Friday, November 16, 2007

The Death of Real Yields v.3

TIPS perform well when real yields drop (since you are locking in a real yield when you purchase them). Stagflation and falling real yields are all part of the same story to me (the real yields in the 1970s were negative as inflation took its bite). In order for Ben Bernanke to help the economy, he needs to force us to spend. He does this by lowering interest rates to the point we can't make money on savings. That's where I think we're heading again. I could be wrong of course.

Treasury real yields aren't the only ones which can suffer during stagflation.

Q3 Financials Sector Earnings Plunge 33.1%; S&P 500 Earnings Decline 8.48%
"The third quarter was one the market would soon like to forget. Consumer Discretionary earnings fell 38.9%, Financials earnings plunged 33.1%, and overall earnings for the S&P 500 declined 8.48%," says Howard Silverblatt, Senior Index Analyst at Standard & Poor's. Silverblatt notes that if homebuilders (CTX, DHI, KBH, LEN and PHM) and General Motors (GM) were excluded from Consumer Discretionary (which represents 8.8% of the S&P 500), the sector would show a 4.2% gain for the quarter.

If ifs and buts were candy and nuts, we'd all have a Merry Christmas. You know an article is somewhat bullishly biased when it doesn't offer similar things to exclude from the bearish perspective. In other words, you don't see me suggesting that we strip out Health Care's 14.8% year over year gain to make things look even worse, now do you?

Well, one reason might be that the 14.8% year over year gain in Health Care earnings actually scares the living daylights out of me (especially if I extrapolate out a few decades)! So perhaps I am (bearishly) biased too.

Here's a long-term TIP fund chart (keep in mind it pays interest).

Real yields are fairly low now and TIPS have had a fairly good run this year. If I am wrong to like TIPS, I could be wrong in a spectacular way. As I have said previously though, I'd prefer to be wrong. That would mean real yields are rising. It would also mean that my nest egg would have a better chance of keeping up with inflation in the long-term. There would be pain in the short-term though (since TIPS perform poorly when real yields rise).

This is most certainly not investment advice.

See Also:
The Death of Real Yields v.2
Features and Risks of Treasury Inflation Protection Securities

Source Data:
FRB: Selected Interest Rates
Treasury Direct: I Savings Bonds Rates & Terms


Anonymous said...

It truly is sad about the death of the real yield.

Once Japan and its little sister China found the US in the 80's, they learned to invest abroad, and have continued to do so. Thus increasing the supply of investable money.

As a result of risk aversion by japan and china, the spreads between treasury and investment bonds dropped.

As a result of small spreads, investment banks created risky debt -> issued more loans -> resulting in an extraordinary increase in money supply.

As a result of increase in money supply, real yields continued to drop...

Unfortunately, this cycle only ends if we have an incredible productivity boost (not likely), or a sharp contraction in money supply (ie. japan the last 10 years)

Stagflationary Mark said...

You've summed up why I felt confident enough to call it the death of real yields.

I may not be able to decide between inflation and deflation but I do think real yields are coming down (even from these very low levels) for the reasons you have stated.

It could be higher inflation with higher interest rates (1970s), lower inflation with lower interest rates (Japan), or simply the same inflation with lower interest rates (we just muddle through it). I'm not confident enough to make the call on that. I fear the former though, simply because I believe low real yields lead to inflationary pressure (as people choose to hoard goods instead of currency).

Further, since inflation hurts me far more as a saver than deflation (because higher inflation creates even lower real yields once taxes are considered), I have an extra reason to attempt to defend myself more against the inflation than the deflation.

Neither a short-term borrower nor a long-term lender be. - Warren Buffett, 1979

Adjustable rate mortgages turn homeowners into short-term borrowers (locked in long-term).

Using the same logic in reverse, the adjustable rate nature of TIPS turns me into a short-term lender (locked in long-term).

That's probably one reason Warren Buffett said TIPS weren't a bad investment if you are worried about inflation.

Anonymous said...

Here's my question, can anyone look-up what real yields were during the 1920's and 1930's? I seem to recall they were quite high and anyone with money was doing quite well thank you very much.

If one believes our betters at the Fed are going to prevent that at any cost, it might be good to know what real yields were then. There is so much cliche about the Great Depression, it seems possible to me that the Fed is looking at aspects of it pajama economists and high school historians miss. If they believe real yields perpetuated it, then look out real yields.

Finally, Mark, you are always talking about TIPS & I-bonds, have you considered foreign fixed income investments? Just curious.

Anonymous said...

I had another comment I wanted to make but couldn't remember it... I just did.

Among the cliches of the Great Depression is that protectionism of the Smoot-Halley Act was a major contributor. As one that believes history does rhyme, I wonder if competitive currency devaluation might be the 21st century equivalent. Any one else considered this, or have an opinion? Many thanks.

Stagflationary Mark said...


Real yields during the Great Depression were EXTREMELY high, but rather low heading into it (there was little inflation because the currency was backed by gold limiting the monetary printing presses). Deflation hit with a vengeance. You would have made a killing being in cash.

It could very well be the case that it wasn't paper dollars that had the real yield, but was in fact the gold behind it (similar to now perhaps).

We were an export power then. Now we are the opposite. We are an import power. We have abused the long standing stability of our currency to spend beyond our means. We send foreigners paper dollars and in return they send us actual goods. At some point they start questioning the value of our paper promises. That's not deflationary. That's currency crisis thinking.

During the Great Depression there was a run on the banks. Money became more valuable (people wanted their money because they feared banks would fail).

During Argentina's currency crisis there was also a run on the banks. Money became less valuable (people wanted their money so they could spend it on something tangible before the prices went up).

We seem to have both. People are worried about the banks right now AND they are worried about the currency. We're walking the tightrope between a great deflationary event and a great inflationary event.

I just have a hard time believing that our paper dollars are going to suddenly become even more desirable should we go through seriously hard times.

If all it took was a bad economy to get deflation (as in the Great Depression), then Zimbabwe's ~80% unemployment and hyperinflation is well into conundrum mode.

Hey, just my 2 cents.

Stagflationary Mark said...


Among the cliches of the Great Depression is that protectionism of the Smoot-Halley Act was a major contributor. As one that believes history does rhyme, I wonder if competitive currency devaluation might be the 21st century equivalent. Any one else considered this, or have an opinion? Many thanks.

This goes back to the idea that we were an exporter then and are an importer now.

Protectionism hurts both the exporter and the importer, but in opposite ways.

Let's just look at an example.

If we were to suddenly stop importing Chinese toasters what would happen to toaster prices for us? Since there would be a shortage of toasters, the price would go up for us. If we did this for all products, we'd have an inflationary mess.

Meanwhile, the Chinese would be awash in toasters. In theory, the price of toasters in China would drop substantially. They'd be stuck with a deflationary mess.

Stagflationary Mark said...

As one that believes history does rhyme, I wonder if competitive currency devaluation might be the 21st century equivalent. Any one else considered this, or have an opinion?

Seeing as how I'm full of opinions, I'll offer some more. ;)

Competitive currency devaluation is what turns deflation into stagflation. The growth stops, you are due for a deflationary mess (post-dotcom bubble comes to mind), but instead you try to print your way out of the problem using the power of the monetary printing press.

If China's growth was 100% real, why would they be trying so hard to competitively devalue their currency with us? Why are real yields so low in their country?

There's too much money, that's what I think. It floods into real estate (pushing prices up), the stock market (pushing prices up), treasury markets (pushing yields down), oil (pushing prices up), and commmodities (pushing prices up). Normally one rises at the expense of another, but these days almost everything rises in unison. That's a sign something is terribly amiss in my opinion.

Anonymous said...

Thanks Mark. You confirmed what I thought was the case. Like Ben and so many others have said, the Great Depression is not an operative scenario under a fiat currency.

I totally agree something is amiss in China. They have negative real yields at the bank and price controls on diesel and was it, rammen. Those are not indicators of a properly functioning economy.

The more I think about it the more I think bonds of a country that just doesn't give a damn are the way to go. Switzerland, perhaps. Japan and the Euro I don't think would work because they do give a damn. Canada I'm not sure.

Stagflationary Mark said...


I'm having a real hard time with even my short-term deflationist stance. As long as there are no shocks to the system, I think the government can inflate. If there was a moral to the story I think it might be the following.

A government always has the ability to make its fiat currency worth less, but hopefully not to the point of worthlessness (although history has not been kind to such hopes).