Are TIPS expensive? A look back into recent history …

A New York Times article with the headline ‘An Inflation Hedge Carries Its Own Risks‘ spells out why TIPS mutual funds appear to be overpriced, and possibly risky, after substantial gains. Some of its major points:

Investors who placed bets on mutual funds specializing in inflation-protected Treasury securities were among the bond market’s biggest winners over the last two years, even as other Treasury funds struggled. … “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.”

The surprise is that this article was written July 11, 2011, practically to the day that TIPS base yields began moving into negative and TIPS mutual funds started a strong move higher. Here is the chart for the TIP ETF, which has risen about 8.9% since July 11, 2011:

TIP return since July 2011

Obviously, you can’t trust the experts. But …

I will admit that back in July 2011, I agreed with this New York Times article. TIPS seemed pretty expensive. Looking back, boy, were we wrong. Yes, TIPS were expensive relative to history, but not expensive at a time of massive Federal Reserve manipulation in the Treasury market.

Since July 2011, yields have literally turned upside down to what I would call the ‘Real World.’ Now we are living in the ‘Fed World.’

Real World. On July 21, 2011, a 10-year TIPS auctioned with a yield of 0.639%, meaning that buyers would receive 0.639% above inflation over 10 years. That looked expensive at the time, but in retrospect …

Fed World. This week the Treasury reissued a 10-year TIPS with a yield of -0.75%, meaning that buyers were accepting 0.75% less than inflation for the next 10 years. They  were betting big on higher-than-expected inflation.

A yield of -0.75% is expensive, right? Can we finally settle on that? But it was another in a string of record-low yields for TIPS. Until we see that trend turn around, I think we can say the Fed World is still going strong.

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12 Responses to Are TIPS expensive? A look back into recent history …

  1. John says:

    I’m trying to decide when the Fed world bubble ends. I’m thinking when the 30 year TIP goes negative? We are less than 50 basis points away :)!! But then I will never be mistaken for Nostradamus or even the Great Swami. Good article

    • tipswatch says:

      John, I have been in denial about the 30-year TIPS yield going negative. That would be an amazing event. Here is the yield trend for the last few 30-auctions:

      TIPS Auction Date Yield
      29-YEAR 8-MONTH 6/29/2012 0.52
      30-YEAR 2/29/2012 0.77
      29-YEAR 4-MONTH 10/31/2011 0.999
      29-YEAR 8-MONTH 6/30/2011 1.744
      30-YEAR 2/28/2011 2.19
      29-YEAR 6-MONTH 8/31/2010 1.768
      30-YEAR 2/26/2010 2.229

      This trend definitely leads to zero and beyond. Will buyers be willing to accept less than the rate of inflation over 30 years? Yes, if they really fear a spike in inflation.

  2. joe says:

    I think if Helicopter Ben Shalom Bernacke continues to drop money out of the sky, we will see a real negative yield of a 30 year TIPS. I think someone would have to be insane to invest in that to be honest. I refuse to participate in a TIPS auction if the real yield is going to be negative. I even just got some EE bonds, 10k worth, this year cause I know I will have a guaranteed 3.6% nominal yield if held for 20 years with a put option to cash out early if inflation spikes. I think besides I bonds, those EE bond are the second best safe deal this year.

  3. tipswatch says:

    Joe, the problem, which the Fed is presenting to us, is the possibility of much higher than expected inflation. Based on the current TIPS 30-year bond, expected inflation is around 2.5% over the next 30 years, versus the traditional 30-year Treasury. Does that sound right? What if inflation ended up averaging 3%? Or 5?. Or 10%? Or .. If inflation was 15%, or 1500%, would the Treasury end up defaulting on that TIPS?

  4. John says:

    Fellas, isn’t the problem really deflation? This is now the fourth installment (I’m including “Let’s Twist Like We Did Last Summer”) of “making sure it never happens here.” Our famous self-appointed “Dr. Leader” has to find a way to devalue the US dollar because his hero did it in the thirties and now he is left with jawboning forever based on the quackery that printing money will somehow solve our unenjoyment problems. Thus the not so subtle hints that inflation will rise, ’cause ya just know that Benron plays the S&P futures along with his banksta and PPT buds at Trashury Dept. Its the first thing he looks at in the morning, he acknowledged recently.

    But if you look at the real world, people need money, and they are trying to liquidate assets, the value of which our hero so furiously defends. Thank the lawd, that these geniuses have invented alternative currencies called food stamps, disability and welfare, so that we don’t have embarassing photos of bread lines like during Herbert Hoover’s time. As the song said, “we could use a man like Herbert Hoover again,” and we may just get one, or maybe it will be forced upon us. Stay tuned!!

  5. tipswatch says:

    On deflation … the Fed does seem determined to move the needle toward inflation rather than deflation. Inflation combined with low interest rates makes the U.S. debt more tolerable. If deflation strikes, holders of traditional Treasuries will be the winners. If inflation were -2% for a year, the holder of a 10-year Treasury earning 1.8% gets a real return of 3.8%. The holder of a 10-year TIPS paying -0.75% gets a real return of -2.75%, much worse than the traditional Treasury.

  6. John says:

    The Fed’s real mandate is to enable government spending, which has grown 700% compared to GDP since 1913 and to protect banks. If bank derivative positions blow up, as they started to in 2008, what will be sold–EVERYTHING–see 1931 and 1932. Good luck to everybody, we’ll need it.

  7. John says:

    I think if Helicopter Ben Shalom Bernacke continues to drop money out of the sky<<

    If Bennie really wants to end unemployment, the best way is to drop unemployed people out of his chopper. That would be both messy and politically incorrect!! But he really doesn't care–he is too busy building gov't and banksta empires.

  8. John says:

    We are now just 34 ticks away from the whole TIPS stable sporting the real negative yield.

    http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

    • joe says:

      And when that happens I will cash out and put the money into gold because one one have to be insane to invest money into a financial product for 30 years with a real negative yield.

      • John says:

        I have bought a small amount of TPS and will add as TIP goes up. I don’t hate TIPs–I will buy after the next deflationary episode and i do think we will someday see double digit rates on the 30 year bond again. TIP, the fund, is one of the bond bubbles that Uncle Bennie has given us to replace the housing bubble, along with HYG and LQD. The bankstas who run TIP haven’t paid a cent in divis for three months–that being said–the bigger the bubble gets, the louder the pop! Good luck Joe.

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