Are Bond Yields Too Low?

Bonds have had a dream run since bottoming late last year, particularly the longer end of the curve (I checked one popular longer-term US Treasury ETF and it was up almost 30% off the low point!). Interestingly enough that followed a period of fairly miserable performance last year (mark to market returns were worse than -10% for the year at one point). It's often the case in markets that you see this taxonomy of price action.

That is, miserable performance is often followed by fantastic performance, and when it runs "too far too fast" the opposite plays out. This tends to be especially the case when the misery/euphoria is particularly accentuated in terms of speed/magnitude.

And so, with bonds having a particularly accentuated euphoric run (fair to say both in terms of speed + magnitude), I think it's definitely worth asking if bond yields are too low.

I have a few charts I wanted to share with you on this topic, and the first one is perhaps a little bit controversial - but bear with me. It shows the 10-year treasury yield against the 10-year growth rate in US nominal GDP (with IMF forecasts shown for the projection period). And it's fair to say that something seems a little off here...

(Click on image to enlarge)

Indeed, a couple of things should be standing out at this point. First: bond yields over the long run tend to roughly follow the path of longer term nominal growth. Second: bond yields have significantly diverged from the same recently. Third: the degree of divergence is similar to when we saw previous major cyclical/short-term bottoms in yields. 

Basically, it's another way of saying that bonds are overvalued.

And on my metrics, they look extremely overvalued, in fact, my composite valuation model shows US 10-year treasuries as the most expensive on record... or said differently, on this model, bond yields are certainly in the "too low" space.

(Click on image to enlarge)

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