scumbag-warren-buffett-e1378296915444
Posts

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.

Standard
dollarsigns
Posts

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.

Screen Shot 2015-04-27 at 1.24.37 PM

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.

Standard
johntempleton
Posts

I’m Hearing A Lot Of Smart People Use “The Four Most Dangerous Words In Investing” These Days

Let me begin this post by saying that the three sources I quote here are among the handful of voices on social media and the financial blogosphere I respect most. This is also why I’m especially concerned about this new trend.

What worries me is that I’m now hearing the “four most dangerous words in investing” from some of the smartest guys in the game. Each of the arguments I’m going to look at represent some version of “it’s different this time” in relation to overall stock market valuation.

I’ve made the case for months now that stocks are extremely overvalued. In fact, I believe there is a very good case to be made that while we may not have another full-fledged tech bubble on our hands, the broader stock market is just as overvalued today as it was fifteen years ago, at the peak of the internet bubble.

To counter or to justify this idea, some very smart people have gotten very creative. First, Alpha Architect recently ran a post on valuations determining that, “the stock market isn’t extremely overvalued.” It’s “normalish.”

However, and they do acknowledge this in the post, they are looking at today’s valuations in relation to the history of just the past 25 years. The problem with this is that the past 25 years represent the highest valuations in the history of the stock market so, obviously, today’s valuations will look much more reasonable when framed in that light.

In acknowledging the limitation of using just the past 25 years, however, the author of the post questions whether, “market conditions 100+ years ago may be different than they are today.” In other words, ‘it’s different this time’ so those historical measures are no longer be relevant. To their credit, they recognize, “this sounds a bit like the ‘new valuation paradigm’ thinking that prevailed during the dotcom boom when valuations went crazy.” Still, they are putting it out there for less circumspect investors to rely upon.

Similarly, my friend Jesse Livermore of Philosophical Economics recently posited in a terrific piece that there are very good reasons justifying the persistent high valuations of the past 25 years.

Should the market be expensive?  “Should” is not an appropriate word to use in markets.  What matters is that there are secular, sustainable forces behind the market’s expensiveness–to name a few: low real interest rates, a lack of alternative investment opportunities (TINA), aggressive policymaker support, and improved market efficiency yielding a reduced equity risk premium (difference between equity returns and fixed income returns).  Unlike in prior eras of history, the secret of “stocks for the long run” is now well known–thoroughly studied by academics all over the world, and seared into the brain of every investor that sets foot on Wall Street.  For this reason, absent extreme levels of cyclically-induced fear, investors simply aren’t going to foolishly sell equities at bargain prices when there’s nowhere else to go–as they did, for example, in the 1940s and 1950s, when they had limited history and limited studied knowledge on which to rely.

My problem with this line of thought is that it assumes that human beings have essentially begun to outgrow the behavioral biases that have ruled them throughout a history that encompasses much longer than just the past century. We have seen “low real interest rates” and “aggressive policymaker support” in the past. See Ray Dalio’s excellent letter on 1937 as an analog for today’s economy and markets. So this argument really hinges upon, “the secret of ‘stocks for the long run’ is now… seared into the brain of every investor…. For this reason… investors simply aren’t going to foolishly sell equities at bargain prices when there’s nowhere else to go.”

In other words, we have entered a new era where human beings have fully embraced “stocks for the long run” for the long run and without reservation so cycles will be muted and valuations remain elevated for the foreseeable future. Never mind the fact that the recent history of the financial crisis may contradict this idea. I think the burden of proof for this argument lies squarely with its author. I have my doubts. In fact, this sounds strangely similar to Irving Fisher’s famous line just days before the 1929 crash, “stock prices have reached what looks like a permanently high plateau.”

Finally, Alex Gurevich wrote a fascinating think piece over the weekend on the Fed, the economy and how they relate to stocks and bonds. While I truly appreciate following Alex’s thought process (as I do both of the previous authors’), it’s his case for owning stocks that strikes me as a clear rationalization of extreme valuations:

Singularitarians (such as Ray Kurzweil)  believe that we are on the brink of explosive self-acceleration led by computers designing better computers, which design better computers even faster, and rapidly surpassing every aspect of human intelligence. Singularitarian philosophy is migrating out of the province of science fiction writers into the  mainstream, and can no longer be ignored by long horizon investors… The idea of economic singularity allows me have a clear and consistent theory of unfolding events. I can be positive on stock market without being scared of valuations.

I don’t dispute the awesome idea of singularity. It seems inevitable and inevitably beneficial for society (though some very smart people would disagree). What I dispute is the idea that singularity should justify high valuations.

As I tweeted this morning, it reminds my of Warren Buffett and Charlie Munger on the awesome innovation of air conditioning and air travel. These things were miracle innovations that dramatically improved the lives of human beings but did they justify abandoning tried and true investment methods developed over long periods of history? In retrospect, the answer is obvious. Amazing innovation is truly inspiring but it shouldn’t inspire you to overpay for a simple stream of future cash flows that have been very easy to value accurately over very long periods of time.

Ultimately, only time will tell if it is, in fact, “different this time” or if history will rhyme once again and today will only represent another stanza in the poem it’s been writing for centuries. With all due respect to these three very wise market philosophers, my money is on the latter.

Standard
Ulysses_and_the_Sirens_by_H.J._Draper
Posts

Don’t Be Seduced By The Siren Song Of The Stock Market

I recently wrote that, “the single greatest mistake investors make is to extrapolate recent history out into the future.” As an example of how dangerous this natural tendency is, I shared a bit of Warren Buffett’s warning from late 1999 in which he wrote that the amazing returns from the stock market during that period had led to investor expectations rising far too high. He forecast that the coming decade would not be nearly as rewarding as investors were hoping it would be. Clearly, the “lost decade” that followed vindicated this idea.

Recently, the Wall Street Journal ran a story about investor expectations once again becoming “delusional.” And with the 200% gain in the stock market over the past six years we probably shouldn’t be surprised. When stocks return 20%+ per year for a few years investors become accustomed to it. It’s only natural to extrapolate recent history into the future even if it is also extraordinarily dangerous to your financial health.

Earlier this month, Nautilus Research shared on twitter the chart below which shows exactly how dangerous this natural tendency really can be:

This is only the fourth time in history the stock market has risen 200% over a six year period.  Exactly six years ago, when I wrote that the market presented investors with an ‘opportunity of a lifetime,’ I was rip snorting bullish but still never dreamed the following six years would be so rewarding.

And while it may be difficult to base anything on only 3 previous occurrences, returns after each of these amazing runs were lackluster at best. History has not been kind to investors acting on their natural tendency to extrapolate.

In fact, only the 1955 occurrence shows a positive subsequent return on a 2, 3 or 5-year time frame. The one thing that sets this occurrence apart, however, is that valuations back then, based on Warren Buffett’s favorite metric (total market capitalization-to-gross national product), were about half what they are today.

fredgraph

As I wrote previously, today’s stock market is priced just as high as it was in November 1999 when Buffett wrote his warning in Fortune. For this reason, the April 1999 occurrence in the Nautilus study is probably much more relevant to our current situation than the 1955 one. And there is good reason to believe that this market is even more insidious than the one that peaked 15 years ago this month.

The stock market today is calling to investors just as the sirens of Greek mythology called to sailors drawing them into their rocky shores only to be shipwrecked. Extrapolating the fantastic recent returns into the future despite all the evidence against it is succumbing to the stock market’s perfidious seduction. And history suggests that’s almost a sure way to shipwreck.

Standard
legendary-investors-buffett-and-munger-drink-coke-and-eat-candy-while-answering-shareholder-questions
Posts

I Have One Question For Warren Buffett At The Next Berkshire Meeting

I’ve been dying to ask this question of Mr. Buffett for the past few months. After reading his 50th annual letter to Berkshire Hathaway shareholders over the weekend I submitted it to Carol Loomis in hopes she would ask it at the upcoming shareholders meeting:

In November 1999 in Fortune magazine you wrote that you believed the coming decade couldn’t possibly witness returns in the stock market similar to those of the prior decade. That forecast proved very prescient as it preceded what is now called the “lost decade.” Considering the fact that stocks are just as highly valued today as they were then, in terms of your market cap-to-GNP valuation yardstick, do you feel the same about the coming decade for the stock market as you did then? If not, why?

Fingers crossed.

Standard