1. Asset valuation
Overall, asset valuations and risk appetite remain somewhat elevated
Asset valuations remain high relative to their historical ranges in several major markets, suggesting that investor appetite for risk is elevated. Compared with the previous FSR, valuation pressures have eased slightly. Equity prices relative to forecast earnings remain above the median value over the past 30 years. Spreads on high-yield corporate bonds over benchmark rates are inversely related to valuations and are low relative to their historical range. However, spreads on leveraged loans over benchmark rates have widened since the previous FSR and now are above the median value over the past 20 years. Prices have been growing faster than rents in commercial and residential real estate for the past several years, although price increases in residential real estate have recently slowed somewhat.
Table 1 shows the size of the asset classes discussed in this section. The largest asset classes are those for residential real estate, equities, and commercial real estate (CRE).
Table 1. Size of Selected Asset Markets
Item | Outstanding (billions of dollars) |
Growth, 2018 (percent) |
Average annual growth, 1997–2018 (percent) |
---|---|---|---|
Residential real estate | 33,945 | 5.3 | 5.5 |
Equities | 30,476 | -7.8 | 7.8 |
Commercial real estate | 18,409 | -.1 | 7.1 |
Treasury securities | 15,566 | 7.8 | 7.5 |
Investment-grade corporate bonds | 5,712 | 4.9 | 8.6 |
Cropland | 2,523 | 2.2 | 5.7 |
High-yield and unrated corporate bonds | 1,256 | -4.1 | 6.5 |
Leveraged loans* | 1,147 | 20.1 | 15.8 |
Price growth (real) | |||
Commercial real estate ** | -1.4 | 2.0 | |
Residential real estate*** | 2.4 | 2.1 |
Note: The data extend through 2018:Q4. Growth rates are measured from Q4 the year immediately preceding the period through Q4 of the final year of the period. Equities, real estate, and cropland are at market value; bonds and loans are at book value.
* *The amount outstanding shows institutional leveraged loans and generally excludes loan commitments held by banks. For example, lines of credit are generally excluded from this measure. Average annual growth of leveraged loans is from 2000 to 2018:Q4, as this market was fairly small before then.
** **One-year growth of commercial real estate prices is from Dec. 2017 to Dec. 2018, and average annual growth is from Jan. 1998 to Dec. 2018. Both growth rates are calculated from value-weighted nominal prices deflated using the consumer price index.
*** One-year growth of residential real estate is from Dec. 2017 to Dec. 2018, and average annual growth is from Jan. 1997 to Dec. 2018. Nominal prices are deflated using the consumer price index.
Source: For leveraged loans, S&P Global Market Intelligence, Leveraged Commentary & Data; for corporate bonds, Mergent, Inc., Corporate Fixed Income Securities Database; for cropland, Department of Agriculture; for residential real estate price growth, CoreLogic; for commercial real estate price growth, CoStar Group, Inc., CoStar Commercial Repeat Sale Indices (CCRSI); for all other items, Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States."
In Treasury markets, yields and term premiums are low
Since the previous FSR, yields have fallen for longer-dated Treasury securities (figure 1-1). Treasury term premiums capture the difference between the yield investors require for holding longer-term Treasury securities—whose realized returns are more sensitive to risks from future inflation or volatility in interest rates than shorter-term securities—and the expected yield from rolling over shorter-dated ones. Estimates of Treasury term premiums are near the lowest level of the past 20 years, and an increase in term premiums, if not accompanied by a strengthening of the economic outlook, could put downward pressure on valuations in a variety of markets (figure 1-2). Forward-looking measures of Treasury market volatility derived from options prices are also low by historical standards (figure 1-3).
1-1. Yields on Nominal Treasury Securities
The 2-year and 10-year Treasury yields are the constant-maturity yields based on the most actively traded securities.
Source: Federal Reserve Board, Statistical Release H.15, "Selected Interest Rates."
1-2. Term Premium on 10-Year Nominal Treasury Securities
Term premiums are estimated from a three-factor term structure model using Treasury yields and Blue Chip interest rate forecasts.
Source: Department of the Treasury; Wolters Kluwer, Blue Chip Financial Forecasts; Federal Reserve Bank of New York; Federal Reserve Board staff estimates.
1-3. Option-Implied Volatility on the 10-YearSwap Rate
Implied volatility on the 10-year swap rate 1 year ahead, derived from swaptions.
Source: Barclays PLC, Barclays Live.
Spreads on high-yield corporate bonds remain low, while spreads on leveraged loans have widened somewhat from very low levels
The drop in Treasury yields since October has been accompanied by declines in corporate bond yields, which remain at low levels compared with history (figure 1-4). However, spreads on corporate bonds over comparable-maturity Treasury securities, which reflect the extra compensation investors require to hold debt that is subject to default or liquidity risks, are at levels similar to those observed in the previous FSR (figure 1-5). High-yield corporate bond spreads, in particular, are a fair bit below their 20-year median. However, investor appetite for corporate bonds seems to have decreased moderately in recent months. The excess bond premium, which is measured as the gap between bond spreads and expected credit losses and is inversely related to investor risk appetite, is above the low levels observed in recent years and has increased since the previous FSR (figure 1-6).5
1-4. Corporate Bond Yields
The 10-year triple-B reflects the effective yield of the ICE BofAML 7-to-10-year triple-B U.S. Corporate Index (C4A4), and the 10-year high-yield reflects the effective yield of the ICE BofAML 7-to-10-year U.S. Cash Pay High Yield Index (J4A0).
Source: ICE Data Indices, LLC, used with permission.
1-5. Corporate Bond Spreads to Similar-Maturity Treasury Securities
The 10-year triple-B reflects the effective yield of the ICE BofAML 7-to-10-year triple-B U.S. Corporate Index (C4A4), and the 10-year high-yield reflects the effective yield of the ICE BofAML 7-to-10-year U.S. Cash Pay High Yield Index (J4A0). Treasury yields from smoothed yield curve estimated from off-the-run securities.
Source: ICE Data Indices, LLC, used with permission; Department of the Treasury.
1-6. Corporate Bond Premium over Expected Losses
Data are normalized to have a sample mean of 0 and standard deviation of 1.
Source: Federal Reserve Board staff calculations based on Lehman Brothers Fixed Income Database (Warga); Intercontinental Exchange, Inc., ICE Data Services; Center for Research in Security Prices, CRSP/Compustat Merged data, Wharton Research Data Services; S&P Global Market Intelligence, Compustat.
Interest rate spreads on newly issued leveraged loans, which widened substantially late last year, reversed part of those increases in the first quarter (figure 1-7). Spreads on lower-rated leveraged loans are above both their historical median and their levels in the previous FSR. Lending standards and loan covenants generally remain weak, reflecting high investor demand for leveraged loans in recent years (see the box "Vulnerabilities Associated with Elevated Business Debt").
1-7. Spreads on Newly Issued Institutional Leveraged Loans
Breaks in the series represent periods with no issuance. Spreads are calculated against three-month LIBOR (London interbank offered rate). The spreads do not include up-front fees.
Source: S&P Global, Leveraged Commentary & Data.
Equity market prices relative to forecast earnings appear somewhat elevated
Over the past couple of years, equity prices have been generally high relative to forecast earnings. The S&P 500 forward price-to-earnings ratio dropped significantly over the last two months of 2018, but it subsequently reversed this decline and is now slightly above both its October level and its median value over the past 30 years (figure 1-8). The gap between the forward earnings-to-price ratio and the 10-year real Treasury yield, a rough measure of the premium investors require for holding equities, is still low relative to its range over the post-crisis period but is slightly higher than it was in the previous FSR (figure 1-9). This premium, however, is well above the low levels seen during the dot-com era. Both realized and option-implied equity market volatility spiked in December and have declined since (figure 1-10). The option-implied volatility measure, which in part reflects expectations about market volatility in the next month, is low by historical standards.
1-8. Forward Price-to-Earnings Ratio of S&P 500 Firms
Aggregate forward price-to-earnings ratio of S&P 500 firms. Based on expected earnings for 12 months ahead.
Source: Federal Reserve Board staff calculations using Refinitiv (formerly Thomson Reuters), IBES Estimates.
1-9. Spread of Forward Earnings-to-Price Ratio of S&P 500 Firms to 10-Year Real Treasury Yield
Aggregate forward earnings-to-price ratio of S&P 500 firms. Based on expected earnings for 12 months ahead. Real Treasury yields are calculated from the 10-year CPI inflation forecast and the smoothed nominal yield curve estimated from off-the-run securities.
Source: Federal Reserve Board staff calculations using Refinitiv (formerly Thomson Reuters), IBES Estimates; Department of the Treasury; Survey of Professional Forecasters.
1-10. S&P 500 Return Volatility
Realized volatility estimated from five-minute returns using an exponentially weighted moving average with 75 percent of the weight distributed over the past 20 days.
Source: Bloomberg Finance LP.
Commercial real estate prices are high relative to rents...
CRE prices have increased substantially over the past seven years, though prices for large commercial properties are similar to one year ago (figure 1-11). However, rents, in real terms, have been stagnant over the past year for most CRE sectors. Capitalization rates, which measure annual rent income relative to prices for recently transacted commercial properties, have been declining steadily since 2010 and are at historically low levels (figure 1-12). Spreads of capitalization rates over yields on 10-year Treasury securities, which are a rough measure of the premium that investors require for holding CRE over very safe alternative investments, have trended down over the past few years and are now at post-crisis lows, although well above the low levels seen in the mid-2000s (figure 1-13). Data from the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) indicated that CRE lending standards at banks had tightened a bit over the fourth quarter of 2018, which may suggest a modest reduction in risk appetite on the part of lenders (figure 1-14).
1-11. Commercial Real Estate Prices (Real)
Series deflated using the consumer price index and seasonally adjusted by Board staff.
Source: CoStar Group, Inc., CoStar Commercial Repeat Sale Indices (CCRSI); Bureau of Labor Statistics consumer price index via Haver Analytics.
1-12. Capitalization Rate at Property Purchase
The data are three-month moving averages of weighted capitalization rates in the industrial, retail, office, and multifamily sectors, based on national square footage in 2009.
Source: Real Capital Analytics; Andrew C. Florance, Norm G. Miller, Ruijue Peng, and Jay Spivey (2010), "Slicing, Dicing, and Scoping the Size of the U.S. Commercial Real Estate Market," Journal of Real Estate Portfolio Management, vol. 16 (May–August), pp. 101–18.
1-13. Spread of Capitalization Rate at Property Purchase to 10-Year Treasury Yield
The data are three-month moving averages of weighted capitalization rates in the industrial, retail, office, and multifamily sectors, based on national square footage in 2009.
Source: Real Capital Analytics; Andrew C. Florance, Norm G. Miller, Ruijue Peng, and Jay Spivey (2010), "Slicing, Dicing, and Scoping the Size of the U.S. Commercial Real Estate Market," Journal of Real Estate Portfolio Management, vol. 16 (May–August), pp. 101–18.
1-14. Change in Bank Standards for CRE Loans
Banks' responses are weighted by their CRE loan market shares. The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research: March 2001–November 2001 and December 2007–June 2009. CRE is commercial real estate.
Source: Federal Reserve Board, Senior Loan Officer Opinion Survey on Bank Lending Practices; Federal Reserve Board staff calculations.
...farmland prices are elevated relative to rents and income but are trending down somewhat...
Farmland prices nationally and in several midwestern states have been trending down from their recent peaks but remain high by historical standards (figure 1-15). Moreover, farmland rents have decreased faster than prices, pushing price-to-rent ratios even higher in recent years (figure 1-16). Net farm income remains well below the high levels seen in the early years of the decade, mostly reflecting low agricultural commodity prices.
1-15. Cropland Values
The data for the United States start in 1997. Midwest index is a weighted average of Corn Belt and Great Plains states. Values are given in real terms.
Source: Department of Agriculture.
1-16. Cropland Price-to-Rent Ratio
The data for the United States start in 1998. Midwest index is the weighted average of Corn Belt and Great Plains states.
Source: Department of Agriculture.
. . . and house prices have been rising, but less so in recent months
House prices have risen substantially since 2012, although house price increases have slowed materially in the past year (figure 1-17). The aggregate house price-to-rent ratio is higher than its long-run historical trend that includes the effect of carrying costs, but this implied gap is not very large and is far below the extraordinary levels observed in the run-up to the financial crisis (figure 1-18). House price-to-rent ratios vary significantly across regional markets, but the price-to-rent ratios for metropolitan areas at the high end of the distribution are much lower than they were just before the 2008 financial crisis (figure 1-19).
1-17. Growth of Nominal Prices of Existing Homes
Source: CoreLogic; Zillow.
1-18. Housing Price-to-Rent Ratio
Chart shows the log of the price-to-rent ratio. Long-run trend is estimated using data from 1978 to 2001 and includes the effect of carrying costs on the expected price-to-rent ratio. The last value of the trend is normalized to equal 100.
Source: For house prices, CoreLogic; for rent data, Bureau of Labor Statistics.
1-19. Selected Local Housing Price-to-Rent Ratio Indexes
Seasonally adjusted. The data for Phoenix start in 2002. Monthly rent values for Phoenix are interpolated from semiannual numbers. Percentiles are based on 19 metropolitan statistical areas.
Source: For house prices, CoreLogic; for rent data, Bureau of Labor Statistics.
References
5. For a description of the excess bond premium, see Simon Gilchrist and Egon Zakrajšek (2012), "Credit Spreads and Business Cycle Fluctuations," American Economic Review, vol. 102 (June), pp. 1692–720. Return to text