“ Why should the negative 'return' on 10-yr TIPS be giving you problems?

“ Investors want a TOTAL return, that is capital plus[or minus] income, so they are assuming there will be a capital lift.

“ Sure, it's a valuation anomaly that generates an interesting chart, because the instrument was issued with a formula-type coupon.

“ But the emergence of the reverse-yield gap in the 60s was also thought to be fairly freaky. Now, the market once again sees inflation coming but it will only be with hindsight that asset survival will be accurately predicted. ”

Eoin Treacy's view Thank you for this email which may also be of interest to the Collective. TIPS offer a very convenient way of depicting the negative real interest rates which predominate across the fixed income sector.. As you point out, total return is of the utmost importance. However, it is also important to appreciate what is contributing to that return.

As I pointed out on Friday TIPS yields remain in a consistent downtrend whose chief consistency characteristic is a progression of lower rally highs. The total return on US Treasuries remains in a consistent uptrend and we will know what a loss of consistency looks like when it occurs. For the meantime the benefit of the doubt has to be given to the upside. However, to rely on hindsight for prediction in a market with bubbly characteristics is akin to closing the barn door after the horse has bolted.

When real interest rates are negative and have been trending lower for a long time, then I believe it is reasonable to conclude that the valuation proposition is becoming increasingly less convincing. The argument that this market is reliant on momentum appears more rational, particularly when the Fed is so active in the Treasury market.

Perhaps more important is the fact that high quality equities are outperforming by a considerable margin. Since the beginning of the year, the S&P500 Dividend Aristocrats total return index has outperformed the Merrill Lynch 10yr+ futures total return index by 11.3%. Total returns on government bonds have been less volatile than stocks but that does not mean the situation will persist indefinitely and one is sacrificing significant potential returns for that lower volatility.