Dec. 4, 2008
We reminded Buffett of the old play on the Kipling lines: “If you can keep your head when all about you are losing theirs … maybe they know something you don’t.”
Buffett responded that, yes, he was well aware that the world is in a mess. “What the DeBeers did with diamonds, the Arabs are doing with oil; the trouble is we need oil more than diamonds.” And there is the population explosion, resource scarcity, nuclear proliferation. But, he went on, you can’t invest in the anticipation of calamity; gold coins and art collections can’t protect you against Doomsday. If the world really is burning up, “you might as well be like Nero and say, ‘It’s only burning on the south side.’”
Let’s start by defining “investing.” The definition is simple but often forgotten: Investing is laying out money now to get more money back in the future--more money in real terms, after taking inflation into account.
Now, to get some historical perspective, let’s look back at the 34 years before this one--and here we are going to see an almost Biblical kind of symmetry, in the sense of lean years and fat years--to observe what happened in the stock market. Take, to begin with, the first 17 years of the period, from the end of 1964 through 1981. Here’s what took place in that interval:
Dow Jones Industrial Average
Dec. 31, 1964: 874.12
Dec. 31, 1981: 875.00
To understand why that happened, we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That’s because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward. The basic proposition is this: What an investor should pay today for a dollar to be received tomorrow can only be determined by first looking at the risk-free interest rate.
Consequently, every time the risk-free rate moves by one basis point--by 0.01%--the value of every investment in the country changes. People can see this easily in the case of bonds, whose value is normally affected only by interest rates. In the case of equities or real estate or farms or whatever, other very important variables are almost always at work, and that means the effect of interest rate changes is usually obscured. Nonetheless, the effect--like the invisible pull of gravity--is constantly there.
Then, in the early 1980s, the situation reversed itself. You will remember Paul Volcker coming in as chairman of the Fed and remember also how unpopular he was. But the heroic things he did--his taking a two-by-four to the economy and breaking the back of inflation--caused the interest rate trend to reverse, with some rather spectacular results. Let’s say you put $1 million into the 14% 30-year U.S. bond issued Nov. 16, 1981, and reinvested the coupons. That is, every time you got an interest payment, you used it to buy more of that same bond. At the end of 1998, with long-term governments by then selling at 5%, you would have had $8,181,219 and would have earned an annual return of more than 13%.
That 13% annual return is better than stocks have done in a great many 17-year periods in history--in most 17-year periods, in fact. It was a helluva result, and from none other than a stodgy bond.
The second thing bearing on stock prices during this 17 years was after-tax corporate profits, which the chart, After-Tax Corporate Profits as a Percentage of GDP, displays as a percentage of GDP. In effect, what this chart tells you is what portion of the GDP ended up every year with the shareholders of American business.
The chart, as you will see, starts in 1929. I’m quite fond of 1929, since that’s when it all began for me. My dad was a stock salesman at the time, and after the Crash came, in the fall, he was afraid to call anyone--all those people who’d been burned. So he just stayed home in the afternoons. And there wasn’t television then. Soooo ... I was conceived on or about Nov. 30, 1929 (and born nine months later, on Aug. 30, 1930), and I’ve forever had a kind of warm feeling about the Crash...
By WARREN E. BUFFETT
Published: October 16, 2008
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.
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.
market. I haven’t the faintest idea as to whether stocks will be higher or lower a month —
or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you
wait for the robins, spring will be over.