The Contradictions of Warren Buffett….

Fortune is out with an excerpt of the 2014 Warren Buffett annual letter. It’s full of useful nuggets of knowledge as usual. I always tell people that the best education you’ll likely ever obtain in this business is to go back and read all of his annual letters (read them here & here).  But you also have to take some of his comments with a grain of salt because he often engages in vague generalizations.

For instance, in this letter he promotes the idea of picking individual common stocks.  But then he adds the caveat that it’s okay if you’re  a bad stock picker because you can just own the index.  But whatever you do, don’t engage in macro forecasting:

“Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”

But then, just a few paragraphs later he says:

“American business has done wonderfully over time and will continue to do so”

That’s a macro forecast.  And he uses this macro forecast to promote the idea that people can and should just buy index funds.  But what’s interesting about all of these long only index fund advocates is that none of them seem to realize that they’re engaging in a very specific macro forecast.  I call it lazy macro because long only indexing is based on the long-term forecast that “American business…will continue to do…wonderfully”.  It’s probably a pretty good bet if you ask me.  I am certainly no long-term pessimist.  But let’s be clear about how we go about formulating our processes and projections.  The sorts of contradictions in the commentary above are not helping anyone understand how to go about engaging the world of finance.  In fact, I am concerned that it’s causing a great deal of misconception.

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    Great clarification. I don’t take anything Buffett says at face value. It’s nice to see someone challenging his views rather than just kissing the ground he walks on.

  • GLG34

    Buffett doesn’t really understand macro so he probably isn’t crystal clear on what it even is. I doubt he’d disagree with your point here.

  • http://orcamgroup.com Cullen Roche

    I’ve got big time respect for Buffett and I often kiss the ground he walks on. But I’ve also learned that what Buffett does is nothing remotely as simple as the things he discusses in his letters.

  • Tom Brown

    O/T: I had another forum post go to spam I think. It was basically a link to this:
    http://brown-blog-5.blogspot.com/p/extra.html
    But I offered some extra credit for anybody interested. :D

  • john-r

    Buffett is actually an astute macro-player. look at his early years. at one point he was all cash.

    Unfortunately, he now manages a multibillion, multi-industry conglomerate. timing the market is impossible because he would essentially become the market if he tried to buy and sell his holdings in a meaningful way.

    if he sold his holdings, everyone else will take his cue and sell alongside him. that would crash the market and diminish his profit. he has no choice but to hold and talk up the market.

    i am pretty sure he knew the housing crash was coming. but what could he have done?

  • LVG

    Berkshire Hathaway has basically become one big macro index fund anyhow. That’s why it doesn’t outperform the S&P 500 any longer. It’s just too big to do so. Buffett likes to think he’s some micro player in a macro world, but he can’t be that stupid.

  • FXTRader

    This “buy and hold” index fund thing seems to be a uniquely developed market phenomenon. There’s no John Bogle in Greece, Japan or China where stock indexes have been sideways for decades or suffered catastrophic decade long declines.

    I like the way you call it “lazy macro”. If you don’t realize you’re making a specific long-term forecast you’re more likely to fall into the trap of believing that Japan or Greece can’t happen to your portfolio. A better term for this might be “blind macro”.

  • SS

    Buffett has spent an entire career crafting the mirage that he’s a stock picker and someone who hasn’t benefited from a huge macro trend. He can’t trick his believers into thinking he’s a genius if he just admits that he built a unique company and rode a big macro trend to riches. That doesn’t sound nearly as cool as claiming to have picked all these stocks without putting too much effort into it.

  • http://thebuttonwoodtree.wordpress.com Romeo Fayette

    I think his nominal preference to ignore macro is an implicit expression of the idea that:

    ‘Productivity growth is inevitable, so if you lack the expertise or discipline to value companies–figuring out which stock has overvalued its future production and which undervalued–then latch on to productivity growth via an index. A sufficiently long term investor will make money over a long time horizon, even if he unfortunately starts investing at a cyclical or secular top.’

    I don’t think Cullen’s characterization of “lazy macro” is fair or accurate. Instead of the hopelessly naive “American business…will continue to do…wonderfully,” I think Buffet’s implication is that productivity growth is inevitable–a la this Dalio illustration: http://thebuttonwoodtree.files.wordpress.com/2013/09/dalio-cycles.png

    Buffet certainly can speak paradox and contradiction (e.g. derivatives as WMDs), but this is a poor example.

  • SS

    “Productivity growth is inevitable”.

    That’s not true though. Economic growth and increased productivity is not “inevitable”. It’s probable. It’s not inevitable.

  • http://thebuttonwoodtree.wordpress.com Romeo Fayette

    …In addition, Cullen and I already discussed our feelings regarding the indexing debate. My comments were as follows (http://pragcap.com/most-index-funds-are-macro-funds/comment-page-1#comment-159865):

    “The real naivety of the active vs passive or value vs macro debate is that no strategy is best all the time. I love the work of guys like Cullen, Josh Brown & other bloggers, but the active/passive prescription for a retail or institutional investor is so much more complex than blanket recommendations. (And all Alternatives are not created equal–hedge funds & particularly PE.)

    “…it’s a cycle: More & more active managers chase alpha, alpha opportunities thin-out, investors pile into beta strategies, correlation increases, active managers go out of business, correlation drops, so on.”

  • http://orcamgroup.com Cullen Roche

    You’re mischaracterizing my use of the term “lazy macro” as pejorative. That’s not my intent. I actually think the lazy macro perspective is pretty smart. It’s intuitive and generally implemented by people who implicitly understand that economic growth is likely to expand in the future. But that doesn’t change the fact that this is a specific macro forecast. Frankly, I think it’s a bit disingenuous of the index fund community to claim that they’re not making forecasts about the future when they obviously are. There’s nothing wrong with indexing, but let’s stop pawning it off as some sort of “passive” do nothing approach to the world. It’s not. That whole concept is a sales pitch devised by people who benefit from differentiating themselves from a more active view of the investment world. I don’t find it helpful except in constructing an investment ideology.

  • http://dismalecon.blogspot.ca DismalEconomist

    Even deciding what index to buy involves a macro forecast. Do you buy the S&P 500, the Dow, Russell 2000, MSCI World Index? Do you have a home country bias to your portfolio? Ultimately it becomes very easy to end up with some kind of firm size or geographic bias to your portfolio unless you somehow objectively equal weight all the possible indices you could hold. But for most small time investors with limited capital, the cost to do so would outweigh any potential diversification benefits, so you’re back with a portfolio that ends up with some kind of embedded macro bet, intentionally or otherwise.

  • BAlex

    I would suggest that Mr. Buffett is urging the average investor not to engage in macro forecasts as a tool of managing behavior rather than suggesting “macro” doesn’t matter.

  • http://thebuttonwoodtree.wordpress.com Romeo Fayette

    I did misinterpret that as “pejorative,” you’re right, Cullen. I still think it’s a weak argument or a penatrating-glimpse-of-the-obvious to say, essentially, “by not having a macro opinion, you’re having a macro opinion” or “by thinking macro is short-term unpredictable or long-term inevitable, you’ve made a macro prediction.”

    More precisely, Buffet’s saying that he always & everywhere is constructive on US economic growth (a macro opinion, so you say), but he’s not always keen on investors’ aggregate discounting of that growth (value).

    SS is right (above) in saying that it’s “high probability”–not inevitable–but Buffet seems to concede the small chance that he’ll be wrong about productivity growth given all the tailwinds from population growth & mankind’s penchant for progress. Considering all this, I don’t think he’s violating his own rule against macro forecasting.

    What I wholehartedly agree with, as I’ve mentioned here before, is that the index industry is as much of a sham as anything else out there. Bogle is as enterprising as any hedge fund manager. It’s hilarious that these index purveyors are looking to grow their business by marketing allocations (60/40 or “smart beta” or diversified optimization) while preaching the passive mantra out of the other side of their mouths.

    Further, yes, it’s annoying that indexers ignore the fact that the S&P 500 itself is pretty much an actively managed index.

    That’s infuriating…

  • http://orcamgroup.com Cullen Roche

    I guess my point is that I think we should be clear about what we’re doing when we’re allocating assets in a particular way. I am probably being overly stingy about this stuff, but that’s just the way I am. When you allocate funds in a long only index fund approach you are most certainly making a very specific macro forecast. Now, it’s a smart macro forecast and one that need not change or expose you to all sorts of behavioral traps and excessive frictions, but it’s still a macro forecast. As I said, I just think the whole concept of “passive, forecast free” indexing is a sales pitch that’s designed to differentiate “passive” investing in such a manner so as to make it more marketable. It’s misleading in my view.

  • Anonymous

    Isn’t the belief that ‘credit will always expand’ another form of optimistic lazy macro?

  • http://orcamgroup.com Cullen Roche

    Yeah. It definitely is. For the aggregate global economy though I think that’s a pretty safe bet in the long-term. But yes, definitely a “lazy” sort of prognostication. :-)

  • Anonymous

    Hey Cullen,

    Did your site get hacked,
    All i can see is your picture over and over

  • http://orcamgroup.com Cullen Roche

    Well, that would be a cruel joke!

    I am seeing everything fine on my end. Let me know if you continue to have problems. Thanks. And sorry about the face! I know it’s not easy to look at.

  • micro2macro

    In the first quote he is talking about “the market”. In the second he is talking about “American business”. They are two diffierent things I think…

    Steve

  • HankB

    Warren Buffett is full of sh*t.

    1) He derides hedge funds even though he ran one for 20 years.
    2) He says derivatives are “weapons of mass destruction” and stockpiles them in Berkshire.
    3) He tells everyone to buy index funds while constantly pumping the idea of value investing and stock picking.

    I have no idea why people glorify this man. He’s the ultimate rentier. He doesn’t even run the businesses he owns. The Fortune article could have been titled “Better to be Lucky than Good”.

  • SS

    You forgot to point out that he would have been wiped out in the financial crisis if it weren’t for Uncle Sam and the rest of us bailing out his biggest holdings.

  • Brmr

    In the same letter, he also talks about buying a farm and valuing it and elaborates that productivity increases as does price increases provide upside ( he refers to corn). Which in terms of productivity is at least acceptable due to the last 200 years of progress, but as to the prices it smacks of prediction, which though he made it at a low point in terms of prices in 1986 They were range bound for a long time while inflation ate some of the productivity gains. He does say not make macro predictions, but does so on prices & productivity, though productivity gains have not been the same and are not quiet as assured as he claims.
    http://chartsrus.com/charts.php?image=http://www.sharelynx.com/chartstemp/free/chartind1CRUl.php?ticker=FUTC

  • Suvy

    I’ve been wondering this for a while. I’m just starting to think that as people get older, they get crazier.

    Note: Buffett is less crazy than 99% of old people.

  • John Smith

    Cullen you are continuing to stretch in your attempts to “start something” that of course will get the attention you need- yet will work to the detriment of most investors most of the time. The thing that you can’t grasp being so young the the effect of time on your lines- that’s those charts that can always be found when needed. I have watched and listened to the other guys in my investment club dismiss Buffett and his writings repeatedly over the years and they seem to always be rewarded (by the charts of course) in the short run and then by the time the long run comes along they are out of the club, dead, or whatever, and just wrong, wrong, and more wrong. And the club follows each trend believing like middle school kids that they are thinking uniquely about the world- thoughts never before used of course. And our results are just so predictable.

    But in the short run it seemed so rewarding to contradict Warren Buffett and be right! Oh it is the major source of so many publications by so many seeking so much validation!

  • What?

    What are you talking about? Buffett was the one doing the bailing out (Goldman Sachs). I don’t recall Wells Fargo or Coke needing a bailout.

  • What?

    I somewhat disagree with you here. Buffett’s point seems to be more about ignoring the market prognosticators that jump back and forth between calling all-in or all-out macro calls, either recessions/depressions and all-out raging bull markets. While believing in the long term prospects for America might technically fall within the definition of a macro call, I don’t think it contradicts his earlier statement. It’s a short-term/long-term distinction.

  • bnme

    Maybe, maybe, you can make the argument that it isn’t really a macro call.

    Didn’t Buffett once say that he tries to buy “businesses that are so wonderful that even an idiot can run, because sooner or later, one will”?, and he also once referenced that line in one of his letters to describe America (at a time when the President wasn’t one he viewed highly).

    So maybe he’s just viewing America as a best-of-breed country like he would view [insert whatever company he views as a wonderful business].

    Maybe.

  • Reggie

    Buffett was a major insurer of the finance industry as well as holder. if things had played out without government sorry there’s no doubt his firm would have been bankrupted or severely harmed.

  • Reggie

    why is it okay to make predictions about companies, but not the economy????? Buffett is contradicting himself ask the time.

  • Reggie

    *all*

  • bnme

    You could say the same for a lot of other businesses where the founder was not Buffett.

    No government intervention in 2008 would’ve wiped a lot of businesses and people out.

    Not gonna get into the debate on whether that would’ve been better for the country overall in the long-run though. :P

  • Johnny Evers

    I think the mistake people make with Buffet and other market gurus is seeing them as financial advisors.
    He is not. He knows nothing about your individual goals, risk tolerance, history, hopes, dreams, fears, whatever. Does he know if you want to leave a legacy? Does he know your insurance situation. Does he know what your employment risks are?
    I sometimes gets prospects or clients saying, ‘Buffet tells us to be all in the stock market,’ or ‘Bogle tells us never to pay any fees,’ or ‘Suze Ormand says annuities are evil,’, to which I often feel like saying, ‘Buffet’s time horizon is forever and he never needs money; does that apply to you?’ and ‘You’ve screwed up your portfolio and your financial planning; if you had ben willing to pay for a little advice, you’d be much better off,’ or ‘If annuities are evil, why does everybody love Social Security? If you got a lump sum instead of Social Security, you’d be in the poorhouse in 10 years.’
    End of rant.

  • Kumar Neeraj

    I don’t think anyone will care to read my comment on this – but I do feel Cullen this time you probably are stretching the point. WB talks about owning businesses – and he qualifies that by saying those where he understands earnings, so that is the micro part. However he again says that he owns a set of businesses (micro). Now if I have a portfolio of micro, would you call it a macro play just because the performance this collection of investments is going to be highly correlated with American economy in the long run.

    Don’t believe there is any contradiction in what WB says, at least on micro investing.

  • http://orcamgroup.com Cullen Roche

    Thanks for the comment. My point is that the macro still matters even for a micro investor. For instance, in 2009 the Athens Stock Exchange was trading at 2000 after having fallen 60%. Anyone who piggybacked Warren Buffett’s bullishness during that period had to undergo another 50% decline in prices before the market bottomed out in 2012. Anyone who bought major Greek banks was crushed. The macro dynamics in the European Monetary Union were more important than any micro trends in Greece or Portugal or Spain or Italy. So the macro matters. When the current is as strong as it tends to be in today’s macro world, the micro sometimes just can’t overcome the power of these interconnected trends. You can invest in the micro, but I think you need to also understand the macro and how the macro is going to influence your strategy. And that means, to some degree, that you’re inevitably making a macro forecast.

  • lessismore

    Except for people playing with options and other such games, pretty much everyone who buys stock hopes that it will go up. Even granting that this hope can be construed as a bullish macro forecast, what difference does it make? There would not be much of a market without it.

  • Al

    This is actually one of Buffett’s most dangerous quotes. If you read his actual descriptions of sound businesses, he takes a “you have to know what you have to know” attitude. But then he promotes this sort of macro blindness. As Roche notes, Buffett’s business assessments incorporate broad macroeconomic views.

  • Al

    It seems like you are using terms that you heard other people use, but that you don’t know what they mean. If you think harder about why Berkshire Hathaway is “unique”, and why a “macro trend” doesn’t explain disproprortionate CAGR, then you will appreciate the shallowness of your comment about stock picking.

  • Al

    This is a silly line of reasoning that amounts to little more than category affiliation. There is no Team Buffett or Team Cullen. There is an argument that you missed, which is that any investment position incorporates macroeconomic environments that allow for reasonable returns.

  • Al

    But presuming long term macro environments that produce a reasonable return on your investment is still a macro presumption!

  • lessismore

    Well, if you ever watched Suze’s show, you know she presents herself as a financial adviser. Since most people do not have enough money to qualify for a professional adviser, they have to find advice wherever they can. They also read all the articles (as I am sure you have) that tell us that professional advisers perform no better than an index fund, but get their fee regardless of performance. Some advisers do not like to be benchmarked like that, but honestly, put yourself in the shoes of most people.

    Suze is not the only one recommending against annuities. Any financial product the buyer does not understand can be “evil” for that buyer. People trust theitr financial advisers to have a duty of care, but that trust is often misplaced. I know lots of advisers who have the same recommendation for every client: some recommend (sell) only insurance, others annuities, others … What attracts clients to these adviser-salesmen is the ready and affordable access to advice because as I noted earlier most people do not have enough money to qualify for a true professional who by all accounts is not usually worth the fees anyway (see Morgan Housel’s recent article).

  • Virginia Scanlan

    I appreciate your comments about risk tolerance. I am horrified when people say that you can’t afford to be out of the market, or that a certain age your allocation should be x and y. I know plenty of people who had just retired and were allocated at 60% stocks when the collapse came, only to see the value of their holdings fall by 30%+. Some held on, but others sold out at the bottom, not knowing what was ahead. Matching your allocation to your liabilities and risk tolerance is very important.

    At the moment, I know plenty of physicians who are struggling to keep their practices open by dipping into their own assets to stay afloat. They can’t accept the fact that the government is determined to put private practice out of business, and that the bureaucrats have no interest in the fact that they can’t cover their overhead, which continues to rise while reimbursements are continually cut. So what is the risk tolerance of many physicians right now? Almost zero.

  • lessismore

    I do not care to enumerate all the ways I am connected to health care in America. I will say the government is certainly has no aim to put private physicians out of business. The trend right now among private practices is to cut office hours. Maybe if some of these doctors saw patients more than 2 1/2 – 3 days per week…And doctors should bill patients themselves rather than outsourcing the task to billing offices. And many more things they could do.

    Probably the biggest thing they could do is get tough with private insurance companies and set fair rates for all patients whether insured or uninsured. Doctors should also make their prices clearer up front. It is crazy that patients cannot get the simplest question, (How much will it cost) answered, or that the costs vary so widely. I recently saw two bills for cataract surgery, both performed by the same physician in the same surgery center with the same itemized list. One bill, $3000, the other $20,000. Makes no sense.

  • J Thomas

    “Probably the biggest thing they could do is get tough with private insurance companies and set fair rates for all patients whether insured or uninsured.”

    But if one doctor did that, the insurance companies would refuse to do business with him. They’d have to organize.

    If the MDs joined a union they could do collective bargaining….

  • lessismore

    Or perhaps we need a completely new system wherein the insurance companies have a lot less power. Perhaps the American people should be lobbying their congressmen for health care reform. Oh wait, we tried health care reform and it became (and still is) a political turf war resulting in a new law that pleases no one, and certainly does not address the major problems of health care in the US. Our government does not govern anymore. It is merely a playing field where each team tries to score the most points.

  • J Thomas

    “Our government does not govern anymore. It is merely a playing field where each team tries to score the most points.”

    Except in wartime, that’s usually how voters want it. A whole lot of voters did not want government interference in the free market with lots of health care providers and a few insurance providers.

    Sometimes the free market is three wolves and a sheep bidding on who’s the product and who’s the consumer.