Good short article series on TIPS and correction to a major misperception

Discussion of the Bond portion of the Permanent Portfolio

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Kevin K.
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Good short article series on TIPS and correction to a major misperception

Post by Kevin K. » Thu Aug 27, 2020 3:42 pm

I recently reread both William Bernstein's "Deep Risk" and Mssrs. Rowland and Lawson's book on the Permanent Portfolio - a great combination as the former book is essentially a commentary on and response to the PP.

Anyway in the "Bonds" chapter of the PP book the advice given is to only own LTT's and to forget about TIPS since they don't offer deflation protection AND did so poorly in the 2008 market crash. But the reasons given for their poor performance turn out to be incorrect, and the third article in this series tells the fascinating story of what actually happened:

https://movement.capital/the-largest-ar ... s-in-2008/

I recommend the entire (very short) series to anyone interested in learning a bit more about TIPS. They haven't been around very long but after reading about how Bridgewater deploys them in their recent paper on prolonged zero returns from bonds plus Jonathan Clements' decision to move his entire bond allocation into a STT/Short Term TIPS barbell I decided to take a fresh look.
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mathjak107
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Re: Good short article series on TIPS and correction to a major misperception

Post by mathjak107 » Thu Aug 27, 2020 4:06 pm

I don’t like tips simply because the entity in charge of your inflation adjusting index has a vested interest in keeping the index reporting as low as possible in high inflation.

It is like putting the fox in charge of the hen house
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Re: Good short article series on TIPS and correction to a major misperception

Post by Kbg » Thu Aug 27, 2020 4:15 pm

mathjak107 wrote:
Thu Aug 27, 2020 4:06 pm
I don’t like tips simply because the entity in charge of your inflation adjusting index has a vested interest in keeping the index reporting as low as possible in high inflation.

It is like putting the fox in charge of the hen house
Except for the small inconvenient fact that the initial interest price and all secondary TIPS in the market are market priced.

Oh hey, look at all those upcoming TIPS auctions. https://www.treasury.gov/resource-cente ... ctions.pdf

If the market believes the treasury is fudging the numbers it follows that the market will then discount them further...exactly like it already does with TIPS and normal treasuries...next conspiracy theory please.
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Re: Good short article series on TIPS and correction to a major misperception

Post by Hal » Thu Aug 27, 2020 4:28 pm

Thanks Kbg, looks like an interesting read.

<snip>
The most important thing to remember about TIPS is that they protect against unexpected inflation. Expected inflation is built in to the yield of a regular Treasury bond.
<snip>
Aussie GoldSmithPP - 25% PMGOLD, 75% VDCO
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mathjak107
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Re: Good short article series on TIPS and correction to a major misperception

Post by mathjak107 » Thu Aug 27, 2020 4:46 pm

Kbg wrote:
Thu Aug 27, 2020 4:15 pm
mathjak107 wrote:
Thu Aug 27, 2020 4:06 pm
I don’t like tips simply because the entity in charge of your inflation adjusting index has a vested interest in keeping the index reporting as low as possible in high inflation.

It is like putting the fox in charge of the hen house
Except for the small inconvenient fact that the initial interest price and all secondary TIPS in the market are market priced.

Oh hey, look at all those upcoming TIPS auctions. https://www.treasury.gov/resource-cente ... ctions.pdf

If the market believes the treasury is fudging the numbers it follows that the market will then discount them further...exactly like it already does with TIPS and normal treasuries...next conspiracy theory please.
The CPI index determines the inflation kicker not the markets
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Re: Good short article series on TIPS and correction to a major misperception

Post by Kbg » Thu Aug 27, 2020 6:18 pm

mathjak107 wrote:
Thu Aug 27, 2020 4:46 pm
Kbg wrote:
Thu Aug 27, 2020 4:15 pm
mathjak107 wrote:
Thu Aug 27, 2020 4:06 pm
I don’t like tips simply because the entity in charge of your inflation adjusting index has a vested interest in keeping the index reporting as low as possible in high inflation.

It is like putting the fox in charge of the hen house
Except for the small inconvenient fact that the initial interest price and all secondary TIPS in the market are market priced.

Oh hey, look at all those upcoming TIPS auctions. https://www.treasury.gov/resource-cente ... ctions.pdf

If the market believes the treasury is fudging the numbers it follows that the market will then discount them further...exactly like it already does with TIPS and normal treasuries...next conspiracy theory please.
The CPI index determines the inflation kicker not the markets
I understand that and if the kicker is substantially below what the market believes is in store for inflation in the future, TIPS market prices will be adjusted just like regular treasuries will be. Rational/arbitraged pricing will basically be the following:

Treasuries = Interest rate of bond + coupon + duration adjusted for demand and inflation expectations (there are few more IIRC)

TIPS = Interest rate of bond + coupon + duration adjusted for demand and inflation expectations - kicker

That's pretty much it. This is why TIPS get hammered just like normal bonds when interest rates go up.

Finally, the CPI calculation isn't a state secret. Everything about it including its data sources are in the public domain and verifiable independently. We can argue all day long if the CPI accurately measures or is a good measure of inflation (and that argument has been going on for decades) but what you can not assert is that the CPI number can be easily manipulated and not be detected later.
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Re: Good short article series on TIPS and correction to a major misperception

Post by mathjak107 » Thu Aug 27, 2020 6:52 pm

The govt will do what it has to to if we hit another high inflation period to get those numbers as low as they can ...... as someone here I think said about tips you are buying fire insurance from the arsonist
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Re: Good short article series on TIPS and correction to a major misperception

Post by mathjak107 » Fri Aug 28, 2020 3:53 am

i forgot who brought up these points on tips but they are very true . it may have been eric deslauriers . it had so many points i wanted to save it .
but forgot wgho said it .

"Don't mess around with using TIPS vs. gold as your inflation asset.

Not all of this is going to be analytical-based. Numbers in a spreadsheet do not tell you about political risk that often comes with high inflation. You have to use some intuition and historical extrapolation to guess what results from high inflation and why you don't want to use TIPS.

1) High inflation is a political problem in almost every case. The people causing the inflation know they are doing it.
2) Because high inflation is unpopular with the masses, the people in charge are always going to lie about it as long as possible to deflect blame.
3) Then when lying doesn't work, they will implement policies like price controls to make it look like they are doing something. This always makes it worse.
4) Along the way, they will manipulate economic numbers to try to trick the markets. However the markets are much smarter than the typical politician, who is usually an idiot based on my experience.

But these things are not going to show up in Excel. There is no =IDIOTPOLITICIAN(A2:A11) function you can call. There is no way for you to anticipate what actions they will take to lie about the situation. And, there is no way for you to know how the markets are going to react to the mess.

I will only suggest that the markets will figure out the right thing to do and that right thing usually is not relying on government numbers about inflation.

Someone mentioned Argentina already. They are in the process of destroying their currency again. It's taken them about five years now to get to this point so it's a bit of a slow-motion trainwreck, but still instructional. Watch what the government there is doing to figure out what the government here will do.

Or you can simply go back and read Nixon's, Ford's and Carter's speeches about inflation in the 1970s. It was lie after lie after lie. A decade of lies.

TIPS may be OK for the cash portion of the portfolio. But I wouldn't rely on them in the slightest for protection against high inflation. For lower inflation the bonds and stocks are all you need.

Caveat emptor.
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Re: Good short article series on TIPS and correction to a major misperception

Post by europeanwizard » Fri Aug 28, 2020 5:36 am

Fascinating read, thanks!
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Re: Good short article series on TIPS and correction to a major misperception

Post by Smith1776 » Fri Aug 28, 2020 7:12 pm

Gotta agree with mathjak on this one. The basic idea behind TIPS is using a government promise to protect you from the fact that they broke their first promise (maintaining gold/silver as money). That's absurd. It's like trusting your spouse's promise to not hit you again. That kind of shit doesn't show up in a spreadsheet.
Price is what you pay; value is what you get.
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Re: Good short article series on TIPS and correction to a major misperception

Post by Kevin K. » Fri Aug 28, 2020 11:15 pm

Smith1776 wrote:
Fri Aug 28, 2020 7:12 pm
Gotta agree with mathjak on this one. The basic idea behind TIPS is using a government promise to protect you from the fact that they broke their first promise (maintaining gold/silver as money). That's absurd. It's like trusting your spouse's promise to not hit you again. That kind of shit doesn't show up in a spreadsheet.
I disagree. Kbg has already explained the mechanics of TIPS which aside from the inflation adjustment are no different from any other Treasury bond. The government paranoia stuff and references to the old gold standard are exactly why folks outside these forums thing we’re all eating MRE’s in a bunker while fondling our gold bullion and MAGA hats.
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Re: Good short article series on TIPS and correction to a major misperception

Post by Smith1776 » Fri Aug 28, 2020 11:24 pm

Kevin K. wrote:
Fri Aug 28, 2020 11:15 pm
Smith1776 wrote:
Fri Aug 28, 2020 7:12 pm
Gotta agree with mathjak on this one. The basic idea behind TIPS is using a government promise to protect you from the fact that they broke their first promise (maintaining gold/silver as money). That's absurd. It's like trusting your spouse's promise to not hit you again. That kind of shit doesn't show up in a spreadsheet.
I disagree. Kbg has already explained the mechanics of TIPS which aside from the inflation adjustment are no different from any other Treasury bond. The government paranoia stuff and references to the old gold standard are exactly why folks outside these forums thing we’re all eating MRE’s in a bunker while fondling our gold bullion and AR-15’s.
I’m not assuaged. It’s not like I trust the creditworthiness of normal treasury bonds either. I mean, if I were, I wouldn’t be using the PP to begin with.
Price is what you pay; value is what you get.
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