Flaws in Warren Buffett's reasoning re: Treasuries "bubble"

harkm · Mar 1, 2009

Quote from Cutten:

No one has yet said why it's a bubble. All the arguments against have just said it's poor value. Let's take each in turn.

It does matter if it's a bubble. Why? Because bubbles eventually burst, *even if the good fundamentals stay intact*. High price alone is enough, when sustained for years, to cause a huge bust. Technology has continued to boom in the 2000s, the promise of the internet was arguably *underestimated*, yet here the nasdaq languishes 75% off its highs from 2000. Therefore if its a bubble, you should exit and not invest, even if you think we have 10 years of depression.

Whereas if you are a bear because you expect future inflation, or massive issuance, a la Pabst, then you can only be bearish *if those fundies stay intact*. In other words, if this slump turns into a depression, and there is huge demand even in the face of rising supply and debt/GDP ratios, then you have a direct challenge to your thesis in the form of fundamentals getting more bullish for the bond market. You can be flexible, because your position is dependent on a view of the future. With a bubble, it is a sell (at least in value investment terms) *under all possible future scenarios*. That's why it's an important distinction.

Secondly, a lot of people have been saying off-hand that the market is expensive. Historically the yields are low, no doubt. But a low yield does not necessarily imply expensive, as I pointed out previously. Under deflation, or even 0% inflation, 3% yields are reasonable for a low-risk safe haven asset. Once you throw in an unstable banking system and insolvent FDIC, 3% could actually be *cheap*.

All the arguments for inflation, supply, government spending, currency debasement etc were also present in the 1930s and 1990s Japan, times of long-term collapsing yields and soaring bond mega-bulls. FDR took the dollar off the gold-standard, massively expanded the federal government, spent and borrowed significantly, issued lots of new supply - inflation was non-existent and bonds kept going higher. Japan in the the 90s and early 2000s saw a lot of the same things - huge supply increases, huge spending increases etc. Yet inflation was non-existent and yields went lower and lower to 0.5% on the 10 year.

Here we are facing a similar banking and real-estate crisis. Volcker, Soros and others have made the comparisons. Since the inflation drivers did *not* cause inflation in the 30s and 90s, why would they this time? Since credit collapse and a historic real estate and stock market bust caused zero inflation or deflation in the 30s and 90s, why wouldn't it do the same this time? And if it does, why wouldn't bonds rally just like they did those other two times?

That's the question every bond bear - let alone the "bubble" crowd - have to answer. So far I have not yet heard a convincing argument.
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No argument will be convincing to you because you have already made up your mind and are completely fixated on the term "bubble". I personally believe that the 26 year bull market in bonds is over and this last rally was the final blowoff. Rates will go higher from here unless they are manipulated, which is certainly a possibility.

Acumen · Mar 1, 2009

It is only being called a bubble because anyone can tell its not going to last.

The target FF rate cant stay under 0.25% forever, when it goes up, the price appreciation T's have experienced will turn into a depreciation and the "bubble" will pop.

Its not rocket science.

TBT all the way.

scriabinop23 · Mar 1, 2009

I believe we are in a bubble times of calling bubbles. Ever since the tech bubble, everyone is trying to beat everyone to it calling out every perceived misvaluation, as if there is some little karate trophy to be claimed doing so.

scriabinop23 · Mar 1, 2009

Quote from Acumen:

It is only being called a bubble because anyone can tell its not going to last.

The target FF rate cant stay under 0.25% forever, when it goes up, the price appreciation T's have experienced will turn into a depreciation and the "bubble" will pop.

Its not rocket science.

TBT all the way.
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why not. How long have Japan's overnight rates been at 1.0% or under ?

http://www.stat-search.boj.or.jp/ssi/mtshtml/d_en.html

That's an aweful long time to wait to be correct. Not to mention TBT can compound against you even if underlying goes flat, adding a virtual theta holding it. (yes I own some, and have experienced this, but I hold it as a hedge against a much larger variable debt liability.. so its worth it to me)

number22 · Mar 1, 2009

OP has very legit question about Buffett's claim, first of all, if Buffetts thinks Market is wrong, then he should trade to take advantage of it. yet he isn't, he is losing on his equities bet, (paper lost so far until 2019). Anyway, he is the best loser so far, only down 9.6% last year, compare to most of index (s&p and dow) down of more than 50%.

harkm · Mar 1, 2009

Quote from scriabinop23:

why not. How long have Japan's overnight rates been at 1.0% or under ?

http://www.stat-search.boj.or.jp/ssi/mtshtml/d_en.html

That's an aweful long time to wait to be correct. Not to mention TBT can compound against you even if underlying goes flat, adding a virtual theta holding it. (yes I own some, and have experienced this, but I hold it as a hedge against a much larger variable debt liability.. so its worth it to me)
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If the treasuries are such a good bet at these levels why is our Secretary of State traveling to China to make sure the Chinese will continue to buy them?

"I appreciate greatly the Chinese government's continuing confidence in United States Treasuries. I think that's a well grounded confidence," Clinton said. "We have every reason to believe that the United States and China will recover and that together we will help to lead the world recovery."

Asked if China might someday rethink its purchases of U.S. Treasuries, Yang provided little direction, saying only that China makes decisions on how to invest its foreign exchange reserves so as to ensure their safety, value and liquidity.

Was Japan out campaigning to other countries for money?

Voodoo-king · Mar 1, 2009

Quote from Cutten:

No, that is not the question. The question you posed there is simply "are 30 year treasury bonds yielding 3% going to outperform inflation?". I am not, in this post, saying whether they will or won't outperform inflation. I am asking "are they a bubble, similar in magnitude to the dotcom and housing bubbles, as Warren Buffett is claiming?". My contention is that they are not.

Your criteria for judgement - what "most people would say" - is also flawed. Most people in 1997 would not have said that investing in US stocks for the next 12 years would underperform inflation, but that is exactly what happened. Most people in 2007 would not have said house prices would crash by the most in 75 years, or that the S&P would fall 50% in just over a year, but that is exactly what happened. Most people don't have the slightest clue about how to forecast financial markets or investments. That is why I am not relying on the judgement of "most people".

Remember, an investment asset being a bit overvalued, or losing some money, does not mean it was in a bubble. The Nikkei is lower than it was in 1998, but no one in 1998 thought it was a bubble and no one in 2009 thinks that the Nikkei circa 1998 was a bubble. A bubble has strict criteria - INSANE overvaluation, and the certain loss of huge amounts of capital. Not mild overvaluation and *possible* (not certain) small loss of capital.

For what it's worth, I will actually put forth some arguments for why the conventional wisdom might be wrong i.e. that a 10 year at 3% might actually be not only fair value, but possibly *undervalued*. But you don't need to agree with that to think Buffett is wrong in his bubble claim. Even people who would not touch bonds at current prices can accept my reasoning, and just say they are too expensive, or have too much risk at current levels.

Your post does raise the question what is a US treasury. I am focusing on the 10 year, and I do agree that the 30 year seems worse value and more risk. However, I do not think even the latter is a bone fide bubble, let alone comparable to the dotcom era or housing bubble.

So, back on topic - are US Treasuries a bubble? Please can anyone posting here only address the points that I make in this thread relating to bond market valuation, NOT spurious, extraneous, or arbitrary and meaningless assessments such as "most people say" or "Buffett says" or "the trend is down" or whatever. I am not arguing based on those factors, I am arguing based on universally accepted valuation metrics for bonds, and for bubbles. So please limit your criticism or agreement to those metrics and the conclusions I draw from them.
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What you in essence are doing is defining out the existence of bubbles. Nobody knows for sure inflation or deflation. Most people think 0.95% inflation, nobody can dismiss this as implausible, this does not mean bonds cannot be in a bubble, what most people think or not is irrelevant, it is a persons right to call whatever a bubble or not, in the future we will know, if 4% inflation happens bonds are a bubble, if most people are wrong it does not matter, they are wrong, this is not to say I am bearish on bonds..

squirly309 · Mar 1, 2009

Quote from vhehn:

the question you need to answer is if you loan the us government money for 30 years for a 3% return will you make or lose money after inflation at maturity in 30 years. most people would say no.
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+1

Daal · Mar 1, 2009

Buffett calls Bill Gross one of the smartest guys he ever met, and interestinly enough even though Buffett is considered a grand guru lots of Buffetts opinions are just stuff he got off Gross like 'government is all-in', 'people are delevering and the Treasury needs to use its balance sheet to lever up' and now of course 'treasuries are in a bubble'(gross said it had 'bubble elements')

We all know gross is just trying to pump the agency market and his opinion is highly suspect anyways as he works for a bond fund and tends too optimistic, if he makes his clients too fearful they will just redeem and buy gov bonds

So it seems we ought be more careful to jump in a Buffett bandwagon and check his facts if he will rely in suspect opinions and expose them as if they were totally true

Cutten · Mar 1, 2009

Quote from Voodoo-king:

What you in essence are doing is defining out the existence of bubbles. Nobody knows for sure inflation or deflation. Most people think 0.95% inflation, nobody can dismiss this as implausible, this does not mean bonds cannot be in a bubble, what most people think or not is irrelevant, it is a persons right to call whatever a bubble or not, in the future we will know, if 4% inflation happens bonds are a bubble, if most people are wrong it does not matter, they are wrong, this is not to say I am bearish on bonds..
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Many, many of the acknowledged prior investment bubbles, if not all of them, would easily qualify under my definition. What are your grounds then, for saying I am defining out the existence of bubbles? My post even mention at least two that have happened in the last decade.

I defined "bubble" in a way that I felt was consistent with almost all past examples now commonly accepted as bubbles, and that does not include what are not considered bubbles, that nevertheless had adverse price movement afterwards. If you think there are past bubbles that would not have met my conditions, perhaps you could list some? Or if you think some things would have fit my definition of bubbles but were not in fact real bubbles, again, perhaps you could give some examples?

I am interested in how you would define "bubble" - if my definition is wrong or misleading, please explain *why* it is wrong, and offer a better definition.