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So why the disconnect?

An interesting disconnect, as you note.

His conclusions presumably come from some mix of top level quantitative rules of thumb
and direct (and very insightful) close observation of specific firms he knows well.

One possibility is that he's more interested in certain types of firms
rather than the cap-weighted broad market and some of those firms are
not particularly overvalued, which affects the "feel" side of things.
Think of IBM or Wells Fargo, perhaps.
That "direct observation" side might be combined with his use of
relatively simple/bad/crude quantitative metrics for broad market
valuation which is not his specific interest or main tool for investment.
Mr Buffett has said nice things about market cap to GDP which is simple,
but a markedly crude tool compared to Shiller PE. Most notably cap/GDP compares
the price of one set of things to the potential earnings of another set.
Mr Buffett knows it's only a rock-and-roll rule, of course:
"The ratio has certain limitations in telling you what you need to know."

Another separate aspect may be that he is a perennial optimist about
the growth and earnings power of the US economy. This has worked well,
if only because he looks to the eventual recovery rather than any current storm.
However, it means that he is unlikely to be trying to factor in any
fragility which is specific to the current situation.
Mr Watsa and many macro advisers are scared spitless about various massive
and unsustainable imbalances. Without even trying to comment on whether
the scaredy-cats are right or wrong, or whether it's even worthwhile
trying to spot big storms, this is simply an aspect of valuation
that doesn't seem to be part of Mr Buffett's style.
Other than having sold out of Fannie Mae, even if Mr Buffett had seen
the credit crunch coming with some moderate degree of clarity it's
likely he wouldn't have changed his capital allocation much.

He comments that things were "ridiculously cheap" five years ago, which is certainly
true in the specific (WFC at 2x normalized earnings) but not in general.
Looking at the broad market, things were vastly cheaper in 1982 and
the market bottom in 2009 would at best count more in the range of
"fairly priced to mildly cheap" compared to history.
As but one rock-and-roll metric, the absolute bottom in March 2009
represented price/book of 1.27x for the S&P 500 ($525 book for the S&P from Goldman).
Another source shows a temporary dip in book value that quarter to about 450 meaning instantaneous price/book was 1.48x.
The figure was 0.84x in 1974 (figure from Mr Buffett's 1977 Forbes article),
though other sources (e.g., Ned Davis Research) suggest it was around 1.0x at that time and in 1982.
Right now it's about 2.50x.
Average since 1979 2.38x, though the long run average is a lot lower.
It was over 3x for about 6 years during the tech bubble and peaked at 5x,
which throws things off if the historical era examined isn't long enough.
I mention all this because I don't personally see a simple way to
reconcile the broad market valuation levels in 2009 with the comment
of being "ridiculously cheap" without concluding that Mr Buffett was
more interested in a specific subset of firms, since that
characterization doesn't seem to fit the broad index very well.

Anyway, the reasoning above is my own feeling, and likely wrong.

Another possible factor is that Mr Buffett believes in discounting cash
flows based on government bond rates. He thinks lower rates make
stocks more valuable and vice versa. I don't agree.
Current interest rates do not change the value of equities, they change the current
relative attractiveness of equities and therefore their short term prices.
[I note that his phrasing in this discussion is more nuanced than in
his past writings---he speaks of "variables in the valuation of assets"
prices rather than things being worth more]
A change to the long run average real interest rate makes a difference
in that the true value of net debtors will be lower and of net
creditors will be higher, but current interest rates don't really say
anything at all about the long run average real rate, and therefore
don't affect the future earnings or value of equities either.
There's a difference between "prices are about where they should be
to provide typical long run real returns" and "prices are about as anomalously
high as you would expect them to be given the interest rate environment".
Prevailing prices are probably "fair" on the latter definition but not on the first.
Historically future real total return from stocks has varied with the
cyclically adjusted earnings yield at purchase time and has not correlated at all
with the interest rates prevailing at the time of purchase, exactly as makes sense.

A last thought:
He ends and sums up the discussion saying they're "having a hard time finding things to buy" because he's not finding much that's attractively priced.
At "normal" broad market valuation levels that's not what happens,
as dispersion of valuations usually ensures that some good stuff is cheap.

Personally I think that both the asset values and current subsidiary operating
income of Berkshire both need cyclical adjustment downwards in our valuation models.
Not big ones.

Jim
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