Buffett Bounce

Just because the stock market rises on any given day does not mean that the bad times are done. In fact, I will be the first to point out that one day does not amount to a trend, but these are trying times, so we’ll take it! Chalk it up to sheer exhaustion, more buyers than sellers or perhaps a “Buffett Bounce,” but stocks actually increased in value yesterday without the government announcing a new zillion dollar rescue plan.

Yes the stock market continues to be oversold on a technical basis, but this article is about Mr. Buffett, a guy who is used to putting his money where his mouth is. In Friday’s New York Times, Buffett wrote an Op-Ed entitled “Buy American. I Am.” Although the title seems patriotic at first glance, country is not what prompted Buffett to pen this article—greed was his motivator. As Buffett likes to say “Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.”

Buffett was not suggesting that buying in this particular moment would amount to instant riches. Indeed, the stock market actually fell on the day that Buffett’s article was published, so my “Buffet Bounce” is a stretch. Additionally, his two recent investments in Goldman Sachs and GE are under water, which may be why he admitted that he “can’t predict the short-term movements of the stock market.” But in his personal account (not Berkshire Hathaway), where he has been parking money in government treasury bonds, he is now selectively adding to his stock position. Buffett anticipates that his non-Berkshire net worth will “soon be 100 percent in United States equities.”

What would prompt someone like Buffett to encourage the masses in such a way? My guess is that he sees himself as a teacher, a market Yoda, if you will. Buffett is a cool head that is prevailing amid panicky investors, both individual and professional. He sees green in a sea of red: “fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.” There is a disclosure that accompanies Buffett’s advice: “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over…bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price…over the long term, the stock market news will be good.”

OK, so maybe we can’t all be Warren Buffett—we don’t have billions, nor do we have a perpetual time horizon. But he does make valid points about valuation and emotions surrounding the current period. He specifically calls out those who have succumbed to the pressure and bailed out of the market all together. Buffett notes that “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 accounts. Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.” A billionaire who invokes the Great One? It sure is hard to argue with that!

Warren to the Rescue

People are getting ornery about the financial rescue plan, known as “TARP”. Taxpayers of all stripes are voicing frustration and anger about the situation, which is understandable. For those folks, as well as those who want to learn more about the situation, I urge you to listen to Charlie Rose’s interview with Warren Buffett (http://www.charlierose.com/shows/2008/10/01/1/an-exclusive-conversation-with-warren-buffett).

Over the course of sixty minutes, the Oracle of Omaha did what Henry Paulson, Ben Bernanke, President Bush and countless members of Congress could not: he explained how we got to this place, why government intervention is necessary and his view about where the US economy is going.

[The interview was recorded before the Senate vote, but Buffett assumed that it would pass and that the House would follow, when it votes later today. He was right--the Senate handily passed a TARP but did so by adding some provisions, some of which are good, other that were just pork. The interesting additions include an increase from 100K to 250K for FDIC limits, a suggested change to mark-to–market accounting rules and a $150.5 billion package of unrelated personal and corporate tax cuts.]

Back to Warren…one of the best analogies that he provided was comparing the US economy to a fine-tuned athlete that is in cardiac arrest--something must done quickly to revive the patient so that he can return to his previous form. Obviously as the athlete is lying on the ground, there is not time for discussing why he is in cardiac arrest--maybe he worked out too much, maybe he should have rested between workouts. Who cares? He’s lying on the floor and we need to get him out of harm’s way! No, the first priority is to treat him so that he survives this event. Note that Mr. Buffett did not say that the patient on the floor is Wall Street, it is the US economy—and therefore, we all have something to lose if the patient is left to wither.

In essence, while the patient is on the floor and his condition is unknown, financial institutions do not want to do anything--they don't want to lend to each other (who knows which bank will fail next?), they don't want to lend money to consumers (sure, you seemed like a good risk a few years ago, but today, who knows?) and they don't want to lend to businesses (your biz could be next if the bottom falls out!) And while the patient is in trouble, those who are making loans are demanding higher interest rates and raising the hurdles for qualifying.

And here is the ripple effect that nobody wants to talk about: while the patient is not functioning, credit dries up, municipalities can't finance projects (poof--there goes your after-school program and new roads), businesses stop earning as much money, they lay off more people, who then can't make mortgage payments and we start on a terrible downward spiral. That is what we are trying to avoid with the rescue plan.

For those who want the patient to suffer to curb his behavior, that does not seem reasonable right now. The Wall Street fat cat has suffered but he will not die. Maybe his net worth has gone from $25 million to $5 million, but he still has $5 million—he will be just fine. You on the other hand, could lose your job, watch your home equity erode, lose basic services and if you are lucky enough to have a retirement account, you may see value erode.

Let’s save the patient and then rehabilitate him. After all, as Mr. Buffett notes, the Americans are likely to be better off in ten years—but only if we don’t allow the patient to die on the floor without any assistance.