On page 13 of the Berkshire Hathaway 2018 chairman’s letter, released February 23, 2019, Warren Buffett launched into his familiar refrain on American exceptionalism, this time titled “The American Tailwind.”
In the report, Buffett divides American history into three 77-year periods, the last beginning in 1942 when he first started investing. After recounting several of the seemingly insurmountable challenges the nation faced in its first 154 years—including the Civil War and the Great Depression—he notes that the prophets of doom have long preached that government budget deficits would destroy our currency. He points out that our national debt has increased roughly 400-fold since 1942 but, had investors sought refuge in gold in the face of such profligacy, they would have but 1% of what they would’ve earned from a simple, unmanaged investment in American business.
One year later, on February 22, 2020, page 11, his letter returns to his mantra, with several caveats sprinkled throughout the following consecutive quotations.
What we can say is that if something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.
That rosy prediction comes with a warning: Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater. But the combination of The American Tailwind, about which I wrote last year, and the compounding wonders described by Mr. Smith,[1] will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware! [Italics added.]
The In-between Years
Less than two months later, Buffett’s partner and alter ego of 60 years, Charlie Munger, shortened the expansive 77-year time frame to zero in on the present crisis. If ever there’s to be found a dispassionate voice of reason in the middle of chaos, it’s in the person of 96-year-old Munger. As reported in a Wall Street Journal interview with Jason Zweig on April 17, Munger weighed in personally, forthrightly addressing several tough issues that fall between the cracks of The American Tailwind.
First, however, those who don’t have a history with Mr. Munger may not fully appreciate his stupefying brilliance paired with a suffer-no-fools demeanor. As quoted in A Decade of Delusions, he uttered, with his typical deadpan delivery, an apt preamble to what follows: “The wise ones [investors] bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.”
The “patience as a virtue” and “waiting for the fat pitch” mental framework that distinguishes Munger and Buffett was discussed at length in our June 2017 post, “Dining at Buffett’s Buffet.”
Another defining characteristic of both Buffett and Munger is their capacity to compartmentalize decision making into what is knowable and what is not. The “too-hard pile” is the repository for questions they don’t know how to answer. That humble capacity, to be able to admit that despite their enormous wealth and success there is much they don’t know, is part and parcel of their collective genius. The narcissism, hubris, and other forms of pride often evident in other similarly situated investors stand in stark contrast.
Outwardly uncharacteristic for the team famous for advocating to be “greedy when others are fearful, and fearful when others are greedy,” Munger has expressed great reticence in the face of a tsunami of uncertainty. In point of fact, the market actors who through their buy-and-sell decisions actually help set stock prices in the short run, have seemed to be expressing neither collective fear nor greed but rather something akin to a chicken careening around the barnyard headless.
When asked whether Berkshire would step up to the plate and invest tens of billions of dollars in American companies, Munger demurred.
“Well, I would say basically we’re like the captain of a ship when the worst typhoon that’s ever happened comes,” Mr. Munger told me. “We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity. We’re not playing, ‘Oh goody, goody, everything’s going to hell, let’s plunge 100% of the reserves [into buying businesses].’”
He added, “Warren wants to keep Berkshire safe for people who have 90% of their net worth invested in it. We’re always going to be on the safe side. That doesn’t mean we couldn’t do something pretty aggressive or seize some opportunity. But basically we will be fairly conservative. And we’ll emerge on the other side very strong.”
Despite Berkshire’s vast holdings in railroads, real estate, utilities, insurance, and other industries—which give Buffett and Munger more and better data on U.S. economic activity than anyone else, with the possible exception of the Federal Reserve—Jason Zweig could not elicit a guess from Munger as to how long the downturn might last or how bad it could get: “Nobody in America’s ever seen anything else like this,” said Mr. Munger. “This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.”
Zweig inquired whether another Great Depression is possible.
“Of course we’re having a recession,” said Mr. Munger. “The only question is how big it’s going to be and how long it’s going to last. I think we do know that this will pass. But how much damage, and how much recession, and how long it will last, nobody knows.”
He added, “I don’t think we’ll have a long-lasting Great Depression. I think government will be so active that we won’t have one like that. But we may have a different kind of a mess. All this money-printing may start bothering us.”
Zweig again probed: Can the government reduce its role in the economy once the virus is under control?
“I don’t think we know exactly what the macroeconomic consequences are going to be,” said Mr. Munger. “I do think, sooner or later, we’ll have an economy back, which will be a moderate economy. It’s quite possible that never again—not again in a long time—will we have a level of employment again like we just lost. We may never get that back for all practical purposes. I don’t know.”
History Says the Odds Are in Buffett’s Favor
“American exceptionalism” has a storied history—from the ideology born out of the American Revolution to the country’s hope of transforming the world implicit in the closing phrase of Lincoln’s Gettysburg Address: “shall not perish from the earth.” Earlier in the mid-1800s France’s Alexis de Tocqueville had described the United States as “exceptional.” Interestingly, it was Joseph Stalin who actually coined the phrase in 1929.
At this stage of America’s evolution, we admittedly feel awkward when we read the phrase. It’s arrogant, even condescending, and simply untrue if the president’s campaign slogan, “Make America Great Again” (or its latest iteration, “Keep America Great”), is to be taken at face value.
Homing in on the present moment, even Buffett, the perennial optimist whose latest incarnation of American exceptionalism is the title of this post, admits, though, that in the shorter term, anything can happen. The 1929–32 Crash that foreshadowed a 10-year Depression tested the mettle of investors, including his mentor Benjamin Graham, and most saw their long-term compounded returns decimated.[2] As for what challenges lie ahead, in his 2019 shareholder letter (quoted above) Buffett narrows the parameters of those who will likely prevail. “The individual who does not use borrowed money and who can control his or her emotions. Others? Beware!”
We don’t use borrowed money, and we have largely demonstrated the capacity to avoid being ruled by our emotions—and thus view the future opportunistically. Our ideological approach for these times begins with the famous Buffett dictum, “To win, first you must not lose.” Munger is more cryptic: “The key to long-term investment success is to avoid wealth-destroying catastrophes.”
In the meantime, we observe and patiently sit. To paraphrase Munger,
[O]ne should continuously search and wait for conspicuous, logical, and simple investment opportunities that will be recognizable as such. They will be few and far between, but if one bets heavily when the odds are highly favorable, “using resources available as a result of prudence and patience in the past,” one’s lifetime investment results will be improved dramatically.[3]
[1] In a 2019 annual letter section “The Power of Retained Earnings,” Buffett indirectly lauds Edgar Lawrence Smith who, in 1924, wrote Common Stocks as Long-Term Investments, leaving the highest praise to come from another reviewer of the book, John Maynard Keynes: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest [Keynes’ italics] operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.”
[2] The S&P 500 index, inflation-adjusted, did not return to its 1929 peak until 1954. The lost 25 years is, however, an overstatement. For most of the span, inflation was quiescent. The number of years to break even with 1929 on a total-return basis was much shorter. For those who held their stocks, dividends averaged 5.7%. In order to reach the yield level today, the S&P would have to fall to 1,040. Is there any more compelling case for heeding Munger’s advice?
[3] Martin, Frank K., A Decade of Delusions: From Speculative Contagion to the Great Recession (p. 346). Wiley. Kindle Edition.