The Sage of Omaha and the Wayback Machine

Forbes magazine is the best even though they once savaged the wife of a friend of mine for her work as the CFO at Polaroid.  I still don't think it was her fault. 

But back to Forbes.  One column I always read is the Flashbacks section where they revisit articles from 25, 15, and 10 years ago.  The one that caught my eye this month is the 25 year old column.  Now get in the Wayback Machine and revisit the good old days where 1) Reagan had just been elected president after Jimmy Carter threw in the towel saying there was a 'malaise on the people' (note to all future presidents out there-you don't get elected by telling somebody it's their fault.  If you are in a bind tell the electorate how WE are going to fix it.), unemployment was 10% or more, inflation was surging and interest rates were zooming thru the teens.  Also, Japan was going to take over the world and New York, Cleveland, Pittsburgh, and Chicago were all lumped together as the Rust Belt and would soon blow away.  The good old days and one less than enthusiastic investor was the Sage of Omaha, Warren Buffett. 

Here is the article.

Putting Stock In Buffett-October 26, 1981

Are stocks a great buy again?  Alas.  If you expected a happy answer from Warren Buffett, you won't get it.  "There won't be any great buying juncture for stocks until there's one for bonds," he says.  How can stocks compete with bonds at current yields, he asks.  Buffett is not yet convinced the Administration has inflation licked, and until it eases, bonds will be under pressure.  But don't sell all your stocks.  Buffett says he's fully invested in them.  Why?  "You lose less to inflation than with most other investments," he says.  But he doesn't expect a bull market soon.  He doesn't feel the old sap rising.

That's it.  The sum total of the article and the sum total of Buffett's investing philosophy and all you need to know to get rich.  Let's break it down.

"There won't be any great buying juncture for stocks until there's one for bonds." 

Huh?  He was saying that the time was not ripe for investing in FINANCIAL assets.  Inflation was raging and neither stocks nor bonds were a buy, yet.  But interest rates were above 10%.  What a buy.  Not really if the inflation rate, or the expected inflation rate, was 15%.  You made 10% but lost 15%.  And stocks were dead in the water because they couldn't even compete with the return on bonds.  No, the 'smart' investors were piling into 'hard' assets--gold, silver, Swiss francs, Persian rugs.

"Buffett is not yet convinced the Administration has inflation licked, and until it eases, bonds will remain under pressure."    

So what happened?  Reagan understood that inflation was the enemy and he brought out the only tool that works.  He created a recession.  When somebody loses their job, they quit buying and inflationary pressure goes away.  Harsh but it works.  How do you create a recession?  Crank up interest rates way above inflation.  And he did.  Short term rates went into the twenties.  25% minus inflation of 15% equals a real return of 10%.  Money flowed into bonds.  Wish I had done that.  I knew a lady that did.  She made a fortune.  I think she is the CFO at Qwest now. 

"But don't sell all your stocks.  Buffett says he's fully invested in them."

WHAT?  Interest rates below inflation.  Stocks dead in the water.  Doesn't trust the Administration.  And this IDIOT is fully invested?  Yep.

And what happened?  As noted, real interest rates came on creating Buffett's 'buying juncture' for both stocks and bonds.  Inflation disappeared, unemployment went down, albeit slowly.  Gold and silver sank like the rocks they are.  AND STOCKS WENT ON A 20 YEAR RIDE UP, WAY UP.

So what was Warren thinking back then?  What did he know that everybody, and I mean everybody, missed?  Warren knew, and knows,  that stocks historically return 11% a year vs. 7% for bonds vs. 3% for cash.  He is also an optimist that knows cooler heads will prevail and while the world is far from perfect, it's not all that screwed up either.

And that is all you need to know.

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