Good Evening: With almost each passing week in 2009, investors have become more concerned with the fate of both the economy and the stock market. The usual investment strategies for dealing with a post-WWII recession (“wait it out”, “buy the dips”, etc.) have not worked, and the entire school of “buy and hold” investing has come under assault with each fresh new low in the major averages. As I mentioned in February, market participants seem to have passed beyond the denial phase and have entered the despair/capitulation phase of the 2007-2009 bear stock market.
This upwelling of angst became genuine worry today when many investors read Warren Buffet’s annual letter to Berkshire Hathaway shareholders. Mr. Buffett opined that “the economy will be in shambles throughout 2009 — and, for that matter, probably well beyond…” The mainstream media played up this aspect of his letter, and considering Jim Cramer’s latest advice that investors with shorter time horizons should get more liquid, many long term bulls felt orphaned heading into today’s session. A closer read of Mr. Buffett’s letter is not nearly as bearish sounding as the snippets suggest, and while today reminds us that bottom fishing is a dangerous sport in this environment, Mr. Buffett would like to remind us that this is part of the value creation process investors like him tend to savor.
U.S. stock index futures were significantly lower prior to this morning’s open, partly due to the Berkshire letter and partly due to much weaker markets overseas. Personal income and expenditures data released well before the bell rang were better than expected, though some economists rightly pointed out that these figures were flattered by Uncle Sam (pay increases for government workers and rising unemployment benefits). Stocks opened some 2% lower, but a quick rally vaulted the major averages back toward the unchanged mark. This rally peaked when the ISM manufacturing survey came in a bit better than had been expected (see below). The 35.8 reading was 0.2 better than the one taken in January, and it was a full two points higher than consensus estimates. Still, 35.8 is a very contractionary reading, and the 3.3% decline in construction spending released in tandem with the ISM survey was below even the lowest forecasts by economists.
Once the economic news had been dispensed with, the major averages began a slow and orderly descent. Reeking more of despair than of panic, the down move could only muster one pop of 1% before setting new lows into the bell. Some technicians were hoping for a dramatic, “new lows on the open, close higher for the day” type of reversal, but it never materialized as all but 6 out of 500 names in the S&P finished in the red. Just as there were few places to hide in the stock market, the credit-sensitive sectors in fixed income were also under pressure today. Only Treasurys managed to finish higher, but here, too, there was order. Yields dropped 10 to 17 bps in uneven fashion across the coupon curve (see below). Gaining 1%, the dollar was a beneficiary of a flight to relative quality among fiat currencies, but commodities gave back all of last week’s gains in one brutal session (see below). Crude oil was down 10% today, precious metals finished down after a higher open, and the ag complex bled out as the CRB index fell more than 5%.
“Say it ain’t so, Warren!” was a cry heard on train platforms and trading desks alike this morning. It was only last fall (sorry, but “autumn” just doesn’t capture the mood of last October and November quite so well as “fall’) when the “Oracle of Omaha” advised readers of the New York Times to “Buy American. I am”. With the S&P 500 now well below the levels reached when Mr. Buffett penned those famous words, his annual letter to shareholders contained a little less of the trademark confidence upon which many investors have come to rely. I’ve been reading Mr. Buffett’s annual letter to shareholders for years, and a close inspection of this year’s edition (see attached), reveals none of the fear so prevalent in the characterizations by mainstream media outlets.
Let’s first look at Mr. Buffett’s views of the economy. Headlines blared that Mr. Buffett foresaw a U.S. economy “in shambles”, but let’s review the whole sentence. “We’re certain, for example, that the economy will be in shambles throughout 2009 — and, for that matter, probably well beyond — but that conclusion does not tell us whether the stock market will rise or fall”(italics are mine). Yes, the economy is bad, but the far more crucial question is whether this dim outlook is yet reflected in market prices. He then goes on to describe that he and his partner, Charlie Munger, will continue to do what they always do in managing Berkshire’s various businesses and in selecting future investment candidates. Sounds like the same old Warren to me.
Others were troubled to hear that Mr. Buffett let go of some previously “core” stock positions, reducing Berkshire’s exposure to JNJ, PG, and COP. But as he patiently explains to those who bother to continue reading until page 16, he did so to fund the purchases of convertible preferred shares of Wrigley, Goldman Sachs, and General Electric. He says he didn’t want to part with the equity holdings, but felt compelled to do so in order to “run Berkshire with more than ample cash”. I took these moves as a lesson in risk management and not a bait and switch move away from his “Buy America” proclamation. For further evidence that he has not abandoned his autumnal bullishness, I refer readers not to Mr. Buffett’s remark about being “like a hungry mosquito in a nudist colony”, but to his “long-avowed goal to be the ‘buyer of choice’ for businesses…”. Having plenty of cash on hand to take advantage of “bargain merchandise” has always been Mr. Buffett’s strategy, and it is more important today than it has been in at least 25 years.
I won’t cover every topic Mr. Buffett wrote about with a seemingly effortless pen, but he does cover derivatives (he still feels they are dangerous, but can lead to handsome returns if carefully implemented and monitored), subprime loans (Berkshire’s Clayton Homes subsidiary profitably lends to many subprime borrowers, but they ask for quaint items like down payments and verified incomes before extending credit), treasury bonds (in bubble territory), the disaster of politically charged regulation (or, lack thereof, as Fannie and Freddie have proved for years), mark-to-market accounting (he favors it), and the intervention in our financial system by our government last fall (necessary to prevent “a total breakdown”).
As the dreadful action in our stock market today and over the last 16 months demonstrates, bottom fishing is indeed still dangerous in these swirling waters. But, like Mr. Buffett, I do welcome the cheaper prices a bear stock market brings. With each declining handle on the S&P 500 (which will soon sport a “6”), we proceed with what Jim Grant calls “the value restoration project”. And, like Mr. Buffett, I believe America will (eventually) overcome the financial challenges facing it. I also agree that “like it or not, the inhabitants of Wall Street, Main Street, and the various Side Streets of America” are “all in the same boat”. It may be a bit too early to turn bullish just yet, but the prices get enticingly cheaper with each passing day.
— Jack McHugh