Wednesday, October 8, 2008

We've seen the bottom

I'll go out on a limb and say we've seen the bottom in stocks. This is a fantastic buying opportunity. TIPS are also a great buying opportunity, with long-dated TIPS trading with a real yield of almost 3%.

UPDATE: More on the TIPS opportunity. Earlier today you could buy TIPS (Treasury Inflation Protected Securities) maturing in 20 years with a real yield of almost 3%. These securities are guaranteed by the US government just as regular Treasury bonds are. They pay an annual coupon of 3%, and their principal amount is adjusted upwards based on the increase in the consumer price index.

There was a big selloff in TIPS today, for reasons I'm not yet aware of. The upshot is that the difference between the real yield on TIPS and the nominal yield on 20-year Treasuries fell to 1.4%. That means the market is figuring that the CPI will average 1.4% or so for the next 20 years. That's a remarkable assumption, given how weak the dollar is, and the fact that gold today is over $900/oz. If inflation ends up being 3-4%, then these securities will give you an effective nominal yield of 6-7% with NO RISK. If inflation is higher the yield will be higher.

Most important, though, is that these securities offer a 3% guaranteed real yield every year for the next 20 years. The long-term real yield on equities has not been a whole lot higher, and there is NO guarantee you will get any positive real yield on stocks going forward. So it's a valuable bird in the hand vs. two you don't know about in the bush. In short, TIPS today are very attractive relative to equities on a risk-adjusted basis.

UPDATE: Obviously I got this wrong. Fear has probably reached the level of irrational now (Oct. 9th).

No comments: