Buffett made a very interesting talk in 1999, on the stock market craziness, and it would be more than apt to review it now. He said:
Now, to get some historical perspective, let's look back at the 34 years before this one--and here we are going to see an almost Biblical kind of symmetry, in the sense of lean years and fat years--to observe what happened in the stock market. Take, to begin with, the first 17 years of the period, from the end of 1964 through 1981. Here's what took place in that interval:
DOW JONES INDUSTRIAL AVERAGE Dec. 31, 1964: 874.12 Dec. 31, 1981: 875.00
Now I'm known as a long-term investor and a patient guy, but that is not my idea of a big move.
Note that in the interim, the market did go above 1,000 at least two times, in the late 60s and then in the 70s, and then reversed back down. This was a period of high inflation, the breaking away of the dollar from Gold, the oil fuel crisis and then the massive interest rate hikes by Volcker to tame inflation once and for all, with two back-to-back recessions.
The next 17 years were fantastic:
Let's say you put $1 million into the 14% 30-year U.S. bond issued Nov. 16, 1981, and reinvested the coupons. That is, every time you got an interest payment, you used it to buy more of that same bond. At the end of 1998, with long-term governments by then selling at 5%, you would have had $8,181,219 and would have earned an annual return of more than 13%.
That 13% annual return is better than stocks have done in a great many 17-year periods in history--in most 17-year periods, in fact. It was a helluva result, and from none other than a stodgy bond.
The power of interest rates had the effect of pushing up equities as well, though other things that we will get to pushed additionally. And so here's what equities did in that same 17 years: If you'd invested $1 million in the Dow on Nov. 16, 1981, and reinvested all dividends, you'd have had $19,720,112 on Dec. 31, 1998. And your annual return would have been 19%.
The increase in equity values since 1981 beats anything you can find in history. This increase even surpasses what you would have realized if you'd bought stocks in 1932, at their Depression bottom--on its lowest day, July 8, 1932, the Dow closed at 41.22--and held them for 17 years.
This was an incredible time for India as well, and in 1999, at the end of that 17 year period, we saw US stocks collapse after the dotcom bust. Then they recovered into 2007 on the back of big economic stimulus which created a big housing bubble, and then there was a bust in 2008. We saw another massive economic stimulus and now we’re seeing asset prices go back up big time.
And then Buffett talks about the psychology:
What was at work also, of course, was market psychology. Once a bull market gets under way, and once you reach the point where everybody has made money no matter what system he or she followed, a crowd is attracted into the game that is responding not to interest rates and profits but simply to the fact that it seems a mistake to be out of stocks. In effect, these people superimpose an I-can't-miss-the-party factor on top of the fundamental factors that drive the market. Like Pavlov's dog, these "investors" learn that when the bell rings--in this case, the one that opens the New York Stock Exchange at 9:30 a.m.--they get fed. Through this daily reinforcement, they become convinced that there is a God and that He wants them to get rich.
And in too many ways, the US is getting closer and closer to that point, but we don’t yet know how far away it is. In India, we’re getting a lot of foreign capital, which must be that same divine-right-to-profit thing that is driving dollars into anywhere that can take it and is not annexing Ukraine.
Buffett reasoned out that stocks wouldn’t do that well in the next seventeen years - and he was spot on. But his reasoning said markets could go up substantially for one or more of three reasons:
- Interest rates should fall from the 6% they were at
- Corporate profits should grow tremendously as a relation to GDP
- Some sectors can make profound changes on the world and those investors will make lots of money
I think all three have come true, and yet markets have fallen short.
- Interest rates are at all time lows (less than 3% on the US ten year).
- Corporate profits as a percentage of profits are at 10.4%, higher than ever before!
- The third point is nuanced but let me just say Whatsapp just sold for $19 billion.
The reasoning was wrong, but the answer was correct - markets haven’t done all that well in the last 17 years in the US. Interestingly, that 17 year phase will end in 2016 (from 1999). Where will markets end up in two years?
For India, we might not yet have this analysis but it’s apparent we are in a phase of:
- High inflation which is coming down now
- High interest rates which might come down by the end of the year
- A rising market - at an all time high
- High foreign investor inflows.
What’s your call for the next five years? (I can’t see into 17!)
Btw, that letter is a phenomenal read. Buffett might have gotten a few things wrong, but he sure does know how to present a position in the most attractive, simple and easy to understand manner.