Warren Buffett talks about Great Depression - Nobody knows what the market is going to do tomorrow

 Another great article from Rolf Suey

The ever positive and optimistic Warren Buffett investment guru sounds cautious during  Berkshire Hathaway (BH) Annual shareholder meeting recently.

NOBODY KNOWS WHAT THE MARKET IS GOING TO DO TOMORROW.

QUOTED WB

“I don’t know, and perhaps with a bias, I don’t believe anybody knows what the market is going to do tomorrow, next week, next month, next year. I know America is going to move forward over time, but I don’t know for sure, and we learned this on September 10th, 2001, and we learned it a few months ago in terms of the virus. Anything can happen in terms of markets, and you can bet on America, but you got to have to be careful about how you bet, simply because markets can do anything.”

UNQUOTE

Comments Rolf:

I agree entirely that nobody knows what the market is going to do tomorrow or next year or the year after next. If you are having the mindset that wow… stock market is cheap and I am going to throw everything in, think again! Or if you think stock market is expensive now because it has risen 20% since late March low and you miss the boat, and are waiting for stock to retest March low, before you throw every cash you have in, also please think again. If you are trading, and in the last few months whether long or short and you managed to win $ and think highly about yourself, that you are going to win loads and loads of $ during this downturn, think again too! Your pride can just be your biggest misery, because nobody knows what the market is going to do going forward.

WB RECOUNTING GREAT DEPRESSION

It is almost first time I recall (correct me if I am wrong) that WB talks a great length about Great Depression during his annual meeting. An event that he himself having almost 80 years of investing experience did not experience the greatest collapse of the stock market in the last centure. Perhaps that is why he rarely talks about the Great Depression because WB loves to relate his experiences when he is giving a speech or answering during interviews. But this time, he sounds different and cautious!

To recap,

WB highlighted on September 3rd, 1929, the Dow average closed at 381.17, and people were very happy and buying stocks on margin that worked wonderfully. His dad, who was 26 years of age back then, was an employee in the bank who sold stocks to people.

Few months later 13 Nov 1929, Dow drop 48% to 198.69. His dad was too ashamed to face those people he sold stocks to, and stay at home and 9 months later WB was born.

The last trading day before WB was born on 30 Aug 1930, Dow was up 20% to 240.42 from 1929 low.

QUOTE WB:

People did not think in the fall of 1930, they did not think they were in a great depression, they thought it was a recession very much like had occurred at least a dozen times, although not always when stock markets were important, but we’d have many recessions in the United States over that time, and this did not look like it was something dramatically out of the ordinary. For a while, actually for about 10 days after my birth, that’d be …and the stock market actually managed to go up all of 1-2% there in those 10 days, but that’s the last day. UNQUOTE.

Almost 2 years later 7 Aug 1932, Dow was at low point of 41.22.

QUOTE WB:

if somebody had given me $1,000 on the day I was born, and I’d bought stocks with it, and bought the Dow Average, my $1,000 would have become $170 in less than two years, and that is something that none of us here have ever experienced that we may have had it with one stock occasionally, but in terms of having a broad range of America mark down 83% in two years, and mark down 89% of the peak, that was in September 3rd, 1929, was extraordinary.

UNQUOTE

1 Apr 1951 Dow 240.85, after more than 20 years, a buyer on WB’s day of birth finally gets even (though dividends had been received).

Comments Rolf:

Rolf: If you buy a stock in 1930 believing the crash in late 1929 is the worst and has bottom, it will take you 20 years in 1951 for your stock to recover to breakeven price. Likewise if you are buying a stock in late March 2020 and think that in the next 2-3, or even 3-5 years the recession will be over and you will earn a lot of money, think again. There can be a chance that you may end up in the mindset or situation with those who invested in 1930 and have to wait for over 20 years to breakeven your stock price.

I never say for sure it will happen, but what I am saying is there is a chance it can happened because nobody knows. Of course, I also think there is an equal chance the market will recover and hit high again.

Therefore when it comes to investment, when it is uncertain, you have to weigh RISK and REWARD carefully and cannot just bet for sure that market will improve within next few years. And if you do not throw all your eggs into the market and only thinking about recovery, then you are betting and not investing. Better to be safe than sorry! It is better to win less money with backup for worst of the worst, than having to wait for 20 years like what happened during 1930-1950s.

CONCLUSION

If you think that you know what is going to happen in the market next month, or next year, or next few years, YOU DON’T!

If you think that you are very smart because you utilize significantly large percentage of net cash buying into the market at its lows in March, YOU ARE NOT!

If you think that you are smarter than the rest because currently you are making money now in the market, YOU ARE NOT!

You are just fooled by randomness, and using betting mentality rather than weighing risk and rewards.

Always be humble and have the prepare for the worst mindset, while staying cautiously optimistic about the future.

Always seek the truth and be realistic and use data, risk and reward metrics to justify your actions.

Last but not least, do not overspend time looking at the market or news, as life encompass more things other than your desire to make money from the market.

Aside from work (if you still have it now),

Spend time enjoying with your family.

Spend time calling your good friends.

Spend time doing some exercise.

Spend time in your hobbies.

Spend time helping others if you are called to.

And of course spend time to relax enjoying nature.... 

The Great Depression (Part 1) – Contraction of Money Supply & Tax Increase Explained

 Great article from this blogger, Rolf Suey

When I was in secondary school, the Great Depression (GD) use to be a major topic together with World War 1 and 2 in our history lessons. Many years ago, I also watched several documentaries on GD and Great Financial Crisis which kickstart my interest in financial blogging and research.

For those who are unaware, the GD was the worst economic downturn in the history of the industrialized world, lasting from 1929 to 1939. It began after the stock market crash of October 1929, which sent Wall Street into a panic and wiped out millions of investors.

If you “wiki or google” Great Depression” and try to find the cause of it, you will find two main causes take precedence. Monetary and Keynesian reasonings. In this article, I will focus on what is the Monetary and Keynesian theories, and why did the US government back then push policies that contracted the money supply, or even raise interest rate during the worst crisis.

MONETARY THEORY

Monetarists believe that the GD started as an ordinary recession, but the contraction of the money supply by Federal Reserve greatly exacerbated the economic situation, causing a recession to descend into the GD. There is a general consensus that the Federal Reserve back then should inject money (e.g. literal printing like what is happening now) to save the economy and not just allow liquidations of companies, which monetarists believe is the main cause of GD. In a speech honouring monetarists Milton Friedman and Anna Schwartz, Ben Bernanke (former Fed Chair 2006-14 ) stated:

"Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression, you're right. We did it. We're very sorry. But thanks to you, we won't do it again." — Ben S. Bernanke

KEYNESIAN THEORY

Another school of thought is from British economist John Maynard Keynes. Those who studied economy in JC or University like myself, will know Keynesian theory is the basis of our modern economic studies. Keynesians explained that if there is a fall in consumer spending due to recession, savings will increase. This cause interest rate to decline, which will then lead to increase borrowings and spending. But investments will not necessary increase due to drop in interest rate. This is because business make investments based on expectation of future profits. Therefore, if the consumption crunch is anticipated to be long-term, business investments which requires a great degree of optimism will fall, leading to rising unemployment and worsening of the economy. Henceforth, Keynes argued that the GD is caused by the lack of government spending to increase employment and to help the economy recover the money that normally will have spent by consumers and business firms.  

PRESIDENT HOOVER'S DEFLATIONARY POLICY 

Republican Herbert Clark Hoover became US President in Mar 1929. Shortly after he took office, the stock market crash. The next four year of his presidency spells the worst nightmare for the nation. In dealing with the crisis, Hoover administration underestimate the gravity of the crisis, and opted for non-intervention policy. They contracted money supply and allowed companies to go bankrupt, and even raise tax to reduce budget deficit, which led the worst crisis in the history of US. Monetarists and Keynesians put almost all blame of the GD on the incompetence of Hoover administration.

So why did Hoover implemented deflationary policy? Is he really that stupid with so many so-called experts in his administration.

Hoover administration believed that companies who is badly run with high debts should be allowed to go bankrupt.  The free market economy will then self-adjust to absorb the bankruptcy. Injecting excessive liquidity from taxpayers’ monies by the Federal Reserve will only postpone the bad debts and magnify the social costs in the long term.

The argument was not without basis! When dealing with the economic crisis of 1920-21, US implemented deflationary policies and allowed liquidation of companies, which subsequently created the economic growth later in the decade. Nevertheless, the magnitude of the 1929-1930s crisis is too big. Not only that deflationary policy did not work, it worsened the crisis.

Why not print money? – The Gold standard

US had almost always adhere to the gold standard until 1971 when President Nixon introduced fiat currency. For non-fiat, currency has to be backed by gold. For e.g. in 1905, US$20 bill is called demand note, backed by 1 oz of gold. This mean the US$20 bill is a note that can demand for 1 oz of gold or equivalent silver. The Federal Reserve Act in 1913 requires the central bank to have gold backing 40% of its demand notes. The adherence to the gold standard prevented the Federal Reserve from expanding the money supply (i.e. money creation) to stimulate the economy, or to fund insolvent banks and fund government deficits that could possibly pump up an expansion, although long term structural problems will worsen.   

Real interest rate increase

From 1929 to 1933, unemployment was as high as 20-25% in 1932-33 and inflation was more than negative 10% in 1931-32. While the nominal interest rate decrease, the real interest rate actually increases due to the negative inflation. This is because bad debts and bank runs driving huge number of banks into insolvency. And banks that survive makes business borrowing criteria more stringent as repayment ability drop. Hence while nominal interest rate decrease, borrowing levels drop.

Why increase Interest rate?

In the midst of the crisis, the US dollars loss its value as no international investors will want to invest into America. Hence demand for dollars plummeted. In the early 1930s, in order to attract foreign investors, Federal Reserve defended the dollar by contracting the Money Supply and raising interest rates, aiming to increase the demand for US dollars. Target is to have net inflow of investments or money (gold and silver) into USA to improve the budget deficit.

WHY MONEY SUPPLY FURTHER SHRUNK

Bank Runs

When the crisis worsened, bad debts resulted in bank collapse. Years of savings were just wiped out like that. The fear of more banks’ collapses led to bank runs. A bank run occurs when large number of depositors lost confidence in the security of the bank, and started to withdraw their funds all at once. Banks typically hold only a fraction of cash reserve, lending out the rest to borrowers or purchase interest-bearing assets like bonds. During a bank run, a bank must quickly liquidate loans and sell its assets often cheaply to meet cash withdrawals. In extreme cases like in 1930s, bank’s reserves are insufficient to cover the withdrawals leading to insolvency. When deposits in banks plummeted, money supply contracted.

Hoarding Precious metals leading to Gold Reserve Act

Since the dollar bill is a demand note for gold or silver, and seeing banks collapsing, people fear that their demand notes can no longer exchange for gold and silver which they deem as a better store of value rather than the dollar bill. People began to hoard precious metals. At the same time, there is farm crisis due to drought, and people also rush to stockpile food supplies. Money supply further contracted.  

On 30 Jan 1934, US congress passed the Gold Reserve Act changing the value of the dollar from $20 to the troy ounce of gold to $35 to the troy ounce, a devaluation of over 40%. This is money creation, not much different to the modern Quantitative Easing (QE) to print money digitally.

CONCLUSION

After reading the above article, most people will take at face value that either Monetary or Keynesian theories or poor decision by President Hoover MUST be the direct root cause of GD.  

IT IS NOT TRUE. I believe that the non-implementation of monetary or Keynesian policies are just indirect consequential reasons for the GD. There are not the root causes of the depressions.

In my opinion, the root cause is really the sinful nature of human of greed and the love of self and pleasure.  It is the over-confidence, over-optimism, over-spending, irrational stock market exuberance during the “roaring twenties” period, that cause the onset of the crash.

Stay tune to Part 2.

5 things you need to know about SRS when you are 40 and older

 During the end of the year, the topic of Supplementary Retirement Scheme (SRS) and Central Provident Fund (CPF) contributions will become frequently searched topics for wealth management. This is because for every additional dollar contributed, we might pay lesser in taxes. If you are 40 and older, this article is for you. We are going to talk about taxes, retirement and worse case situations.