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A Tip About TIPS

Aaron Levitt Oct 14, 2015


I think most people at this point, religious or not, have heard the old parable about Noah and The Great Flood. The real gist of the story, minus any sort of religious context, is that everyone thought Noah was crazy for building his boat and laughed at him until the rain came. Then everyone wished they had an ark of their own. The story is really a lesson on planning and having some sort of insurance.

Essentially, the “time to build an ark is when the sun is shining.”

Today, that message and lesson has some real meaning for investors. Especially when looking at the cold portfolio-killing specter known as inflation. These days the phenomenon is far out of investors’ minds, which is why you should start taking it seriously.


Always Lurking


What a difference a few years makes. Rewinding the game clock back to 2010, inflation expectations were the talk of the town. The Fed had finally begun its massive quantitative easing programs, money printing and bond buying. Many analysts, market pundits and economist predicted these efforts, as well as the similar measures constructed by the European Central Bank and others, would create moderate to severe inflationary pressures in the world’s economy. While the calls for hyperinflation were total B.S. and complete bunk, certainly there would be some inflationary repercussions.

Swing and a miss.

None of the pressures have come true. So far, in the last five years we’ve had zero in the way of inflation. I know your grocery bills may have gone up by a lot, but “officially” we’ve actually been pretty mild in the way of inflation. The latest Consumer Price Index for All Urban Consumers (CPI-U) actually decreased 0.1% in August on a seasonally adjusted basis, sitting at 1.8%. Last year, inflation averaged just 1.62%. Back in 2013 it averaged 1.47%.

All of those metrics are well below the 3.82% average inflation rate since the end of the Second World War and the current ten-year moving average, which is now 2.09%.

In this brave new world of zero inflationary pressures, investors have sort of become complacent in ignoring inflation in their portfolios. The latest Treasury Inflation Protected Security (TIPS) auction is a testament to that. The reopened auction, which the Treasury does from time to time, back on September 18 resulted in a real yield to maturity (post inflation) of 0.60%. That auction was actually a discount to par and basically means that investors aren’t really considering inflation as a threat these days. Back in 2012-ish, investors were clamoring so hard to snag TIPS and funds like the iShares TIPS Bond ETF (TIP) that we were trading at fierce premiums.


“The Sun Is Shining”


Inflation expectations have headed lower and lower since 2013. The sun is certainly shining. Well, not exactly. There are some clouds. The current low expectations may not be fully justified, especially over the longer haul.

For starters, low crude oil prices have really skewed the data. As boom has gone bust, oil prices have fallen by a lot, down from about $115 per barrel to today’s price of around $45. And as one of the major components and heavily weighted factors in the CPI-U, you see those lower prices taking the inflation data for a run. Looking at core CPI-U, which kicks out energy, we actually saw an increase in August’s inflation rather than a decrease. Also not helping is the rising dollar, which then hurts the prices of commodities.

All of this is creating some interesting break-even points on the ten-year TIPS. Ten-year expectations are currently hovering around 1.5%. Now seriously ask yourself, is inflation only going to run at 1.5% or is oil going to stay this low for ten years or more?


Building the Ark


The answer is probably not. And if you look towards Noah, the time to build your ark could be now. Individual TIPS, the TIP ETF and even I-bonds all look like interesting values now, given long-term historical norms.

Noah’s lesson perhaps goes further into portfolio planning as well. Complacency kills portfolios and it always makes sense to have a bit of insurance. Whether that’s inflation protection or some other sort of diversifier, “insurance” is often on sale when we don’t need it. Don’t miss the opportunity to snag it while it’s cheap.


Image courtesy of hywards at FreeDigitalPhotos.net

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