The Market市场

I have no idea were the market is going to go. I prefer it going down. But my preferences have nothing to do with it. The market knows nothing about my feelings. That is one of the first things you have to learn about a stock. You buy 100 shares of General Motors (GM). Now all of a sudden you have this feeling about GM. It goes down, you may be mad at it. You may say, "Well, if it just goes up for what I paid for it, my life will be wonderful again." Or if it goes up, you may say how smart you were and how you and GM have this love affair. You have got all these feelings. The stock doesn't know you own it.

The stock just sits there; it doesn't care what you paid or the fact that you own it. Any feeling I have about the market is not reciprocated. I mean it is the ultimate cold shoulder we are talking about here. Practically anybody in this room is probably more likely to be a net buyer of stocks over the next ten years than they are a net seller, so everyone of you should prefer lower prices. If you are a net eater of hamburger over the next ten years, you want hamburger to go down unless you are a cattle producer. If you are going to be a buyer of Coca-Cola and you don't own Coke stock, you hope the price of Coke goes down. You are looking for it to be on sale this weekend at your Supermarket. You want it to be down on the weekends not up on the weekends when you tend the Supermarket.

The NYSE is one big supermarket of companies. And you are going to be buying stocks, what you want to have happen? You want to have those stocks go down, way down; you will make better buys then. Later on twenty or thirty years from now when you are in a period when you are dis-saving, or when your heirs dis-save for you, then you may care about higher prices. There is Chapter 8 in Graham's Intelligent Investor about the attitude toward stock market fluctuations, that and Chapter 20 on the Margin of Safety are the two most important essays ever written on investing as far as I am concerned. Because when I read Chapter 8 when I was 19, I figured out what I just said but it is obvious, but I didn't figure it out myself. It was explained to me. I probably would have gone another 100 years and still thought it was good when my stocks were going up. We want things to go down, but I have no idea what the stock market is going to do. I never do and I never will. It is not something I think about at all.

When it goes down, I look harder at what I might buy that day because I know there is more likely to be some merchandise there to use my money effectively in.

WB: I could expand on that question, but I couldn’t answer it. Charlie and I haven’t the faintest idea where it goes next week, next month or next year. We are not in that business. It isn’t our game. We see thousands of companies priced every day. We ignore 99% of what we see. Every now and then, we find an attractive price for a business. When we buy it, we would be happy if the market was closed for a few years; you wouldn’t get a price quote daily if you owned a farm. We look at expected yield, cost of taxes. If you buy a farm, you would look at the cost of fertilizers, what a farm produces relative to the purchase price, price per acre, production per acre, etc. We make judgments.

CM: Nothing to add. WB: He’s been practicing for weeks. [laughter]

[Q - In 2008 you highly recommended buying US stocks. What is your opinion on market going forward? What is reasonable rate of return?]

WB: I write articles on general level of market itself rarely, only 4 or 5 times in forty years. It turned out I was pretty premature in Oct 2008. But I felt it would be way better to own bonds or cash. I thought I would be eventually alright. I have no idea what the stock market will do this week or next year. I do think I’d rather own equities than cash or 20yr bond over the long term. This is partly because I am unenthusiastic on alternatives. I think there will be a modest positive real return over time.

CM: Equities are best of a bad lot of available opportunities. I think you are right, and people should get used to ordinary real returns – not exciting.

WB: We like owning businesses. They do beat holding cash or 5, 10 or 20yr bonds.

[Q -Is there a bear market coming?]

Humans are still made up of the same psychological makeup, and opportunities will always present themselves. All these people have not gotten more rational. They are moved by fear and greed. But I'm never afraid of what I am doing.

[CM: People have always had this craving to have someone tell them the future. Long ago, kings would hire people to read sheep guts. There’s always been a market for people who pretend to know the future. Listening to today’s forecasters is just as crazy as when the king hired the guy to look at the sheep guts. It happens over and over and over.

In 1998, there were incredible opportunities. Just like today, there were a lot of smart people with 150 IQs running around with lots of money, but there was a panic. For example, there was a 30 basis point difference in the yields of on-the-run and off-the-run 30-year Treasuries. Literally, a 29 1/2- year traded 30 basis points higher than a 30-year because of the slight liquidity difference. You could have made a lot going long one and short the other. You wouldn’t have thought this kind of thing was possible, but it happened.

The high-yield market went crazy as well. In the span of only 14 months, you had yields go from 25%-60% to 7%. [Buffett put up the following chart:]

What's going to happen tomorrow, huh? Let me give you an illustration. I bought my first stock in 1942. I was 11. I had been dillydallying up until then. I got serious. What do you think the best year for the market has been since 1942? Best calendar year from 1942 to the present time. Well, there's no reason for you to know the answer. The answer is 1954. In 1954, the Dow … dividends was up 50%. Now if you look at 1954, we were in a recession a good bit of that time. The recession started in July of '53. Unemployment peaked in September of '54. So until November of '54 you hadn't seen an uptick in the employment figure. And the unemployment figure more than doubled during that period. It was the best year there was for the market. So it's a terrible mistake to look at what's going on in the economy today and then decide whether to buy or sell stocks based on it. You should decide whether to buy or sell stocks based on how much you're getting for your money, long-term value you're getting for your money at any given time. And next week doesn't make any difference because next week, next week is going to be a week further away. And the important thing is to have the right long-term outlook, evaluate the businesses you are buying. And then a terrible market or a terrible economy is your friend. I don't care, in making a purchase of the Burlington Northern, I don't care whether next week, or next month or even next year there is a big revival in car loadings or any of that sort of thing. A period like this gives me a chance to do things. It's silly to wait. I wrote an article. If you wait until you see the robin, spring will be over.

[In response to a shareholder expressing the many reasons why he is concerned about the future outlook for the economy and the market, Buffett replied:]

I would say that at any given point in history, including when stocks were the cheapest, you could have found an equally impressive list of negatives. In ‘74, you could have written down all kinds of things that would show the future would be terrible.

We don’t pay any attention to this kind of thing. Our underlying premise is that this country will do very well and that businesses will do very well. We used nuclear bombs, endured the cold war, etc., but over time the opportunities have won out over the problems. I expect this will continue, barring use [against us of] weapons of mass destruction – it would be hard for businesses to win out over this.

Going back to ‘59, I can’t think of any discussions Charlie and I have had in which we’ve passed on something because of a view on macro conditions. It won’t be the economy that will do in investors; it will be investors themselves. If you’d just owned stocks over time, you’d do fine. We’re unaffected by the variables that you mentioned. Show us a good business tomorrow and we’ll jump.

[CM: We wouldn’t be surprised if professionally managed money in the US will have unimpressive returns relative to the high returns we had until three years ago.

Our expectations were more modest than most three years ago [see Buffett’s Fortune article, Mr. Buffett on the Stock Market, 11/99]. We didn’t project the end of the world, but said anyone who thought they could sit at home and day trade to double digit returns was living in a fool’s paradise. It’s hard to understand how people could believe such things. To some extent, they’re sold these beliefs.

Can see anything in markets. Don't see any cases of incredible under valuation, if we did find it they probably will have been bought out.

[CM: Present time is a very unusual period. Residential real estate and common stock value grew so quickly.]

Company's that themselves couldn't borrow 100 million and is worth billions. Most extreme time period, even including the 1920's.

[CM: I think it's the most extreme period since modern capitalism, the 30's created worst depression in 600 years. This time period is almost as extreme as 30's but in a different direction.]

Doesn't make it easy to predict an outcome. No question in last year the ability to monetize shareholder ignorance has been exceeded.

Regardless of the market, I will keep buying businesses. We like low prices.

We’re not good at forecasting markets. Charlie and I spend no time thinking about where the market’s going. We do know when we’re getting good value [when we’re buying a stock or business].

There are always going to be some good and bad things happening.

I’ve seen more people lose more money by getting focused too much on one factor. We’ve never not bought something due to macroeconomic concerns.

Very infrequently you can say something intelligent about the market as a whole – when circumstances are so extreme that you predict the next 5-10 years with some degree of certainty. This was the case in 1969 and 1974. But most of the time, we’re in some in-between zone.

Obviously you can get more for your money now than in 1999 when I wrote that Fortune article (“Mr. Buffett on the Stock Market”). I knew I’d be right.

If I had to make a choice today between long-term bonds yielding 4.5% vs. equities over the next 20 years, I’d prefer equities. But people who expect 6-7% after-tax or double digits [pre-tax] and think they can do it or hire someone else to do it will likely be disappointed.

I don’t think we’re in bubble times or bargain times.

I think you’ll get a chance to do something screamingly intelligent within a few years, maybe much sooner, relative to current choices.

If you believe that American businesses in aggregate can earn the kind of returns they have been earning in the past couple of years, and you postulate no change in interest rates, you can justify 7000 on the Dow and 800 on the S&P. Now, if interest rates go higher, the valuation goes down automatically. And, more importantly, if the returns on equity of American industry, which are at historic highs, and which classical economics tells you would be hard to maintain--if those returns go down, that also would pull it down.

I'll give you a little quiz: What two years has the Dow had the greatest overall gain? The two years in the 1900s are 1933, which most of you don't think of as a banner year, and 1954, and in both of those years the Dow was up over 50%, counting dividends. In March of 1955, because of the fact that the Dow had gone up, they decided to have Congressional hearings about it (laughter), and my boss Ben Graham was called down to testify, and Ben's opening comments about the market at that time were, "The market looks high, it is high, but it's not as high as it looks." Which brings about the current situation--the market certainly looks high, but there have been huge changes in earnings and return on equity and you've had this big move in interest rates. Now those are underlying fundamentals that have powered a huge bull market. After a while, people get captivated simply by the notion of rising prices without going back to the underlying rationale and that's when you get very dangerous conditions in terms of possible developments. I have no idea where the markets will go, but you have the kind of conditions that could cause real excesses, just like you had excesses in 1973-74 in the other direction, when you could buy businesses for 20 cents on the dollar. People behave in extreme ways in markets and over time that's very good for people who keep their heads.

22% returns are sustainable in a world where the long-term interest rates are 7% and where the capability of saving large amounts in the economy are quite dramatic. You could just think that there would be some sort of leveling effect between 7 and 22, that as savings got directed within the economy, and as the competitive forces operate that we've been taught will operate over time, will come into play, but I've been wrong on that subject. Let's say you have a 22% perpetual bond, and let's say a third of that coupon would be paid out. So, a bond with a 22% coupon, and say 7% is paid out, being the dividend payout on the S&P we'll say, and the other 15% is reinvested in more 22% bonds with similar characteristics. Now what's that instrument worth on a present value basis? A lot of money. In fact, it's worth so much that it becomes a mathematical fallacy at some point, because when the compound rate becomes higher than the discount rate you get infinity, and that's a concept we like to think about around Berkshire though we may not attain it. There's a book called The Petersburg Paradox and the Growth Stock Fallacy by David Durant, written about 25 years ago, and it gets into this bit where the growth rate is higher than the discount rate, and it shouldn't work for an extended period of time. Charlie?

[CM: I think a couple of things contributed to this phenomenon that we so carefully mispredicted. Number one, it became very fashionable for corporations to buy in shares, and I think that we helped in a very small way to bring on that. I think that was a plus in terms of corporate decision making. The other thing that happened is that the anti-trust administration got way more lenient in allowing people to buy competitors. And I think that those two factors helped raise returns on capital in the United States, but you wouldn't think that could go on forever. What 15% per annum compounded will do is grow way faster than the economy can grow, way faster than aggregate profits can grow over the long haul ... I don't think we've reached a new order of things where the laws of mathematics have been repealed ... All of you should be aware of this, because all the people who are professional sellers of investment advice and brokerage services, etc., etc., have an immense vested interest in believing that things that can't be true, are true. And not only that, they've been selected in a Darwinian process to have formidable sales skills and large incomes. (laughter) That makes it dangerous for the rest of us.]

And you've been selected to be the recipients of their advice. (more laughter)

[Q - Are corporate profit levels sustainable?]

Corporate profits as a percentage of GDP are at a record. I’ve been amazed. After being in a range for decades, it’s jumped up. I’d have to look at a chart, but other than maybe a year after World War II, I think there have only been two or three years in the past 75 where corporate profits have been as high [as they are today]. I would not think it would be sustainable. When they get up to 8% or more of GDP, that’s high, but so far there’s been no reaction like higher taxes.

You have lots of businesses earning 20% on tangible equity in a world where corporate bonds are yielding 4-5%. That’s astonishing. If you read a book, it would say it’s not possible. This is high, which means someone else’s share is going down, namely labor’s. Does it become a political issue? Congress has power to change this very quickly. Corporate tax rates used to be 35%, but now many companies are paying only 20%.

Corporate America is living in a great time. History shows this is not sustainable. I would imagine that it will not be.

Munger: A lot of profits are not in manufacturing or retailing, but in financial sectors. There’s been a huge flow of profits to banks and investment banks. That has no precedent. I don’t think it’s ever been as extreme as it is now.

Buffett: We’ve invested in and owned banks. If 20 years ago you’d asked me whether it was possible, in a world of 4.75% bonds, that countless banks would earn 20%+ returns on tangible equity, I’d have said no. In part this is due to leverage. A 1.5% return on assets leveraged 15 times is a 22.5% return on equity. But even so, you’d think once everyone was doing it, return on assets would drop to 1%, but it hasn’t happened yet.

Munger: Some of this is due to consumer credit, which has been pushed to extremes. Other countries that have done this have suffered bad consequences – South Korea, for example, really suffered for two or three years. I don’t think this is a time to swing for the fences.

Buffett: In South Korea, it produced some of the cheapest stock prices I’ve ever seen.

If I were limited to only marketable securities investments, I’d probably put it out to the partners to decide what they’d want to do. But we own many wonderful businesses, so we’re not in exactly the same position. In those days, the expectations had been raised so much, I felt tremendous internal pressure to keep it up; I didn’t want to fail delivering, so I folded it up.