Monday, July 11, 2011

The 'New Normal' & 'Black Swans'

"We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops..." - Bill Gross of PIMCO in his September 2009 Investment Outlook

"Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse." - Nassim Taleb in his book: The Black Swan

Warren Buffett, the CEO of Berkshire Hathaway (BRKa), and Muhtar Kent, the CEO of Coca-Cola (KO), were recently on CNBC. Below are some excerpts of their responses to questions about the so-called 'New Normal' and 'Blacks Swans'.

On the 'New Normal'
Buffett: "...there's always a new normal...I think the luckiest person around is the baby that's born in the United States today. I don't think there's any question about it. I mean, I— it— that person is going, on average, to enjoy a far better life, you know, than John D. Rockefeller had many years ago or that I have now."

He later added...

"...so I think if there's a new normal, it will be a higher normal in terms of the average person of how they lived 20 years from now and 50 years from now."

Coca-Cola's CEO Muhtar Kent added the following...

Kent: "We have a young population. By 2040, in terms of the number of people over 60, the United States is going to be a lower percentage than China or certainly Japan and Western Europe. We have a young population.

We've got a very enterprising demographic and population, diverse, multicultural, more than 50 percent of the educated immigrants around the world are coming to the United States. Innovative, you know, we've got— we register more than 50 percent of the patents around the world. The women entrepreneurs in the United States account for $4 trillion. That's the same economy— size as the Chinese economy."

On 'Black Swans'
Buffett: "...we will have black swans, but we'll overcome black swans. Carl, I was born in August of 1930. You know, if a genie had come to me and said, 'Warren, in the next— in the next two years, the Dow is going to go from 180 down to 40, there's going to be 4,000 banks close. You know, there's going to be a dust bowl in Nebraska where you live, and farm prices are going to go to hell, and in another 10 years we're going to have a surprise attack by an enemy that looks like it's going to win the war for a while, we're going to have nuclear bombs', you know, I'm not sure I would have come out? But the truth was that America, in the 80 years since I've been born, the average person lives six times better than when I was born. It's unbelievable what this country delivers. And we haven't— we haven't lost the magic potion at all. If anything, we've got more opportunity now than we've ever had."

It seems, post-financial crisis, we have many very compelling explanations of why the future beyond 2011 is somehow destined to be subpar.

In the context of what has recently happened, it makes some sense that those with dire predictions would have the upper hand in terms of prevailing opinion and media coverage.

So what does this mean for investors? It's worth keeping what Warren Buffett said back in 2001 in mind:

"People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them." - Warren Buffett in Fortune, December 2001

"The public's monumental hangover from its stock binge of the 1920s lasted...through 1948. The country was then intrinsically far more valuable than it had been 20 years before; dividend yields were more than double the yield on bonds; and yet stock prices were at less than half their 1929 peak...But rather than seeing what was in plain sight in the late 1940s, investors were transfixed by the frightening market of the early 1930s and were avoiding re-exposure to pain.

Don't think for a moment that small investors are the only ones guilty of too much attention to the rear-view mirror. Let's look at the behavior of professionally managed pension funds in recent decades. In 1971--this was Nifty Fifty time--pension managers, feeling great about the market, put more than 90% of their net cash flow into stocks, a record commitment at the time. And then, in a couple of years, the roof fell in and stocks got way cheaper. So what did the pension fund managers do? They quit buying because stocks got cheaper!" - Warren Buffett in Fortune, December 2001

More recently, in the late 1990s when extreme optimism was pervasive and stocks were expensive, many were buying stocks aggressively.

In early 2009, it was pretty much the opposite. These days, we're somewhere in between those two extremes.

Neither extreme view had a great probability of being correct in the long run. The imbalances and systemic risks generally get sorted out even if not a pleasant experience while it's happening. It's not like the Great Depression leading straight into World War II was a cakewalk. Some of the best opportunities to invest are when the headlines are the worst (I'm guessing buying a stock circa 1938 didn't feel so great).

There may be new forms of messiness and kinds of risk in the world but it's not like the journey has historically ever been smooth sailing for investors or otherwise. Over the long haul, despite the many often severe financial/military/political disruptions, living standards increased substantially while the value created by good businesses continued to multiply many times.

None of this, of course, applies to traders. The time horizon has got to be measured in more than days or weeks (or even just a few years for that matter).

From this New York Times article:

The 'New Normal' is Actually Pretty Old

Everyone needs to get over the fear of the "new normal."

Chief among these advocates was David Laibson, an economics professor at Harvard who was recently co-author of a paper on exactly this subject. In the paper, and in person, Professor Laibson argued that the economy will always revert back to its long-term growth trend, but people still tend to freak out about sudden shocks to the system in the short-term and assume they present a permanent diversion from that long-run trend. 

If an extremely bearish or bullish view of the future happens to be trumpeted louder, more frequently, and more articulately in the media at any point in time that doesn't make those views more correct.

I've Had Just About Enough 'New Normal' to Last Me a Lifetime

The known global economic problems we face are not small. There are no doubt other serious challenges not even on our radar as of yet. Some of these known or as yet unknown troubles will create very significant disruptions in the future.

Some of this will even mean stocks end up much lower from time to time. Another crisis is always out there, some foreseeable, others not so much. Consider it a normal part of the investing environment and focus on buying a good businesses at the right price.

"You make most of your money in a bear market, you just don't realize it at the time." - Shelby Davis

Successfully timing these things is impossible to do consistently. The good news is timing doesn't matter much when quality businesses are bought when selling at a discount to conservatively calculated value.

Businesses don't sell at discounts during the good times. The best chances to invest with a margin of safety will always be well before the clouds have cleared from the skies.

Adam

Long BRKb and KO

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