August 21st, 2011
by Guest Author Andrew Butter
I’m a little slow, but perhaps someone can tell me what happened to the crowd of people who were jumping up and down screaming that US Treasuries were a bubble when the yield was 3.7%? If that was a bubble in 2009 and 2010 then 2.0% has to be an UBER-BUBBLE so you would think those guys would be having foaming-at-the mouth fits by now, I don’t know what happened to them, perhaps they all got sore throats?
Follow up:The valuation model presented here started out in February 2010 in response to all the noise being generated by the Treasury Bubble Crowd; what the model said (then) was that yields would go down, which they did until Ben started buying under QE-2 and then they went up until Bill Gross sold at the top of the market at precisely the point this model said yields were going to go down to 3%, which they did. (See discussion here and here.)
So far so good, so how does that work? When you build a valuation model you feel more confident if you can get to a similar answer by at least two independent routes, typically those are income capitalization and depreciated replacement costs, but there are other ways, I always try for a minimum of two, at least when someone is paying me.
In this case the first line of reasoning was based on the idea that you can define the “fundamental” of something bubbling, or what people who do valuations (at least in line with International Valuation Standards) call “other than market value”, from the square root of the top multiplied by the bottom.
The green line on the chart is a valuation estimate. That’s what I do, valuation; to me it makes no difference if it’s twenty-year old jack up barge, a Costa Coffee franchise, or someone’s left-foot, the principles are the same.
That’s nothing to do with economics by the way; valuation is an estimate of what you can sell something for in certain defined circumstances, that’s it.
Economics, on the other hand, is about lofty ideas like, sentiment, inflation targeting and other ways of playing Mickey Mouse, much too complicated for a simple soul like me.
A valuation is just a simple-minded prediction of what might happen in the future to one particular thing, nothing else; what many people don’t understand about valuation, is that when the circumstances change, the value changes too; the acid test is were you in the ball-park.
The credit crunch was all about valuation, the valuations got messed up and so everyone paid 35% more for houses than they should have (or pulled out “equity” based on that), and banks used that as collateral, and the rest was just inevitable. Perhaps as part of its role as a “regulator” the Fed might consider mandating that valuations used to work out capital adequacy of moron-banks are done using International Valuation Standards, instead of the Voodoo Valuation Standards used by the rating agencies? Just a thought, for next time America is considering shooting herself in the foot. Not that I care - I’m not American - and there are a lot of places governed worse than America to "worry" about, Somalia for example.
The second line of attack was looking for a nominally independent driver; a good place to start on that sort of investigation is nominal GDP:
That didn’t surprise; the analysis on the chart basically says that you can predict the yield on US Treasuries from the moving average of the past four years of nominal GDP growth, there is nothing particularly new there; plenty of other people know that, although that’s the first time I saw anyone doing a simple regression.
But there is not a lot of what International Valuation Standards calls “market-derived-data”, (from USA at least) about what happens if nominal GDP starts going negative, but in any case that’s a four year leading indicator, which I call a driver, in the sense that I suspect nominal GDP “drives” yields.
So that brings us to now and what that valuation model says is that a 2% yield on US Treasuries is not “correct” right now and was probably a result of some sort of mania.
The reason for the mania could be because of “X” or “Y, although personally I’m not very interested in what particular drug the deadbeats are using, from the point of view of valuation, the reason is irrelevant.
There again, since the survival of USA might be at stake, perhaps the FBI or Homeland Security should be put on the case, or even better how about the team that proved there were WMD in Iraq? Perhaps drone attacks on some bankers and kick-back addicted members of Congress might improve things? I’m sure if that idea was put up in a referendum in USA, it would get a 90% approval rating.
Anyway, at some point, probably quite soon (a few months), it’s likely that the 10-Year will head up back towards 3%, like it did after the last mini-bubble caused by traders front-running the Fed in anticipation of QE-2.
One thing is that when they get released (in November 2011), it looks likely that the Q3 numbers for nominal GDP in USA (covering July thru September), will, let’s say, “disappoint”.
There are four (valuation) predictions there, lets see if they pan out, like the last ones did? But see – I put numbers on my predictions, how many “gurus” do that?
The Year of the Rabbit
2011 is the Year of the Rabbit, and when I did my predictions back in January for the Chinese new-years, which starts on 4th February, on the subject of US Treasuries I remarked:
If ever nominal GDP in USA starts to take off, US Treasuries will too, I’ve got the 10-Year pegged for 3% in March (now it’s 3.4%), plenty of people think I’m wrong. I say there was a bit of a bubble after the rumour got out that there would be QE-2 and the dealers played with Ben like a cat with a mouse by front-running the price, here’s a tip Ben, if you want to spend $600 billion on something, don’t tell everyone first.
I’m not too ashamed about that although I gotta admit I did get the timing of the return to 3% totally wrong (by about four months).
My implicit assumption then was that nominal GDP would grow by 3% minimum, that was based on looking it up in the back-page of The Economist, how much of that was going to be inflation or “real” is of course irrelevant to valuation.
This is the first time I’ve attempted to “do” GDP, although I did notice that Nouriel Roubini who is often right on matters of economics (and often wrong about everything else), had something to say about that recently. His view was pretty similar to these conclusions, this is what he said:
The first half of 2011 showed a slowdown of growth – if not outright contraction – in most advanced economies. Optimists said this was a temporary soft patch. This delusion has been dashed. Even before last week’s panic, the US and other advanced economies were odds-on for a second severe recession.
America’s recent data have been lousy: there has been little job creation, weak growth and flat consumption and manufacturing production. Housing remains depressed. Consumer, business and investor confidence has been falling, and will now fall further…
Until last year policymakers could always produce a new rabbit from their hat to trigger asset reflation and economic recovery. Zero policy rates, QE1, QE2, credit easing, fiscal stimulus, ring-fencing, liquidity provision to the tune of trillions of dollars and bailing out banks and financial institutions – all have been tried. But now we have run out of rabbits to reveal.
I’ll go along with that, apart from the bit about rabbits, if you run out of rabbits to pull out of the hat in the Year of the Rabbit, all hope is lost!!
I don’t think things are THAT bad, and in any case, perhaps there is a silver lining, perhaps the realization is slowly starting to sink in to the minds of the corrupt morons in US Congress that you can’t create economic growth by getting the Fed to playi with the base rate, and build bubbles, whilst denying any responsibility?
Here are some other rabbits that could be pulled out of the hat, which would turn America round:
1: Impose a 3% wealth tax on all personal assets more than $5 million of anyone who enjoys the protection of America (including non-Americans domiciled in USA and 6% on any who are members of Congress), that would bring in $1.5 trillion a year. And if anyone objects, well they can just go away and live in Mogadishu or somewhere, they will find out pretty quick that the cost to protect their wealth in places like that is a lot more than 3% a year.
2: Halve US military expenditure - $500 billion a year, the past ten years have proved beyond doubt that throwing stupid money at the military does not make America, or Americans, safer.
3: Put a $4 tax on gasoline to bring what end-user pay up to the same level where oil consumption is not subsidized by the government; that would generate $500 billion a year plus a reduction in the amount of money America has to borrow to pay foreigners to import it.
4: Eliminate corporate income tax which hardly brings in any money anyway, and was the main driver for off-shoring, do that and it would make sense for US corporations to start investing (and creating jobs) in USA again.
Do that and America will balance her budget in 2012 and unemployment will go down to 7% by end 2012 (U-3). It’s either that or QE-3 and there is no evidence that third-time-lucky will cut it this time around, any more than the previous versions.
Of course, suicide is always an option....
About the Author
AAndrew Butter started off in construction in UAE and Saudi Arabia; after the invasion of Kuwait opened Dryland Consultants in partnership with an economist doing primary and secondary research and building econometric models, clients included Bechtel, Unilever, BP, Honda, Emirates Airlines, and Dubai Government.
Split up with partner in 1995 and re-started the firm as ABMC mainly doing strategy, business plans, and valuations of businesses and commercial real estate, initially as a subcontractor for Cushman & Wakefield and later for Moore Stephens. Set up a capability to manage real estate development in Dubai and Abu Dhabi in 2000, typically advised / directed from bare-land to tendering the main construction contract.
Put the unit on ice in 2007 in anticipation of the popping of the Dubai bubble,defensive investment strategies relating to the credit crunch; spent most of 2008 trying to figure out how bubbles work, writing a book called BubbleOmics. Andrew has an MA Cambridge University (Natural Science), and Diploma (Fine Art) Leeds Art College.