Could the Warren Buffet Stock Investing Strategy Be Wrong?
“Buy American. I am.” To quote Warren Buffett’s opinion piece published recently in the New York Times.
Warren Buffett appears to be quite a decent man and, perhaps, his most admirable quality demonstrated in recent years is his personal charity underscored by a deep sense of humility. He certainly doesn’t live the lifestyle of most multi-millionaires and billionaire investors that tend to be far more flamboyant, if not entirely pretentious by recklessly self-indulgent, decadent behavior.
Warren Buffett is quite the savvy investor, not because of his personal considerations, but due to his shrewdness and business acumen. It would be more proper to characterize Warren Buffett as an opportunist which is a kinder, gentler way of describing a predator who stalks its prey and waits patiently for the moment to capitalize on other people’s distress.
It’s difficult to think of Warren Buffett in these terms because he is an affable and charming person but, in truth, he is no different than the archetypal Hollywood character of Mr. Potter in “It’s a Wonderful Life.” After all, what was Mr. Potter symbolic of if not the Wall Street titans of the world that, literally, followed the wisdom of Nathan Rothschild who was famously quoted: “buy when the blood is running in the streets.” One technique used in Crisis Investing.
If you break down the terms of his recent buys such as Goldman Sachs (GS) and General Electric (GE), you understand that Buffett’s money costs more to borrow than a local bookie charging the going loan shark rate or ‘the vig” for betting on ponies. To call his terms with GS and GE a “friendly negotiation” is another euphemism for asking someone’s permission to borrow keys to the car while holding a gun to their head.
Buffett crafted quite the favorable contract terms by taking preferred shares in combination with warrants and a 10% dividend yield. Perhaps, his endorsement alone was worth more in public sentiment than seeking alternative financing through frozen commercial paper and credit markets. If the issues plaguing solvent companies was a crisis of confidence, who could be a better marketing tool to inspire trust than one of the most revered investors in the history of capital markets?
The irony throughout these notable cash injections is that he was wrong in his timing, not even the venerable voice of Berkshire Hathaway (BRK.A) can call the exact bottom. Those that wanted to follow him into the deep end of the pool have had ample opportunities to buy the same stocks at cheaper valuations due to extreme volatile aberrations of the market.
And certainly, as has been reported, Warren Buffett lost approximately 9.6 billion dollars in equity value due to decreases in company market capitalization and share prices. Of course, unlike the recent forced liquidation against CEO Aubrey McClendon of Chesapeake Energy (CHK), who involuntarily sold over 30 million shares due to excessive margin calls, Buffett’s holdings remain paper losses.
If the wealthiest individuals lost 90% of their wealth, they would still remain multi-millionaires and, more importantly, accessible to cash to take advantage of buying at fire sale prices. If you or I lost 90% of our income or wealth, we would be in the soup kitchen lines. So, there’s no comparison and very little reason to feel sorry for those that will navigate this crisis from the luxury of skyboxes and protected enclaves.
However, to be fair, a bottom isn’t necessarily a pivot point as much as it is a natural formation and process once the panic selling and forced liquidations hit their crescendo before tapering down to normalizing levels. Markets become exhausted because such volatility is unsustainable as weak hands are flushed from the system and earnings multiples collapse under their own weight.
If you’ve read my previous article on “How To Catch A Falling Dollar,” you can see that I was quite bullish despite the panic that ensued both before and during the week of option expiration. But I disagree with those that insist that we need to reach this technical bottom of absolute capitulation–whatever that term is supposed to mean. As if you need to see Wall Street brokers coming out of the trenches with their hands in the air to surrender before the all clear sign is put out to buy stocks.
If this massive sell off that has been orchestrated over the past year since the Dow was above 14,000, now hitting the inverted peak of disparity during the last month, then what would constitute a true sign of capitulation? Zero? One thing that has been proven throughout this calamity is that fundamentals, charts and rationale thoughts or behavior simply are out the window once panic ensues.
But I’m not Warren Buffett and, like most of you out there, I face similar daily stresses and concerns of being capable of paying bills and expenses. I have never seen markets behave like this and even professionals that have been involved for decades will admit this is unprecedented action where conventional rule books don’t apply anymore.
People continue to refer to the ’87 market crash as the signature comparable and yet, nothing compares to the volatility we’ve seen which has been the equivalent of more Black Monday’s than I can count. I fear no differently than most of you out there and remain very concerned for not just the stock markets, but the underlying economy that seems convincingly problematic for our generation going forward.
REAL ESTATE IS THE UNDERLYING CRISIS OF CONFIDENCE
Asset devaluation is a systemic risk in the global economy. Many people that you would consider rich not that long ago, were considered as such based on their equity holdings and combined leveraged assets. In effect, they were “paper valuations” waiting to become whacked with a sledgehammer like a pinata.
The real estate bubble has created vast illusions of equity and fictitious degrees of separation from achieving true wealth and prosperity. Those that would like to believe housing is beginning to bottom seems disproportionately premature, disconnected from the reality of vacancies and the incomplete construction projects that were unable to retain financing to finish the job.
Most people don’t own stocks directly and the home has been the largest source of wealth and prosperity for the average American household. This story is broken for at least a generation. And by generation, I really mean an entirely new wave of buyers that are willing to bid on the market which can only come from sustained job growth and the willingness for lenders to pump money into circulation to qualified borrowers.
How many people own multiple homes and property, each leveraged on top of the other asset like a house of cards? How many people bought that expensive car through tapping the equity in their home? How many people’s credit cards and HELOC’s were based on perceptions of net equity in a property that has evaporated into this vortex of wealth destruction?
We forget that for the majority of people real estate is a leveraged asset, more than the normal 2:1 ratio on a margin account, or even 4:1 for those day traders out there. And no different than a house call on a brokerage account, once market value drops in real estate you have a systemic deleveraging process of a rising debt to equity ratio.
For the past decade, no one assumed the fatal flaw in their metrics was based on the rising value of home prices and not the possibility of a depreciating asset. The reason why a car is considered a depreciating asset and not an investment, is because the underlying value deteriorates at an accelerated rate of decline. If there is no underlying price stability in our housing markets, then every dollar spent for renovation, maintenance, property taxes and insurance erode net equity. When an asset costs more to keep than the value you could receive, it no longer is a good investment, even if you have to live in it.
Where are all those con artists that prostituted their “get rich quick schemes” on no money down seminars in real estate? Or those Tony Robbins style paid speakers that tell you that not being rich is based on your negative attitude of not being positive enough? Do we really need Suze Orman wannabes to tell us what we can or cannot afford? Are all these seemingly helpful news specials that have sound bytes on how to manage this unfolding crisis really conducive to prosperity, or are they fueling the fire?
Because, folks, it’s not your lack of positive attitude that prevents people from paying bills as much as it is the reality of the situation changing all around us. A positive attitude won’t determine whether or not a bank lends money, nor will a higher FICO score when the presumption is that asset valuation continues to fall much further amid a rampant global recession.
What makes it worse is that we all have this fixed price in our heads of what a property is worth based on the last appraisal when the markets were peaking. It is psychologically disturbing to even admit to ourselves what the markets are telling us.
The same may be true with how we perceive stock prices. There is absolutely no question that stocks look cheap on a relative historical basis. But you must wonder if stocks look cheap only because we still have those fixed prices in our head when the market was up.
The multiples are extremely low but that is only predicated on continued net earnings growth. If the earnings continue to slide, then multiples are not low enough to be considered a bottom. Cheap? Yes, but not necessarily an absolute bottom.
Because you have to ask yourself why aren’t more companies buying back their stock at these low levels? If you are looking for a signal of a true bottom it would probably occur when companies start to acquire others, but this can only happen when the financing is available in vast, ample quantity.
The reason I am bullish on the stock market is less to do with the underlying struggles of our economy because I recognize that, unlike the stalled real estate market, the equity market is the last and only viable asset class that remains liquid and, for the most part, transparent.
Money has to be put to work in one asset class over another and fund managers or private equity cannot remain hidden in their respective foxholes indefinitely. Money has no value if it ceases to flow in one direction or another, and this is why the stock markets will always run ahead of the curve in anticipation of what is to come…
But, what if I am wrong?
In a sense, the economy would only have to mimic the 70’s and early 80’s to feel like the Great Depression, because our generation has been so spoiled by material wealth and excesses that any draw down on consumer purchasing power will drastically alter our perception of what it means to be rich and poor.
THE TOOTH FAIRY EFFECT
I ask myself this daily, wondering if the market truly is oversold? Yes, in technical terms based on how fast and how far the markets dropped we were due to bounce. But was I bullish because I was tempted to fade the market, or was I bullish based on a hopeful and blind assumption in regard to history? These are the internal dialogues that I struggle with, but I am quite sure they reflect some of the sentiments others feel.
As I’ve stated previously, I am a huge proponent of Fed Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson. What they are doing is absolutely necessary to restore the trust and solvency of the financial markets. However, just because I want to believe it will work does not mean that it will work. And although I hope these liquidity injections will take effect as intended, I realize that in the back of my mind it is more due to the fact that I’m trying to convince myself it will work.
The nagging issue is not so much about the individual companies we choose to invest in as much as it is the overall feeling that the “Emperor has no clothes.” This entire deleveraging process has uncloaked the naked truth about wealth creation over the last several decades.
To describe this ordeal as a crisis of confidence is an understatement. The real problem is that once people no longer believe in mythical fairies and dragons, it’s hard to get people to sleep at night with the same ol’ bedtime story.
In terms of the credit markets, it will be extremely difficult to get banks to lend money based on projected asset valuations or simulated mark-to-model metrics. The system works well when people believe it, but when people lose their belief criteria hope cedes to despair.
Think of yesteryear when you believed in the Tooth Fairy. This was one of the very first introductions to basic economics. Each dollar placed under your pillow at night was exchanged for the asset valuation or current market value of each tooth. Or at least that’s how it seemed, but the real system of exchange depended exclusively on your belief in the Tooth Fairy and the guarantee of your parents to back stop the fabrication. Hence, if you no longer believe in the myth of our financial system or the obscure ability for Uncle Ben and Big Daddy Hank to reinflate us out of this crisis, there is no buyer for assets even if you were willing to sell all your teeth and wear dentures.
The craziest thing about all this volatility and market panic is that it has become more evident than ever that asset value was predicated on perception and not intrinsic value. The exaggeration of wealth was created through leverage tied like a noose around our necks, waiting for the day people hang themselves out to dry.
The earnings multiples across the board have come down to very, very attractive levels. Yet, this oversold theory only holds true if we are facing a liquidity crisis based on deleveraging and not a fundamental breakdown of the drivers in the global economy.
A short-term recession is priced into the markets. But a sustained chasm and black hole is not factored into the markets and, thereby, would mean that stock prices would be far from reaching a bottom. Again, this is only if all the liquidity being pumped into the system fails to deliver proper resuscitation to jump start the economy.
And this draws me to the inevitable conclusion that if Warren Buffett were truly wrong and the economy reached a real depression, all bets are off the table and the consequences of such an economic demise would mean that no municipal bonds, Treasuries or cash holdings would protect you. In other words, the actions by the Treasury and Federal Reserve better work otherwise it will look like a George Romero horror movie with zombies running in the streets looting for survival.
This is unthinkable in reality but remains the very fear that draws near. But if you play your most wild fears out in your mind, you may find a calming sense of peace in your existence by the knowledge that things cannot possibly be allowed to get that bad, can they? Because if they did, money would cease to have value and the last thing anyone would be thinking about would be bills, mortgages and frozen credit markets.
THE BUFFETT CLARION CALL TO ARMS
Warren Buffett is, undoubtedly, an American success story and many would welcome a mere slice of his performance as they try to mimic his portfolio but fail to achieve equal measure.
The difference for the average investor is that while it’s common for legendary traders of Wall Street to mock how the sheep get sheared by buying at the top and selling at the bottom, they neglect to remember that most people sell not because they want to, but because they have to make bill payments and pay for basic necessities such as food and shelter. Sound advice by professional money managers falls on deaf ears when the margin of error means being able to feed your family or not.
Warren Buffett can buy with impunity, unlike the rest of us with limited resources. Because he is rich enough that whatever decision is made to invest, he can, literally, afford to be wrong until the markets turn around and agree with him at some point or another.
This is not a criticism of the man or the individual, rather, this is more about a growing disparity between those with money and those without. The advantage is that the money he puts to work doesn’t need to be pulled out or withdrawn to feed a family, pay a utility bill, or keep the mortgage going for one more month.
It’s arrogant to presume that the sage’s wisdom applies to the average American investor that isn’t necessarily looking to get rich, but simply hoping for a nest egg to supplement a retirement income.
Warren Buffett is right to buy stocks and equities after the markets have been utterly obliterated. But he is wrong to assume that everyone else can enjoy the same luxury of spending free cash flow on anything beyond basic necessities, let alone investing in the market once their 401k’s and retirement funds have been cut in half or more.
But, in truth, Buffett’s op-ed piece was not intended for the majority of average American investors. Instead, it was the clarion call meant to trumpet a message for the professional money managers that ran to the sidelines in cash during this massive deleveraging and liquidation cycle.
A call to arms so that a support level or underlying buy exists in the markets that can help stabilize price volatility to inspire confidence in a broken system. While many professional money managers are seeking cash reserves to cover a potential rising redemption period, without their underlying bid in the market there continues to be a systemic free fall of stocks.
I’m very appreciative that Warren Buffett did make public statements during this crisis because his words do carry weight. And since the dislocation between fundamentals and perception has been largely exaggerated during this volatility, it is prudent for the sages of Wall Street to commit both words of wisdom backed by real capital into the equity markets.
While we all like to believe we can be whatever we want or do whatever we desire, the truth is that the American dream is an illusion for many, smashed and broken on the backs of taxpayers that will always get less than what they paid or bargained.