A lot of people are asking me what I think of Bernanke’s testimony before Congress this week. He has been explaining how he is going to deftly remove the 900% increase in bank reserves from the market before it turns into inflation. Here’s my answer. I have started adding inflation-protected bonds to my portfolio.
When you buy inflation-protected bonds (we call them TIPS in the U.S.) you are basically shorting the central bank. I think that is a good idea today, especially for the U.S.. Here are some ideas how to do it.
For the U.S. you can own IPE and/or TIP. Both are bond portfolios and, therefore, negatively impacted by rising interest rates. The biggest difference is the duration (a measure of the sensitivity of its price to a change in interest rates; you can think of it as the weighted-average maturity.) The duration of IPE is 7.89, roughly double the 4.02 duration of the TIP. That means a one percentage point increase in the level of bond yields, say, from 4.0% to 5.0% will reduce the value of IPE by 7.89% but only reduce the value of TIP by 4.02%.
Another idea is WIP, the exchange traded fund that attempts to reproduce the performance of the non-U.S. inflation-indexed bond sector. That is important today because the primary inflation risk in the world today is the Fed’s 900% increase in bank reserves since last September. That reserve increase won’t only push U.S. inflation up; it will push the dollar down against the Euro, the yen and other currencies. By owning WIP you own bonds that are protected against inflation in other countries and a drop in the dollar. The duration of WIP is 8.87, which means the bonds are of somewhat longer maturities than the U.S. portfolios above. It is made up of inflation-protected bonds from a number of countries. Its largest holdings are UK (20.4%), France (17.6%), Sweden (5.8%), Canada (5.3%), Italy (5.2%). These are all “museum economies”, places that have become calcified and stopped growing but are still great places to go on vacation to visit the museums.
I like the idea of keeping my equity bets in places that are groaing (China, Singapore, Korea, Brazil, Russia, India) and my (inflation-protected) bond bets in museums. I own all 3 of the stocks I have discussed above.
Oh, and the Bernanke testimony. The Fed has no chance at all of pu;ing off the maneuvre he talked about this week and sucking nearly a trillion dollars of bank reserves out of the banking system without knocking something over. These are the same idiots who created this mess in the first place.
JR
