The U.S. Treasury is ramping up its issuance of inflation-protected securities (TIPS) this year, in order to address foreign investors' concerns about soaring fiscal deficits and the inflation risk they create. TIPS issuance for 2010 is expected to increase by approximately 40% over the amount sold in 2009. Should you be following China's and Japan's impetus and raising your exposure to TIPS?
How do TIPS work?
TIPS are government bonds with semi-annual coupon payments and principal that are indexed against inflation, using the Consumer Price Index (CPI). Individuals can purchase TIPS directly from the Treasury, but the iShares Barclays TIPS Bond Fund ETF (NYSE: TIP) is a more convenient option. The trouble is, while TIPS guarantee a positive after-inflation return, at 1.28% for the 10-year TIPS, the current "real yield" will only inch your purchasing power forward.
Traditionally, investors have sought protection against inflation in gold and other commodities, but there may be a more straightforward option.
A tip from Bill Miller
Last Tuesday, Bill Miller, the manager of Legg Mason's (NYSE: LM) flagship Value Trust fund remarked on CNBC that "the top 10 names in the S&P 500 today trade at around 12 times earning ... they should trade somewhere between 14 and 18 times earnings."
By my calculations, the market-value weighted price-to-earnings ratio for the basket of these 10 stocks is actually 16.3 (see table below), but half of them do trade below 15 times earnings: ExxonMobil (NYSE: XOM), Wal-Mart Stores (NYSE: WMT), Johnson & Johnson (NYSE: JNJ), IBM (NYSE: IBM), and Procter & Gamble (NYSE: PG).
| Category |
Dividend Yield |
Price / Earnings Multiple |
Long-Term Estimated EPS Growth |
|---|---|---|---|
|
Top 10 S&P 500 stocks -- market-cap weighted average |
1.7% |
16.3 |
11.2% |
Source: Capital IQ, a division of Standard & Poor's.
Lower initial yield ... with upside
Although the average dividend yield (which is a pre-inflation figure) for this basket of 10 stocks is lower than the real yield on TIPS, I'll take the former -- along with the 11% expected annual growth in earnings per share. My guess is that this basket will outperform TIPS on an inflation-adjusted basis over the next 10 years. More broadly, asset manager GMO has "high-quality" U.S. stocks (our basket certainly qualifies) earning an average real return of 6.8% over the next seven years, a full 6 percentage points ahead of its projection for inflation-indexed bonds.
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