TIPS vs. LT Bonds

[EdwardjK]

The 30-year decline in interest rates have cause the long-term bond component of the Permanent Portfolio to make a significant contribution to the Portfolio's annual return.  Now that interest rates are near zero, I wonder whether they still represent a viable component.

It is widely expected, although by no means guaranteed, that the Federal Reserve will begin to increase interest rates sometime in 2015.  Once that occurs, we can expect the long-term bond component to decrease in value.  So, does it make sense to replace the long-term bonds now with something else, such as TIPS?

TIPS provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index.  Some people believe that with all the money printing caused by the Federal Reserve QE actions, that significant inflation in the future is all but assured.

I am interested in your thoughts.  Thank you.

[Mark Leavy]

There is a good chance that you are right.  It might be a profitable bet.  But who knows?

I tend to view the Permanent Portfolio as four buckets that the money sloshes around in.  If interest rates rise and the money sloshes out of long term treasuries, then it might slosh into one of my other buckets.

On a purely ideological basis, I mistrust TIPS - as they are the fox guarding the henhouse.  Not to say that it wouldn't work out as you've outlined.  It very well could.

There are some pretty sound reasons for moving out of every one of the PP assets.  People who surmise correctly could do very well.  I have a long history of poor predictions.  Solid, well thought out, brilliant predictions.

[Pointedstick]

This happened in the 70s. Rates rose, eventually hitting 15% for long-term bonds I believe, and needless to say, bonds got whacked. But gold saved the day. The PP performed as advertised. And due to the rebalancing effect, the people who were following the portfolio at the time bought some sweet bonds that gave them 15% interest until just a few years ago!

And of course, the Fed may not raise rates in 2015. They may not do it until 2016. Or 2020. Or 2030. Who knows? Stranger things have happened?

[MachineGhost]

The Fed raising rates is a short term (bills) issue, not long-term bonds.  It would be a "tight money" condition and the entire PP would crunch into losses for awhile until people adjust.  If the Fed raises short term rates because of the economy recovering, then that is not bullish for bonds because the economy has recovered, not because of the Fed.  Not bullish doesn't imply a bear market, just lack of upside movement or going sideways.

QE -- where the Fed actually buys the long-term bonds outright -- has ceased and long-term rates did not go up.

Inflation expectations are another issue and aren't worth worrying about until the after the next bear market.

[barrett]

Some people believe that with all the money printing caused by the Federal Reserve QE actions, that significant inflation in the future is all but assured.

I should preface this by saying that I have the same concerns about long bonds as you do, but...

Harry Browne always said that the future was unknowable and I think what we have seen in recent years regarding the Fed's inability to create some inflation is a good example of what he meant by that. People have been saying that inflation was imminent for years now. Japan has been trying for a couple of decades to get some inflation going. Europe is now trying to deal with this as well by introducing their own "quantitative easing."

If you really know that inflation is coming, then no, you don't want to have 25% of your money in US long bonds. Remember that TIPS have only been around for 15 years or so, but among people implementing the PP, it's generally thought that they don't have a place in the portfolio... meaning that possible future economic scenarios are already covered by the four assets. For severe inflation we have gold. If we get moderate inflation, stocks will probably do OK and cash will start to yield something. The 30-year treasuries are there to protect you against deflation and we may get more of that. Even if the rate on the long bond goes to 1.5%, I'm not positive I'd be bailing on them because I'd have a fourth of my portfolio kicking off a return (in interest payments) that was greater than what I could get elsewhere.

I guess what I am saying is that there is still some potential upside to holding the long bonds.

[yankees60]

Some people believe that with all the money printing caused by the Federal Reserve QE actions, that significant inflation in the future is all but assured.

I should preface this by saying that I have the same concerns about long bonds as you do, but...

Harry Browne always said that the future was unknowable and I think what we have seen in recent years regarding the Fed's inability to create some inflation is a good example of what he meant by that. People have been saying that inflation was imminent for years now. Japan has been trying for a couple of decades to get some inflation going. Europe is now trying to deal with this as well by introducing their own "quantitative easing."

If you really know that inflation is coming, then no, you don't want to have 25% of your money in US long bonds. Remember that TIPS have only been around for 15 years or so, but among people implementing the PP, it's generally thought that they don't have a place in the portfolio... meaning that possible future economic scenarios are already covered by the four assets. For severe inflation we have gold. If we get moderate inflation, stocks will probably do OK and cash will start to yield something. The 30-year treasuries are there to protect you against deflation and we may get more of that. Even if the rate on the long bond goes to 1.5%, I'm not positive I'd be bailing on them because I'd have a fourth of my portfolio kicking off a return (in interest payments) that was greater than what I could get elsewhere.

I guess what I am saying is that there is still some potential upside to holding the long bonds.

Barrett,

Saw what you'd written this morning and just now read the above.

Vinny

[yankees60]

The 30-year decline in interest rates have cause the long-term bond component of the Permanent Portfolio to make a significant contribution to the Portfolio's annual return.  Now that interest rates are near zero, I wonder whether they still represent a viable component.

It is widely expected, although by no means guaranteed, that the Federal Reserve will begin to increase interest rates sometime in 2015.  Once that occurs, we can expect the long-term bond component to decrease in value.  So, does it make sense to replace the long-term bonds now with something else, such as TIPS?

TIPS provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index.  Some people believe that with all the money printing caused by the Federal Reserve QE actions, that significant inflation in the future is all but assured.

I am interested in your thoughts.  Thank you.

The Song Remains the Same?

https://www.youtube.com/watch?v=dRnKvXqti6M

Vinny