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Is The Next Bubble In US Treasury Bonds? at Trader’s Narrative

Is The Next Bubble In US Treasury Bonds?

The mad rush into US government treasury bonds has pushed their yields to never before imagined levels. But according to the simple 1 year rate of change, we may be close or have already seen the end of this “bubble”, as this long term chart shows:

30 year US treasury bond yield long term chart 1 yr ROC

Although I think the bond market will return to its senses soon enough, US government bonds are not in a real “bubble”. But the extra-ordinary demand for US treasury bonds is at least partially responsible for the strength of the US dollar. Which I’m sure itself is surprising and confounding the gold bugs more than anyone else. After all, how can a near meltdown of the world’s financial system result in gold falling and the dollar going up? Isn’t that the exact opposite of what a sane person would expect to happen?

This recent chapter in financial history is chock full of unprecedented extremes and “Black Swans“. Among them, the yield inversion between equities and treasury bonds (Bloomberg):

dividend yield compared to 10 yr treasury yield bloomberg

Something that we haven’t seen in 50 years. And something that was just as jarring when it was witnessed in 1958. The sharp drop in rates is half the explanation, the other half is the dramatic rise in stock dividend yields.

Most market watchers are perplexed about what this means, if anything. The only explanation offered which makes some sense comes from Cliff Asness of AQR Capital:

From the 19th century through the mid-20th century, the dividend yield (dividends/price) and earnings yield (earnings/price) on stocks generally exceeded the yield on long-term U.S. government bonds, usually by a substantial margin. Since the mid-20th century, however, the situation has radically changed. In addressing this situation, I argue that the difference between stock yields and bond yields is driven by the long-run difference in volatility between stocks and bonds. This model fits 1871-1998 data extremely well. Moreover, it explains the currently low stock market dividend and earnings yields. Many authors have found that although both stock yields forecast stock returns, they generally have more forecasting power for long horizons. I found, using data up to May 1998, that the portion of dividend and earnings yields explained by the model presented here has predictive power only over the long term whereas the portion not explained by the model has power largely over the short term.

More about the relationship between dividend yields and US treasury bonds:

John Mauldin: Two Little-Noted Features Of The Markets And The Economy
Bloomberg: S&P 500 Payout Tops Bond Yield, a First Since ‘58: Chart of Day
Barron’s: Reversal of Fortunes Between Stocks & Bonds
Mark Hulbert: Stocks vs. bonds

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5 Responses to “Is The Next Bubble In US Treasury Bonds?”  

  1. 1 Stan The Man

    So the TLT is rocketing to new all time highs every day and the Fed/Treasury secretary have unlimited power and resources at their disposal, correct?
    The Housing markets need some form of stimulation. Rates for Mortgages are starting to drop as the Fed has said he is seeking 4% and possibly lower rates.
    Does this look the Fed is buying the 10year to achieve this result?

  2. 2 Avi

    The Fed is buying longer term bongs, as the short end is constrained by the zero rate. its called quantitative easing. I dont think this bubble has even gotten going yet. In a deflationary environment bonds are the best investment.

  3. 3 bob

    the difference is driven by expectations of equity risk and dividend growth. higher risk tends to push the equity yield up, higher growth tends to push it down. up until recently, the growth effect dominated the risk effect, now they are basically the same as perceptions of risk have increased and growth forecasts have been slashed.

  4. 4 Bolsaspain

    I believe that the markets it(he,she) has initiated a serious rebound.
    The experts say that still(yet) we have not come to the capitulation but what it(he) is true it(he,she) is that the markets estan overbooked and they need a “alteration” to continue going down.

    The graphs indicate upward(rising) differences in the MACD and the VIXth he(she) presents the H-C-H’s clearest figure, which of be confirming might give us a rebound of several months.

  5. 5 Shannon Melton

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