A rational look at TIPS: Are they overpriced? A poor investment?

Posted on October 12, 2011 by Tipswatch

Scott Grannis, a SeekingAlpha.com blogger who calls himself Calafia Beach Pundit, has written a crystal-clear, totally rational look at Treasury Inflation-Protected Securities titled ‘TIPS Update: Betting On A Stuck Economy.’

Grannis, an economist, came up with this wonderful chart showing the entire history of the real yield on a 10-year TIPS, along with his judgements of value:

I love this chart because it exactly matches my sentiment. I have been buying TIPS since the late 1990s and while I suspected then that those near- or plus-4% rates were a good investment, who knew then they were so FABULOUS? They were.

If you examine the chart, you can see there was a great buying opportunity to grab TIPS in late 2008 (an excellent time to buy TIPS mutual funds) and even in early 2011 prices approached Grannis’s ‘fair value.’ Right now, though, TIPS are solidly in the ‘expensive’ range and seemingly not very attractive.

But is this rational? Grannis points out that TIPS are tracking expected economic growth and therefore are signalling a miserable economy for the foreseeable future, but with continued moderate inflation. He writes:

10-year TIPS are trading at a real yield of almost zero because the market fears that the outlook for economic growth is absolutely dismal. But buyers of TIPS and Treasuries today have almost no doubt that inflation will be about 2% per year for the foreseeable future. Put another way, if you worry about deflation, then you will shun TIPS and prefer Treasuries instead.

And then the conclusion, which points out the danger of TIPS at these current rates if the economy begins to turn around:

… If you expect the economy to have even the slightest chance of growing in the years to come, then you will find both TIPS and Treasuries to be very unattractive. If you expect the economy to eke out at least some degree of growth and if you expect inflation to rise, then you had better be prepared to see TIPS prices fall.

A very nice analysis that I happen to agree with. Check it out.

Posted in Investing in TIPS | Leave a comment

Next up: Reissue of a 30-year TIPS on Oct. 20, 2011

Posted on October 9, 2011 by Tipswatch

The U.S. Treasury will auction a reissue of a 30-year Treasury Inflation-Protected Security, CUSIP 912810QP6, on Oct. 20. Although the announcement was to come next week, it is already posted in the official list of upcoming auctions.

Reissues are always interesting, because this 30-year TIPS already trades on the open market, and you can get an idea – but only an idea – of the likely yield to maturity of this auction. Here is the current status (as of Friday) of this TIPS, which matures 2041 Feb 15:

30-year TIPSSo at this point, it looks like buyers will be getting about 0.925% yield to maturity for the next 29 years. In addition, the principal of this TIPS continues to grow with the rate of inflation until it matures.

Is that a good rate? Well, sort of. If you look at the full maturity ladder of TIPS, you can see that the base rate to maturity is negative, all the way up to 2020 Jan 15, almost 10 years out. So buyers of any TIPS less than 10 years are willing  to accept a return less than the rate of inflation. In that context, a payout of 0.9% above the rate of inflation looks pretty good.

On the other hand … a rate of 0.9% would set a record low – in a massive way – for any 30-year TIPS ever auctioned. Here is a chart of all the previous auctions:

As you can see, the current record low of 1.744% was set in the last reissue of CUSIP 912810QP6 (I was a buyer of that one, by the way, in June.) And this issue was first auctioned on Feb. 17, 2011 (this year!) at 2.190%.

I’m not a big fan of 30-year TIPS, because I am a buy-and-hold investor and I might not be around in 30 years. But I am a fan of 1.744% above inflation, and so I was a buyer in June on the first reissue.

This time, I will probably sit it out.

Reminder on I Bonds – act before Oct. 31.

One investment still stands out for the small investor: I Bonds. If you haven’t bought I Bonds this year, you can still buy $5,000 in Treasury Direct and $5,000 in paper bonds. A couple can buy twice that. (Paper bonds will no longer be issued after Dec. 31, except as a tax refund.)

  1. I Bonds currently pay a base rate of zero percent, plus a second rate based on inflation. The current inflation-adjusted rate is 4.6% for half a year, which guarantees that an investor will earn 2.3% (probably more) for the required 1-year holding period. (That 4.6% rate will change on Oct. 31, and probably fall a bit. If you buy before Oct. 31, you will get the 4.6% for six months.)
  2. I Bonds can be sold after one year with a three-month interest penalty, and after five years with no penalty.
  3. Interest payments on I Bonds are not taxed until the bond is redeemed, which can be 30 years from when they are purchased. That is a huge advantage over TIPS.
  4. Because of that tax advantage, I Bonds traditionally offer a base interest rate about 1% lower than a 10-year TIPS. But since I Bonds cannot go below a zero interest rate, the advantage shifts powerfully to I Bonds when TIPS are paying near zero.
  5. I Bonds are a much easier investment to keep track of. There are no yearly taxes due, and you can track your investments with the Savings Bond Wizard.
Posted in I Bond, Investing in TIPS | 3 Comments

Reissue of 10-year TIPS auctions at 0.078%

Posted on September 22, 2011 by Tipswatch

The U.S. Treasury just announced the result of today’s $11 billion auction, a reissue of CUSIP 912828QV5. It auctioned with a base-rate yield to maturity of 0.078%, which is a record low for any 9- or 10-year TIPS auction. The previous record low was 0.409%, set in July 2010 just before the Fed launched QE2.

There had been some speculation today’s yield could go negative. The rate of 0.078% was up slightly from yesterday’s market rate (0.04%) for this issue, which first auctioned in July 2011.

The very low yield is an indication of very strong pessimism about the U.S. economy. From MarketWatch.com this morning:

With a yield of zero, “you only get inflation protection that’s a very dismal view of the econ over a 10-year horizon,” said Anthony Valeri, fixed-income investment strategist at LPL Financial.

Posted in Investing in TIPS | Leave a comment

Yes or no on 10-year TIPS auction on Sept. 22?

Posted on September 20, 2011 by Tipswatch

The U.S. Treasury is offering a reissue of CUSIP 912828QV5, which originally auctioned on July 21, 2011, with a yield to maturity of 0.639%. This TIPS has a coupon rate of  0.625% and will mature on July 15, 2021. The auction will close Sept. 22 at 1 p.m.

If you are looking to buy this Treasury Inflation-Protected Security, remember that the yield to maturity is set at the auction. It is likely to be well below the coupon rate of 0.625%, meaning that you will pay more than $1,000 for $1,000 of this reissue. In addition to base yield, the principal of a TIPS continues to rise with inflation until maturity.

What is the likely yield to maturity? Because this TIPS was first issued in July and trades on the open market, you can get a good idea of the likely yield. As of Monday, that yield was 0.047%. You can use this chart to check the yield daily (look for the issue with a maturity of 2021 Jul 15).

Is that an attractive yield? No. It will be a record low yield – by a wide margin – for any 9- to 10- year TIPS ever auctioned. The current record low is 0.409%, set in July 2010 just before the Fed launched QE2. (I posted a chart recently showing all 10-year auctions in history, check it out.)

Will yields keep falling? They certainly won’t keep falling. They will rise, but the question is: When? And what is the lowest they can go? Some experts say that the 10-year TIPS base yield rises along with the U.S. Gross National Product. A yield near zero seems to indicate investors are very pessimistic about the U.S. economy.

To get an idea of the decline, look at this TIPS being reissued Sept. 22. It was first issued two months ago, on July 21, and it went off at a rate of 0.639%. In two months, that rate has fallen to 0.047%, a drop of 59 basis points. In January 2011, 9 months ago, a 10-year TIPS was auctioned at 1.170%. That is 112 basis points higher than this week’s likely yield.

Incredible. But the near-term history shows that TIPS rates could turn around very quickly, rising to ‘more-normal’ rates of 1% to 2% for a 10-year TIPS. When that happens, TIPS will be much more attractive.

Nevertheless, the rate trend is currently down and has been for all of 2011.

The tax issue. Since this TIPS will pay almost zero as its base interest rate, investors will get very little cash flow from it. The principal does rise with inflation, but it is taxed as income in the year it was added. So that means this 10-year TIPS will have negative cash flow (near-zero base interest minus taxes owed) until maturity.

This wouldn’t be an issue for a TIPS held in a tax-deferred account.

Are there better alternatives? One investment stands out for the small investor: I Bonds. If you haven’t bought I Bonds this year, you can still buy $5,000 in Treasury Direct and $5,000 in paper bonds. A couple can buy twice that. (Paper bonds will no longer be issued after Dec. 31, except as a tax refund.)

  1. I Bonds currently pay a base rate of zero percent, plus a second rate based on inflation. The current inflation-adjusted rate is 4.6% for half a year, which guarantees that an investor will earn 2.3% (probably more) for the required 1-year holding period. (That 4.6% rate will change on Oct. 31, and probably fall a bit. If you buy before Oct. 31, you will get the 4.6% for six months.)
  2. I Bonds can be sold after one year with a three-month interest penalty, and after five years with no penalty.
  3. Interest payments on I Bonds are not taxed until the bond is redeemed, which can be 30 years from when they are purchased. That is a huge advantage over TIPS.
  4. Because of that tax advantage, I Bonds traditionally offer a base interest rate about 1% lower than a 10-year TIPS. But since I Bonds cannot go below a zero interest rate, the advantage shifts powerfully to I Bonds when TIPS are paying near zero.
  5. I Bonds are a much easier investment to keep track of. There are no yearly taxes due, and you can track your investments with the Savings Bond Wizard.

I Bonds versus TIPS. I have been a frequent buyer of TIPS in the last 12 months. The strategy was to move money out of a higher stock market and into the super-safe portion of my portfolio. Since July, the stock market has corrected somewhat and TIPS yields have fallen sharply.

TIPS have lost some of their appeal at these rates.

I Bonds are the clear choice for the first $10,000 to $20,000 you are seeking to place in a super-safe investment.

Posted in I Bond, Investing in TIPS, Savings Bond | Leave a comment

Auction on Sept. 22: Reissue of 10-year Treasury Inflation-Protected Security

Posted on September 14, 2011 by Tipswatch

Update: Yes or no on this 10-year TIPS reissue? Read my analysis.

The U.S. Treasury will announce tomorrow (Sept. 15) that it will auction a reissue of CUSIP 912828QV5, which originally auctioned on July 21, 2011, with a yield to maturity of 0.639%. It has a coupon rate of 0.625% and will mature on July 15, 2021. The auction will close Sept. 22 at 1 p.m.

Since this is a currently traded TIPS, we can get a decent idea of its likely yield to maturity on the auction date. Here is the rate as of Tuesday, Sept. 13:

The decline in Treasury yields since the original July auction has been remarkable, dropping from a an already-low 0.639% to the current rate of 0.030%. (The principal balance on a TIPS also rises with inflation until maturity, so a buyer of this reissue will get – in effect – the rate of inflation for the next 10 years.)

Is this a good investment? If you buy and hold TIPS to maturity, I would never call a TIPS investment a horrible decision. It won’t be like buying the NASDAQ just before the massive collapse of 2000. But it could mean – potentially – committing to a lousy return for 10 years. One thing for sure: You will get your money back, plus inflation.

It is important, though, to recognize that a yield of near-zero on a 10-year TIPS is an incredible anomaly. (That isn’t to say that rates could go lower, that is certainly the trend of 2011.) Here is a chart for every auction of 9- to 10- year TIPS in history, showing that the record low rate is 0.409% in July 2010, just before the Fed launched QE2:

Posted in Investing in TIPS | Leave a comment