The (Currently) Most Overvalued Assets

Earlier this week I ran across an interesting article on overvalued assets. In it, the author highlighted what, in his opinion are currently the three most overvalued asset classes. Care to guess what they were?

For starters, I’ll tell you a couple of things that weren’t on the list: stocks and gold. While the stock market has certainly had its ups and downs in recent years, they’re not particularly overvalued at present — at least not relative to historical valuations. Consider, for example, that the P/E ratio of the S&P 500 currently stands just above 16 vs. the historical average of just under 15.5.

As for gold — which still gives me the heebie-jeebies, in part because it’s just so hard to value — the meteoric price increases of the past few years seem to have flattened out but prices are still quite high. Consider, for example, that the gold:oil ratio (i.e., the price of an ounce of gold divided by the price of a barrel of oil) is hovering around 20. Not unheard of, but it’s near the high end of its historical range. Nonetheless, gold didn’t make the list.

So what did make the list? Bonds. With interest rates at historic lows, bond prices are at historic highs — that’s how it works. When rates on new issues fall, the value of existing bonds naturally increase. And when rates on new issues increase, the value of existing bonds decreases.

Number one on the list was long-term treasury bonds. Yields on long-term treasuries have fallen dramatically since 2007, when they stood at 5.25%. Now in the mid-1% range, they can’t go too much lower. And at some point, they will move higher, causing prices to tumble.

Next up, Treasury Inflation-Protected Securities (TIPS). We’ve talked recently about TIPS and the fact that they can help protect your portfolio against the insidious effects of inflation — but also that they’re quite expensive rate now and carry a lot of interest rate risk.

As it turns out, when you subtract the inflation adjustment from TIPS yields, you arrive at a negative value. In other words, you’re actually paying the government (in real terms) to hold these bonds. And when rates rise, prices will fall, just like with any other bonds.

And finally, high yield corporate bonds. As it turns out, high yield corporate bond yields have nearly reached all-time lows, meaning that the prices of such bonds are nearing all-time highs.

Other candidates for the list include real estate investment trusts (REITs) and master limited partnerships (MLPs) — basically anything with the potential for income generation.

So what’s an investor to do? Your guess is as good as mine. As for me, I’m sitting tight. We have an investment allocation that we’re comfortable with and we rebalance whenever things get out of whack. Thus, we’re automatically selling high and buying low (at least in a relative sense).

What about you?