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Chapter 18 TIPS Appreciated

Chapter 18 TIPS Appreciated - )le ‘ 34R POI/3‘/—-3 37...

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Unformatted text preview: )le ‘ 34R POI/3‘ . /—-3-), 37 ugaa‘ngawan straws” azbyanagu w.7|=br§y'th"' TIPS Appreciated , , inflation-shielded Treasuries' potential double-digit returns LAST TUESDAY’S NEARLY 11% SURGE IN STOCKS WAS AWELCOME FEE-HALLOWEEN 2; i P treat—but only displayed the violent nature of bear-market rallies. The trick was V ’ , that the $850 billion added to the value of the US. stock market on Tuesday pales next , to the $6.3 trillion of losses since the Dow Jones Wilshire 5000’s 52—week high on All Hallows’ Eve a year ago. . I But over in the Treasury securities market, some really weird things have been happening, particularly to"l‘reasury inflation- - i , protected securities: Their sorry performance \ has made TIPS look attractive to investors. N E .0 N, L . I Indeed, TIPS noWofferthepotentialofdou— ’ . 4 . _ . - ble-digit returns —without the credit risk A vars-yon 0 this article a cared , - 'Wednesday,f06t 29 in Bafing 07mm that s spooked world markets. (bum. com) Regular Treasury notes and bonds have , been the benefic1aries of the credit horroras in— :3- vestor demand for safety has boosted their prices and lowered their yields. Not so with TIPS; they got dumped. ' There’s some logic to TIPS’ underperformance. They pay a fixed coupon, but their principal is adjusted annually according to the rise in the consumer-price index. N or- ' mally, a 10—year TIP might yield 2%, versus 4% for a- 10—year Treasury note. . The difference—the so-called TIPS spread —would represent the expectedrim'lation 1 adjustment. Implicitly, the market is expecting the CPI to rise 2% per'annum in this hy- 1 Meal case. If inflation expectations rise, the yield on the Treasury note would rise while the TIP yield would remain the same or decline (all else being equal). ' . , Of course, the bogeyman of inflation has been slainl‘byfieereditcrisismhich has sent , conunodity-priees plunging along with stocks and corporate bonds. That means the value . 0f the inflation protection offered by TIPS has also diminished. The simple TIPS spread already had started torecede from its high—watermark of over 250 basis points(;2,5 per: centage points)-to 219 basis points in lateAugust. Now, the TIPS spread has}, pf to a > Einena75 basis points, as the yield on the most active IO—year'TIP'has WSW _ 1.60%—resulting in sharp price declines. As a reflection, the‘iShares TIPS Bend ex- ' change-traded fund (ticker: TIP) plunged ,t0,93.67fijom J0§38,- 312% loss over that ., Span—net as bad as the decimation of the Dow, but a huge'difl'er‘ence from the 3% gain in _ the {Shares 20+ Year Treasury Bond ETF (TLT). , , :7 According-1:0 Rob Arnott, the head of Research Affiliates, the TIPS market is priced for deflation of 1% per annum for the next five years, anddeflation of 0.6% per year for seven years, ramping up to inflation of 0.8% for 10years and 1.4% for 20 years; Any investor who thinks that consumer prices will rise faster than that glacial pace over that time span will be better off in a TIP. And the worse the’inflation, the greater benefitto the TIP. ' , . ' V , _. ' ' : -, But, if 20:190-30~year TIP yields just return to the 2% levels of eight weeks ago, from rammid3'25% currently, Arnott calculates this would produee20%_capital appreciatiortlf that-recovery is spread over twoyears, you’d still get double-*digfltotal returns. > . ' Investors have to ask howprobable that is. “With the massive rim-up in aggregate government indebtedness this year, with noend-in sight, I don’t see how we can not , _ have reflation in the years ahead, though deflation during the early stages of thisreces- ’ 5 sionseems likely,” says Arnott. . , V V ‘ f ' , 7 * ."*"“"?~“ 1. “‘ my insanely. .,. f‘ i: mfiy whammy eNYS m ,. ' thesreatestbaymg . weakness W88 meatball than WEE , I L = yearly j yey‘e’nitim" jugaybu don’t'getan”? cas‘ 'h'paym‘ e W ; :érow’ftha‘t‘ ._ _. . TIPSarebestsuitedfortax—shelteredaccounts ‘ Wientor529cdllege§ e-mail: [email protected] ...
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