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1 September 2003 Financial Analysts Journal Volume 59, Issue 5

The Mystery of TIPS

  1. Robert D. Arnott

Practitioners are accustomed to thinking of TIPS (Treasury Inflation Indexed Securities) as an alternative to conventional bonds, not an alternative to stocks. But TIPS are not much different from stocks: Both securities provide income that rises with inflation, or a fall in the relevant real cost of capital. So, TIPS should be viewed as "government stocks." Yet, TIPS have yielded as much as four times the stock yield. The only explanation for this mystery is that many in the investment community still consider TIPS (if they consider these securities at all) to be an alternative to conventional bonds rather than an alternative to stocks. TIPS yields and stock market yields (plus a 1 percent growth premium) are the best measures of the cost of capital for, respectively, the government and the corporate world. Because of the parallels in the ways the two assets deliver returns to their investors, a comparison of the two is today's best measure of the relative attractiveness of stocks and bonds.

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