I’ll be the first to admit that the stock run-up and crypto craze are certainly far more exciting topics. The stock run up has been thrilling and has moved to some pretty significant extremes in sentiment and certain technical measures. My equity thoughts are generally quite long term [feel free to check out the November post on relaxing a bit on valuation multiples]. But we are at a point where I highly recommend that you make sure to follow my colleague Andrew Thrasher, CMT at athrasher.com for some excellent context on these recent sizable stock moves and what they mean going forward. As for this post I will be going in another direction and sticking to the more boring stuff and where I think I can add some value.
Last summer, I put out a lengthy piece explaining why it was time to begin allocating towards inflation protected bonds (TIPS) for at least part of your portfolio. I won’t revisit the details or foundational work, but will provide a quick update as it is vital to pay attention to the nickels and dimes that can be gained through active bond management. They add up over time! A quick summary of the summer’s thesis was that while TIPS had been a miserable place to have been invested since late 2012, a few solid reasons were presented as to why it was time to begin putting some money there (a new argument at the time for me and FEG).
Fast forward the beginning of this year and we are finally beginning to see the possibility of inflation hit major financial publications like the Wall St. Journal and Barrons. The attention has been there because several commodities ended 2017 quite strongly and inflation breakeven spreads have moved back above 2%.
Again, I’ll leave the details and foundational work to the August article, but, in a nutshell TIPS bonds are where you want to be when the breakeven spreads are rising, because that means the yields on regular bonds are rising faster (and thus, prices underperforming). In other words, 10 year treasury bonds have taken quite a hit over the last several months while TIPS have been generally stable. You can see that probably in a more straightforward fashion on the chart below.
While TIPS have certainly been a major upgrade relative to their nominal brothers – there has still been a slight income shortfall to their corporate cousins. Investors have still been better off with the higher yields earned by corporates. However, this income advantage has been at a much lower run rate than it had been – meaning it has been that costly to hold the safety of treasuries.
In summary – we have been quite pleased to have started and subsequently increased our position in tips. Around 2% was where the breakeven advance had stalled the last time, and we should expect at least a little stall or pullback here. But over the intermediate term I would expect inflation protected securities to remain strong at this part of the cycle. Along with these increased market based expectations a few other signs (PPI vs. CPI, a few commodity rebounds and slow but steady increases in wages) indicate this to be the case as well.