The Oracle of Omaha Says, "Buy American"

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Tagging along as a spousal unit today at an investment forum by the Davis Advisors group, I listened to a fascinating presentation by portfolio manager Chris Davis on "What Happened and What Do We Do Now?" Basically, Davis argued that this is a normal financial cycle that got magnified by a financial "doomsday machine." Generally, a financial cycle has four stages, (1) an asset class produces good returns, (2) money pours into the class fueled by envy and commissions, (3) leverage is added reducing asset quality, and (4) the mix proves toxic and a collapse occurs. Davis pointed out that the tech bubble asset class was only $3 to $4 trillion whereas the financial asset class totaled about $20 trillion.

The "doomsday machine" that has magnified and accelerated the current collapse works the following way: (1) an asset price goes down, (2) it must be marked to market (thanks Sarbanes-Oxley), (3) which then lowers a company's stock price, (4) then rating agencies lowers the company's credit rating, (5) which results in forced selling, which (6) lowers asset prices and so the positive feedback loop continues ad nauseam.

I don't pretend to know if this analysis is right, I'm just reporting here. Davis and other participants were quite fond of quoting the legendary investor Warren Buffett's aphorism: Be fearful when others are greedy, and be greedy when others are fearful.

And today, the Oracle of Omaha has an op/ed in the New York Times reprising his advice and looking past the gloom of a looming recession to a more profitable future:

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So … I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now….

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price.

Whole Buffett op/ed is well worth reading here.

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  1. Buffett might be right.

    There’s one theory that says we’re seeing the correction of unrealistic asset inflation, triggered by the combination of the subprime crisis and investors getting capital gains out ahead of an Obama tax hike.

    I’m sticking with bonds myself.

  2. Good to see TallDave agreeing that the temporary reduction in revenues from capital gains tax increases is a consequence of time-shifting their transactions.

  3. The “doomsday machine” that has magnified and accelerated the current collapse…

    Wouldn’t sending a busted up starship into the maw of this machine be a whole lot cheaper than $700 billion plus?

  4. I’m starting my 401k now. The market is low, and it’s historically done best under Democratic presidents.

    (BTW, someone posted a link on this subject addressed to me in a thread yesterday; it was a dead link).

  5. Reminds me of an idea I read a few years ago:

    Even desperate times can be made positive. The winds that dash a boat against the rocks are the same winds that can guide a boat safely to shore, for it is not the wind but the set of the sails that matters most.

  6. I’m starting my 401k now. The market is low, and it’s historically done best under Democratic presidents.

    Sorry Joe, that’s pretty much bullshit. Though it looked good the way NYT presented the graph, the details left something to be desired:

    See here: http://blog.wolfram.com/2008/10/16/stock-market-returns-by-presidential-party/

  7. Wouldn’t sending a busted up starship into the maw of this machine be a whole lot cheaper than $700 billion plus?

    Can Paulson be Commodore Decker?

  8. stoneymonster,

    Nice link. Of the adjustments, I think the dividend reinvestment is the most important.

    I also liked the conclusion – regardless of which party is better (depending on the assumptions you use) the best result is being invested in the market thru both.

    Personally, I always liked the congress in session vs congression out of session results.

  9. Don’t you think I know that!There was, but not anymore!

  10. Wouldn’t sending a busted up starship into the maw of this machine be a whole lot cheaper than $700 billion plus?

    No, you forgot to adjust for cosmic inflation.

  11. Be fearful when others are greedy, and be greedy when others are fearful.

    They aren’t fearful enough yet.The blood in the streets isn’t topping my boots yet.

  12. stoneymonster,

    The entirety of his refutation relies upon the arbitrary “1-year delay for policy effects.”

    Gee, I wonder why a Republican would want to give Clinton credit for 2001?

    And the inflation argument gets a big SO WHAT? If there is inflation, that makes it MORE important to me to be invested in high-growth stocks. Oh, btw, he doesn’t apply the “one year delay” rule to inflation. So what we get is all of the stock market decline in the first year of Bush being attributed to Clinton, and all of the inflation in the first year of Carter going to Carter.

  13. I also liked the conclusion – regardless of which party is better (depending on the assumptions you use) the best result is being invested in the market thru both.

    Of course. One doesn’t empty one’s 401k when a new president is sworn in. I have one time decision to make – when to start. I say, now, when the stock market is low and the party with better performance is coming into office.

  14. This is beside the point of the article, but thank you for correctly identifying the self-reinforcing behavior of the market in this situation as a positive feedback loop.

    A week and a half ago, a New York Times article on the stock market got this wrong, and opened with the sentence:

    The technical term for it is “negative feedback loop.” The rest of us just call it a panic.

    If you’re going to use a really clever sciencey-sounding phrase to impress people, you should make sure you know what it means.

  15. Joe, I think the message is: don’t try to time the market if your time horizon is longish. And don’t try to time it based on the presidency. I.e. buy stocks and hold over the long term.

    So invest by all means. But don’t make choices based on an analysis this easily fudged around.

  16. I’m starting my 401k now. The market is low, and it’s historically done best under Democratic presidents.

    I’ve heard this before, too. Apparently the theory is that Dem presidents turn out to “not be as bad as the market expected” and does well. And under a GOP prez, well, it’s worse than expected. I think there might be something to this. One can always “hope.”

  17. joe,

    You’re just now starting a 401k? How old are you? Like 35?

  18. joe,

    I say, now, when the stock market is low and the party with better performance is coming into office.

    I agree with your decision.

  19. joe,

    Oh, btw, he doesn’t apply the “one year delay” rule to inflation.

    He gave you a tool to adjust for that to. His examples showed the different effects from different assumptions.

    I like the 1897 one myself, I see know reason to arbitrarily start sometime around 1930. The dividend reinvestment (while not really changing much) is the most important adjustment for accuracy.

  20. Whats the result with a libertarian president?

    🙂

    Using CC as a proxy for an LP president, the results look damn good.

  21. triggered by the combination of the subprime crisis and investors getting capital gains out ahead of an Obama tax hike.

    I guess the “blame the democrats” game is in full swing now that McCain is all but done.

  22. Strange that he starts with “The financial world is a mess, both in the United States and abroad” but then makes a jump to “I’ve been buying American stocks”. There are troubled international stocks, too.

  23. @Mike Laursen-

    That is intriguing. The op-ed itself is titled “Buy American” but there is no backing for why American is a better buy than foreign. Based on Buffet’s biography, I would be expecting him to do something like buy Iceland (not stocks, the country – only half joking too). Obviously, he thinks America has a relative advantage, but given the way he thinks and communicates, it’s just as likely he forgot to get to the point as it is he’s keeping his cards close to his chest.

  24. “There are troubled international stocks, too.”

    Yeah, but this is about the time the europeans go all fascistic and racial purifying and destroy their continent.

  25. Muslims Raus!

  26. I have a close relative who says this is a huge opportunity for someone my age. Her net worth, btw, is about $4M.

  27. Absolutely buy American equity. I have 100 shares of Washington Mutual that I will sell to you for $34/share. That’s a discount from the $40/share I was asking for last week!

    Naturally, this is an excellent time to buy. Some stocks are dramatically undervalued now. Buffet, having the cash to play, will make a trillion.

  28. Thank you Stoneymonster. I made the point about inflation not being factored in when the first blog on the NYT article came out.

  29. But then, I have an advantage on a lot of you. I started my adult life under Nixon, and lived it through Carter, Reagen, Bush I, Clinton..

  30. No one can time the market, so just start investing when you have the ability. Over the long term you’ll beat inflation and come out with a hefty profit. I think the index relies more heavily on innovation and ideas. Our market has grown because of the American people and their entrepreneur spirit. f the president, I’m doing work son!

  31. Buy low, sell high.

    Makes sense.

  32. When I’m sure the market has hit bottom on this, I’ll call my broker and tell him I’d like to start transferring some of my funds back into the stock market. With any luck, I’ll avoid the inflationary devaluation of the bonds I’m currently holding.

  33. Buffet is also heavily invested in Chinese stocks. He recently threw a crap ton of $ in a Chinese car battery maker (http://www.ridelust.com/warren-buffet-invests-in-chinese-battery-company-byd/)

    The point he is making is that the American economy has some great deals, and the only way we’re going to get out of this mess is by having confidence in our system. Confidence/faith is the only thing that holds the system up. It’s a shame we don’t teach this information in our school system. If all America knew how easy and good it was to invest, I imagine they’d all start at a very early age. Then again, we don’t want to commit to investing…that would mean capitalism is a good thing.

  34. And no BYD is not the Boyd gaming (casino) Co. It’s on the Chinese index. That would be funny though if he was heavily invested in the world’s tendency to gamble their lives away.

  35. Don’t worry, Joe’s Mr. Hopey-Changey is going to wave his magic wand and make everything all better.

    As long as you define “all better” as making everyone equal…equally miserable.

    The Obama administration will be a good time for homeless bums…free cigarettes and booze passed out and not just at voting time! Gotta show that trickle-up economics in action. I can’t wait to get a job from a homeless person.

  36. A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.

    Oldest (and truest) market adage around. Buy when the blood is running in the streets, sell when they’re dancing in the streets.

  37. Hoping for change. Pennies, nickels, dimes, a quarter if you could spare it, sir.

  38. Naga,

    I mean, one for my new job. I rolled my existing retirement fund into an IRA.

    Yes, economist, JB, and Newt Gingrich, we all know the drill. The incoming Democratic president is going to destroy the economy with his socialisty socialism, and we’re going to be in bread lines. So anyway, heard any of that music coming out of Seattle?

    He should do something smart, like a big tax cut from the top-down, in order to guarantee a really strong economy. And also, neu-metal rulez!

  39. Except that Obama is to Bill Clinton’s left. My own reaction to Clinton was “meh” whereas my reaction to Obama is “bleagh!”. Then again, my reaction Bush I was “meh” too and my reaction to McCain is “bleagh!”

  40. Buffett has been making unhedged foreign investments and trashing the dollar for years. Now all of a sudden it’s “buy American”? (After the dollar has rallied)

    Whatever…

  41. Confidence/faith is the only thing that holds the system up.

    After very careful consideration, sir, I’ve come to the conclusion that your system sucks.

  42. Don Luskin had an interesting piece last month in the WSJ about whether the economy/stock market does better under a Democrat or Republican administration.

    http://online.wsj.com/public/article_print/SB122117691244025843.html

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