SECTOR: FINANCE

Warren Buffet on the stockmarket
Extract from an Essay by Warren Buffet distilled by Carol Loomis in Fortune Magazine on December 10, 2001. Also reprinted in the Australian Financial review on 8th January 2002.
SkilledGeoscience
31st January 2002

Warren Buffet, after Bill Gates, is the second richest man in the world (Forbes list his investment worth at US$ 32 billion). Here he reflects on investment trends since 1964. ....' To refer to a personal taste of mine, I'm going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the 'Hallelujah Chorus' in the Buffett household. When hamburgers go up, we weep. For most people, it's the same way with everything in life they will be buying--except stocks. When stocks go down and you can get more for your money, people don't like them anymore'...

...'[in] today's stock market 'hamburgers,' so to speak, are cheaper. The country's economy has grown and stocks are lower, which means that investors are getting more for their money. I would expect now to see long-term returns run somewhat higher, in the neighborhood of 7% after costs. Not bad at all--that is, unless you're still deriving your expectations from the 1990s.

In a long essay Buffet looks at the US economy and investor returns from the period from 1964 to 1999 in two 17 year periods. The first, despite strong GNP growth was lean for investors and the second, although having a lower percentage GNP growth, was 'fat' for investors. Critical factors favoring investment include a lowering of interest rates. US bond rates moved from 4.2 % to 13.65 %between 1964 - 1981 and then back to 5.09% in 1998. In the first 17 year period the combination of low profits and high interest rates stagnated the market by 1981. Investors lost confidence. The reversal of those conditions from 1981 - 1999 created a bonanza for investors despite much lower GNP gains.

Buffet refers to two important fundamentals. First, quoting EL Smith (1924) ....'Why do stocks typically outperform bonds? A major reason is that businesses retain earnings, with these going on to generate still more earnings--and dividends, too'. JM Keynes, who reviewed Smith's book in 1925 agrees... 'Thus there is an element of compound interest operating in favor of a sound industrial investment.' Buffet concludes by highlighting an important macro quantification as a barometer of when to invest and when to consider withdrawing from the market. The chart below graphs the market value of US stocks as a percentage of GNP...'for me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire. As you can see, the ratio was recently 133%.

For the full article click on this link to Fortune Magazine

Acknowledgment

This article first appeared in the SkilledGeoscience newsletter dated 4th February 2002. The content is based on a much longer article by Carol Loomis in Fortune Magazine (December 10, 2001). Also reprinted in the Australian Financial review on 8th January 2002.

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