TIPS are the Surprising Star of 2020

Despite a pandemic and plenty of political uncertainty, major asset classes are managing to ubiquitously produce positive returns for 2020. From U.S. mortgage-backed securities at +3.8% to the rapidly recovering U.S. cyclical equities at +26.4%, investors have been rewarded.

The average Sharpe ratio for major asset classes in 2020 does not compare to the heights seen in 2017 and 2019, but are nothing like many expected given the gravity of COVID-19. Hefty volatility incurred in March and April were ultimately dwarfed by strong year-over-year returns.

U.S. 10-year TIPS look poised to become the shining star of 2020 with a Sharpe ratio of 1.26. In fact, TIPS have not taken the top spot according to Sharpe ratios since 2002.

Remember TIPS began 2020 with a stellar gain of +7.2% through March 6th before liquidity issues caused a significant drawdown. The Federal Reserve’s bond purchases and programs (e.g. SMCCF) coupled with the CARES Act helped drive 10-year real yields below -100 basis points by late July. Fervent demand for inflation protection may look seriously overbought, but relative to U.S. Treasuries may still have room to run. U.S. 10-year TIPS breakevens are eyeing the 200 basis point hurdle heading into 2021.

The last chart below shows U.S. 10-year TIPS’ year-to-date total returns since 2002. Double digit returns are somewhat of a rarity. Ultimately, the pace of the recovery and realized inflation will dictate fixed-income performance in 2021. Looking past the inflation mirage, investors will need to see stronger month-over-month inflation gains to keep up this level of performance.

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