Extras RouteMap: Real Yield after Inflation

Buy when the yellow line is low, sell when it is high

Sample of chart showing correlation between bond prices and real yield after inflation (left scale inverted). Forecast year on year changes shown in orange.

This strategy shows how under- or over-valued alternative assets are in real terms after allowing for inflation. 

Given the wide diversity of alternative assets, the most suitable valuation ratio varies by asset class. For inflation-linked bonds it is their nominal yield. For corporate bonds it is the real yield after inflation. For private equity it is the cyclically-adjusted real PE ratio for smaller companies. For hedge funds it is the appropriate choice between those two. As commodities do not generate income, we have utilised instead an estimate of replacement cost calculated by ourselves.
 
The asset index is shown in as the thick white line on the right hand axis. The explanatory variable, the yellow line, uses the left hand axis. For comparability, our indices have been rebased to set year-end 1994 at 100. Please note the differences between charts in the Extras RouteMap and those for other RouteMaps. Since income is a major consideration for investment, alternative asset indices are shown as total return and not in terms of price only.
 
Owing to the conversion of legacy currencies into Euros, analysis of corporate bonds is based on Germany and index-linked bonds is based on France. For Private Equity our proprietary index is a capitalisation-weighted average of leading quoted private equity holding companies and asset managers.  
 
While this valuation ratio is important as the ultimate measure of value for long term bonds, it has fluctuated wildly in a very lagged response to inflation in previous years and recently also during flights to safety. Therefore it has been of little predictive use.