What If Warren Buffett Is Wrong About the Markets?

“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.”

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 his 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. It's 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 is 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 rational 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 Mondays 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 seem 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 HELOCs 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 bites 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 70s and early 80s 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 is the market truly 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 401(k)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.

The article was 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.

Comments

[Cecily S:]

"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."

This is the reason there are so many toothless hookers wandering the streets.

2008 Oct 27 05:02 AM

[gabe borens...:]

The terms of capitali nfusion into selected companies are irrelevant as they are within the context of the market conditions.
The dollar strength is indicative of the global capital flows directed into
the U.S in recognition of our economy and system facing relatively lesser risks .
These flows into the dollar will accelerate as Europe and Asia as well as the Emerging markets are facing the real economic and structural Armagedden our Armagedden is over.
Comparatively speaking ,these economic zones are facing problems similar to American but are way behind the curve in resolving the issues.It is quite clear that even simplest of the global investors recognize the the magnitude of the coordinated response by the FED ,Administration and the Congress to the issues that were facing the U.S economy.
The coordinated plan just simply needs some time to have an impact on the U.S economy.
The magnitude of the selloff is reflective of the most pessimistic assumptions which will not materialize .
Clearly in the environment where every one is using the word Great Depression there is no point of arguing that only mild recession is discounted in the market.
There is such a thing as a monetary and the fiscal lag which requires some time for the current measures to take an effect.
In the meantime the SEC should reimpose the "freeze "on the shorts untill the implemented measures stabilize economy and eliminate the investors paralysis.
The FED should ease another 50 bps.
The mega dollar inflows should should be a positive jolt to the investment community ,as it is reflective of the relative universal confidence in our system and economy.
As the turbulence increases outside the U.S ,our markets will improve substantially as the dollar inflows will be converted into the dollar denominated assets.
Let's not get confused ,we have addressed our issues effectively ,it is the rest of the universe that is behind the curve.
What Switzerland represented once , the U.S represents now as evidenced by the dollar momentum.
I will say this again ,the only thing to fear is the fear itself.
The U.S economy and the markets are pised for the rebound.

2008 Oct 27 05:41 AM

[Steven Hansen:]

it is hard to comment on something where you debated both sides of the issues. this is a great summary of the complexity of this crisis.

2008 Oct 27 05:45 AM

[MDCigan:]

"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."

Well, if this is true, then it is the problem, right? Money invested in the stock market SHOULD be money not needed for at least 5 years, if not even longer. Who in their right mind would invest money in the stock market that they need NEXT MONTH to "feed their family", "pay a utlity bill", or their mortgage payment.

2008 Oct 27 05:49 AM

[venividivici:]

I'll tell you who you sound like, gabe borenstein, George W. Bush, probably the worst president in the history of America. That's exactly what he thinks.

2008 Oct 27 05:58 AM

[mgcolin:]

Everyone can talk all they want about valuation - But in the new world of zero profits for great companies, massive losses for most, shrinking economies, inflation, we cannot use trailing P/E as a metric and forward P/E is meaningless.

The Japanese Market hit a 26 year low today. The US economy today looks exactly like Japan did 10 years ago. So Dow 811 (26 year low) is coming.

Face it - the smart money is liquidating now, this will continue.

S&P 400 within 6 months, S&P 100 will be the low

2008 Oct 27 06:02 AM

[iNVestorUnrest:]

"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."


NOW That is the bald faced truth...It's not that buffett is the smartest investor or that he can predict direction---he is just rich enough to be wrong until the markets prove him right

2008 Oct 27 06:08 AM

[vbierschwale:]

What if he is right.

He would be one of the J.P. Morgans of this century.
There are others.
They all need to step up to the plate and do what Warren did.

This will go a long ways to restoring confidence and housing is not the problem with our economy.

Fear is.
People are losing their jobs left and right.
There arent many families out there that don't know somebody that is out of work because their jobs were sent overseas.

Now our manufacturers are cutting back because people are not buying and so they are laying people off which is making the situation worse.

All that is necessary to restore this confidence is for our corporate leaders and politicians to step up to the plate and say, we realize that we have made a mistake because all of our work being sent offshore is destroying our economy and its reducing the amount of money we have to run our country and our bailout policy is just making it where more corporations are willing to run their corporation into the ground to get a handout.

We are going to immediately bring all of our jobs home so that our people can begin to pay their bills and when they have excess money they will do their part by buying which means our manufacturers will need to hire more people which will make the economy even stronger.

Virgil
www.KeepAmericaAtWork....

2008 Oct 27 08:22 AM

[investor88:]

Yes Warren Buffet can be wrong. Agree with sober conclusion of article that the American dream is probably gone, including easy money from ever rising stocks and assets. For most it will be about survival never mind dreams.

2008 Oct 27 08:40 AM

[CLH:]

Of course Buffett is right. (Unless we have atomic war or a meteor hits the earth). Capitalism works. There is no other system for money creation.

People who panic never make money.

2008 Oct 27 10:17 AM

[notsosmart:]

money is paper.valuations are meaningless.the house you live in is the roof over your head.not an asset.its a liability.the car you drive is not an asset.its a machine to move you around.a liability.unless something puts money in your pocket,its a liability.the financial scammers fooled the dumb sheeples into borrowing & paying interest.it was hard to learn but maybe some have learned.my house paid off early(10yrs).my car paid cash(now 17 yrs old).no heloc.my portfolio down app.40%.so what.dont need the money,collect the dividends & sleep well at night.never rich,but paid all my bills every month.not the american way you say.better it would have been.

2008 Oct 27 11:03 AM

[Engineer:]

A subtle distinction here is that Buffet is primarily an investor, not a trader. His money will "return" based on the strength of the cashflow of the business, not from buying low and selling high.

This is the way investing used to be before Wall Street somehow convinced everyone that trading is investing.

2008 Oct 27 11:16 AM

[notsosmart:]

capitalism+money printing= the new conservative socialism

2008 Oct 27 11:28 AM

[turmoil:]

"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." That sums it all up right there, the cause of this little scratching and clawing atmosphere. I have been buying. Its called a savings account if you don't know what one is or never had one please proceed to your bank and inquire within. The reason for this mess is that too many people were acquiring well past their means using credit. Which to me says turmoil. So I have been saving for this rainy day. If you are living paycheck to paycheck without a safety net then Mr. Buffett's message was not for you, but for responsible individuals that do have the time and patience necessary to see their investments grow. You sound like one of those get rich quick people I can't stand. This is no get rich quick call-to-arms, this is a call to truly build wealth for those with the patience and money set aside for such an endevour. There is a difference between wealth and rich. I will most likely never be rich but plan to accumulate more wealth than I have now. If you need the money to pay bills don't invest; if you worry about money don't invest.

2008 Oct 27 01:21 PM

[D-D:]

Investing is a gray area for each and every individual. Nobody should follow any investing guru blindly. But what Buffet is say is don't lose faith in the American system.
He never said that we should put 100% of our money into stocks.
For a common Joe The Plumber, use dollar cost averaging
valuestockinvestors.bl.../

2008 Oct 27 01:45 PM

[LuceMDiffundo:]

"NOW That is the bald faced truth...It's not that buffett is the smartest investor or that he can predict direction---he is just rich enough to be wrong until the markets prove him right"

Actually, he is the smartest investor, who has a hard time finding things to buy when the market is up, and has plenty of cash to buy bargains when the market is down.

He is rich specifically because of his investing acumen. He was not completely rich to being with, and the accumulated wealth of Berkshire Hathaway is more of a side effect of his flawless math skills than something he prizes or flaunts.

You have the wrong concept of Buffett. Read BUFFETT: The Making Of An American Capitalist, by Roger Lowenstein.

2008 Oct 27 03:10 PM

[Sailhaus:]

If you are living hand to mouth you should not be in the stock market. You should, however, be paying off your home, your car and credit cards. Once you have a nest egg and can afford to make an investment, do it with as much knowledge as you can acquire, put it in there and give your hard earned dollars its' day ... but be prepared to lose it. I have been beating myself up for not taking an active interest in my porfolio sooner and not just letting my supposed broker do it all. At this point, I can just say Wow, I don't have any bills, don't owe anyone anything, and somewhat like Buffet, I can start looking at investing some on my own, with as much information as I can gather. I have invested in G.E. ... perhaps a good choice, we will see. I am most thankful for Cake and the opporutnity to read these comments, add to my knowledge and at least know other folks have varying opinions that run the gauntlet as mine do. The election may be a very telling event. I am Independent at this point but I have made a decsion. I am putting my bet on the most American Candidate and my faith is still in our ability to get ourselves back to some degree of normalcy. Glad we have a Warren Buffett to put his dollars into the market and hope some of the other monied folks will follow. Buy American!!!

2008 Oct 27 07:53 PM

[Zekeko:]

Yeah, what if Buffett is just telling people to buy to shore up his own positions. Even buffett doesn't have enough cash reserves to buy the entire S&P

2008 Oct 28 02:03 AM

[Jack B:]

I agree with you. However, where I have concerns is that even if we're ahead of the curve, our economy is not self contained and depends on the economic well being of our trading partners. Hence we can get into a long term rut from which it will be difficult to extricate ourselves from. Please reply to [e-mail].

Thanks,
Jack

2008 Oct 28 04:54 AM

[sickofthehype:]

When I read about blog posters stating how Buffett is wrong (because THEY are right..), it's a sure sign that siding with Buffett is the right decision. When things are so dire that even ordinary investors claim to know better than a guy like Buffett, that's something to note. And the conspiracy theories arising about him. Complete humor.

2008 Oct 28 11:50 AM

[aryval:]

The fact that everyone seems to be missing is that Buffett mistook the current environment for the 1970s, when inflation ruled the day. Buffett did great in the 1970s and he thought he had this market pegged. Why do you think he's been buying railroads? Because if oil is going up, railroads get more business as other types of freight become more expensive -- but guess what?

This is the start of the Greater Depression -- global DEFLATION -- the likes of which we haven't seen since the 1930's perhaps ever in recorded history.

As such, all assets will be destroyed. The stock market will be under 1000 before then end of 2009 -- bank on it -- and your precious Berkshire will be under 50,000 per share.

2008 Nov 10 11:14 PM