Friday, March 27, 2009

Thoughts on Warren Buffet's Op-Ed

Buffett is an interesting character. There is a lot to learn from him; beyond that it would be folly to emulate him. I lost a lot of respect for him in late 2008 for two reasons: First, I think that op-ed was irresponsible. No one else on earth lives in his world. His advice is perfect for him, probably, but he can afford to lose a few billion. In fact, this man's marginal utility of money is zero.

For a typical American his advice was horrible, even without today's hindsight. (I submitted a piece to the P-I in response; they, of course, declined to publish it). Though he didn't explicitly tell people to buy U.S. stocks, the fact that he is publishing his own actions in the Times makes it a recommendation. There are people, like my Dad, who see him as an icon, and assume he must be right. Most of that audience is unaware of the work that goes into separating value from refuse. They still believe that the stock market only goes up. His piece reinforces the (unfortunately) widely held belief that the market must go back up to its recent highs.

Furthermore, if one wants to evaluate Buffett as a model, one must understand his position. I don't. Why does this guy invest? He doesn't consume anywhere close to his earnings. He doesn't give it to family and friends. He doesn't control his charitable projects. If wealth is accumulated saving and saving is future consumption, this man should have no incentive to increase wealth. That is not the case for those who read the article.

Buffett's most famous quotation is repeated here: Be fearful when others are greedy, and be greedy when others are fearful. This is bad advice, and I don't believe he follows it. Fear and greed are pathogens. They do not balance each other; each reinforces the ills of the other. The key is to keep one's head when fear and greed surround, see value where other's don't - if it is there.

It is certainly true that there is value to be found in the U.S. stock market. Finding it is another matter. If one buys an index as a proxy, he will buy into many failing enterprises. Last March I predict that 20% of the DJIA would be gone by the end of 2010. I don't mean a 20% decline in valuation; I mean 6 of the 30 companies will cease to exist. AIG is now dead, we are just waiting for the funeral. GM, Citigroup, and Bank of America have no chance for survival. Their names might live on, but neither their business model nor their equity will.

There will be great opportunity to pick through battered stocks; I don't believe that opportunity has come. The battering will continue. Right now, buyers are only guessing. Some of those guesses will be large winners, others will lose everything.

In 20 years we will read an article in Fortune explaining that if you bought XYZ Enterprises in 2011 you'd have made a return of 100,000 percent. But for every XYZ there are 249 Pets.coms out there and most people have no clue how to tell one from the others.

For people like you and I to find it worthwhile to devote scarce resources to investing we have to beat the averages. That means taking chances. I believe that, more often than not, taking a chance should mean holding back on buying something of value because it might be cheaper later. If we believe in our own abilities, then future opportunities will offset missed opportunity.

More egregious though, in my opinion, was Buffett's rent-seeking behavior. He bought his stake in Goldman Sachs not because he saw a good business but because he saw an opportunity to take advantage of government action. He made that
clear to his investors. Then he lobbied the government on his own behalf. I think he may have been an Obama campaign advisor.

Like my dad, the American people and their elected officials do not understand Buffett's position. They see his success as an indvidual investor as cause to grant him authority on how to manage the macroeconomy. So his "suggestions" hold weight and they influence policy.

There was one great paragraph in his op-ed, but most people would not even read that far let alone remember it. Here it is:

"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

The 1999 article, by contrast, is fantastic, with some great insights that few understand. I've gone on long enough though so I won't comment on that.

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