Warren Buffett Sounds Like A Hypocrite Because He Just Doesn’t Think Very Highly Of You

Dan Loeb recently drew attention to the many ways in which Warren Buffett contradicts himself and it became a pretty popular little quote. It became popular, I think, because there is a great deal of truth behind it. This is especially true when it comes to Buffett’s advice on investing.

Warren Buffett famously tells us to, ‘be greedy when others are fearful and fearful when others are greedy.’ Then he tells us not to try to time the market.

He tells us to evaluate stocks and bonds and put money into whichever offers the greatest prospective return. Then he says, ‘Screw it. Just put all your money in the stock market.’

He tells us that a “margin of safety” is the most important concept in investing. Then he says, ‘Never mind all that. Just buy stocks today at the prevailing price and focus on the very long-term.’

He tells us the best returns are to be had by owning only the highest quality companies. Then he says, ‘Forget that. Just buy an index fund.’

So what the heck is going on here?

I think part of it is his evolution as an investor. He started out managing a small amount of money which allowed him to take advantage of special situations and things that just aren’t possible when you’re managing over a hundred billion dollars. Now that he is almost forced to become a closet index fund manager, he has modified his philosophy to suit his situation.

The bigger reason, though, that I believe Buffett contradicts himself like this in public is he just doesn’t think you’re capable of becoming a “superinvestor” in the first place.

It’s very difficult to be “greedy when others are fearful.” It’s just as hard to be “fearful when others are greedy.” It takes a great discipline to be able to shut out the crowd and focus on what truly matters. This is an ability most people just don’t have – which is why there is a herd mentality in the first place.

It actually doesn’t take much specialized skill at all to evaluate stocks and bonds to determine which is more attractive at any given time or to recognize opportunities that offer a “margin of safety.” It does take discipline, though, to be able to take advantage of these opportunities when the crowd is screaming, ‘you’re wrong!’

Buffett clearly believes you’re not capable of this sort of discipline. And, based on how most of you have behaved over the past 20 years (see the dot-com and real estate bubbles), he’s probably right. For this reason, he hedges all of his advice and dumbs it down so that you don’t hurt yourself too badly. In the end, Buffett sounds like a hypocrite because he just doesn’t hold a very high opinion of you.

Now if you disagree and want to learn how to be a “superinvestor” like Buffett, I suggest you start right here. And pay no attention to Buffett’s dumbed down advice… unless, of course, you prefer to run with the crowd.


Welcome To The Everything Bubble

This post first appeared on The Felder Report Premium on May 2nd:

Everything is overvalued. Stocks are extremely overvalued. An incredible amount of bonds have negative yields; how much more overvalued can they get? Investment-grade and high-yield credit spreads are near all-time lows on top of some of the lowest rates we’ve ever seen! Prices for high-end real estate, art and other collectibles are off the chart. I’ve thought of calling this the “everything bubble,” because looking at each one on its own (outside of small cap stocks which are largely obscured from view) there’s no obvious bubble similar to the dotcom or real estate bubbles. But taken together we’ve never seen anything like this ever before.

I believe the real problem lies in the growth of “price-insensitive buyers,” as GMO recently labeled them. I’ve also called them “value agnostic.” Ultimately, there’s a growing class of investors (though I believe they don’t deserve that term) who are buying assets like stocks and bonds regardless of their valuations. They will buy stocks to the moon simply because their methodology dictates they do so. I’m referring mainly to so-called “passive” investors here.

Then we also have investors who will buy bonds no matter how negative they get because their methodology dictates it. Just look at pension funds, insurers and central banks. Their policies ensure they continue buying bonds even when that means locking in deeply negative returns over long periods of time.

The incredible growth in this class of price-insensitive buyers is responsible for the everything bubble. Just think about the growth of passive investing over the course of just the past five years or so. Buy and hold has gone from being mocked and disparaged only five years ago to the most popular investment style there is. Witness the growth of robo-advisors as evidence. And how long have central banks been buying assets? It’s only been over the past five or six years. This is a wholly new phenomenon in the markets and it’s now become a huge segment.

Make no mistake. The incredible growth of “value agnostic” investors is just another form of mania pushing asset prices to extremes. These investors use their returns over the past five years as proof that their methodology has merit when simple common sense shows that you can’t possibly be an investor while denying the definition of an “investment,” as Ben Graham defined it:

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

Buying stocks or bonds today provide neither “safety of principal” nor “adequate return.” In fact, these “price-insensitive buyers” don’t even attempt to begin any sort of “thorough analysis.” For this reason they are nothing more than speculators. That they believe themselves to be otherwise despite the obvious fact that they are just the opposite may be the surest sign there is that this is indeed another mania. Sadly, it will only be evident to them in hindsight.


Why A Stock Market Crash May Once Again Be Inevitable

Don’t confuse brains with a bull market. -Humphrey B. Neill

Spending as much time as I do on social media, namely Twitter and StockTwits, I’ve been absolutely astounded by how many traders have begun to “confuse brains with a bull market.” We joke about it on these platforms but there is an amazing amount of hubris out there right now.

One of my favorite investing quotes comes from an interview Paul Tudor Jones gave just after the financial crisis had ended:

Clearly, many fundamental investors were caught off guard by the crisis. Stocks they thought were cheap in 2007 got far cheaper over the coming couple of years. Being unable to “read the tape,” these investors suffered the full force of the stock market crash.

As a response to this failure, many investors have seemingly tried to adapt by becoming “tape readers.” Most notably I have seen an explosion in the number of traders calling themselves, “trend followers.”

Now I have great respect for trend-following. Some of the greatest investors on the planet are trend followers, employing a very simple yet very effective and intuitive strategy across a wide variety of markets.

That said, the problem with most of these newbie trend followers is they ignore one of the key components of the strategy: diversification. They are involved only in one asset class, the stock market. Though they respect the trend, they don’t appreciate just how exposed they are to liquidity risk right now, something experienced trend followers ameliorate by broadening out into as many uncorrelated asset classes as possible.

Emboldened by 3+ years of very low volatility, these traders have become the exact opposite of what PTJ was referring to. Their inability to understand the fundamentals, relying solely on the trend, puts them at great risk, especially in an environment of problematic liquidity.

As I’ve demonstrated over the past several months, this stock market is one of the most overvalued, overbought and overbullish in history. Julian Robertson, Stan Druckenmiller, Ray Dalio, Mohamed El-Erian and other super-investors have recently warned about this in one way or another.

However, when I have shared the their concerns via social media, I’m regularly met with dismissal or disdain. These trend followers have become so emboldened by the bull market that they now believe their brains to be even bigger than these giants of the industry.

I have been bearish but have avoided using the “c-word” until now because crashes, by their nature, are impossible to predict. But the hubris on display in the market by those who believe themselves immune to these massive risks has me wondering if some sort of liquidity event in the stock market isn’t inevitable.

If everyone is a trend follower and the stock market begins to sell off, how can everyone get out at the same time? And in a market already plagued by severe liquidity challenges? It seems to me that there is a lesson here that should have been learned a long time ago.

The quote above comes from a fantastic piece Mark Yusko recently wrote about his personal experience with Julian Robertson, who recently said it is, ‘not at all ridiculous to expect another 2008-style decline in the stock market.’

To turn the PTJ quote on its head, counting on being able to sell once it’s clear to all that the trend has shifted may be precisely how those in the trend following space get annihilated in the future. Certainly, we have seen this movie before. Doesn’t anyone else remember “portfolio insurance”?


It’s Going To Take A Major Bear Market Before Stocks Can Live Up To Investors’ Lofty Expectations

The Nasdaq recently set a new all-time high, 15 years after it set it’s last one. Investors who bought back then believing no price was too high to pay in order to hop on the dotcom bandwagon learned the hard way that, “the price you pay determines your rate of return.” This is an iron law of the markets. If you overpay you essentially lock in subpar returns for a long period of time.

Think about it this way. You’re buying some wholesale product to resell. Let’s just use beard oil as an example. You know you can sell the beard oil for $10 per jar. If you can buy them for $5 you can double your money every time you sell a jar. But if you pay $9 each you’re going to earn a lot less on each sale. Buying the Nasdaq in 2000 was like paying $40 per jar. Inflation (sales and earnings growth, in the case of Nas cos.) has now finally caught up so that these investors can now sell their jars of beard oil for their original cost.

Paying an incredibly high multiple of earnings for the Nasdaq back in 2000 guaranteed buyers that they would receive poor returns over the next 15 years. Even the broader market at the time was priced to disappoint investors as Warren Buffett famously wrote in Fortune back in November 1999.

What investors need to know today is that they are currently priced just as high as they were back then! The problem is they once again want their cake and to eat it, too. Despite paying an extremely high price for stocks today they also expect a high rate of return. A few recent polls show investors expecting to get 10% per year from their equity investments right now. Some are even expecting to generate twice that much and there’s just no chance it’s going to happen.

Warren Buffett’s favorite valuation measure is nearly 90% correlated to future returns in the stock market. It’s what he referred to in his November, 1999 piece when he wrote that investors were destined to be disappointed by their returns over the coming decade (now known as the lost decade). Based on how high this measure shows stocks are currently valued, it forecasts an average annual return of about -0.5% over the coming 10 years.

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Now if you want to generate a 10% return buying the major stock market indexes like the S&P 500 you’ll need to pay a much lower price. Using similar measures, it’s fair to estimate that you would have to pay about 940 on the S&P to generate a 10% forward return for the coming decade. In other words, it would take a decline of more than 50% to set up the opportunity for the stock market to provide double digit returns once again.

So if you do want to earn 10% per year on your stock market investments you should be rooting for a major bear market. Because without one you’re going to be just as disappointed as those who bought stocks back in November of 1999. Like Nobel Prize winner Bob Shiller recently said, you’ll likely wake up 20 years from now and realize your investments have gone nowhere. And during that time, there will undoubtedly be a few opportunities to buy stocks at much better valuations and thus offering much better forward returns just like we’ve seen over the past 20 years.


How To Trade Like Stan Druckenmiller, George Soros And Jim Rogers

The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept everywhere. And if you look at all the great investors that are as different as Warren Buffett, Carl Icahn, Ken Langone, they tend to be very, very concentrated bets. They see something, they bet it, and they bet the ranch on it. And that’s kind of the way my philosophy evolved, which was if you see – only maybe one or two times a year do you see something that really, really excites you… The mistake I’d say 98% of money managers and individuals make is they feel like they got to be playing in a bunch of stuff. And if you really see it, put all your eggs in one basket and then watch the basket very carefully. -Stan Druckenmiller

This quote comes from a speech Druck gave at the Lost Tree Club back in January. I’ve read the speech twice now and I’m sure I’ll read it many more times (and recommend you do the same – here’s the link). For those who don’t know, Druck generated 30% average annual returns at his hedge fund over a period of 30 years and never had a single down year – possibly the best track record ever.

I’m sharing this quote with you here because I think it’s central to what we are trying to accomplish. I want to help you close the gap between being an average investor and being a phenomenal investor. That’s my whole purpose with this thing.

But there’s one huge road block we run into. Being a “pig” isn’t easy. For many people, it may not be possible. As Druck explains in his speech, when he and Soros famously shorted the British pound they put 200% of the fund into that one trade. 200%! They put every penny into the trade and then borrowed against every penny to lever up their returns. That’s what he means by ‘being a pig.’ How many people could put this trade on and still sleep at night? This also goes against everything we are taught when learning how to invest. Step one is to diversify, right? What they don’t tell you is the greatest investors of all time look at step one and call, “bullshit.”

The reason phenomenal investors are able to forego diversification like this is because their skill set is different. They are capable of doing the research such that they can have a high level of confidence in an idea. And when they are very, very confident about an idea they can afford to swing for the fences because their batting average with high confidence ideas is very, very good (and, probably even more important, they’re also willing to admit when they’re wrong and get out quickly). And why put any money into anything else when you have one really, really good idea?

Most investors can’t do this simply because they just don’t have very good batting averages. So bridging the gap between being an average investor and being a phenomenal one is first raising your batting average. This requires both knowledge and experience. The second step is trusting your knowledge and experience when you find a high confidence idea (while also limiting the damage when you’re wrong). And when I say, “high confidence idea,” I’m thinking of a quote from another Soros disciple, Jim Rogers:

One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.” -Jim Rogers

You have so much confidence in an idea that it feels like a “sure thing” or as sure of a thing as there possibly can be in the financial markets. This is how I felt about Herbalife back in January and that’s exactly what I did. I put about half of my own personal liquid assets into that one trade. That’s what “being a pig” meant to me.

Bridging the gap between being an average investor and phenomenal investor is a process. The average investor should be diversified in order to protect them from their own lack of investing skill. But the phenomenal investor throws it out the window and says “I’ll just be in cash until there’s a trade opportunity so compelling that I simply can’t resist. Then I’ll back up the truck.” (This is probably why guys like Jeff Gundlach and Mohamed El-Erian are mostly in cash right now in their personal accounts – they’re waiting for a compelling opportunity and don’t feel compelled to hold anything just to stay invested.)

It’s up to each individual to determine where they are in the process and how their personal risk tolerance should dictate how they implement these ideas in their own investments. A broad ETF portfolio, like any of the models presented in Meb Faber’s new book, is ideal for a beginning investor or one with a very low tolerance for risk. Just via the cost savings versus traditional investment methods this will vault her performance far ahead of most other individual investors. More advanced and aggressive investors, however, should focus more on the most attractive individual risk/reward opportunities they can find based upon their own analysis because that’s where I believe the Druck/Soros/Rogers-type returns lie.

A version of this post first appeared on The Felder Report PREMIUM