Buffetisms in the times of Covid

Lokeshwarri S K | Updated on May 06, 2020

Buffet’s speech in Berkshire Hathaway’s annual meeting implies that the worst may not be over yet

The three-day long annual jamboree, the Woodstock of Capitalism, may have gone virtual this year, but investors across the globe were still hanging on to every word uttered by the legendary investor, Warren Buffet.

With the global economy as well as financial markets ravaged by the ongoing Covid-19 pandemic, people were eagerly awaiting some guidance regarding the future. But Buffet, in his inimitable honest style, threw up his hands, stating that the kind of uncertainty being faced by the world now, has never been faced before.

He bemoaned the fact that the lethal threat from pandemics highlighted many times in the past, have been largely ignored so far. A recent study done by Johns Hopkins University, Nuclear Threat Initiative and the Economist Intelligence Group had shown that all countries got a failing grade in preparedness to face pandemics. The world is currently facing the consequence of this neglect.

Great Depression

While Buffet did not explicitly say so, the anecdotes used by him and his repeated advice to investors to show fortitude, imply that he expects the Covid crisis to have a prolonged impact.

Buffet made it quite clear that the impact of the pandemic on the economy would be far more severe compared to the 2008 crisis. “In 2008 and 2009, the economic train went off the tracks… but this time we just pulled the train off the tracks and put it on a siding and I don’t really know of any parallel (to the current situation).”

After dismissing the 2008 crisis, he went on to describe the Great Depression and the stock market crash of 1929, in great detail. The Dow Jones Industrial Average index was at 381.17 on September 3, 1929, thanks to the economic boom in the roaring 1920s. Investors had flocked to the stock market, lured by the rally, using margin funding and leverage to buy stocks. In the next couple of months, the value of Dow fell by half.

Buffet’s dad, who was 26 then and sold stocks for a small local bank, did not want to go out and face clients who had lost enormous amount of money, and preferred to stay home.

“My dad wouldn’t have been puttering on the yard anyway, and the television wasn’t there, and he and my mother got along very well.” So, Warren Buffet was born nine months later, and by then the Dow was about 20 per cent higher and people were sanguine that the economy was only in a mild recession.

But a little less than two years after his birth, the Dow had lost over 89 per cent from the September 1929 peak. As Buffet points out, we may have seen that happen with a single stock, but not with the entire market. What’s worse, it took the Dow 20 years to get back to the 1929 peak.

Buffet appears to be warning investors to not get sucked into the ongoing rebound and to exercise caution. He is hinting that when the crisis is severe, the cut can get much deeper and it can also take a long time to heal.

Sitting on cash

Berkshire Hathaway’s financials have also been hurt by the pandemic in Q1 of 2020. The company reported a consolidated loss of $49.7 billion, mainly due to the $70 billion unrealised losses on investments and derivatives. That amounts to reduction of around 15 per cent from its investments.

But the intriguing part is, despite a large pile of cash balance of around $136 billion, Berkshire Hathaway did not make any significant acquisition in March 2020. This is in contrast to 2008, when the company had made eight deals, making the best use of attractive valuations. When asked why, the legendary investor says, “Well, we haven’t seen anything attractive.”

Part of the reason, according to him, is the Fed’s quick action in providing liquidity. But Buffet’s wary attitude also shows that this may not be the time to get too excited about attractive valuations.

He also pointed out, in his classic tongue-in-cheek manner, that this is a very good time to borrow money and not such a great time to lend money. This statement highlights the negative consequences of the leeway given to borrowers, on financial institutions.

Flying out of airlines

The pandemic is taking a toll on consumption and Buffet put it thus, “It’s been seven weeks since I’ve had a haircut, more than seven weeks since I put on attire. It’s just a question of which sweat-suit I wear. So who knows how we come out of this.”

The other industry he was extremely bearish about was airlines. Berkshire Hathaway sold its entire stake in American Airlines, Delta Airlines, Southwest Airlines and United Continental airline recently. These four jointly account for at least 80 per cent of air passenger miles in the US. Buffet thinks that, “The world has changed for the airlines,” though there is nothing wrong with the business or management.

He also acknowledged the risk in oil producing companies, saying that these companies did not build assets expecting oil to be at $20 or $15. Companies that bought ‘put’ contracts to hedge themselves could however have been shielded to some extent.

Advice to investors

There were of course plenty of Buffetisms in the annual address. He stressed that markets were unpredictable, so investors should never use leverage to trade. He pointed out that on October 19, 1987, the Black Monday, the Dow crashed 22 per cent in a single session, in 1914, the stock market was closed for about four months, after 9/11 the market was closed for four days. “Nobody knows what’s going to happen tomorrow.”

He was also quite confident that equity will outperform other asset classes over the long run. “Equities are going to outperform that bond. They’re going to outperform Treasury bills. They’re going to outperform that money you’ve stuck under your mattress.” But he stressed that equity investments are sound, only if they are treated as investment and not as a gambling device.

He also illustrated the need to stop looking at the stock prices constantly, with a very witty analogy: Imagine you bought a farm, 160 acres, at x per acre. A farmer next to you had 160 identical acres, same contour, same quality, soil quality. And that farmer was a very peculiar character because every day he would offer to buy your farm or sell you his farm for certain price.

But you are unlikely to heed your neighbour because the farm is an investment. It’s the same with stock quotes of listed companies.

Buffet also made a strong pitch for passive investing in index funds, stating that owning S&P 500 index funds is the best thing that most people can do.

About 90 per cent of funds willed to his widow are invested in index funds.

Published on May 06, 2020

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