The TIPS market put in a solid performance in 2009, after a rocky end to 2008. TIPS started the year with record high yields, reflecting both the impact of forced liquidations on the part of leveraged investors and perhaps general concerns about deflation in 2009 going into 2010. (In times of deflation, the inflation adjustment on TIPS is negative, which reduces the outstanding principal balance.)
Investors recognized that TIPS were cheap early in 2009 and quickly bid up them up in price. The gains, especially on shorter-maturity TIPS, were quite good in the first quarter; but surprisingly, TIPS prices rose steadily, though modestly, throughout the year.
The chart below shows the TIPS yield curve at the beginning, middle and end of 2009:
Chart 1
TIPS yield curve: Dec. 31, 2008, June 30, 2009 and Dec. 31, 2009
Source: Barron's
At the beginning of the year, TIPS yields were relatively high, especially those with the shortest maturities. The TIPS yield curve returned to a more normal upward-sloping shape by mid-year. Since then, shorter maturity TIPS yields have continued to decline, which is consistent with yield trends for straight Treasury securities.
Longer-maturity TIPS also declined in yield at the beginning year, but the declines were much more muted. Since mid-year, longer-maturity TIPS yields have essentially been flat.
The yield on 5-year constant maturity TIPS (shown in Chart 2 below) declined from about 1.80% at the beginning of the year to just over 0.50% at year-end. That yield is actually up from a low of 0.30% in early December 2009. The lowest yield ever recorded on the 5-year TIPS was 0.12% in March 2008 (around the time of the Bear Stearns crisis).
Chart 2
5-year Constant Maturity TIPS yields: 2009
Source: U.S. Federal Reserve
The yield on 10-year constant maturity TIPS also declined in 2009, but not nearly as much. The 10-year TIPS yield dropped from just over 2.00% at the beginning of the year to 1.47% at year-end, as shown in Chart 3.
Chart 3
10-year Constant Maturity TIPS yields: 2009
Source: U.S. Federal Reserve
With the decline in yields, TIPS performance was relatively strong in 2009 when compared against the returns on straight Treasury securities. A summary of their average performance by maturity group is given in Table 1 below:
Table 1
Yield and Performance on TIPS vs. Comparable Maturity Treasurys: 2009
|
|
TIPS |
Comparable Treasury |
Breakeven |
2008 Return |
2008 Return |
|
Averages |
Yield |
Yield |
Spread |
on TIPS |
on Treas. |
|
2010-2014 maturities |
0.16% |
1.41% |
1.25% |
10.1% |
0.2% |
|
2015-2018 maturities |
1.14% |
2.14% |
2.14% |
11.2% |
-4.0% |
|
2025-2032 maturities |
2.02% |
4.53% |
2.51% |
7.9% |
-11.5% |
|
Totals |
0.99% |
2.88% |
1.89% |
10.1% |
-4.1% |
Source: Lark Research estimates calculated from pricing data obtained from Barron's. Returns on TIPS were calculated from Dec. 31, 2008 to Dec. 31, 2009. Returns on comparable maturity Treasurys were calculated from Jan. 2, 2009 to Dec. 31, 2009.
The strongest gains in TIPS were recorded in the short- and medium-term maturity groups. Yields on these TIPS were highest going into the year. By the end of 2009, yields had plunged so much that short-maturity TIPS were yielding just 0.16% on average, not much higher than the yields on T-bills.
Short- and medium-term maturity TIPS posted total returns of 10.1% and 11.2%, respectively in 2009. Longer-term maturity TIPS also generated respectable, but lower, returns of 7.9% on average.
These returns lagged those of credit-sensitive bond sectors, such as investment grade and high yield corporate bonds; but they significantly outperformed comparable maturity straight Treasury securities. As Table 1 shows, straight Treasury securities lost 4.1%, on average, with the longer maturities posting a low double-digit loss of 11.5%.
A quarterly breakdown of total returns for TIPS and straight Treasurys by average maturities is given in the tables below:
Table 2
2009 Quarterly Returns on TIPS and Treasurys by Maturity Group
|
TIPS Returns |
Q1 |
Q2 |
Q3 |
Q4 |
Full Year |
|
2010-2014 maturities |
4.0% |
1.8% |
2.0% |
1.9% |
10.1% |
|
2015-2018 maturities |
4.4% |
0.5% |
3.6% |
2.3% |
11.2% |
|
2025-2032 maturities |
0.4% |
3.1% |
3.1% |
1.1% |
7.9% |
|
Totals |
3.2% |
1.7% |
3.2% |
1.6% |
10.1% |
|
Treasury Returns |
Q1 |
Q2 |
Q3 |
Q4 |
Full Year |
|
2010-2014 maturities |
-0.3% |
-0.6% |
1.5% |
-0.5% |
0.2% |
|
2015-2018 maturities |
-1.7% |
-3.7% |
2.8% |
-1.4% |
-4.0% |
|
2025-2032 maturities |
-5.4% |
-5.8% |
4.9% |
-5.3% |
-11.5% |
|
Totals |
-2.1% |
-2.9% |
3.4% |
-2.4% |
-4.1% |
Source: Lark Research estimates calculated from pricing data obtained from Barron's.
Further insight can be gained into the TIP sector by looking at the so-called breakeven spread, which is the difference between the yield on a straight Treasury security and the TIPS with the comparable maturity. This difference is viewed by many analysts as the implicit rate of inflation that is "built" into the straight Treasury yield. For example, the breakeven spread between a 10-year Treasury Note yielding 3.50% and a 10-year TIPS yielding 1.50% is 2.00%. All other things being equal, if you believe that inflation will average 2.00% over the 10-year period, then you should be indifferent between buying the Treasury Note or the TIPS. If you think that the average rate of inflation will be higher, you will earn more with the TIPS (because the annual inflation adjustment to principal will be higher). If inflation is less, the 10-year Treasury Note will give you a higher return.
Chart 4 provides the spread between 10-year T-Notes and 10-year TIPS over the past six years. It shows that the spread dropped sharply in 2008 during the financial crisis, almost to zero, but it has since climbed back near its historical average of 2.17%. This has happened even though the yield on 10-year TIPS, currently at 1.47%, is about 50 basis points below its long-term average of around 2.00%.
Chart 4
The Spread between the yields on the 10-year Constant Maturity TIPS
and 10-year Constant Maturity Treasury Note: 2003-2009
Source: Lark Research calculations from U.S. Federal Reserve data
Similarly, the 5-year spread at 2.11% is now above its 2003-2009 average of about 2.00%, after having fallen sharply negative during the 2008 financial crisis. The yield on the 5-year TIPS at year-end 2009 was just 0.53%, well below its 2003-2009 average of 1.51%.
Chart 3
The Spread between the yields on the 5-year Constant Maturity TIPS
and 5-year Constant Maturity Treasury Note: 2008
Source: Lark Research calculations from U.S. Federal Reserve data
Returns on TIPS mutual funds are given in Table 3 below. Average fund returns are roughly consistent with our total return calculations for the underlying TIPS, given in Tables 1 and 2 above.
Table 3
2009 Performance on Selected TIPS Mutual Funds
|
|
|
|
|
Performance |
Annual |
||
|
|
|
NAV |
4th |
One |
Three |
Five |
Expenses |
|
Fund Name |
Ticker |
31-Dec-09 |
Quarter |
Year |
Year |
Year |
as % |
|
Am. Cent. Inv. Infl. Adj. Bond |
ACITX |
11.47 |
1.90% |
10.30% |
6.40% |
4.20% |
0.74 |
|
Am. Cent. Inv. Infl. Prot. Bond |
APOIX |
10.25 |
2.00% |
11.10% |
6.70% |
NS |
0.84 |
|
BlackRock Infl. Prot. Bond A |
BPRAX |
10.70 |
2.00% |
10.20% |
7.30% |
5.20% |
0.69 |
|
Dimensional Infl. Prot. Sec. |
DIPSX |
10.88 |
2.20% |
11.00% |
7.00% |
NS |
0.15 |
|
Dreyfus Infl. Adj. Sec. |
DIAVX |
12.46 |
1.80% |
10.20% |
6.40% |
4.40% |
0.55 |
|
Fidelity Infl. Prot. Bond |
FINPX |
11.21 |
1.60% |
9.70% |
5.30% |
3.70% |
0.45 |
|
T. Rowe Price Inf. Prot. Bond |
PRIPX |
11.54 |
2.00% |
10.40% |
6.40% |
4.30% |
0.50 |
|
Schwab Infl. Prot. Sel. |
SWRSX |
10.43 |
1.80% |
9.20% |
5.80% |
NS |
0.50 |
|
Vanguard Inf. Prot. Bond |
VIPSX |
12.55 |
1.90% |
10.80% |
6.30% |
4.40% |
0.20 |
|
Averages |
|
|
1.91% |
10.32% |
6.40% |
4.37% |
0.51 |
Source: Wall St. Journal
See our other reports using the following links:
2010 Market Return on TIPS:
www.larkresearch.com/tipsreturns2010.htm
2011 Market Return on TIPS:
www.larkresearch.com/tipsreturns2011.htm
For additional commentary on TIPS performance in 2009 as well as ongoing analysis of stock, bond and mutual fund investments, subscribe to Income Builder, a newsletter published by Lark Research. You can view sample reports and take advantage of a special introductory subscription offer at www.larkresearch.com/income_builder.
January 6, 2010
Stephen P. Percoco
Lark Research, Inc.
P.O. Box 768
Norwood, MA 02062
www.larkresearch.com
(732) 763-0763
incomebuilder@larkresearch.com
© 2010 Lark Research, Inc. All Rights Reserved. Information is carefully compiled but not guaranteed to be free from error. Specific reference to any specific security should never be construed as a solicitation to either buy or sell. Reproduction without permission from the publisher is prohibited.