TIPS Aren't Working Despite Inflation

Stocks fell this week and bonds slipped again. Last week, I discussed how semiconductor ETFs are down a lot in Q3. They rallied this short week but are still down quarter-to-date.

A Look at the Market

The S&P 500 has returned 12.7% with dividends included, and the price is up 12.1% for SPDR S&P 500 ETF (SPY) in 2026 so far. This leaves the market on track to post a return for the full year right at under 19%. At the same time, iShares Core US Aggregate Bond ETF (AGG) has declined in price in 2026. With dividends included, the return has been -1.3%, which is well below cash.

Interest-rates are spiking higher, and many people are wondering why and what the implications might be. In July, when I discussed here that bonds are bad, rates were a bit lower than they are now. with the middle part of the curve getting hit the hardest. Here is the yield curve for U.S. Treasuries from Bloomberg:

With Fed Funds currently at 3.50-3.75%. unchanged so far this year, the rise in rates in the column on the far right really stands out. 3-month bills have declined from a year ago, when Fed Funds was at 4.25-4.50%, but they yield a lot more than the current Fed Funds rate. The 5-year Treasury has the highest increase over the past year.

I have been cautious on bonds for a long time, as I am concerned about the massive U.S. debt and its continuation of growth. Many were expecting the Federal Reserve to cut rates, but now the expectations are that they will rise to combat inflation, which remains high. Some attribute that to the rise in Energy costs due to the war with Iran, but, looking at the CPI numbers that were released today, the CPI grew 3.4% from a year ago, while CPI excluding food and energy, rose 2.4% from a year ago. This is above the Federal Reserve goal of 2%. I pay attention to the CPI-U, which is used for TIPS, and it rose 3.4% from a year ago.

While I have reduced my exposure to TIPS, it is still very high at 55.9% of the model portfolio and represents 100% of the fixed-income exposure in the model portfolio. Bloomberg posts the TIPS yields, and the 5-year TIPS closed at 2.36% today, which is 2.4% below the 5-year Treasury. The 10-Year TIPS is 2.38% lower than the 10-Year Treasury, and the 30-Year TIPS is 2.27% below the 30-Year Treasury. Since early July, when I discussed that TIPS look attractive, the yields have increased less than the Treasury yields. In that article, I pointed out that the breakeven inflation rate was about 2.25%, and now it is about 2.4%. Yes, TIPS are not performing well, but inflation is picking up. Here is how the three TIPS ETFs that I include in the model portfolio have performed on a price basis quarter-to-date:

I have been reducing VTIP. It has outpaced short-Treasuries on a total return basis in Q3, returning -0.10% with dividends compared to the 0.03% return for VGSH (which I exited). TIP has returned -1.62% compared to the -1.80% return for VGSH. LTPZ has returned -4.74% relative to the TLT return of -5.34%.

It's frustrating that there is such limited interest in the TIPS sector. People got very excited about TIPS after the pandemic hit, but were very disappointed if they held for too long. When the dividends and NAVs were jumping, investors in these ETFs were encouraged. Remember, inflation jumped from an annual 0% to above 8% and then came down to about 2.5%. This increase hasn't been as big, so nobody is that excited yet. Why? Because they can own AI stocks!

The economy is broadly weakening in so many ways, yet stocks keep rallying. Bonds have been in a bear market for a while and aren't attracting investors at these higher rates. Fears of inflation, which are very real in my view, should help TIPS, but they really aren't yet. I continue to believe that there are some very cheap stocks and some very expensive ones. The outlook for stocks will not improve if rates keep rising or if inflation accelerates. I think that the federal debt is a massive problem, and perhaps people will be more focused on it during the upcoming election season.

ETF Model Portfolio Update

This ETF model portfolio, which is measured against 60% SPY and 40% AGG, is up relative to its benchmark. This week, I did one trade again, which was published on here instead of on my Seeking Alpha blog. For those who would like real-time alerts (free of charge for now), just subscribe to the blog.

I posted no articles on ETFs or stocks this week.

Going into the week, my model portfolio equity exposure totaled 37.1%, spread out across two ETFs. Here is what I did this week:

• Wednesday: I sold more VTIP and added to ProShares S&P MidCap 400 Dividend Aristocrats (REGL).

• Thursday: I trimmed VTIP again and added to ProShares Russell 2000 Dividend Aristocrats ETF (SMDV).

• I sold some REGL and added to iShares TIPS Bond ETF (TIP).

  
  

Here is the current model portfolio, which now has 43.7% equity exposure in two ETFs and fixed income exposure in three TIPS ETFs that total 55.9%:

I have been wrong this year, at least so far, as stocks keep rallying. The rally had been until Friday thirteen weeks ago (June 5th), when stocks had their worst day of the year. Since then, the S&P 500 and the Russell 2000 have made new highs. Despite being underweight stocks all year, my return relative to the 60/40 index is higher by about 3.0% in just over eight months. As the S&P 500 and the Aggregate Bond Index fell, the model portfolio, which was down a bit more, underperformed the index.

The year-to-date strong relative performance is not due to superior returns on my current equity ETFs. My TIPS ETFs have done okay relative to AGG, but they aren't exactly boosting the return. So, what has it been? I have had positive returns from three ETFs, two of which I no longer hold and one of which is down a lot year-to-date that I just repurchased recently, and there has been some good trading.

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My ETF articles at Seeking Alpha, written under the alias The Intelligent ETF Investor, shared a lot of my ideas. I continue to share those ideas here on this blog.