If you read investment commentary (it’s hard to avoid, isn’t it?) you surely have seen the rash of stories in 2012 predicting a long-term bear market for traditional Treasuries and their mutant offshoot, Treasury Inflation-Protected Securities. Examples:
- April 27, Kiplinger: Treasury Bonds: A Lousy Deal
- April 18, CNN: Here comes the bear market for bonds
- April 8, Business Insider: Is The US Treasury Market About To Mint A Fresh Generation Of Idiots?
- March 20, Seeking Alpha: Are Bond ETFs Finally In A Bear Market?
I’m not criticizing this train of thought, in fact, I pretty much agree with it. Since the middle of 2011, with massive Federal Reserve intervention in the Treasury market and a boiling economic crisis in Europe, interest rates on traditional Treasuries and TIPS have fallen to all-time lows. Those rates can’t be sustained.
I have been saying that for several months. And I have been wrong.
Here’s the way TIPS have performed in 2012, represented by the widely held TIP ETF:
The TIP ETF closed Friday at 119.54, just pennies off the all-time high of 119.77. Yields to maturity for TIPS are now negative (before the inflation adjustment) all the way up to 2025 Jan 15, nearly 13 years into the future. And this is happening at a time when:
- Inflation is slowing, dropping to 2.7% for the 12 months ending in March.
- The Federal Reserve is winding down ‘Operation Twist’ to force down long-term rates and is not committing to a new round of easing.
- The stock market has soared, slumped and then recovered, leaving the S&P 500 with a year-to-date return of 11.86%.
- The European crisis has stabilized – at least temporarily.
TIPS, so far, have a bit of a ‘safe-haven’ status in the Treasury world. The inflation protection gives them appeal to investors even when their base rates fall into the negative. Look at how the TIP ETF has performed this year versus TLT, the long-term Treasury ETF:
So far, TIPS are the Energizer Bunny of bond investments, they keep going and going. It’s reasonable to expect this long-term, massive move upward will eventually break. But it isn’t happening yet.
What to expect from here? In a New York Times analysis, Jack Duff speculated that the strong run in TIPS could prove to be a loser for future investors:
“TIPS have gone through a period where just about everything has gone right for them,” said Robert Johnson, director of economic analysis at Morningstar. “Now the situation has changed, and they are looking quite expensive.”
But that analysis was written in July 2011, the dawn of a huge surge in TIPS. At the time of the article, the TIP ETF closed at 109.30 and today stands at 119.54, a 9.3% gain since the New York Times article appeared.
Here are some more-recent thoughts from Jeffrey Kosnett’s Kiplinger article I cited above:
Bond markets do not turn around instantly and aren’t vulnerable to a flash crash, as the stock market has shown it is. Pessimists often spin the widespread ownership of Treasuries by people and institutions around the world as a reflection of our dependency on foreign money. But I see the global affection for Treasuries differently: I think it shows that every nation on earth has confidence in the U.S. as a place to keep reserves. But those investors, no matter where they are located, will gradually demand to be paid better by Uncle Sam.
So if you’re a Treasury investor and feel on the spot, you don’t have to rush to decide what to do next.
John, excellent points. I agree with a lot of what you say. On the future TIPS rate: A severe economic downturn could be a ‘disaster’ for TIPS because deflation will make traditional Treasuries much more attractive (TIPS lose additional principal in times of deflation). That would mean buyers would want a higher base rate to compensate. TIPS would suffer.
A big surge in the economy would – almost for certain – raise short-term interest rates and bring a lot of safe alternatives into the market: Money markets, bank CDs, traditional Treasuries. Stocks would also be more attractive. TIPS would lose some of their appeal. The TIPS rate will rise along with any rise in Treasury rates, which are currently at amazingly low levels.
TIPS have been doing very well in an environment of slow economic growth and low- to middle-low inflation, along with artificially low Treasury rates across the board. The fact is there are almost no sensible super-safe options, except for limited purchases of I Bonds.
Experts used to say that the 10-year TIPS base rate would rise and fall with the overall rate of economic growth. If that is true, then the current negative rate is signalling a very bad omen.
Since CPI probably understates inflation, because it is beneficial to the government to have it that way why would anyone pay for a negative real yiled know that you are already getting hosed?
If you are worried about inflation, would it be better to buy gold company stocks?–they are trading at extremely low levels compared to the price of gold (see Gold:XAU ratio). While it is true they could fall further, and they did in 2008, TIP yields spiked under the same circumstances–sending TIPs to positive real yields quickly.
John, I agree that CPI probably understates inflation. My property tax bill has gone up more than 10% this year. Food and gas are up sharply. Is it a government conspiracy to hold down its debt costs? I would say no, but it is a side benefit. CPI holds below 3% and the Federal Reserve at the same time drives down interest rates.
I have dabbled in gold mining stocks recently (didn’t do so well, of course, since they are down sharply). My philosophy is to set aside 25% of my portfolio in super-safe investments, such as TIPS, Treasuries and bank CDs. Stocks don’t get to play in my super-safe corral.
What would cause TIPS rates to rise sharply? I think one factor: Strong economic growth.
What would cause TIPS rates to rise sharply? I think one factor: Strong economic growth.<<
Just the opposite may be the case, although obviously I have no crystal ball. TIPs haven't been around too long, but their rates have spiked in recesssions. My guess is that when inflation worries are not paramount, TIPs are less desirable and therefore investors demand more return to hold them. The other reason may be strength of the US dollar that drives money out of TIPs. I know that sounds kinda stupid on the face of it, but TIPs (or at least TIP, the etf) has a very low correlation to UUP (the bullish US dollar fund). If you look at periods of dollar strength (hint, there haven't been many lately), you will see pronounced weakness in TIP, and also spiking rates on TIPs.
I have dabbled in gold mining stocks recently (didn’t do so well, of course, since they are down sharply). <<
Well I try not to dabble but catch value and based on various ratios of gold to gold stocks, we are near lows in relative values of gold stocks. This does not make it a slam dunk that gold stocks will catch fire anytime soon–but a nice little tiny daily bet in something like BGEIX, while the GOLD:XAU ratio is above 9.5 is not the worse thing you could do. If we get lucky and the ratio goes to 12 or above like it did in 2008, then its time to increase the buys.
My philosophy is to set aside 25% of my portfolio in super-safe investments, such as TIPS, Treasuries and bank CDs. Stocks don’t get to play in my super-safe corral.<<
I am not sure how safe treasuries and TIPS will be if supply overwhelms demand, especially if we head into another recession. You may remember that t-bonds didn't exactly set the world on fire during the intital stages of the last recession, and really didn't start their bubble of Nov-Dec 2008 until TIPs stabilized. Which gets back to the US dollar again and its strange effect on people in crisis. The dollar jumping is a sign of panic and the Fed losing control–it double topped in late 2008/early 2009, first smacking TIPs hard and then in the interlude between its peaks, TLT and t-bonds soared. These days the Fed has kept it in its box, but for how long? We'll see, but my thought is if we see considerable strengthening in the buck, and we are seeing a series of higher lows since March 2008, TIPs will come down with a nasty cold.
You can only buy todays yield, not yesterdays. I feel a good deal is when you are guaranted to beat CPI inflation. And the truth of the matter is if you are in your 20s or 30s, as long as you hold the TIPS until maturity, you won’t lose in nominal terms. It is impossible. That can’t be said of the stock market. I can forsee a day when a 30 year TIPS has a negative real yield. I believe the secret is out…
I am *hoping* we never see a 30-year TIPS with a negative rate to maturity. Ouch. Yes, TIPS are much loved today. I still own a TIPS that matures in April 2029 with a base rate of 3.875% (before inflation). That was issued in 1999, when TIPS were very unloved. It could happen again, but I agree, not anytime soon.