Thursday, November 11, 2010

Is it a Bubble if a Reversal is Already Priced into the Market?

Below is a chart of the 10 year Treasury yield and what the market is pricing in for the 10 year yield, ten years forward (along with the five year average of each).



What we see is that the current yield is well below the five year average (bringing up concerns there is a "bond bubble"), but we can also clearly see that the market is already pricing in the yield to rise to a level that is higher than its five year average in ten years.

If a reversion from these lows is already priced in (past its five year average), I don't see how we are in a bubble (i.e. "bubbles" are not supposed to be priced into the market).

Source: Federal Reserve

7 comments:

  1. Good question! A partial answer might be that the forward yield prices in uncertainty rather than just an expected value. The Cleveland Fed has a couple of research pieces along these lines regarding TIPS spreads:

    http://www.clevelandfed.org/research/commentary/2010/2010-5.cfm?WT.oss=inflation%20expectations&WT.oss_r=2670

    Note that while I think 10-year Treasuries are a terrible value, I do not see any classic characteristics of a bubble.

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  2. curious as to what you currently see as a better value?

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  3. For a 10 year holding period, I prefer gold, silver, large-cap US equities, small-cap Japan, Asia ex-Japan, ex-China, Mexico, global energy stocks, and probably some others. For the next 5 years, I mostly like cash for its optionality, physical gold using GLD as a hedge, and for income some MLPs, a handful of large-cap high dividend growers on dips, distressed credit (via mutual funds), and short-duration Ginnie Maes. And whatever opportunities arise along the way.

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  4. so basically everything else... fair enough

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  5. Love this post Jake, very mind bending.

    Great comments Namazu!

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  6. I read a thought-provoking piece on asset class valuation at the GMO Website. It's called Back to Basics, by Ben Inker, published 11/8.

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  7. GMO link here (free subscription may be required):

    http://tinyurl.com/39s3fzy

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