EC No, Bonds Aren’t Overvalued. They’re A Warning Sign

Bonds Are Sending A Warning

Currently, investors are exuberant in the financial markets due to the “Moral Hazard” created by the Federal Reserve. However, as stated in No Way, This Doesn’t End Badly,”

“Such is where fundamentals become extremely important. When, or if, expectations of recovery are disappointed, the market will begin to reprice itself for its intrinsic value. Given that the market is currently trading more than twice the level of underlying economic growth, which is where corporate profits come from, such suggests a significant risk.”

The correlation between the economic composite” and “rates” currently suggests that the “risk of disappointment” is elevated.

At the peak of nominal economic growth over the last decade, interest rates rose to 3% as GDP temporarily hit 6%. However, what rates predicted is that economic growth would return to its long-term downtrend line. In other words, while the stock market was rising, predicting more robust growth, the bond market was sending out a strong warning. 

Once again, economists predict 6% or better economic growth, yet interest rates are roughly 50% lower than previously. In other words, the bond market is suggesting that economic growth will average between 1.75% and 2% over the next few years.

From our view, rates matter. Given their close tie to economic activity and inflation, we think they will matter a lot.

Are bonds overvalued? No.

But stocks are, and the bond market is ringing alarm bells warning you of the same.

 

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William K. 1 month ago Member's comment

Interesting and profound! In addition, that statement,"While Central Bank interventions boost asset prices in the short-term, there is an inherently negative impact on economic growth in the long term." is so very correct, at least as it applies to the majority of folks. Based on the results over the past 60 or so years, if we look at real growth instead of inflated price growth, the benefit has not been there for a large portion of the population.

So it will be very educational to see what the future actually does bring.