What Warren Thinks
Warren Buffett doesn’t get it either. It might as well be rap music or Jackson Pollock.
The old investosaurus rex is still hunting for value in the antediluvian swamp. He’s apparently unconvinced that the New Era has made value investing obsolete. He’s not buying Jeff Bezos’ Amazon stock. Or even his friend Bill Gates’ stock. In fact, as reported here, he’s moving out of stocks…towards oil and bonds.
If you get a chance to read the article by Buffett (actually written by someone else but approved by Buffett) in the Nov. 22 issue of "FORTUNE," it will be worth the effort. The financial media is full of so much rubbish I can’t keep up with it. But Buffett’s thinking is clear and sensible.
Buffett addressed the question I raised two days ago –granting that the Internet is changing the world, is it also changing the rules by which the investment world functions? Not wanting to leave the busy reader in suspense…I will give you Buffett’s answer — No. The rules of investing are rooted in human nature…tapping down into the groundwater of fear…and nourished by the rich, sun-warmed topsoil of greed. Market psychology is merely a reflection of current weather conditions…and the inevitable human reactions to them.
Buffett begins by describing the two 17-year periods on either side of 1981. From Dec. 31, 1964 until Dec. 31, 1981 the Dow went from 874 to 875. Not much of a gain for 17 years. But the economy did just fine. GDP rose 370%. Stocks went nowhere because inflation (and interest rates) rose during the period…and corporate profits generally fell.
The second 17-year period was just the opposite. Paul Volcker threw out the Whip Inflation Now buttons and attacked it in a serious way. Interest rates came down during virtually the entire period as a result. Meanwhile, corporate profits rose. They did not go to the spectacular levels that today’s investors believe…but returned to the rates of the early `70s…that is, greater than 5%. Nor did the economy grow as rapidly as it had in the preceding period. GDP less than tripled, compared to a near-quintupling in the 1964-1981 period. Nevertheless, falling interest rates and rising profits set the stage for a huge bull market.
The annual return from the Dow since Nov. 16, 1981 has been 19%. That, says Buffett, "beats anything you can find in history." Even if you’d bought stocks at their lowest level ever — on July 8, 1932 — you would not have done as well over the following 17 years as you would over the 17 years just past.
The numbers, however, do not support the enormousness of the bull market. "What was at work also," says Buffett, "was market psychology. Once a bull market gets under way, and once you reach the point where everybody has made money…a crowd is attracted."
Investors become convinced, says the sage of Omaha, "that there is a God, and He wants them to get rich."
God’s purposes are, alas, unknowable. But it is unlikely that He takes a particular or sustained interest in any given investor’s balance sheet. Investors would do well, in my humble opinion, to keep an eye on it themselves. And that would be aided by a realistic assessment of what the stock market might do in the years ahead. Buffett is quite clear that he does not make predictions about the general level of stock prices. But he also makes it clear that he sees little chance that investors’ present expectations can be met. That would require a continued drop in interest rates…down to 1% or lower…and a sustained rise in corporate profits. "The inescapable fact is that the value of an asset cannot grow over the long term faster than its earnings do," he says.
Given the unlikely odds that earnings will soar in a competitive world or that banks will begin giving out money at 1% interest, Buffett guesses about the rate of return over the next 17-year period: "If I had to pick the most probable return," he says, assuming that inflation and interest rates remain constant, "it would be 6%." And that’s with 2% inflation…so it would be 4% in real terms. "And if 4% is wrong," he warns, "I believe the percentage is just as likely to be less as more."
A 4% rate of return can be achieved in a number of ways. The first 10 years of the 17-year period could, for example, produce negative rates of return. Investors in the hot tech and Net stocks could see their investments nearly wiped out. Buffett addresses this issue, too. I have previously discussed the auto industry of the 1920s. Of the hundreds of companies that once were making cars in the United States, only three are still in business. And they were not spectacularly good investments.
Buffett looked at the aviation industry. There were about 300 companies doing business in aviation during the 1919-1939 period. If ever there was a promising growth industry…surely these companies were it. They were the Lycos, Amazon and iVillage of their time. But over the past 20 years there have been 129 airlines that have filed for bankruptcy. "Continental" muses Buffett, "was smart enough to make the list twice." And get this —
"As of 1992, in fact — though the picture would have improved since then — the money that had been made since the dawn of aviation by all of this country’s airline companies was zero. Absolutely zero."
"I mean," says Buffett, "Karl Marx couldn’t have done as much damage to capitalists as Orville [Wright] did."
November 12, 1999
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MORE ON ARMSTICE DAY…FROM FORMER MEMBER OF CONGRESS (WHO, AFTER YEARS OF POLITICAL REHAB, IS A PRETTY DECENT GUY) BOB BAUMAN
Your Nov. 11 commentary on the Great War touched close to home.
My father, John Carl Bauman, was a corporal in the 29th Division, U.S. Army, an enlisted man who lied abut his age (he was 17) when he joined up in Catonsville, Maryland. He trained under General "Blackjack" Pershing at Eagle Pass, Texas (where they saw their first action cleaning up after Pancho Villa’s cross border raids in Texas).
The Baumans have lived in Catonsville since the 1880s when my great grandmother, Marie Dressler from Alsace-Lorraine, and my great grandfather, Jacob Bauman from Bavaria, immigrated to the Baltimore area. I still have a few relatives there.
About 10 years ago, when I was in France, I made a point of driving north from Paris and along the Oise, taking two of my children to see the infamous railway carriage in the Forest of Compiegne (a trip by auto that was an adventure in itself when I absentmindedly locked la clef [the key] in my rental car).
I was struck by the total absence of any historical evidence of what happened there in World War II when Hitler "avenged" the humiliation of World War I and Versailles –but then the French have always been good at selective history — and that was something best forgotten for most.
On another trip to France a few years ago, a friend and I drove up the Valley of the Marne to Epernay (to visit the winery of Moet Chandon, of course, among other things), and I was numbed by the scores of roadside battle plaques and monuments, the numerous small and large military cemeteries with their iron fences and headstones, many with fresh flowers and wreathes evident.
It was this journey that made me realize the magnitude of what happened here in that long ago time. This was so very real — much more than the faded cartes postale and panoramic sepia photos of Army camps my Dad had stored away in a trunk with his olive drab wool uniform, good conduct metal and putees.
Under prodding, he told me that as a bugler with the 29th Division Band, he got within a few miles of the Front just before the Armistice was declared, but he always remembered the rumble of the big guns, American and German. And what might have happened to him.
In Today’s Daily Reckoning:
*** Techs up…Dow down…
*** Gold down, too
*** The Internet paradigm…
*** The tech stocks continue to spike upwards. Will this be the spike that pops the bubble? Hard to say. Greenspan is simultaneously goosing up the money supply…while he threatens the market with another rate increase next week.
*** No matter what happens…it is an extremely dangerous situation — with the Nets and techs rising steeply while the rest of the market slumps.
*** The Dow was down a tad yesterday…with 81 new highs on the NYSE against 145 new lows. Transports and utilities were up.
*** Breadth was lousy and down again…the biggest gap ever between average stocks and the leading indexes.
*** The Nasdaq…where the speculative frenzy is concentrated…rose 41 points. The ninth record high in 10 days.
*** Money is going from ordinary stocks into fewer and fewer of the techs and Nets. Of course, the entire market could turn around and follow the leaders. Or the leaders could, like Italian generals, decide to follow the troops. The troops, of course, are in retreat.
*** What is the likelihood that investments in these high-flying techs and Nets will pay off? In the short run…who knows? But in the long run…near zero. That’s naught. Or naught squared. Warren Buffett explains why…below…
*** Gold picked up $9 on Wednesday…and gave back $4 and change yesterday. Gold wants to rise, I believe, but it is afraid of the deflationary potential of a major crash.
*** Speaking of gold, Doug Casey believes we’re are in a new bull market…not just a cyclical upturn. "We’re at the cusp of another supercyclical bull market, like that of 1971 to 1980," says Doug. How high could gold go? How about $4,000/oz? I’ll explain Doug’s logic in an upcoming message…it’s very interesting. For more…including Doug’s specific recommendations… http://www.douglascasey.com
*** "Barron’s" has done a couple of articles pounding Ivana Trump and her sleazy business partners. One of them is a guy many DR readers may recall — Chuck Arnold. I met him years ago when he was selling franchises for an automatic pizza dispenser called "Papa Primo’s Pizza." I tried a slice. It tasted like cardboard from a Tijuana packaging plant with tomato paste slathered on. I don’t really know anything about Chuck’s business practices. But his partners — Dr. Howard Brown and Bob White…and Dr. Brown’s wife — seemed to die under very suspicious circumstances. On the other hand, I know a guy who did business with Chuck…and who is still alive. So that’s a good sign…
*** Despite Al Gore’s patent claims, most people credit Tim Berners-Lee with inventing the Internet. He solved a couple of critical problems that made the Net possible. The Net, he explains in the current issue of "Forbes," needs rules. But the rules can’t be imposed by legislation. They need to be acceptable to nearly everyone…which ends up being "as close as possible to no rules at all." This is very different from the thinking of the late Industrial Era…when very specific rules were thought to be needed to "make the machine work." Factories are designed to precise specifications for detailed, known purposes. The Internet, on the other hand, is not designed. Nor are its purposes known. The most profound effect of the Internet may be that it is changing the way people think the world should be organized. It could lead to a more fluid, more flexible government…with fewer rules.
*** Even the best laid plans to bamboozle voters sometimes go awry. Bill King reports that Hillary’s trip to the Mideast ran into trouble when Yassir Arafat’s wife, Suha, with whom St. Hillary was publicly schmoozing, accused Israel of using poison gas on Palestinian children. This will not bring out the Jewish vote for the First Lady.
*** Former member of Congress, and DR reader, Bob Bauman, sends his own reflections on Armistice Day…below my comments…
*** It was a very quick trip to Baltimore. I flew back to Paris last night. My assistant Jean called the taxi company we used last time to try to get the same driver I described to you about a month ago. I thought it would be fun to hear what he said. She asked for the "crazy" driver. But the company replied, "Which one?"