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:
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.