"Mother, should I trust the Government?"

Mother, do you think they'll drop the bomb?
Mother, do you think they'll like this song?
Mother, do you think they'll try to break my balls?
Mother, should I build the wall?
Mother, should I run for President?
Mother, should I trust the government?
Mother, will they put me in the firing line?
Is it just a waste of time? 

"Mother" by Pink Floyd

Due to my career (investing) and my wife's career (accounting) we tend to hang out with a lot of number crunchers (CFA's & CPA's), and no matter what you've heard, I can personally attest to the fact that they are not all boring. People who make a living with numbers tend to love the exactness of math, I'm sure the same is true for engineers and most scientist's. Math has a purity to it, in a rather impure world. On todays editorial page in the WSJ Michael J. Boskin writes an excellent piece on how there recently seems to have been an attack on numbers at an unprecedented scale. "Politicians and some scientists, when confronted with data they do not like, have taken to simply changing the numbers. They believe that their end -- socialism, global climate regulation, health-care legislation, repudiating debt commitments -- justifies throwing out even minimum standards of accuracy. It appears that no numbers are immune: not GDP, not inflation, not budget, not job or cost estimates, and certainly not temperature. A CEO or CFO issuing such massaged numbers would land in jail." I, like most citizens of the world have always distrusted the government, or more specifically, politicians, but I always held out hope for scientists. But it even seems that some scientists aren't above trying to push forward their agenda when the numbers don't support it. The most recent blatant example was the efforts by some climate researchers at the University of East Anglia, attempting to hide or delete temperature data when the data didn't show global temperatures rising, in order to halt the publication of studies that differed from their conclusions. Of course Al Gore will run with the numbers that support his case even if they are phony, but to see scientists doing it is just an affront to all lovers of numbers.

OK, if you're still with me you are probably wondering what this has to do with investing? Well so much of what we do as investors is based on data that we receive from the government, and we constantly have to ask ourselves, "Mother should I trust the government?" A timely example is the Consumer Price Index (CPI). CPI is calculated by the governments Bureau of Labor Statistics and is widely used as the nations inflation gauge. Now it has been obvious for some time that it is in the governments best interest to keep reported CPI low, it keeps borrowing costs low, it keeps payments low on inflation adjusted cost-of-living entitlement increases, and it helps stimulate growth through borrowing. Where this becomes an issue for investors is when it comes to buying the right kinds of inflation protection. One very popular inflation hedge has been Treasury Inflation Protected Securities (TIPs). TIPs are issued by the treasury and are designed to pay a fixed return above the rate of inflation, so if inflation goes up the value of your TIPs will go up. The problem is that the creditor issuing the TIPs is the same entity calculating the CPI. So TIPs have flaws when it comes to protecting your portfolio from true inflation, they probably understate the return on true inflation, and in periods of high inflation they will probably lag even more. But, what are the alternatives? As with so much in the investment world, it is all relative. TIPs will clearly outperform bonds in an inflationary environment, and the default risk is minimal. Will they perform as well as gold or REITs, probably not. 

Part of our global tactical asset allocation model is allocated to TIPs (currently 8%), but we also own an International Government Inflation-Protected Bond ETF (WIP at 3%) that invests in 18 countries (diversifying our sovereign risk and our lying risk). Last year WIP outperformed, TIP 17.14% to 8.89%, due mostly to the decline in the value of the dollar. We also have exposure to both gold and REITs. TIPs are not perfect inflation hedges, but they are a valid diversifying tool, as long as the numbers can be at least partially trusted. As with all of our ETFs, if they don't track the underlying benchmark closely enough, or they don't give us the return and risk characteristics we expected them to, then we'll just have to find a better alternative. "Mother should I build the wall?"

Chris Wiles

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.