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Stretched bond valuations pose questions for treasurers

In this edition of Treasury Insights, we look at current bond and equity valuations in a historical context and ask what this means for treasury planning.

We came across a telling piece of data crunching from Deutsche Bank credit strategist Jim Reid in which he suggests that we are currently witnessing the most elevated aggregate global asset prices in history. Using data from 15 developed economy government bond and equity markets going back to 1800, Reid shows that on aggregate, an equally weighted bond and equity portfolio has never been as expensive as it currently is.

The charts above show that while equity valuations are elevated and exceed the peak of 1929, they are still shy of previous equity market highs in 2000 and 2007. Bonds on the other hand are less ambiguous in being more expensive by some stretch than at any other point since 1800, the nearest peak being the immediate aftermath of WW2.

Jim Read’s conclusion: While there are no obvious triggers for historically high global asset valuations to correct, while they remain this high there is always a risk of a sudden correction that could be destabilising to a financial system and global economy that seems to require such elevated asset prices.

This might resonate both with treasurers who witnessed the sharp and sudden increase in gilt yields (25bps) and swap spreads during last week and anyone who believes in longer term mean reversion in financial markets. The near-term question for UK treasurers is whether the Gilt market is over-sold and we will see it settle down with another reduction in yields over the coming weeks. That is a difficult call. But what is looking a lot more certain is that the pressure for a rise in interest rates is building and having tested the 1.90% level once before, will this yield shortly push through 2%? The is good evidence to suggest that it will.

Of course, there have been many premature calls on the end of the 30+ year bull market in rates, but equally, historical context provides a useful guide for treasury professionals making longer term decisions around funding and risk management. If the bond vigilantes do ever wake from their slumber, the path back to median bond valuations (let alone an overshoot to below median) could be a rocky one.