Friday, May 10, 2013

Buffett on Bonds and Productive Assets

From this past Monday's interview of Warren Buffett by CNBC's Becky Quick:

"I bought a piece of real estate in New York in 1992, I have not had a quote on it since. I look to the performance of the assets. piece of real estate have had pull backs, but I don't even know about 'em. People pay way too— way too much attention to the short term. If you're getting your money's worth in a stock, buy it and forget it."

He then added this on interest rates and how they affect all other assets:

"...interest rates act like gravity to other asset prices. Everything is based off them."

Buffett then also said:

"...interest rates have a powerful effect on...all assets. Real estate, farms, oil, everything else...they're the cost of carrying other assets. They're the alternative. They're the yardstick."

Interest rates may be the yardstick, but the time to buy certainly isn't when the world is free of trouble.

"...the fact that there are troubles in Europe, and there are plenty of troubles, and they're not going go away fast, does not mean you don't buy stocks. We bought stocks when the United States was in trouble, in 2008 and— and it was in huge trouble and we spent 15 1/2 billion in three weeks in— between September 15th and October 10th. It wasn't because the news was good, it was because the prices were good."

He also said that, while he doesn't have any idea when, some day bond yields will be a lot higher.

"'s going to happen. And question is...the question is always when. I'm no good on that. The question is to what degree it happens. But you could have interest rates very significantly different than what they are now— in some reasonable period in the future. It's not a game that I can play. I mean, I— I don't have any special insight into that sort of thing..."

As far as Buffett's concerned stocks might have been cheap not long ago, but they're now merely decent values.

"In terms of stocks, you know, stocks are reasonably priced. They were very cheap a few years ago. They're reasonably priced now. But stocks grow in value over time because they retain earnings..."

Bonds, on the other hand...

"There could be conditions under which we...would own bonds. But— they're conditions far different than what exist now."

Becky Quick then pointed out that her co-host on CNBC's Squawk Box, Joe Kernen, went into a retirement specialist recently. The specialist said he should be 40% in bonds. Buffett's response was "you shouldn't be 40% in bonds." He said investors with the "proper attitude" should have "enough cash on hand so they feel comfortable, and then the rest in equities..."

He then added:

"I would have productive assets. I would favor those enormously over fixed dollars investments now, and I think it's silly — to have some ratio like 30 or 40 or 50% in bonds. They're terrible investments now."

Of course, productive assets include not just equities (pieces of businesses) but naturally also entire businesses, as well as things like farms and real estate. As always, they must be attractive assets bought at attractive valuations. Even the best asset can be a dumb and risky investment at the wrong price.

Buffett did explain what he meant specifically by "proper attitude".

He said it's those investors who won't be bothered whether stocks were to drop, for example, 20% in the next month.

Now, 20% over the next month was used to help make his point, but it's not really about a specific percentage.*

It's just that those who tend to react the wrong way to negative price action aren't likely to do very well in equities. In fact, those who react emotionally to price action in either direction will likely end up with poor results in the long run. That more than a few investors tend to buy and sell at the wrong times is, unfortunately, an all too reliable pattern. Buying when the news appears good and selling when the outlook appears less rosy or seems more uncertain isn't a brilliant way to invest. The fact that a favorable outlook makes it feel safer doesn't mean that it is. All else equal, the higher prices that will generally prevail during the good times increases the risk of permanent capital loss (and, of course, the lower prices often available during the not so good times reduce that risk.) Investors often try to time their moves but the evidence is that this is mostly a good idea in theory only. It is likely to increase mistakes and just generally reduce returns.
(Though I'm sure there's some who are able to do this sort of's just that far more seem to think they can do this effectively than the available evidence suggests.)

The intrinsic value of most quality productive assets simply doesn't move around nearly as much as stock market prices. With so much inherent price movement, eventually sound long-term investments should become available at a discount.

Investment is attempting to capture the long-term compounding of real value, instead of the near-term price movements. That the macro environment will go sour from time to time over a true investment horizon is inevitable. Expect it while realizing that attempts at correctly timing it is folly. The evidence that attempts at properly timing moves consistently well is not smart thing to do isn't insignificant yet, no doubt, many will still ignore this reality.

The good news is that timing things well isn't important over the long haul, paying the right price is.

In any case, buying when the skies are clear then selling during the storm is a great way to pay more than necessary for assets and, ultimately, sell them for too little.

More risk, less reward.

It's clearly not impossible to counteract this adverse tendency, but that starts with being aware of it.

Buffett's not always against the ownership of bonds by the way. In the interview, he points out that he made a lot of money in zero coupon bonds in the early 1980s and added that "...the price of everything determines its attractiveness."

Buffett said that a few years ago "The news was terrible, but the stocks were cheap, you know. News is better now. Stocks are higher. They're still not— they're not ridiculously high at all, and bonds are priced artificially. You've got some guy buying $85 billion a month. (LAUGH) And— that will change at some point. And when it changes, people could lose a lot of money if they're in long-term bonds."

Much later in the interview, Buffett once again talked about the folly of trying to buy and sell stocks based on current news. He said those that do this are "giving away an enormous advantage" then added:

"...I bought a farm in 1985, I haven't had— had a quote on it since. But I know what it's produced every year. And I know it's worth more money now. You know, it— if I'd gotten a quote on it every day and somebody's said, "You know, maybe you oughta sell because there's, you know, there's clouds in the West," or something. (LAUGH) It's — it's crazy."

Investment, in contrast to speculation, has as its focus what a productive asset can produce over a long time frame. Of course, what you pay for that asset -- whether it be an entire business, part of a business, or a farm. or other real estate -- matters. Many think of the stock market primarily in terms of where prices will be over the near or even intermediate term. Learning to think primarily about what something will produce over time instead of price action can make all the difference.

In this recent post, I mentioned that Buffett last year said "bonds should come with a warning label." Then, as now, he wasn't saying when yields would rise. Getting the timing right is always difficult at best. In fact, it is mostly a waste of energy or worse. The good news is that timing things consistently well is not a requirement when it comes to getting attractive investment results. Look no further than Warren Buffett himself for evidence of this.

As Donald Yacktman and his team like to say"It's almost all about the price."

That just about sums it up. It's buying productive assets, particularly those that the individual investor understands well, at a price that represents a nice discount to per share intrinsic value.


* To make his point about the "proper attitude", Buffett used stocks going down 20% in the next month as an example. In this interview back in 2009, Charlie Munger talked about stocks dropping more like 50%:

"I think it's in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by say 50%."

The point isn't really the percentage. It's to focus on what an asset is intrinsically worth and buy it cheap enough instead of focusing on what the quoted price happens to be on any given day. If cheap, and you want more of a particular asset, buy more. If expensive, and you want less of the asset, then maybe sell. Otherwise, ignore the quoted prices and use that energy making sure value has been judged well. Better yet, if justifiably confident about an assets prospects, expend that energy elsewhere once enough shares are owned at an attractive valuation. The bottom line is to keep fear and greed in check and just mostly ignore the quoted prices. Emotional reactions cloud investment judgments and destroy returns.
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