The U.S. government has approximately $21 trillion of debt, the largest in the world, and the Federal Reserve is only gradually shrinking its balance sheet. Additionally, the Trump administration’s tax cuts have raised the federal deficit to record levels, with the deficit topping $1 trillion by 2020.
If part of your investment segmentation falls squarely within chasing high yields with new casino sites, consider the other side of the coin, which is that of safer, low-risk government bonds. For investors worried about rising interest rates, there is no better alternative to U.S. government bonds than Treasury Inflation Protected Securities (TIPS). TIPS are the best performing asset class for the first three months of 2018. With a high-quality investment portfolio, you can benefit from the rising inflation outlook and generate higher returns for your portfolio, without taking much risk.
Here are the key features of TIPS, the value proposition, and why the preferred stocks of U.S. government bonds have a low correlation with TIPS.
1. A Low-Risk Investment
Contrary to other securities, TIPS are not sensitive to interest rate movements, thereby providing investors with diversified sources of income. Based on monthly data, TIPS generate annualized returns of 5-6%, which is comparable to a U.S. Treasury bond. The 10-year and 30-year TIPS have both risen about 2% during the first quarter of 2018.
During periods of rising inflation, interest rates increase and yields decline. As a result, there are periods when bond yields may go higher than inflation rates, but this has never happened before since at least 1960. Additionally, the inflationary outlook remains benign, since consumer prices grew by just 0.2% during the first three months of 2018, while the 10-year inflation rate is currently 1.6%.
2. High Returns
The 10-year Treasury bond currently yields about 2.8%, which is less than what it paid in March 2017, when it yielded 2.9% (and is now yielding slightly less). Since 2011, TIPS have offered an annualized return of 6-7% (or over 10% during periods of rising inflation), but are currently offering a lower return than the same period in 2016. On the other hand, the dollar has appreciated almost 5% against the euro and 2% against the yen over the same period.
The yield is determined by the yield to maturity of the bond. Typically, the higher the yield, the lower the risk of losing money. However, this is not the case with TIPS. As a result, in times of rising inflation, TIPS can provide higher returns than Treasury bonds.
3. Low Correlation With U.S. Equities
Unlike government bonds, U.S. stocks are very volatile. The two major sell-offs in the last five years involved U.S. stock indices falling around 30% and 20% respectively. Since 2000, the worst U.S. stock market crash was seen in the fourth quarter of 2008, which saw the S&P 500 plummet 36%, and the worst U.S. equity market crash was in the first quarter of 1929, when the Dow Jones lost 63%.
Despite this risk, U.S. equities have been generally more stable than government bonds over the last 12 months.