Reconciling the two Buffetts...

[Munger]

Came across an interesting and (in my opinion) fair critique of Buffett.

 

Do others agree with me?  If not, how do they reconcile the two Buffetts...

 

More relevant to investing, what does Buffett's Fortune essay (i'm sure all have read but must read as a refresher as we deal with the mania of QE) suggest for future stock returns over the long term (which presumably is the focus of Buffett disciples) and the current margin of safety?

 

Here is my take based on Buffett's own words -- which argue that large interest rate changes overwhelm all other variables in determining future stock market returns, with the other the primary variable being corporate profit growth.

 

Let's take the next 17 years, an interval Buffett cited in the Fortune essay.  With interest rates having DECLINED further since Buffett wrote the essay, would seem even more likely that his prediction for much higher interest rates in the future is almost certain over the long term.  Further, the ridiculous Fed policy is likely to stoke inflation at some point over the long term, which will slow corporate profit growth for almost all businesses and actually reduce corporate profits for many...  So based on Buffett's outstanding Fortune essay on stock market returns (again a must read), the only conclusion can be that we are still headed for the mother of all bear markets.  I can only disgustingly laugh when I see the likes of Bill Miller and David Tepper shout to the masses that this is a once in a generation time to buy stocks in an effort to talk their book for short term gains...  As Buffett has noted repeated, interest rates are to investing as gravity is to physics -- the laws always hold true...  Not to say you can't make money during this period, but pick your spots carefully and demand a high margin of safety.

 

Link to the Buffett Fortune essay:  http://money.cnn.com/magazines/fortune/fortune_archive/1999/11/22/269071/#

 

Buffett critique -- worth a read

 

THE TEMPTATION OF ST. WARREN - THE SEQUEL

by David B. Collum

Professor of Chemistry and Chemical Biology Cornell University

January 29, 2009

 

As the secular bear market that began in 2000 continues, the list of true financial geniuses grows short whereas the rogues’ gallery grows longer.  Whether we are talking about criminals--“A Tale of Two Bernies”--or simply discredited faux visionaries such as Alan Greenspan, is there anybody left to fall from grace?  But, as Obi Won Kenobe said in Star Wars when it looked like Luke had been lost to the Dark Side, “There is another.”  At this point, the CNBC camera pans over to the most famous investor of all time--the legendary Warren Buffett.  Buffett may not be the last Jedi Knight, but his record argues to the contrary.

 

Several months ago Warren Buffett gave the investment community a shot of crystal meth by pronouncing with the succinctness of a bumper sticker that he was Bullish on America and was 100% invested in deeply valued equities within his personal trust fund.  The excitement was palpable; you would think that Detroit won a Superbowl or Paris Hilton garnered a Nobel Prize.  Let us take a breath and consider Buffett’s move. His trust fund totals $500 million--a fortune to most of us but <3% of his total wealth.  Moving Berkshire Hathaway to 100% equities would have been the ultimate Texas Hold’em all-in play.  Did fiduciary responsibility to shareholders prevent him from such a move?  More to the point, onlookers who can resist gulping down Wall Street’s Kool-Aid may have sensed a disconnect between Buffett’s public persona and his actions as an investor.  Through most of his career, Buffett was inscrutable, offering tiny nuggets of wisdom embedded in highly coveted annual reports.   His performances on the public stage, however, have mutated into more of a cheerleader than thoughtful market analyst.  Surely nobody would deny him a few victory laps, but his camera shyness is now on a par with that of Chuck Schumer.  He certainly has the right to say anything he wishes within the constraints imposed by Federal statutes--few remain and nobody really cares about them anyway--but his utterances cause billions of dollars to mobilize into action.

 

While wrestling with the two sides of Warren Buffett and whether his bullishness is well founded, an article penned 17 years ago by Michael Lewis of “Liar’s Poker” fame came across my desk.  In The Temptation of St. Warren, Lewis painted a vivid picture of an egotistical financial carnivore seated at the very top of the food chain--a world-class stockjobber--cloaked by a highly deceptive country boy shtick.  It’s quite a read and surely took guts to publish.

 

Lewis’s challenge to Buffett’s sincerity may seem blasphemous to devoted Buffettologists, but to challenge his judgment as an investor would be madness.  Who could possibly question his bullishness on US equities?  What long-term investor could resist this clarion call to charge into US equities?  There is in fact one man with the qualifications--the gravitas--to declare Warren Buffett’s bullishness misplaced.  That man is Warren Buffett.  In a 1999 editorial for Fortune Magazine, Buffett revealed fundamental tenets of investing by comparing the secular bear market of 1964-81 with the secular bull market of 1981-1999.  In a brilliantly simple analysis, he concluded that the two dichotomous secular moves did not emanate from differential economic growth: the inflation-adjusted gross domestic product (GDP) in the bear market exceeded that in the secular bull market.  He also handily dismissed the role of transformational technologies by noting revolutionary changes are brutally costly, resulting in mediocre returns for buy-and-hold investors.  Providing what seemed like the ultimate nugget of wisdom, Buffett attributed the difference in the bull and bear markets to changes in interest rates on long-term government bonds.  Long-term rates rose from 4% to 15% during the bear market, forcing very large contractions of price-earnings (p/e) ratios on equities.  Those same rates dropped from 15% to 5% during the secular bull market, allowing for substantial expansions of price-earnings ratios.  The contraction versus expansion of p/e ratios to match the changes in bond yields accounts for more than an order of magnitude difference in performance--a ten bagger to use Peter Lynch’s nomenclature.  Buffett’s case was simple and compelling.  

 

The battle lines have been drawn. Warren Buffett circa 1999 argued that you simply couldn’t be bullish in the face of rising long-term interest rates.  The headwinds would be too great. Warren Buffett circa 2008 declared that he was unabashedly bullish with yields on 30-year treasuries hovering around 3%.  Nobody could possibly believe that interest rates will hold steady at these levels over the long haul.  It seems, therefore, that one of the two most famous investors of all time--circa 1999 Buffett or circa 2008 Buffett--will be proven wrong.  Billions of dollars have been bet on the new, more camera friendly, Buffett.  My money is on the time-tested earlier model.  I’m bullish on America too, but not on US equities.  

 

I suspect that the end of the ongoing secular bear market in equities will witness the end of the deification bubble as well.  I’ll concede that Buffett is a brilliant investor, the most successful of the twentieth century, the last Jedi Knight, but I draw the line there.  I think he blew this call, and, if Michael Lewis is correct, he may even know it.

 

 

 

 

 

 

 

[Myth465]

I think Buffett by and large says what he thinks but also knows he is trapped by his position. He could very easily crash the market when its extremely jittery. I think he is negative when the market is high and people ignore him, and bullish when its extremely low. Other then that he doesnt have much to say. Lately he has been bullish on America coming back but I dont think he has commented significantly on the market.

 

I don't think these things are mutually exclusive. Stocks could be like the USD, at the top of a very third rate class. He seems to be saying stocks are cheap, but may get squeezed by inflation if they dont have pricing power, find good stocks as inflation hedges vs holding cash or gold.

 

It doesnt seem like some huge contradiction. It seems to me like he has realized that its not all black and white and this is just a shade of gray, am I missing something?

[goldfinger]

I strongly believe that Buffett considers more what he should be saying than what he thinks when speaking to the press now, if only because of moral considerations. It has to do with his status: what he says can have dramatic consequences on the economy.

[zarley]

Warren Buffett circa 2008 declared that he was unabashedly bullish with yields on 30-year treasuries hovering around 3%.

 

I think this is an overly simplistic assessment of Buffett's 2008 article.  

 

Reread what Buffett wrote.  Here's link to the 2008 NYT article:  http://www.nytimes.com/2008/10/17/opinion/17buffett.html

 

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.  

 

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree.

 

So, Buffett is wasn't arguing that stocks were cheap, or that a bull market would be coming soon.  He argued that stocks in high quality US companies were a better risk/reward proposition than cash.  I see no substantial inconsistency, while I agree that the potential for poor stock returns is real due to the likelihood of rising interest rates.  I think the writer (Mr. Collum) was stretching his interpretation to make for a better story.

 

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edited to fix Buffett quote.  Moved my comment out of quote box and into final paragraph.

[Guest Bronco]

I think the Buffett people worship and the Buffett now are two different things.

 

Buffett can't do some of things he did a while ago.  It is my belief that Buffett now invests primarily in companies that have the greatest liklihood of survival over the next 50 years.  JNJ KFT BUD PG Coke AXP WFC Railroads Pipelines Utilities.  You get it.

 

That being said, he still pulls the pants down on others.  He raised cash up to and including 2008, with no where to put it.  Then he gets GS and GE and others to pay 10% plus warrants plus break up fees.  You can imagine what an erotic turn on this was for the risk/reward fiend, Mr. Buffett.  Fantastic deals for Buffett and Berkshire, without a doubt.  Then he pockets billions more with his put writes on exchanges.  Damn.

 

No more cigar butts.  No more unkown companies where the cash and investments on hand are worth more than the market cap.  No more Geico's and AXP's at crisis level prices.  No need to buy Blue Chip Stamp and National Indemnity.

 

I believe Buffett now looks for companies with durable, competitive advantages.  This is the emphasis.  Nothing wrong with that.

 

Still waiting for the Pritzker type deal for Mars.  I think candy bars and chewing gum would make WEB very, very happy.

[Munger]

They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.

 

In the past, Buffett has always emphasized the importance of holding cash to capitalize on opportunities that present -- waiting for the fat pitch.

 

Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

 

This has been true since the day the federal reserve was created.

 

I see no substantial inconsistency, while I agree that the potential for poor stock returns is real due to the likelihood of rising interest rates.

 

Where did this quote come from?

 

 

 

 

Personally I see a very different Buffett today than in the past (at least in terms of public statements) -- although I have no idea why.  I lean towards goldfinger's assertion -- if Buffett truly spoke his mind, he would risk collapsing the system.  Seems Buffett is more interested in using his influence for social engineering during the twilight of his life than in the capitalistic principles/dynamics that allowed him to reach his current status -- each time he speaks, I am more convinced.

 

 

 

 

 

 

[Munger]

I don't think this is inconsistent.  Generally, higher interest rates lead to lower equity values and lower interest rates lead to higher equity values.  But there is an exception: a financial crisis pushes equity values to depression-like valuations and a central bank rushes to increase liquidity as a result.  In that rare situation, you will have both very low interest rates and very low equity valuations.  2008 was one of those rare situations.

 

I generally agree with this statement.  But now Buffett simplistically states "buy equities" almost every time asked in public.  Will be interesting to see how this plays out...  

 

In the Michigan Q&A, Munger dodged the question of whether stocks are a good long term investment at current levels by stating stocks should do better than long term government bonds -- that is not such a great outlook and I would expect all on this board hope to do better than current long term government bond yields over time.

 

I believe lots of money can still be made but you need to find really cheap stocks with durable competitive advantages (and ideally some real and strong growth) because as Buffett notes rising interest rates are likely to sap any gains from modest earnings growth, regardless of the quality of the company.

[Myth465]

Munger what are his other options for the average investor?

Buy bonds? Buy gold? Hot commodities? Private Equity? Hold cash and time the market?

 

He isnt talking to himself and he knows that, this is Joe and Jane six pack.

 

I feel as though you are trying to reconcile Buffett's words with your actions and not to his own other words. Its a worthy goal, but the title of the thread should be changed.

[RRJ]

Went back and read through Berkshire's shareholder letters from the late 1970s, during periods of high inflation.  I won't rehash, but in I think 1979 or 1980, I do recall Buffett basically saying most stocks were not worth investing in, and Berkshire, with a 20+% return on equity, barely made the hurdle.  In the Fortune interview, at the end, he does admit that despite the gloomy view of stocks, he still invests in them "partly out of habit" and partly because they are "probably" the best hedge, but only if you buy at the right prices. 

 

I think in these probably range-bound markets, what Munger is saying, and Vitaliy Katsenelson and others are echoing, makes a lot of sense.  Call it modified buy and hold -- require a bigger margin of safety, and hold some cash for severe drops and look for companies with really strong pricing power and competitive advantages.  Maybe it doesn't change the approach -- it just demands even more strict adherence to value investing principles than normal. 

 

And I still like me a little bit of gold and silver during times of currency devaluation, notwithstanding the Great One's comments. 

 

[Myth465]

http://www.nytimes.com/2008/10/17/opinion/17buffett.html

 

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

 

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

 

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Munger does it feel as though he is speaking directly to you.

Again he seems fairly consistent, a bit nuanced but consistent.