Monday, March 9, 2009

Kass vs Buffett!

Today's column parodies Warren Buffett's Oct. 16, 2008, New York Times op-ed, "Buy American. I Am."

The portions in italics are meant to represent what Mr. Buffett's updated thoughts might be if the editorial were rewritten today, four and a half months after its original publication:

Published: October 16, 2008

Published: March 9, 2009
Palm Beach

The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

I grossly underestimated the scope of the world's economic problems in October. I suppose when ignorance is combined with leverage, I, in particular, should have better anticipated the consequences we now see today. No longer have the leaks turned into a gusher; they have become more like a hurricane or a tornado in proportion. The accumulated loss of business and consumer confidence coupled with an acceleration in the declines in stock prices have translated into a classical negative feedback loop, which has worsened the fundamental backdrop well beyond what I and most others had expected. Indeed, I expressed a more cautious view in my letter to Berkshire Hathaway investors last Saturday.

So ... I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100% in United States equities.

While I expanded my personal holdings of U.S. stocks during the fall and increased Berkshire Hathaway's exposure to equities since October 2008, over the short and maybe even intermediate term, I was clearly premature in going all-in. In retrospect, back in October I bought too many expensive suits that, at the time, looked cheap to me. I failed to recognize the scope of the world's economic weakness and the depth of the problems in our financial system.

Why? A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But 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 five, 10 and 20 years from now.

What I have learned from my investment experience over the past few months is that public opinion poll is no substitute for thought; sentiment is always trumped by fundamentals. In my October editorial, I expressed an investment strategy -- namely, being fearful when others are greedy and greedy when others are fearful -- which had worked brilliantly for me and others in previous cycles. It was a simple principle that has resulted in profits well beyond my wildest dreams, but this time the strategy ended up being more of an act of a simpleton! Buying the dip, at least at the level that I identified as providing me (and Berkshire) with value, proved wildly unsuccessful against the backdrop of a Black Swan event in equities. With the benefit of hindsight, this time the fear on the part of seasoned and unseasoned investors had validity and the economic damage incurred over the past six months will have a lasting impact.

Let me be clear on one point: I can't predict the short-term movements of the stock market. 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.

My October entry point in buying stocks was poor. I failed to consider what I had previously written in the past about market timing and investment strategy. Firstly, "Don't try to catch a falling knife until you have a handle on the risk." Secondly, I paid too high a price for the value I received in buying stocks and the degree in which I went all-in is another example that I should have practiced what I preached (and wrote!) -- that is, "short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children." Thirdly, I forgot my first rule of investing, which is "not to lose", and I also forgot the second rule, which is "not to forget the first rule."

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30%. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price.

It is clearly different this time. I should have heeded my advice that "if past history was all there was to the game, the richest people would be librarians." I should have paid attention to my Depression reference because there is a growing risk that the current economic downturn might morph into just that! In the past, stocks have anticipated an economic upturn in advance; in this cycle, stocks may not respond positively until it is clear that public policy has gotten traction and is reflected in better visibility of economic stabilization/recovery.

Over the long term, the stock market news will be good. In the twentieth century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

Chains of habit are too light to be felt until they are too heavy to be broken. In the investment world, the rearview mirror is always clearer than the windshield. I have to begin to reassess whether my favorite holding period should still be forever. Maybe my investment relationships should no longer last a lifetime.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

My stock selection has been poor and I have been too concentrated. I, too, have been exposed as swimming naked when the market tide went out over the last six months. I failed to properly analyze the risks of a number of my investment purchases. This is particularly true in my large involvement in financial stocks, as the moats I envisioned that protected their business franchises have flooded, reflecting the commoditization of financial products. Equally important, I materially miscalculated and overestimated the values of my financial holdings' assets, including American Express, Wells Fargo and U.S. Bancorp, to name a few. To borrow from Gertrude Stein, "There was little there, there." Stated simply, in my investments, I thought that I had found one-foot bars that I could step over, but they turned out to be ten-foot bars that I couldn't leap over!

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.

I should have been more risk-averse. The depth of the world's economic problems suggests that deflationary forces will be with us for some time to come. Inflation has been delayed.

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."

Perhaps in recent years I enjoyed the investment process more than the proceeds and rewards. Maybe I should not have made some of these decisions on my own. Maybe I should have sought advice from industry specialists or from analysts who had expressed concerns that the foundations of our credit markets, our economy and the world's stock markets were increasingly on shaky ground.

I don't like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I'll follow the lead of a restaurant that opened in an empty bank building and then advertised: "Put your mouth where your money was." Today my money and my mouth both say equities.

I have put both my foot and my money in my mouth. I went on investment "tilt" and ended up being the patsy at the poker table. I should have taken my own advice when I said that "it takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."

-- Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.

-- Douglas A. Kass is President of Seabreeze Partners Management, Inc. the General Partner of Seabreeze Partners Short LP and Seabreeze Partners Long/Short LP.

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