Barron’s magazine had its annual roundtable issue last week. This is where it gathers several high-profile investors and money managers around a table to discuss new year’s prospects for the economy and the stock market.
There was much consternation about the next twelve months—as has been in the years past—but the general mood was not as gloomy as it was last year. Perhaps it was to be expected since 2019 turned out to be a good year for investors. Many predicted how the economy and the stock market will fare this year. One panelist even forecasted how the market will move in the first half of the year and then change directions in the second half.
Peter Lynch wrote about his time on Barron’s roundtables in the book, Beating the Street. I wrote a blog post last year on this topic. Back in Lynch’s days, there were concerns and worries too. He wrote that in 1987, they worried that the dollar was collapsing, foreign companies were dumping their products in our markets, the Iran-Iraq war would cause a global oil shortage, foreigners would stop buying our stocks and bonds, and President Reagan was not allowed to run for a third term.
Today, the panelists who participate in the annual roundtable are different. But in many ways, their concerns are similar in nature. They worry about the trade war with China, conflict with Iran, the need for increased immigration, stocks’ high valuations, and lack of catalysts to drive stocks higher. Different era, different worries. And yet these worries are ever present. Pick any year’s roundtable issue. You will find the panelists anxious about geopolitical and financial risks of some form.
All of this reminds me of what Warren Buffett said in response to a question at the last year’s shareholder meeting. He was asked how the economy would do over the next couple years. He replied that the economic direction is important but unknowable. He said he didn’t believe he has any insight into what the economy will do. Neither did he think that anybody else did.
Howard Marks had also mentioned this piece of advice from Buffett in one of his memos, appropriately titled Expert Opinion:
… I had dinner with Warren Buffett about a year ago, and he pointed out that for a piece of information to be worth pursuing, it should be important, and it should be knowable. These days, investors are clamoring more than ever for insights regarding the macro future, because it’s important: it moves markets. But there’s a hitch: Warren and I both consider these things largely unknowable. He rarely bases his investment actions on them, and neither does Oaktree.
Howard Marks, Expert Opinion, January 2017
As Bill Miller pointed out in his 4Q 2019 market letter about a week ago, when Paul Samuelson, one of the 20th century’s greatest economists, was asked how far into the future a good economist could forecast, he quipped: “One quarter back”.
It goes without saying though that Buffett has faith in the long-term prospects of the U.S. economy. That’s why he invests in stocks. He believes good businesses will do fine over the long-term—regardless of any short-term bumps. He wrote this in October 2008 when the economy was in a severe downturn:
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.
Warren Buffett, Buy American. I am., NY Times
More than ten years have passed since he wrote this. Clearly, he’s been proven right.
So it’s clear that Buffett does not predict when an economic cycle might turn and a recession comes about. He’d go on holding his investments throughout a recession. His holdings would inevitably go down in value but that wouldn’t bother him. He’s not out to make quick bucks.
If anything, a recession (or a market downturn, even when no recession) is a happy occasion for him. He thrives in a recession. His best investing moves often comes during a recession. The way I look at it, he has two things going for him when he’s in a recession. One, he keeps a significant amount of dry powder cash. [Berkshire reported $128 billion in cash at the end of September 2019.] Second, his company generates huge amount of excess cash every year. [Per Morningstar, Berkshire produced an average $20 billion every year in free cash flow since 2013.] When stocks go down and deals are aplenty, he would use this dry powder cash for investments and acquisitions.
In the same vein, when Barron’s in December interviewed Peter Lynch, the magazine described Lynch as a perennial optimist and quoted him saying this: “The thesis underlying everything, whether you’re an actively managed fund or a passive fund, is that the U.S. will be OK. If you don’t believe that, you shouldn’t be in the stock market.”
How I do it? I try to manage my portfolio in the same long-term spirit. I also plan to ride through the ups and downs of the stock market, picking good businesses along the way. I also keep a measure of dry powder cash in my portfolio. This I use to opportunistically buy stocks when they go on sale. I’ve previously written about my dry powder investing here and here.
Like Berkshire produces annual free cash flow, I too generate regular excess cash flow from my earnings. This I count on to invest. Both my dry powder and future savings are ready and available for the next dip (or a major downturn) in the stock market.
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