Skip to main content
Message Font: Serif | Sans-Serif
 
No. of Recommendations: 105
Good Lord, I guess it’s time I did a post since Chaos is my thing.  For those who don’t know me, my last big flurry was March 2009 (maybe the 11th?) and here we are again.  It’s all doom and gloom and people, me included, are questioning Berkshire Hathaway and wondering what they should do.  For the record, I’ve been intensely attracted to this stock for over 20 years and began investing in earnest in 1998 holding a minimum 50% BRK portfolio position during that time.  It now represents about 90% of my liquid net worth after some major buys on the Monday after the “annual meeting”.  As a military officer (now retired) I’ve been wired to prepare to deal with uncertainty and chaos and strive to prepare for such times in perhaps a vain, arrogant attempt to add stability and certainty upon the scene.  

IT’s A GAME OF 4D CHESS NOW REQUIRING A MULTIDISCIPLINARY PERSPECTIVE MORE THAN EVER BEFORE

Now from out of nowhere we have COVID 19 though Nassim Taleb will certainly argue that this was no “surprise.”  Quite a few people predicted this event and Buffett and Munger certainly thought it through. You mean to tell me that Berkshire didn’t find ANYTHING to buy in the last month?  What the hell is going on here!?  Not even JP Morgan Chase? So obviously what looks cheap may not be so cheap IF CERTAIN EXTREME OUTCOMES HAPPEN which sort of leads us towards more macro analysis which Buffett isn’t exactly known for as an investment factor.  He mentioned “you’d better be careful how you bet.”  He also said, “We don't prepare ourselves for a single problem, we prepare ourselves for problems that sometimes create their own momentum."  Sound like they’re focused on microeconomics?  Nope.  At least not to me though I certainly welcome a counter view.

Which brings us to where Multi-disciplinary decision-making and investment analysis converge.  Ever see a professional reading list?  The Generals I worked with in the Army all had their professional reading lists that everybody down the chain was to immerse themselves with and deepen their professional knowledge.  Every reading list I saw was comprised of countless books on military history and strategy and international affairs and political factors.  I never once saw a book on economics or human psychology or physics or biology.  I suspect that most investment professionals are no different than the Army Generals I worked with.  For investment knowledge we need to read about markets and business!  This is not meant to criticize anybody in particular as it’s standard professional practice.  Yet this sort of narrow specialization often results in a stove-piped, myopic view of the world that can be woefully inadequate in dealing with complex adaptive systems and asymmetric, dynamic problems.  Generally speaking, many go through their analytical life as a one-legged-man in an ass kicking contest as my main man Munger might say.  The market just fell 20%.  Time to buy!

Not so fast.  If one thinks this virus through we already see significant second and third order effects.  Certainly the realm of biology is a lot more significant today than it was in 2009.  Who would have ever thought that biology of all things would have such a significant impact on finance?  I bet they didn’t teach that in MBA programs - not a single MBA program in the country?  Yet here we are.  We now daily search for data and flattening curves related to pathological outcomes.  That MUST be the key!  Yet let’s even forget the pathological impacts for a second and yes I’m cognizant of Bill Gates’ you can’t just “ignore that pile of bodies in the corner” comment.  

Take, for example, the discipline of human psychology and we are just getting started.  We have shut down major swaths of the American economy and human beings are responding and will continue to respond in the future.  Those combined responses, in aggregate, are going to impact each business and some of those businesses may be profoundly impacted - positively or negatively.  As those mass psychological impacts unfold in the months or years ahead it may quite likely change our investment ecosystem.  I happen to think that one big difference between this event and the 2008/2009 Great Recession is the introduction of deep FEAR.  Not just fear of losing money as was the environment deep in 2009, but now fear at the personal level which is an incredibly powerful emotion that can have profound impact on human behavior.  All of these impacts on human psychology brings a lot more uncertainty than what we just had a short while ago.  When will consumers feel safe?  We need a vaccine!  Uh, what if it mutates?  “The world changed.”  

Might these aggregate psychological factors impact say Micro-Economics?  Now we’re in another discipline!  Just maybe I might want to do far fewer shopping trips to multiple stores with different risk profiles in each and instead do bulk purchases that will last me for months in one well run store that knows how to handle shoppers and staff.  Maybe my personal demand for germ killing cleaning agents is permanently increased.  Maybe when I dine out at a fine restaurant I see risks all around me - a permanent feature that causes me to do this pleasant activity far less often.  Maybe I can run virtual meetings at 90% efficiency of face-to-face while substantially cutting overhead costs. Maybe I can have workers work from home and substantially reduce my commercial real estate costs. On and on. 

We haven’t even gotten into the impacts of physics (critical mass and equilibrium) and history or considerations of autocatalysis to borrow a theme from Chemistry.  What about math?  Damn!  Almost forgot but thank goodness I have my Munger checklist!  What are my probabilities of contracting the virus each time I walk into a public place?  Hmmmmmmm.... Add it to the list in our rapidly changing economic goo.  Whether they know it or not, each person is doing some similar thought process in their attempt to put order in their new environment.  Except maybe when they reach into their mental tool box the math or the biology or the economics just aren’t there. The response in this new realm may not be so predictable just yet. That leads to erratic, unpredictable outcomes does it not?  In a linear world, things seem simple.  The market dropped, it’s cheaper, I buy, and it goes back up thus rewarding me.  I’m so smart!  Except this is not linear.  At least I don’t think so.  It feels a lot more like 4D chess that brings in many of the multi-disciplinary factors above.  

HOW DO WE PREPARE FOR A DEEP GAME OF 4D CHESS WITH EXTREME POSSIBLE OUTCOMES?

Buffett spent quite a bit of time going over the history of the stock market during the Great Depression.  He showed, quite clearly, how the market tanked in 1929 then rebounded in 1930 and the participants didn’t even know they were in a Great Depression.  Then within two years they were essentially wiped out.  There’s a nice, uplifting history lesson for ya!  He didn’t tell us that story for nothing.  He was telling us what COULD happen and I know it sure made me feel a bit like the dumb sap in 1930 who thought it was smooth sailing ahead...  it’s all baked in right? We take a big hit 2nd quarter (which we have). It gets worse third quarter. Then starts to recover 4th quarter and we’re on our merry way to prosperity! All so simple even a monkey can see it!

Buffett bought Delta one month and turned on a dime weeks later and sold all four airline stocks.  THAT is radical.  It’s not like we didn’t all know about the virus when he bought more Delta!  Yet, obviously an extreme macro environment will affect those businesses as millions of people consider their individual responses going forward.  Snap the fingers right this second and tell everybody to get back to “normal” life. You’d have to be a fool to think they would.  The fundamentals of that business in particular just radically changed due to micro factors caused by a macro event.  The entire sector is now in a Depression.  Are they solvent? Buffett’s response?  Get OUT! Obviously airlines are on the extreme end but hardly alone when it comes to extreme outcomes - what we don’t yet know is where the line between temporary and permanent outcomes diverges.

Lesson:  Effects of the response to the virus may lead to extreme, unforeseen outcomes both at the macro and micro level. We have a lot of new variables that may have severe depressive effects on economic activity. Choose your investments wisely.

Munger once mentioned canoeists in Scandinavia who were attracted to an uber large whirlpool - trying to navigate it in a thrill-seeking dare.  The death rate of those risk taking canoeists was 100%.  Munger - “I regard that as a normal result.” and,  “My attitude when I see something big and dangerous is to stay a long way away from it.  Other people want to come as close as possible without going in.  That’s too tricky for me, I don’t like it.”  Munger said those quotes before the COVID crisis in talking about massive government spending and unforeseen consequences.  

Lesson:  Although micro-economic factors are paramount we must be wary of macro economic repercussions that government responses may cause. Hyperinflation would be a terrible outcome and if we take government responses to excess and we just might get it.  We are not immune. Choose your investments wisely.

CAUGHT BETWEEN EXTREMES

What are the “whirlpools” today?  Between the government response to shut down vast swaths of economic activity and  millions of consumers maybe permanently changing their patterns, the oil shock and huge demographic forces in Europe and Asia there are obvious and massive deflationary forces.  The supply/demand balance of oil and transport and labor and airplanes to name several is significantly out of equilibrium with way too much supply chasing way too little demand.  Prices for each are gonna drop.  Negative interest rates across the world attest to this.  In a depressed environment what’s the most valuable asset??  Say hello to $140 billion.  Do I think that’s a deliberate position based on a macroeconomic call?  No of course not, it’s probably best viewed as a by-product of circumstance.  And on the flip side the main reason why that cash hasn’t been deployed is extreme intervention by world Central Banks who are now even buying junk assets with the US Federal Reserve now throwing around trillions of dollars as if it’s nothing.  That all inflates asset values.  You can say all of that is helpful and necessary but it also most certainly adds another extreme outcome.  And now that everybody has seen us grab trillions from out of thin air can anyone imagine future policymakers acting with spending restraint?  Munger - “We are using methods today that are so extreme that maybe we can’t use a lot more of them.”  That’s not to say that they won’t try.  

As a brief history lesson.  Munger often refers to Weimar Germany.  History rhymes no?  During WWI Weimar Germany was in a depressive spiral as prices kept dropping due to impacts of WWI.  Born savers, German citizens hoarded PapierMarks and hunkered down.  In response, the Republic quadrupled the amount of PapierMarks in circulation to stave off depression.  And they printed Marks to finance the war.  Yet despite the massive printing, Weimar Germany had no inflation.  None.  Germany got away with printing Marks to pay for the war.  It’s a miracle!  Sort of sounds familiar doesn’t it?

Yet, under the surface, at the micro level individual German citizens were saving every Mark they could.  It’s quite natural for individual human beings to behave that way when scared.  How many people here who just got stimulus checks rushed out to spend them?  Yet by War’s end, consumer confidence returned and suddenly German citizenry started to spend all of those accumulated Marks and consumer prices quickly rose to match the previous monetary increase.  In essence, consumer behavior literally FLIPPED ON A DIME once the war was over.  In gold terms, 1oz went from about 100 Marks at the end of the War to 2,000 Marks by 1920.  Retail prices soon followed gold and rose 10x to 20x.  All that saved cash?  In 1919 it only bought 10% of what it would have one year earlier.  Pretty sudden and extreme and certainly hard to control in such a short timeframe.  Then in 1921 inflation leveled off, the economy began to recover, citizens adapted and Germany seemed to be in recovery.  

But large government expenses loomed just over the horizon.  Enter War reparations.  The reparations mandated by the Treaty of Versailles amounted to about 83% of German GDP. By way of contrast, at the end of 2019, before all of this recent largesse occurred, US debt was about 107% of GDP. Which gets to Buffett’s point that unfortunately for Weimar Germany their debts were not in the home country fiat currency.  Not wanting to tax their citizenry and go for austerity, the printing presses went full steam ahead and by July 1922 consumer prices in Germany rose another 700%.  Imagine being on a fixed income.  Having watched their currency depreciate by 90% in 1919, this time German citizens were determined not to let the same thing happen to their savings and a nation of savers started spending as fast as they could.  The ensuing hyperinflation ruin was soon in the history books and Weimar collapsed.  We here in the US can get away with a lot more due to debt being in our own currency but to Munger’s point, it’s best to stay far clear of a whirlpool and we seem to be taking our dare.

Weimar is Exhibit A of micro human psychology manifested on a national scale.  Rome fell in similar fashion.  And as we see in the Weimar example, the central authorities aren’t necessarily as in charge of outcomes as they may assume.  It ultimately comes down to millions of individuals and you can give them all the stimulus money you want, and all the free stuff you want, but if fear predominates then the money just won’t be spent.  And what’s the response to that?  Maybe give them MORE?  Pushing on a string?  Meanwhile, pension funds, municipalities and states may literally go bankrupt en masse as markets fall and consumers either can’t or won’t spend.  How do you compensate for that?  Raise taxes?  History is pretty clear on what happens next.  And history shows that you can go from one extreme to the next - literally in the blink of an eye once the dry kindling is thrown all over a society.  Munger has REPEATEDLY said the word “extreme” and people are surprised?  You can count me as one, it took this meeting before I realized the gravity of our situation and one outcome of our list of hypothetical end games. And Weimar is of course only ONE of many possible outcomes. But make no mistake, EXTREME is definitely on the table.

So put all of that together and we are standing at home plate in Nationals Park.   If you hit the ball to Left it’s a Depression.  Hit it to Right and it massive inflation.  Hit it to center and maybe it’s Stagflation.  The days of benign and “normal” may well be past for quite some time. What are you gonna do?  Even if you focus on the micro as you want to do you have to be very very careful that what you pick can do well in all of the above.  That might argue for high return on net tangible asset businesses which we love.  Does anybody see a cheap one of sufficient size?  I Know! Berkshire could buy all of capital intensive Boeing! 🤔🤔

With such extremes on either end of the spectrum and so many unknowns it strikes me as a time for extreme caution which is exactly what we see in Omaha.  Recall that Munger in particular grew up in the Great Depression.  For those of us with parents who grew up during that time we well know how deeply traumatic it must have been.  My mother saved EVERYTHING of any potential use to include envelopes which could be sliced open, folded over, taped and reused.  “Anything can happen in markets” and economies.  Munger’s approach to this I see as three fold...  So let’s INVERT using some of his previous commentary.

1.  Avoid activity and maintain your ability to adapt
2.  Reduce your wants
3.  Suck it up and cope

All three work equally well on either end of the extreme economic spectrum. It screams at me that if you’re an individual investor you should probably view all of this holistically.  I get that professional money managers can’t tell their clients to “suck it up and cope” though that sentence might do a lot more good than moving clients around in stocks or asset allocation changes between stocks and bonds.  If you told a client to “reduce your wants” they’d fire you on the spot for cause.  Yet I can think of no more powerful response at the individual or corporate level than living well within your means, reduction in consumption and downsizing of wants while maintaining agility. The root problem of both deflation and rapid inflation is that you don’t have enough money.  I guess Berkshire doesn’t have that problem at least not at the moment anyway.... and that cash gives Berkshire enormous optionality whether as cash ballast in one scenario or as a means to help adapt itself in another. Sun Tzu talks a lot about strategic patience as we wait for opportune times to unleash accumulated strength. Is NOW that time? Certainly not at the micro-economic level. Certainly not at the macro-economic level. As a strategist I say NO. So suck it up and cope.

HB
Print the post  

Announcements

What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.