For our entire careers the US budget deficit has hung over markets like the sword of Damocles. It was a political issue in 1992 when Bill Clinton beat George Bush, a victory enabled by Ross Perot siphoning off Republican voters with his warnings of fiscal catastrophe.

Under Clinton we briefly ran a budget surplus, part of an improving trend Bush had started by reneging on his pledge to not raise taxes (“Read my lips. No new taxes”). That cost Bush the election, and as the Clinton surplus melted away so did popular concern about the deficit. Today there are no fiscal hawks, because they can’t get elected. The bull market in bonds that started in 1982 lasted almost four decades. But it’s over.

When investors consider America’s ballooning debt, they shake their heads at the looming disaster and then forget about it as they select asset classes and securities. Few consider what it might mean for their portfolios.

In the 1970s bond investors suffered negative real returns as inflation rose faster than interest rates. Paul Volcker famously crushed inflation, but bond investors soon demanded higher real returns that briefly touched 10% as compensation for the risk of inflation’s return. Nominal and real yields steadily fell as inflation remained quiescent.

Yields on ten year Treasury Inflation Protected Securities (TIPs) have declined more or less continuously since their first issuance in 1982. Because investors care about returns net of inflation, the decline in real returns has affected all asset classes. The drivers are complex and the subject of much academic research. Inflation uncertainty can cause investors to demand higher returns, which is why the Fed is so focused on restoring it to 2%. Broad technological advancement can improve productivity, driving realized real returns higher, as can an increased need for capital. Central bank buying of bonds, Quantitative Easing, has depressed real returns.

There’s no accepted method for forecasting what real returns will be. But it’s clear that investors want them higher.

TIPs have provided a reasonable forecast on future returns. The third chart overlays ten year TIPs with the subsequent ten year bond return. The 1992 trailing ten year bond return was 8%. In 1982, ten year TIPs yielded 7%. The forecast reflected in this yield was within 1% of what bond buyers realized over the following decade.

It’s in this context that we should consider today’s rising TIPs yields. The downward trend is over. Real yields, which were inexplicably negative during the early stages of the pandemic in 2020, have moved up through 2% and are close to 2.5%.

Treasury Secretary Janet Yellen believes it’s because of the strong economy. US GDP rose 4.9% in 3Q23, driven by a 4% increase in consumption expenditures. Other factors could be at work. Bonds have benefited from substantial buying by the Fed and other central banks who aren’t return oriented. The Fed is now letting its balance sheet shrink. China is reducing its exposure. Perhaps they’re worried about these assets being frozen if at some point we’re at conflict over Taiwan.

The fiscal outlook could be another consideration. As non-commercial buyers are withdrawing, the return-oriented investor is the marginal buyer. Three month t-bills at 5.5% look attractive. But are thirty year bonds at 5% offering sufficient compensation for the chart at the beginning of the blog? The Fed’s commitment to 2% inflation is only as strong as the desire in Congress to support them. Taming inflation caused by the pandemic has brought forward by two years the point at which interest expense equals 3% of GDP (from 2030 to 2028). Higher rates have a deleterious effect on our fiscal outlook, because we owe so much money.

At some point over the life of the new thirty year bond the US Treasury will sell next month, the constraint posed by interest expense on discretionary spending is likely to become a topic of Congressional debate. The fealty to 2% inflation will be considered alongside other worthy goals.

Populism continues to promote deceptively simple solutions to today’s complicated problems in both political parties. We may endure another government shutdown as the new Republican speaker, whose views are right of his predecessor, pursues the facile and incorrect path of refusing to pay for what you said you’d pay for.

Populists aren’t a good credit risk.

Naturally a blog on midstream energy infrastructure will express the belief that it offers protection from the reckoning of decades of fiscal incontinence. Meaningful cash returns now will be preferable to the delayed gratification of future growth when the purchasing power of those deferred cash flows is uncertain.

Rising TIPs yields may just reflect the dawning realization of what investors already know – that our fiscal future is unlikely to be pain-free.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

Important Disclosures

The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy,  completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments.  Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)

This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r

Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.

All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.

Past performance of the American Energy Independence Index is not indicative of future returns.