From the Oracle's latest missive:
Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle's scathing comment: "You don't know how easy this game is until you get into that broadcasting booth.")
I'm sorry, this is sage advice, and at one time I lived by it. That was before 2008-2009. In the wake of that debacle, I always maintain an opinion on market level. I further remain alert for information on the accumulation of wretched excess in critical areas of the global economic and financial system. I want to know where tomorrow's equivalent of sub-prime or CDS is, how much of it there is, and how bad it is.
I take my cue from Whitney Tilson. After the crisis, he remarked that he formerly had neglected the macro issues along the lines suggested by Buffett, but afterword he felt 25% of his time and energy should be directed toward that activity. Maybe 25% is high, but there is no reason ever to traverse a battlefield without knowing where the minefields are.
During the financial crisis, I watched substantial holdings in the Vanguard S&P 500 Index fund go down 55% from their high. That wasn't as bad as it sounds, for the fact that I had an opinion on the worth of my holdings and didn't sell any of it.
My discretionary portfolio was another topic. At the worst point in March 2009 I was looking at the same handle, but one less decimal place. I was down somewhere between 85% and 90%. As the situation played out, 2009 was a banner year for me, during which I had the first of several years of significant outperformance based on my willingness to make heavy use of leverage in a situation where my analysis called for rapidly increasing share prices.
What I didn't know, and perhaps could not have known in 2008, was exactly how bad the quality of mortgages had become. It wasn't until I started reading the complaints filed by the likes of MBIA (NYSE:MBI) and Ambac (NASDAQ:AMBC) against the big banks that I saw the nature and extent of the egregious fraud perpetrated by our largest and most respected financial institutions. The entire basis of the financial system, which rests on assets such as mortgage loans, had been turned to quicksand. I correctly called the huge size and scope of the litigation against banks, but was unable to come up with a constructive way of investing in it. The point was, they were going to get away with it.
We know that the Chinese are building up an incredible amount of bad loans, for which the risk has been passed off to investors through "wealth management" products. Wealth mismanagement would be more like it. In our own system, covenant-lite loans are making a comeback, and yield starved investors are being drawn into products containing these questionable assets. Who is holding the bag on loans made with farmland as collateral?
As far as the integrity of the big banks, I long ago gave up on the issue. The rogue of the month series never got written. Why bother, it wouldn't give anybody any additional information. The latest is, the Gold Fix was fixed. For the love of God, fixing a fix. Can't we have an honest fix?
As far as market level, my opinion is that we are on the high side of the midpoint, but there are still good quality US equities that will be profitable investments when viewed in the context of their future earnings. I'm beginning to suspect that the normal state of the market is valuations that are relatively high compared to the historic average CAPE or other metrics. The catch is, there's always a build-up of bad assets or political tensions somewhere which will precipitate the next serious market event.
Buffett usually stays away from the minefields. But it seems like he always has to test where the edges are. There were those derivative bets, where he was guaranteeing a future level of the S&P 500. This year we get a confession, he got involved in a bad loan to an energy company. The decline in natural gas prices made the loan go bad, but the underlying cause was excessive leverage, with Uncle Warren as one of the co-enablers.
Buffett is always able to write checks, and big ones, at market bottoms. Think back to 2009, there he was, making big bets on Goldman Sachs (NYSE:GS) and General Electric (NYSE:GE). Of course he got the warrants, as well as the high rate of interest. Please keep that in mind, when listening to his sage advice about macro opinions. Emulate it, if you can. I'm conducting my investments in ways that ensure I will have dry powder at low points.
One thing I know: I am never, ever again going to learn about something like the sub-prime and CDS mess by watching my discretionary portfolio drop a decimal point.