Most of us never even ask this question, since such investments by definition don’t even appear on our radar screens. But, as contrarians constantly remind us, we are vulnerable to making big mistakes by blindly following the consensus, as well as to missing some truly once-in-a-generation opportunities.
The question with which I led my column can perhaps be rephrased: Which investment is as out of favor today as Treasurys were 40 years ago? The implication is that now would be a good time to invest in inflation hedges. Think of it as cheap insurance against the possibility that inflation is unexpectedly high in coming years. And it wouldn’t take much for that insurance policy to pay off. Currently, the break-even 10-year inflation rate is just 1.1% annualized; the 30-year break-even rate is 1.5%. In other words, investors collectively are betting that inflation will be really, really low for at least the next 30 years.
But retirees are being misled if they think of these negative yields in nominal terms. They instead are real yields—yields relative to inflation. So a better way to think of the current TIPS yields is that your return over the next 10 years will be 0.65% below whatever the CPI’s rate of growth will be. For example, if the CPI increases 10% annualized over the next decade, your return would be 9.35% annualized--guaranteed.
An alternative strategy for hedging inflation would be to go short Treasury bonds. That would be precisely the opposite strategy that Seiver pursued in the early 1980s. But think about it this way. Even if inflation over the next 40 years is what the markets currently are expecting—1.5% annualized—an inflation-indexed annuity’s payout 40 years from now will be nearly double what it is in the first year. And, by the same token, the inflation-adjusted value of a nominal annuity’s payout will be nearly half of what it is today.
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