

Such changes put the "mild inflation all the way down" scenario in jeopardy.

This is exactly why I prefer TIPS over nominal bonds. I think the mild scenario is most likely but that could still mean the odds are...

35% mild inflation
32% no inflation (think Japan)
28% heavy inflation
5% hyperinflation

That's why I prefer TIPS and I-Bonds, although even they have a 5% chance of not protecting me with those odds. Hyperinflation would crush me.

My non-expert, non-quantitative analysis is we currently have a credit bubble that "naturally" warrants deflation, but the bubble is being propped up by a political status quo that has enough clout to sucker people into buying Treasuries, despite the increasing risks at decreasing yields.

It's all relative. When faced with an environment in which the average investor MUST lose, the goal becomes simply to lose less. That's exactly how I feel when I buy 0.0% I-Bonds. I know I will lose once taxes are considered. That said, I could easily lose more elsewhere.

Everyone (but one) loses eventually, but you try to stay in the game for as long as possible.

Your example reminds me of Linens N' Things vs. Bed, Bath, & Beyond. When Linens N' Things went under, BBBY got a nice boost. I don't think it is a permanent boost though.

It seems increasingly foolish for someone like me to try to predict what's coming, though I'm curious to hear what other people such as yourself have to say.

I can totally relate to this. Let me assure you that it seems increasingly foolish for ANYONE to predict what's coming.

If you want to improve, be content to be thought foolish and stupid. - Epictetus

Better to remain silent and be thought a fool than to speak out and remove all doubt. - Abraham Lincoln

I try to keep these things in mind when offering opinions on my blog. I can't say that I'm always successful though, lol.

Stagflationary Mark said...

I don't mean to imply that those are the actual odds by the way. I just threw them out there as an example.

Craig M. Brandenburg said...

It sounds like you're making a smart bet. If you think there's a good chance of mild or heavy inflation for a long time to come and a small-to-nil chance of a true economic recovery, then you may as well discount hyperinflation, deflation, social upheaval, and any other financial apocalypse—never mind the odds—and hope for the best.

Stagflationary Mark said...

I lived near an air force base in college (1980s). My plan in the event of all out nuclear war was to sit on a lawn chair and try to enjoy the light show. I had little desire to join hundreds of thousands of my neighbors attempt to flee to "safety".

We now have an apocalypse pantry. It isn't that I'm planning for the apocalypse though. It just seemed a better use of my money than 3-month treasury bills.