Tech stocks are overpriced. It’s possible that the tech sector is in a bubble.
Now, it’s not clearly a bubble since rapid growth is expected. If earnings grow fast enough, then stock prices could go higher.
However, that doesn’t mean investors should plunge fearlessly into tech. This sector is priced as if every company will be a winner.
Another sector priced for perfection is the fixed income (or bond) market. Bond yields are low, which implies slow growth.
The link between yields and growth forecasts isn’t widely followed by individual investors. But it should be.
Why Investors Need to Watch the Bond Bubble
Yields, or interest rates, are the price of money.
When companies are growing rapidly, they should expand. Expansion costs money, and they often borrow to fund those costs.
As more companies compete for funding, they raise the price of money.
Based on expectations reflected in stock prices, we should see interest rates rising. But they aren’t. Instead, they remain at record lows.
That means bonds are priced at record highs.
The chart below shows the prices of 10-year Treasury notes. Prices of bonds rise as interest rates fall.
The chart shows a 39-year trend of falling rates and higher prices.
This could be a bubble, a market that’s priced irrationally.
Interest rates on 10-year Treasury notes are below 2%. Inflation is likely to be more than 2%.
The Federal Reserve’s policy recently changed because, as Chairman Jerome Powell noted, the economy is expected to run hot, and higher inflation is likely.
If inflation exceeds yields, then bondholders lose buying power.
For retirees, this means they could lose the ability to maintain their lifestyle.
For state and city pension funds, this means they won’t be able to fund payments without raising taxes or cutting services.
This chart of 10-year Treasury notes is the chart investors should be worrying about. Yet, few are.
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Michael Carr, CMT, CFTe
Editor, One Trade