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October 19, 2012
Four ways to squeeze inflation risk from your portfolio
(Reuters) - While inflation has been tame in recent years, there are few forecasters who believe it will remain so in the future.
I have to tell you. I love opinions stated as facts. Always have, always will.
The bond market expects inflation to average 2.52% per year over the next 30 years (today's 30-year nominal 2.94% minus today's 30-year TIPS 0.42%). Perhaps the bond market is somewhat biased by the Federal Reserve Board setting a long-term inflation target of 2%. I am not suggesting that hindsight will be kind to the bond market's predictions, but I am suggesting that more than a few investors believe that the bond market is right. For what it is worth, I am relatively indifferent.
Treasury Inflation-Protected Securities (TIPS), are the natural choice, but they are linked to the flawed Consumer Price Index (CPI).
Ah, yes. We're back to the flawed CPI argument again. It is certainly very popular these days. Everyone loves to complain about the CPI. Many seem to even think that it doesn't include food and energy. Kudos to the author for bringing this subject up. Let's just keep picking at the wound. I love it!
A blended portfolio that employs a number of inflation beaters is the best approach.
We're now past inflation hedges and well into inflation beaters? Excellent! Clearly if we can come up with a complete set of inflation beaters then we can protect ourselves against inflation. Why didn't I think of that? Genius! In 1966, Alan Greenspan stated that there can be no safe store of value in a welfare state. This author is single-handedly proving him wrong! He's not just got one thing that can safely store value, he's got a number of them!
Further, if we use his set of "sure thing" inflation beaters then perhaps we should borrow money and leverage up our "sure thing" bets! Right? We'll not only squeeze all that inflation risk from our portfolios but we'll make out like filthy rich bandits too! Why hasn't anyone tried this before? Genius!
TIPS gain in value when inflation is rising, but are an imperfect gauge of prices.
This is a fact. If we hyperinflate then TIPS will be worth an amazing amount. We just need to ignore the enormous taxes on the inflationary gains that will financially ruin us. I had a point here. I forgot what it was. Pay no heed. TIPS gain in value when inflation is rising! That's what it says and who am I to argue differently? Further, there has been an ungodly amount of inflation since 2000. 2.4% per year! That's why long-term TIPS and I-Bonds bought in 2000 are worth so much now! Inflation is raging out of control! It has nothing to do with deflating long-term stocks and deflating long-term housing prices (as primary mainstream investments). Rest assured of that.
While TIPS are an imprecise, though less-volatile, tracker of the cost of living, they move in the opposite direction of stocks.
Absolutely. Just look at how TIPS performed when stocks crashed during that deflationary crash in 2008. Oops. Also note how TIPS and stocks have both performed since that crash. Oops again. Bad examples. As I have stated previously within this post, I always love opinions stated as facts. I'm therefore going to have to love this too. He's got an opinion and by God I'm going to make it work! I'm no hypocrite!
Let's try it again using hard science.
Click to enlarge.
Yes! Never mind that extremely weak correlation of just 0.06! As stocks rise, TIPS yields fall! Oh, wait. TIPS bonds go up in value as the real yields fall. I suppose I should factor that in. I guess I just can't see the correlation he sees. If anything, the correlation goes in the other direction. Oh, well. Can't say I didn't try to throw his opinion a bone here though.
The author is a Reuters columnist and the opinions expressed are his own.
Now that is something I can truly believe. He won't be a columnist for long though. He's got the stock and bond markets completely figured out. Watch out Warren Buffett! He's coming for you and he's bringing his readers with him.
In all seriousness, it's pet peeve city again. I apologize for the outburst, lol. Sigh.
Disclaimer: I've got a head cold and am under the influence of NyQuil. Perhaps it is sympathy pain for reading mainstream media's take on our economy. It is certainly possible.
Source Data:
St. Louis Fed: S&P 500 vs. 5-Year TIPS
8 comments:
Good stuff. I read that rental REITs keep pace with inflation because rents track inflation. I'm not sure if it is true or just something that makes theoretical sense
. I love opinions stated as facts.
Is that both a fact and an opinion?
If you want an entire magazine full of pet peeves, just pick up Money, or the even smarter Smart Money!
I prefer Smarter Money, Smartest Money, or Genius Money, but no one has started those magazines yet. I sense an opportunity. Hmmm.
Perhaps the bond market is somewhat biased by the Federal Reserve Board setting a long-term inflation target of 2%.
Perhaps the bond market is somewhat biased by the FRB being virtually the sole buyer of longer-dated Treasuries.
jeff,
I read that rental REITs keep pace with inflation because rents track inflation.
I strongly suspect it works only when most other inflation hedges work.
I do not think it would work during hyperinflation. Too much money would be funneled into food. There wouldn't be much left to pay rent.
I think it is also rather simplistic, since clearly there would be a rental problem if way too many housing units were built.
Mr Slippery,
I subscribed to Smart Money in the distant past but I'd like to think I'm a bit less naive now.
I'd like to think that. I could be wrong of course, lol. Sigh.
TJandTheBear,
It is my belief that interest rates would be even lower if the Fed had done nothing (we'd be directly in a Great Depression).
I would therefore argue that although the Fed is distorting rates, it is not 100% clear which way they are being distorted.
Hey, it is just an opinion.
Mark,
Initially, yes, but IMHO the economy would've already hit bottom and be growing again so I would expect rates to be climbing by now (albeit slowly).
My point goes to that the Fed is clearly and deliberately underpricing risk these days.
TJandTheBear,
We'll certainly know more when (not if) the next recession hits. I agree that the Fed is distorting risk these days. Sigh.
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