You may have heard about Warren Buffett’s op-ed piece in The New York Times titled, Buy American. I Am. In it, Mr. Buffett strongly counsels against seeking refuge in the “safety” of fixed income and start buying stocks as there is widespread fear and panic:

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.

It is very rare for Mr. Buffett to write an article in a major newspaper or magazine on the level of the stock market. While the timing of his latest piece remains to be seen, the last time he publicly took an opinion on the stock market, his timing was impeccable.

In late 1999, investors were enthusiastically bidding up stocks to sky-high levels. It wasn’t just the dot-coms, which hadn’t earned a dime in their entire existence, going public and fetching multiples of their IPO price. Many blue-chip, growth stocks were trading at unheard of multiples. Mr. Buffett, written off as a fuddy-duddy who didn’t “get” the new economy, wrote this article in Fortune magazine making a strong case for lower equity returns:

Let me summarize what I’ve been saying about the stock market: I think it’s very hard to come up with a persuasive case that equities will over the next 17 years perform anything like–anything like–they’ve performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate–repeat, aggregate–would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that’s 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.

He further reminded investors the sorry history of new-fangled industries destroying their wealth:

Move on to failures of airlines. Here’s a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. 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.

Sizing all this up, I like to think that if I’d been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough–I owed this to future capitalists–to shoot him down. I mean, Karl Marx couldn’t have done as much damage to capitalists as Orville did.

Within a few short months, the dot-coms bombed and equity markets began a long, slow, painful slide that finally ended in 2002. Surely, investors who read that article would have wished they had taken Mr. Buffett’s advice (I read that column and was stupid enough to buy Yahoo! shortly thereafter). Could this time be any different?

This article has 20 comments

  1. Actually, when he had that piece in Fortune, it was a good time to get out of tech and into Buffett’s company, Berkshire Hathaway.

    Anyway, there’s an interesting background to the Fortune piece. He delivered the keynote address to the swanky and prestigious annual Sun Valley Conference, put on by Herb Allen, one of Buffett’s friends.

    This particular conference is written about in the new Buffett biography by Alice Schroeder. The first two chapters are available free online, and happen to cover the conference in question:

    http://www.randomhouse.com/catalog/display.pperl?isbn=9780553805093&view=excerpt

  2. The regular retail investor does not have the scale of capital to invest that Mr. Buffet has & therefore will not get the terms he no doubt has been able to get. He is certainly hedged for the downside of the equation just in case. Even the Oracle of Omaha is sailing in uncharted waters here. The conditions out there are unlike anything he or anyone have ever seen and besides, he’s what in his 80’s? What does he really have to lose? I think he has become implicit in the biggest pump and dump scheme yet. My question is, can we really save this thing by “buying American”, creating more debt & inflating our way out of it? What about the CDO timebombs? Are we having a fake rally here or are we really at a bottom? It doesn’t seem plausible that things can turn around positively so quickly…I am soooo confused. Is the dollar cruising for destruction? How can the Fed create all of this new debt and not have it come back and bite hard? Someone please advise!

  3. Actually you have two ways to profit from his advice – either buy Berkshire Hathaway B shares costing 4129 as of yesterdays close..
    or you could follow Berkshire Hathaway’s stock holdings
    http://www.thediv-net.com/2008/10/warren-buffetts-berkshire-hathaway.html

    Anyways, the wise thing for an investor to do is to keep dollar cost averaging into this bear market, Do not confuse the advise of Mr Buffett with him calling the bottom.. Noone knows when we will keep the bottom.. That’s why spread your purchases, keep your asset allocation and keep getting dividends :-)

  4. Canadian Capitalist

    gene: I picked up Snowball from Costco over the weekend but haven’t started reading it yet. Looking forward to it though.

    Yve: Buffett doesn’t make public calls too often and as someone who cares deeply for his reputation, he wouldn’t stick his neck out. Also, he stresses that he has no idea about the short-term but over 5, 10 or 20 years stocks will turn out to be better than competing asset classes.

  5. I can’t picture Warren Buffet ever being accused of a “pump & dump”, even if it is just because he rarely dumps before holding for his 10 year minimum strategy. He is however, buying with a safety net when he gets preferreds with 10% returns. Even if stocks languish, the 10% looks pretty decent.
    I agree with DGI, it is a time to start to get involved, not a time to dive into the deep end. We have many false rallies ahead before this era ends!

  6. Buying stocks simply because the price is low may or may not prove to be wise. We could be in a range bound market for several years. Until an uptrend develops, I’m staying out of stocks.

  7. Yve,

    Since every government is saving their banks with more liquidity, and the banks are deleveraging, so far, we haven’t seen inflationary pressures, but DEFLATIONARY pressures. With every country only entering the turmoil that the US has had for over 8 months now, the US is poised for the benefits more than every other country. In addition, with the intangible asset value of all its global companies, the US should certainly do better over the next 20 years than it has over the last 12. I have hedged my exposure to the market turmoil with ETF’s, and now I’m taking Buffett’s advice, and slowly closing those positions for “Buffett” and “Graham” companies.

    Good luck everyone!

  8. I hope Buffett will be right. I am a net buyer in the next years, but would still like to see it going up!!!

    For us Canadiens, $CA falling each and every day, making US and International ETFS more expensive (and currency-neutral investments looking bad).

    I am looking to buy soon, but each day I see the $CA fall making the purchase more expensive, really bad…

  9. Russian Capitalist

    Chris Martenson did a good piece about it few days ago. In his opinion, the problem is that Buffet is counting on inflation in his prediction, but all signs are pointing to deflation at this point of time. So if it is deflation, then we have to look at Japan’s experience. It has been battling deflation for the last 19 years and counting. The Japanese stock market is still 80% below its former peak in 1989 and cash has been a better investment than either stocks or real estate for the last 19 years. While I think Buffet’s advice is valid if inflation wins this battle, one has to take into account the possibility of deflation and to diversify accordingly.

  10. ETF2X said: Buying stocks simply because the price is low may or may not prove to be wise. We could be in a range bound market for several years. Until an uptrend develops, I’m staying out of stocks.

    But even if we are, companies with strong fundamentals paying over 6% in annual dividends has to be as good or better than you’ll see sticking to cash. There are lots of companies in this position now, so if you believe their fundamentals are strong….

    DAvid

  11. David:

    In the end you may be right. At this point, I don’t know how comfortable I would be in attempting to determine which companies are not going to cut their dividend.

    Another strategy would be to buy a stock that you plan to hold come hell or high water and sell calls on it. However you look at it, this is a very tough market to make money in.

  12. CC. I believe Yve was referring to what Buffett is actually purchasing. For example, he didn’t buy Goldman Sachs’ “common shares” – they issued a new series of Preferred Shares yielding 10% per annum and with a buyback strike price which is about 20% higher than what he paid, and this series of Preferreds is not publicly listed and it’s JUST FOR Warren Buffett / Berkshire Hathaway. We the retail investor cannot get the same deal that Berkshire got. In fact, if we buy Goldman’s common shares, we actually hand over the benefit Warren Buffett because the money raised from the common shares will re-capitalize Goldman Sachs and then they will use the cash to buy back the Prefs back from Berkshire for the aforementioned 20% premium. And Warren Buffett will laugh all the way to the bank, leaving the common shareholder in the lurch because all of the company’s cash will be deployed to meet the punishingly high dividend yield on the remaining Pref Shares. So, of course Warren Buffett wants you to pour your money into Goldman now!

  13. For me, I would prefer to stay in CDIC insured instruments until I see the macro-economic conditions bottom out. I don’t necessarily mean that we have to wait until we start to see some GOOD news, but more like an ABSENCE of BAD news would be a nice change.

    But for full disclosure – that’s also because I work in the manufacturing sector and I could be out of work tomorrow… So, just because I’ve become ultra-conservative in my investing doesn’t mean that some civil servant somewhere with a fat pension would be wrong by buying up a storm right now.

  14. Canadian Capitalist

    Phil: Buffett’s mentions in his article that he is buying US stocks in his personal account as opposed to the special preferred share deals that he did with Goldman and GE.

    One reason for my excitement is dividend yield on the S&P 500 is now more than 3% compared to just 3.7% for a 10-year treasury. That doesn’t mean yields can’t go higher, just that stocks sport reasonable valuations now.

  15. Canadian Capitalist

    ETF2X, DAvid: It’s not just price we are talking about here. It is also valuations. Even the broad market sports a dividend yield of more than 3% both in Canada and the US. Compared to just a slightly better rate for bonds. I think odds are very high that stocks will handily beat bonds over the next 10 years. As for the short term, I have no idea. If stocks go lower from here, I won’t be complaining.

    Cash Instinct: It is extremely hard to time the markets. Just like you point out, while US stocks are falling, C$ is falling as well. Market timers here should get both the direction of the stock market and currency right. Quite a tall order, if you ask me.

  16. Nouriel Roubini predicts the significant contraction in the developed countries’ economies and the real crisis in the developing ones.
    I am starting to give a serious thought to liquidating my portfolio if there’ll be any significant bear market rallies. ..Yeah, I know, I know all the arguments against it, but this is not going to be your garden variety recession..
    All of a sudden, locking in the losses for tax purposes and buying back the same stocks at some future point (when they will be significantly cheaper) starts to make a lot of sense..

  17. Buffet doesn’t buy stocks just because they’re low. Buffet buys stock of PROVEN COMPANIES which a fundamentally profitable, but which he thinks are just undervalued due to negative market sentiment. Buffet has always stressed the importance of looking for stocks with a continuous stream of dividends, increasing revenus, reasonable debt, and low stock price to earnings multiples.

  18. I’m extremely bearish on ANY fiat currency over the long-haul. Currencies do what they have always done, become worth less through inflation.

    I agree with Buffett that equities are a better choice (well certain equities anyways :) ) than holding cash equivalents. I also agree that this major down swing (recession) in the economy and the stock market has brought prices back down to where you can find value (and even some really good bargains!). Now might not be a bad time to buy great companies for a whole lot less than you might have paid two years ago.

    That said, I’m concerned about the health of the economy under Obama’s socialist policies for eight years. If taxes spike like he proposes, the incentive to invest in America is almost completely gone for foreigners, like us. Why bother, when there are better places (like here at home) to invest our money?

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