Buffet's Idea Of What Is To Come
by Guy Baker
When Billionaire Warren Buffett says (as quoted in Bloomberg.com from the Buffet letter to shareholders) “the economy will be ‘in shambles’ for the rest of this year as financial firms take losses tied to reckless loans made during the housing boom.” You get a pretty good idea what to expect in the coming few months.
Buffet projected the Standard & Poor’s 500 Index will probably gain in three-fourths of the next 44 years, just as it did in the period since Buffett took over Berkshire Hathaway Inc. in 1965. History never lies.
Word is out that the Gross domestic product (GCP) shrank at a 6.2 percent annual pace from October through December, the most since 1982, according to the Commerce Department. Buffett said the consequences of the U.S. housing bubble are now “reverberating through every corner of our economy.”
Buffet also pointed out that “Home purchases should involve an 'honest-to-God down payment of at least 10 percent,' and that 'Putting people into homes,' though a desirable goal, shouldn’t be our country’s primary objective.” (Are you listening Congress?) Buffett endorsed efforts by the U.S. government to prevent the failure of financial firms including Bear Stearns Cos., which was sold to JPMorgan Chase & Co.
“Whatever the downsides may be, strong and immediate action by our government was essential last year if the financial system was to avoid a total breakdown,” Buffett said. “Had that breakdown occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America are all in the same boat.”
By the fourth quarter of last year, “the credit crisis, coupled with tumbling home and stock prices, have produced a paralyzing fear that is engulfing the country,” according to Buffett. He also wrote, “A freefall in business activity has ensued, accelerating at a pace I have never before witnessed. The U.S. - and much of the world – is trapped in a vicious negative-feedback cycle. Fear has led to business contraction, and that in turn has led to even greater fear.”
As a result, Berkshire experienced a terrible year, almost the worst since Buffett took over (1965) – net worth declined 9.6% with nearly a 96% reduction in profit. Most of it was attributed to its finance/insurance activities, though the company owns nearly seventy different business entities.
There is significant empirical evidence to support Buffett's remarks:
- As noted, GDP fell in the fourth quarter of 08 - 6.2%. This is a great deal more than many analysts predicted and is the biggest drop since 1980. All components of GDP were down - Personal consumption, exports, and fixed investment. The global recession has heavily impacted U. S. exports.
- Jobless claims increased again last week soaring by 667,000 additional new claims which is far above predictions.
- Housing is still in a black hole. Home sales continued to fall (both new and used) in January while foreclosures continue to mount.
- Durable goods orders also declined 5.2% in January. This is the sixth consecutive monthly decline.
- Inflation is at 1% according to the Fed and projected to stay in that range for the next two years.
- ISM Manufacturing Index rose to 35.8 in February. This the 2nd month it has beaten the consensus predictions. Above 50 signals expansion.
- Personal income rose 0.4% in January. Personal consumption did as well. This rise indicates that the fear gripping consumers is loosening some and that spending is increasing, finally.
It is no wonder our consumer driven economy is in the tank. According to the latest index from the Conference Board, consumer confidence fell sharply in February, reaching a record low. It fell 12 points in February to 25, down from a revised reading of 37.4 in January, the lowest numbers seen since it began in 1967. Same time last year the same index stood at 76.4. The Present Situation Index, measuring consumers' views on current economic conditions, fell from 29.7 in January to 21.2 this month. And finally, the Expectations' Index, which measures consumers' outlook for the next six months, fell from 42.5 to 27.5 for the month. No wonder people are sitting on their money and riding out the storm. Declining income, unemployment and falling home prices have all contributed to the paralysis our nation is enduring.
So will President Obama's resuscitation plan help? In his speech to Congress last week, the President indicated tax rebate checks from the stimulus package would be released in late March, early April. But will consumers spend it or sit on it? Probably depends a lot on what happens with the banks and foreclosures in the coming weeks. But regardless, a one time rebate is hardly going to give people confidence in the long run. What America wants to see is restoration of economic activity. Unfortunately, that may be awhile in coming.
THE MARKETS
The markets were underwhelmed with the Administration’s first budget. The Dow fell [-4.11%; -19.52%], the S & P 500 declined [-4.53%; -18.59%], and the NASDAQ Composite Index fell [-4.38%; -12.63%]. All this was Wall Street’s reaction to higher taxes and higher spending. Doesn’t seem to be a strong boost for economic engineering.
The numbers being thrown around are disconcerting at best. Does anyone really know how much a Trillion is? Yet, spending is slated to be $3.5 trillion to pull the economy out of this tailspin. And even though the President says his goal is to cut the deficit by half through his first term, we have already seen words do not really mean what they used to mean. “No earmarks” means earmarks. “Tax cuts” mean welfare. “Pullout from Iraq” means leaving 50,000 troops in Iraq. You get the picture. If that fellow from Texas were saying any of these things – I wonder what the hue and cry would be like from the other party and the media? The proposed $1 Trillion tax increase on the top 5% should really stimulate the economy, shouldn’t it?
Another strong odor emanating from the nation’s capital is the heavy stench of possible "nationalization" of several major banks, including Citicorp and Bank of America. Now that the federal government owns about 40% of Citi, who is next? The autos? The mortgage industry? Health Care? Financial Services? America will never be the same once all of this “change” sets in. This is change we can believe in.
Here is a change. General Electric announced a big cut in dividends dropping the current dividend from $1.24 to $0.40 per share. This following their announcement they were going to maintain the current dividend through the end of 2009. A growing list of companies are impacting the standard of living of their shareholders by holding on to their cash. Can’t blame them though, but it hurts.
U. S. Treasury Bills continue to be the safe haven for short term money. But where else can it go? It is better to earn nothing than lose a lot – as the saying goes. Long term returns rose, but short term yields slipped a few basis points. Still, money is flowing into the government right now.
Mortgage rates remained steady during the last week of February. While we are seeing a few fundings, it is taking a long time to get approvals and the checks written. Until the financial markets settle down and the banks gain control of the imposed GAAP “mark-to-market” debacle, declines in value will continue. It is going to be a bumpy ride. This could last through the end of the year and beyond, although we are hopeful the government ‘home bailout” will bring life back to the dead.
Some good news, I think? The U. S. dollar continued strengthen against the Euro (€), ending the week at about 1€ = $1.27. While this hurts our exports, it does improve our ability to buy foreign-made products, increasing imports. So look for the trade deficit to increase some and for there to be more pressure on domestic GDP. Also, watch what is happening to Eastern Europe as they try to refinance over $1.4 trillion of short term debt that is coming due. Newsflash!!! The whole world is in a financial mess right now. It is not just the U.S.
Our economic malaise has overshadowed any oil and gas news. Prices were stable during the last week of February and no one seems to be following it in the media, at the moment. Energy prices are not adding to the crisis currently. Issues like job security, health care costs and hope for the stimulus package have taken front row center.
LESSONS IN PERSONAL FINANCE – Be Patient
Many portfolios have seen a 50% decline over the last months. The psychological loss and fear of this decline takes its toll on even the most calm of us. No one can blame anyone for being concerned and wondering if this wealth will ever be restored.
Let’s look at the math. To double your existing portfolio how long would it take at various rates of return?
@ 5% |
15 years |
2024 |
@6% |
12 years |
2021 |
@7% |
10 years |
2019 |
@8% |
9 years |
2018 |
@9% |
8 years |
2017 |
@10% |
7 years |
2016 |
As is the case with money, patience is the order of the day. The historical return in the market has been 10%. If we return to that level in the near term, it would take six to seven years to get back to your original principal. We would all take that right now.
If you are in a position to make additional capital contributions, you will get back quicker. So it would seem people will be working longer, retiring later and hoping the government’s efforts will take hold sooner rather than later.
www.berkshirehathaway.com – the Oracle of Omaha (Warren Buffet), includes his closely watched annual letter to shareholders. His comments this year are particularly sobering, but Buffet does express his confidence that the U.S. economy will recover in the long run. But who would have thought otherwise?
FACTS AND FANTASY
A recent analysis of corporate dividend payments shows dividend reductions are in the neighborhood of $22 billion in the past quarter.