10.13.08 - 10.17.08
Should we 'Buy America'?
Taking stock going into the weekend: Questions about inflation, tighter credit, and reduced growth
As opposed to economists Nouriel Roubini and Paul Krugman -- who see the economy as in deep trouble and communicate with accompanying language -- the famed investor Warren Buffett admits that the positions of US companies is declining but communicates in more hopeful language about this decline. Is Mr. Buffet's hope legit or is it an attempt to get people to believe what will materially benefit him? Both, I think. His investments -- that is, his material interest -- reflect his honest argument: he sees reasons the equity markets will go up.
What are his reasons then? He puts his argument roughly this way: 'the American markets will finally go up, and my evidence is that they always have.' In fact, he says, the stock market probably will go up earlier than the rest of the economy goes up. He writes:
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 5, 10 and 20 years from now.
Interestingly, the arguments of Prof. Roubini, Prof. Krugman, and Mr. Buffett are not contradictory. All see an intense, short-term (2-4 years) economic recession. All consider the $700 bailout plan necessary and the crisis sharp.
If it will be so deep and long, why not just stay out of the markets a little longer and hold your cash? Buffett argues that holding money is risky:
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.
. . . .
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. 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.”
Buffett's argument that we are about to see significant up-ticks in the rate of inflation is well taken. Inflation won't happen across the board, but it will be a real force. Wal-Mart and many retailers will continue to be able to keep prices low. Housing prices will continue to drop. But just about everything else will face upward price pressure. Inflation simply must be considered because of the monetary framework that continues to dominate the US government (the Federal Reserve and the Treasury Department). For about thirty-seven years, give or take a few, we've all been monetarists. The consensus is that money got us into the crisis. The consensus is that money will get us out. With all this money that the world's central banks are injecting into the system, it is hard to imagine a scenario in which prices of just about everything do not rise. They could rise significantly. In fact, they already are. Wholesale prices are up 8.7 percent the past year, and even that number is lower than the previous two months.
Bottom line, for me, inflation is a negative for business performance as much as it is a reason to invest.
Ok, inflation, but what about growth? My view is that the sooner individuals, businesses, and the country face up to tighter money conditions, the better. There is a lot of economic growth to be had, but it requires research, knowledge, workers, higher wages, and real productivity. With the collapse of Wall-Street and the partial collapse of the hedge funds, economic growth needs sources other than technical financial knowledge.
So, invest in American companies?
With high inflation and a transition period for economic growth, investing in American companies right now is for me a tough call. For one, I am persuaded by the near-term pessimism of the economists. Mr. Buffett agrees, but he points to every other recession in the last hundred years and says we got out of them just fine. Good point, but every contraction happens in a new context, and today, the context seems significantly different in the following respect. The rise of China, Russia, India, and the emergence of sovereign wealth funds (SWFs) -- in short, a significant flow of wealth away from the US -- makes it unclear if right now America's economic future is straight up.
I lean toward thinking that American businesses, individuals, and families can better prepare themselves for the future by preparing for a decline in the standard of living (as defined by the ability to access easy credit) to which organizations and families have grown accustomed. I think this contraction will affect companies and investors, both of whom have in the recent past been dependent on finance/credit. The stocks of many established companies, as a result, will have difficulty sustaining any move up.
In short, with less credit, we will need to find new, productive ways to prosper. In the end, Buffett is betting many existing companies adapt to the new conditions. I agree in certain cases, but I am generally cautious. For my sense is that in a world of nationalized, tax-payer-funded credit, it will take creative production of real goods rather than fancy understandings of finance, to make a business succeed and the economy grow.