Mutual Fund Buzz: Inflation or Deflation—What's It Going to Be?

Monday saw the first-ever TIPS sold with a negative yield.

By SHARE

Monday was an historical day for the Treasury Inflation-Protected Securities (TIPS) market. For the first time ever, a group of TIPS were sold with a negative yield, of -0.55 percent. Investors generally use TIPS to protect their money from inflation. These securities are intended to generate a gradually rising stream of interest payments as inflation rises. The question is: Why would anyone buy a security that looks like it will trail the Consumer Price Index slightly? Mark Hulbert of Marketwatch has the answer. "According to Luis Viceira, a professor at Harvard Business School, TIPS don't just provide protection against unexpectedly high inflation; they also protect the investor from deflation as well," Hulbert writes.

[See top-rated funds by category ranked by U.S. News Score.]

Hulbert, who edits The Hulbert Financial Digest newsletter, goes on to detail how investors who purchased this security could benefit in both an inflationary and deflationary environment. If investors see high inflation of, say, 5 percent over the next five years, the TIPS sold on Monday will have an average yield of 4.45 percent. (The TIPS were issued with a five-year maturity.) Compare that with today's dismal treasury yields. On the other hand, if the Consumer Price Index declines by 2 percent over the next five years, the investor would get a real return over the next five years of 1.45 percent annually, according to Hulbert. With all the uncertainty in the markets right now, he sees it as a win-win situation for investors.

MarketWatch: Heads I win, tails I win too

[See U.S. News's How to Inflation-Proof Your Portfolio.]

Inflation concerns are growing as many investors are predicting that the Federal Reserve will initiate another round of quantitative easing at its rate announcement meeting next week. PIMCO's chief executive, Mohamed A. El-Erian, said that since the Fed is scared of deflation, it will do anything to spur inflation, according to Bloomberg. "One thing that the Fed cannot do is stand still, it is terrified of deflation," El-Erian said. "[Quantitative easing] on its own means we'll have the same issues in six to nine months time with the rest of the world being inflated." U.S. bond yields show that investors increased bets on inflation to the highest level since May. The difference between yields on 10-year notes and TIPS, a gauge of trader expectations for consumer prices, widened to 2.18 percentage points, matching the most since May 19, according to Bloomberg.

Bloomberg: Fed's Deflation Terror to Spur Easing, Inflation, El-Erian Says

[See U.S. News's Why Quantitative Easing Could Be a Mistake.]

Democrats and Republicans may both have something to celebrate after the midterm elections: A stock market rally. From 1922 to 2006, the average gain of the Dow Jones Industrial Average over the 90 trading days following midterms (roughly November until mid-March) was 8.5 percent, according to a new study authored by Brian Gendreau, market strategist for Financial Network. That's almost 5 percent higher than the Dow's gains in non-election years.

It's rare to find a trend this consistent, Gendreau says. The Dow has risen following 19 of the last 22 midterm elections. He attributes the Dow's rise in the past to a number of different factors, but mainly the idea that with a greater balance of power between the White House and Congress, compromise is generally more likely. That's something he says the markets seem to like. Since 1942, the party in control of the White House has lost an average of 28 seats in the House and four in the Senate.

[See U.S. News's Why the Dow Usually Rallies After Midterm Elections.]