There was a lot of anticipation about what Warren Buffett would finally say when he held his virtual annual meeting of shareholders on Saturday, May 2, 2020. He had not spoken publicly since his interview with Yahoo Finance’s Andy Serwer on March 10, just at the beginning of the most severe period of covid-19 spread. His comments followed a day during which the Dow Jones Industrial Average dropped more than 2,000 points and occurred just prior to the suspension of the NBA season and the cancelation of the NCAA tournament. In short, as he was speaking, change was coming fast.
At that point, he still planned to hold the Berkshire Hathaway annual meeting – affectionately dubbed “Woodstock for Capitalists” – in his beloved Omaha in early May for as many as 40,000 people. But it was precisely that week that our new normal really started. Three days later, he announced that “events have moved very fast” and that the meeting would be an all-virtual format with no shareholders in attendance.
In prior crises Warren Buffett has been – or at least has seemed to be – somewhat more vocal, an omnipresent cheerleader and calming influence who is always talking about the value of investing for the long term, never betting against America, ignoring the short-term movements of ticker symbols and focusing on stocks as ownership interests in businesses. Nothing about those pronouncements has ever fundamentally changed. He said nothing, however, during the tumultuous weeks between mid-March and the first of May, when the stock market (as measured by the S&P 500 Index) went from 2,882 down to 2,237 and back to 2,830 (there’s a rollercoaster for you while the Disney parks are closed). People speculated about what he was buying, knowing he had over $100 billion he could put to work at a moment’s notice (not counting the minimal amount of liquidity he has always pledged to keep in reserve). Maybe he was buying back Berkshire stock. Maybe he was adding to beaten-down banks.
But what he did was instructive: he went from net buyer to net seller.
As late as the final week of February, Mr. Buffett had added to his stake in beleaguered Delta Airlines, which was already beginning to feel the covid crunch. By the beginning of April, he had started selling. At the virtual shareholders meeting last Saturday, he announced that he had sold out his entire stake in four airlines at a significant loss. What had changed a temporary price disruption into a longer-term impairment of value? The facts changed. And as the economist John Maynard Keynes said, “When the facts change, I change my mind. What do you do, sir?”
There is a troubling behavioral finance problem that both business owners and investors face called the sunk-cost fallacy. They become invested in particular lines of business, products or stock positions, having invested research time, financial resources and intellectual energy into decisions that have not turned out as planned. The tendency can be to stick with those choices in the hope that they will move “back to even,” or to be slow for other reasons in recognizing the error and taking corrective action. Warren has said, instead, that one of the most valuable characteristics of a good investor or a good businessperson is to be as rational as it is humanly possible to be. In this situation, he knew that the facts had changed. Here’s another example. According to Berkshire Hathaway’s quarterly report filed with the SEC, he was buying back Berkshire stock (albeit in very low volumes) up through early March at $214 per B-share, presumably a value he saw as reasonable. But he bought back none on March 23, when he could have paid just over $162 per B-share. Why?
Once again, the facts had changed. He gave a very nuanced answer during the Q&A period of the annual meeting around this topic. For one thing, it takes time for Berkshire to put large sums of money to work in the market, and in this case Berkshire Hathaway stock rebounded into the $170’s fairly quickly. But the other reason is more telling: his assessment of price relative to value, considering the current circumstances, hadn’t really changed that much. Stop and think about what that means. Remember that Warren Buffett thinks about stocks as pieces of businesses, not as ticker symbols. He’s telling us that the underlying value or prospects of the business (in this case Berkshire Hathaway) – in more than the immediate near term – might have changed somewhat.
His other comments at the annual meeting required a little reading between the lines as well to fully match his actions to his message. The long-term optimism about America was still there. The focus on the fundamentals of any investment as being part ownership of a business was still there. The context, however, was a bit different.
Here’s what I thought to be the most important takeaway of the entire 4.5 hour session. Buffett said that while the range of health outcomes had narrowed somewhat – meaning we probably won’t see the most horrendous outcome, nor will we see the optimal scenario – the range of possible economic outcomes is still exceedingly wide. In fact, when one question was posed to him asking him to elaborate on what some of those worst-case economic outcomes might be, he deferred, saying that any discussion of those outcomes could lead to a self-fulfilling prophecy. Still, he clearly has some of those possibilities in his head as his cash on hand has swelled to more than $134 billion.
Perhaps he provided a hint when he said: “Fear is the most contagious disease you can imagine. It makes the virus look like a piker.” Remember that we are a services based, consumer economy. Many economists say that roughly 70% of economic activity in the United States is driven by consumer spending. With massive unemployment (hopefully temporary) and a deliberately stalled economy, how fast will it ramp back when we reopen? It’s an experiment no one has ever tried: taking the largest economy in the world and deliberately stopping it on a dime. What will be the ultimate result? Nobody really knows.
That’s the problem: nobody really knows. It’s why Warren Buffett is a great businessman as well as a great investor. He naturally thinks in probabilities. He thinks about a range of possible outcomes. He is a second- and third-level thinker. Most market participants are thinking in immediacies: run to buy Zoom stock while people are stuck at home. Buy Peloton because people will never go back to the gym. Buy Netflix at an 85 price/earnings multiple even though it has no free cash flow at all (in fact, it’s burning through billions in cash every year) just because people are sheltering in place. Maybe they’ll all go up, but it’s short-sighted thinking.
Warren Buffett’s deeper pondering is more disturbing. Where is the long-term value impairment? What is the worst-case outcome for massive intervention by the Federal Reserve and the most rapid unemployment spike we’ve ever seen? What happens to those consumers that power the economy over time, and how long will it really take to all play out?
I am always skeptical of pundits who say that the world will never be the same because of any series of events. I’m sure it was said during WWI. It was said during the depression. It was said during WWII, and later after Kennedy’s assassination. It was said following 9-11 and during the great recession. It’s almost never true as stated or intended at the time, even though clearly some patterns of thought and behavior change. Will the covid pandemic mean we’ll never go to the theatre again? Or that we’ll never need office buildings because we’ll all be working from home forever? It may seem like that right now, but just like buying the “stay at home” stocks because they’re temporarily in fashion, it’s not an effect that will last.
Bet on America? Absolutely. But bet a bit more carefully in the near term. That goes for business owners making capital investments, for investors choosing stocks, for those taking out loans to bridge to better times. Duration is a factor here: how long will it be before the “new normal” reverts to an older, more familiar normal, and how much damage will have been done in the meantime? That’s a very important – and unknowable – unknown.
If you want to discuss any of these ideas in more detail, please email me at keith@riverfall.is. We’re happy to talk about ways we can help you build a better business at the same time. Stay safe!
At Riverfall Strategies we do not give investment advice of any kind, nor are we licensed to do so. None of the above comments should be considered to be an investment recommendation or actionable commentary on any stock or security.