Bonds: Valuation

Buy when the coloured lines are at the low end of their range, sell when they are high

This tool is intended to show the attractiveness of long-term bonds in real terms after allowing for inflation. It is designed not only to show the current position but also to provide a best guess as to the future trend. This is useful for spotting extremes of over- or under-valuation. It does so by measuring the real yield on bonds after inflation, in those countries where there is an active ten-year government bond market. For comparability, government bonds indexes have been rebased to set year-end 1994 at 100.

In each chart the bond price index is shown as the thick white line on the right hand axis. The main explanatory variable, the real yield, shown as the thin yellow line, uses the left hand axis. A Best Guess as to the future development of the valuation ratio is also shown on the left hand axis, as the orange line.

Best Guesses suggest what would happen to the valuation ratio based on forecasts for bond yields and inflation, assuming constant bond prices. The base level is the average for the last completed calendar year. Forecasts are consensus estimates.

An extreme of overvaluation does not necessarily indicate that negative returns are to be expected because returns also include the accumulation of interest earned. Furthermore valuation extremes can be worked off either by a change in bond prices or by a change in inflation.

Owing to the conversion of legacy currencies into Euros, analysis is provided on a common bond market denominated in Euros, rather than for individual countries. Historical data is provided by creating synthetic GDP-weighted time-series for the component currencies, expressed in the European Currency Unit.

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