Inflation Investing

Geopolitics, Domestic Affairs and Investing in a Time of Uncertainty

Introduction: A Break from Tradition

This letter has an established tradition of bringing a highly specific and pointed approach to our commentaries. Always trying to be honest, these communications stick as closely as possible to the facts. While unusual for our team, we ask that you indulge us one page to discuss, in brief and general terms, some geopolitical and domestic affairs that attempt to summarize a challenging period in history. After which, of course, we will move to investing – the topic which has consumed the vast majority of our energies.

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Geopolitics:

While it is my overwhelming belief that one should be bullish on America there simply is no denying that we inevitably suffer moments of imperfection.[i] Global tensions and the rising risks from nuclear brinkmanship are, obviously, dire.² Having recently reviewed a manifesto authored by legendary thinker Bertrand Russel and Albert Einstein, a small plaque with the words “Remember your humanity, and forget the rest” now adorns my desk as a reminder of what really matters.[ii] I am neither pacifist nor isolationist.³ When it comes to activities that put our young men in harms’ way we should not be afraid to demand honesty from our elected officials.[iii]

Domestic Affairs:

The recent death of a brilliant advocate for nonviolent civil rights, a man whose oratory skills moved me to my core,[iv] has left our nation in a troubled state of racial conflict.[v] Subsequent to his death, a recent event integral to our democratic process devolved into a violent confrontation between police and protestors.[vi] Our nation’s social fabric is tearing with both sides fiercely attached to angry views. Hearing first-hand accounts about the brutal behavior that occurs when a crowd of otherwise regular people are whipped into a mob has left me convinced that even in America, the seemingly unfortunate and impossible is possible.[vii] Martin Luther King once said “The laws are not to change the heart, but to restrain the heartless.” The message is not just germane to maintaining social order but also essential to any credible effort to fulfill the basic premise of our founders that all men are created equal.[viii]

Investing:

Examining the state of geopolitical and domestic affairs seems like a compelling basis to suggest that history does indeed rhyme.[ix] Hopefully the prior two paragraphs have not dissuaded you from the ensuing discussion of what is my primary sphere of competence – investing in America.[x] Unfortunately, there is little in the way of good news to report here. Inflation, a word from the past, is suddenly on everyone’s lips again.[xi]^,[xii] This is troubling enough, but the rise of a new breed of investors lacking the painful memories of crashes and crises have sent stock valuations soaring to never-before seen levels.[xiii] Groups of stock traders engage in what is little more than poorly organized pyramid schemes.[xiv] Transaction volumes from such activity have reached such a level that stock trading nearly failed in some well publicized instances.[xv] Rumors of criminal activity in market operations has become the norm.[xvi]

With this backdrop it is not surprising that finding cheap stocks of high quality is unusually difficult.[xvii] Markets have become grossly overvalued.[xviii] Paradoxically, the government’s pursuit of many social programs that may be necessary for the greater good of society, has likely created the potent mix of loose money and optimism.[xix] This combustible mix is driving markets to behave in a manner that leaves me feeling completely out of sync.[xx] Today is as dangerous a time for investing as any in my career and I will not partake in the get-rich quick methods so prevalent and popular today.[xxi]

Hopefully, everyone understands that this is our attempt to paraphrase some key items from Warren Buffet’s shareholder letters from 1967 – 1969 and his brilliant biography by Alice Schroeder. We hope this reminds our readers of Mr. Buffett’s thinking about the world in the late 1960s just before he shut his partnership, inflation broke out and stocks tumbled. Understanding the past will be critical as markets may force us all to become bear traders should history rhyme and inflation, deflation or an economic shock occur.

As always, we will provide any paid up subscriber with a complimentary copy of “The Snowball” by Alice Schroeder. Please find below the substantive annotations for every sentence above.

The below is based on some of our views derived from Warren Buffett’s biography “The Snowball.” Written by Alice Schroeder, who spent 1,000s of hours with him, we believe the book an instrumental look into the mind of one of America’s most accomplished investors.

We wrote the above in such a way that we hope readers can see the world today has many eerie similarities with the years leading to the close of the 1960s. This is important in light of the extensive research we published on the Great Inflation that began in 1969 and the impact on equity investing during an inflation. We recognize this exercise is, by its nature, prone to error.

The goal is to create some historical resonance between the state of the US today and the years ending in 1969. We enjoy reading books and recognize those better versed in history may highlight variances between the two periods. We also may be guilty of oversimplification and narrative error but believe that, generally speaking, there is plenty of “rhyme” between then and now. We would be remiss if we did not reiterate our enormous faith in America’s institutions and future prospects.

Simple summary comparisons between today and 1969:

1. 1. Today: There has been soaring nuclear brinkmanship with North Korea

1969: There was soaring nuclear brinkmanship with Russia post the Cuban missile crisis

1. 2. Today: There has been an uproar over the use of false information to influence the American population in response to a national crisis (Covid) which launched a culture war between believers and disbelievers in the causes and solutions to the crisis with Communist China held up as a source of the problem

1969: There was an uproar over the use of false information that kept America in a conflict with Vietnam, killing 57,000 Americans and launched a culture war between believers in the war and disbelievers in the reasons and solutions to the conflict in which Communist China was held up as a source of the problem

1. 3. Today: There has been a violent clash at the capitol between police and protestors with talk of a possible descent into fascism

1969: There was a violent clash after Alabama Governor George Wallace, a pro segregation candidate arrived in Oklahoma City to promote his platform of racial division with mob violence breaking out and the nation talking about the possible descent into fascism

1. 4. Today: There has been a marked increase in racial tension and polarization that escalated dramatically after the death of John Lewis/the murder of unarmed black men resulting in rioting

1969: There was an explosion in racial tension and polarization that escalated dramatically after Martin Luther King and a number of unarmed black men were killed resulting in rioting

1. 5. Today: The government has pursued and continues to pursue unprecedented and ever larger programs of social spending that specifically, even at the Fed level now, is tasked with mitigating racial income inequality and heal a nation badly divided. This cost continues to spiral higher and has been cited as causing a speculative and overpriced stock market. Suddenly everyone is talking about inflation for the first time in 20 years which may or may not lead to an inflation.

1969: The government pursued a series of aggressive and, at the time, unprecedented series of social spending programs in an effort to mitigate racial income inequality and heal a nation badly divided across party lines due to Vietnam – a cost which spiraled ever higher – where the consequences of that spending were first a speculative and overpriced stock market that later caused everyone to start talking about inflation for the first time in 20 years which led to a terrible outbreak of inflation

1. 6. Today: There is a fury about the outages and margin calls at Robinhood and other retail trading apps with rumors of “pay for order flow” making these organizations beholden to a “Hedge Fund mafia”

1969: As exchanges struggled to computerize there were outages caused by soaring retail order flow leading to rumors of actual theft and corruption by the mafia

1. 7. Today: Buffett is sitting on $140 billion in cash as the market sits at valuations that are well above those seen in 1929

1969: Buffett found himself priced out of a market that had become as expensive as any time since 1929

We recognize very few people actually read endnotes. However, in this instance, we encourage our readers to do exactly that! It is our belief that the text below is a terrific “quick look” into the mind of Warren Buffett during a period strikingly similar to today. Even our piece “What Is Volume In Stocks?” explaining frenetic trading today offers unsettling resonance with the speculative stock investing and trading Buffett observed immediately prior to the explosion in inflation and collapse in equity valuations.

[i] This is a recurring theme in many of Warren Buffett’s communications. Some examples from 2021, 2020 and 2009 found here… https://www.cnbc.com/2021/02/27/warren-buffett-says-never-bet-against-america-in-letter-trumpeting-berkshires-us-based-assets.html, https://markets.businessinsider.com/news/stocks/warren-buffett-joe-biden-share-views-america-taxes-earnings-guidance-2020-10-1029693830, https://newsroom.businesswire.com/press-releases/press-release/2009/Warren-Buffett-is-Bullish-on-Americas-Future-but-Says-That-a-Full-Economic-Recovery-Will-Take-a-While/default.aspx

[ii] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Warren was far from indifferent to social and political causes, however. He had become deeply concerned about the potential for nuclear war—a vivid and seemingly impending threat in the early 1960s, since President Kennedy had urged families to build fallout shelters in order to survive a nuclear attack and the United States had barely averted a nuclear war after a standoff between Kennedy and Khrushchev over the removal of Soviet missiles from Cuba. When Buffett discovered philosopher Bertrand Russell’s 1962 antinuclear treatise, Has Man a Future? it affected him powerfully. He identified with Russell, admired his philosophical rigor, and frequently cited his opinions and aphorisms. He even kept a small plaque on his desk quoting a phrase from an influential antinuclear “manifesto” on which Russell had collaborated with Albert Einstein: “Remember your humanity, and forget the rest.” – Pg 171

[iii] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Warren was not an ideological pacifist like many of those who were marching, nor an extreme isolationist like his father, but he did feel strongly that the war was wrong, and that U.S. involvement in it was based on deception—especially troubling for a man who placed such a high value on honesty. – Pg 171

[iv] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Finally King strode to the podium, dressed in his preacher’s robes. He had chosen the theme of “Remaining Awake During a Revolution,” and his resonant voice rang out with a quote from poet James Russell Lowell’s “The Present Crisis,” the anthem of the civil-rights movement. Truth forever on the scaffold, Wrong forever on the throne: Yet that scaffold sways the future, And behind the dim unknown, Standeth God within the shadow Keeping watch above His own. He spoke of the meaning of suffering. Inspired to nonviolent resistance by Gandhi, King invoked the lessons of the Sermon on the Mount. Blessed are the persecuted, it said, for theirs is the kingdom of heaven. Blessed are the meek, for they shall inherit the earth. As touched as she was by Dr. King’s powerful words, Susie must also have been deeply moved by the way he transfixed her husband. Buffett had always responded to powerful, charismatic orators. Now he saw King standing before him: moral courage in the flesh, a man who had been beaten and imprisoned, put in shackles and sentenced to hard labor, stabbed and clubbed for his beliefs, a man who had carried a movement on the strength of his ideas for nearly a decade despite enraged opposition, violence, and limited success. King had once described the power of nonviolence, which “has a way of disarming the opponent. It exposes his moral defenses. It weakens his morale and at the same time it works on his conscience…. Even if he tries to kill you, you develop the inner conviction that some things are so precious, that there are some things so dear, some things so eternally worthful, that they are worth dying for. If an individual has not discovered something that he will die for, he isn’t fit to live. When one discovers this, there is power in this method.” King was a prophet, a man who saw a vision of glory, of evil exposed through visible suffering, of people roused from sleep by the sight of horrors. He called his followers to nail themselves to his vision, to lift it up behind them and drag it through the streets. Christianity, he said, has always insisted that the cross we bear precedes the crown we wear. One of his lines, which he repeated in many of his speeches, struck Buffett’s heart and pierced his reason. “The laws are not to change the heart,” he said, “but to restrain the heartless.” “With that great voice of his, he just rumbled that out, and then went on and used that as a theme.” – Pg 184

[v] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; King’s warning earlier that year about mass social unrest potentially leading to fascism required no explanation to Warren Buffett. His own commitment to siding with the underdog went beyond instinct and rested partly on this train of logic. Many people thought such a thing was inconceivable in the United States, but the seemingly impossible happened time and again. The law is not to change the heart, King said, but to restrain the heartless. And who are they, the heartless? That he did not say. A few weeks later, King flew to Memphis to speak at the Masonic temple. He reflected on a woman who had stabbed him in New York City and the persistent rumors that an assassin was waiting for him. “I don’t know what will happen now,” he told the audience. “We’ve got some difficult days ahead. But it really doesn’t matter with me now, because I’ve been to the mountaintop.” The next day, April 4, as he stood on the balcony of the Lorraine Motel preparing to lead a march of sanitation workers, he was fatally shot in the neck. Grief, rage, and frustration poured out of black communities across America, turning urban centers into fiery combat zones. – Pg 186-187

[vi] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Then, in March 1968, the most controversial man in America, former Alabama Governor George Wallace, arrived at the Omaha City Auditorium to campaign for President. More than five thousand people crammed into a room designed to seat 1,400 to see the man who had run for governor seven years before on the platform “Segregation now, segregation tomorrow, segregation forever. It took less than eight minutes for his supporters to collect the signatures to place him on the Nebraska ballot. The odor of stink bombs filled the air. When Wallace began to speak, demonstrators pelted the platform with sticks, bits of placards, paper drinking cups, and stones. Chairs flew, nightsticks cracked, blood splattered, and the police sprayed the crowd with Mace. As the melee spilled out along 16th Street, rioters pulled drivers out of cars and beat them. People started throwing Molotov cocktails, flames raced through the neighborhood, sidewalks filled with broken glass, and looters pawed through the stores. Hours later the violence passed, and calm finally began to descend. Then an off-duty policeman shot and killed a sixteen-year-old black boy inside a pawnshop, mistaking him for a looter. – Pg 186

[vii] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Howard Buffett had recounted over and over to his children a scene he had witnessed when he was sixteen years old—a day when thousands of people converged on the Douglas County Courthouse, broke in and attempted to lynch the mayor of Omaha, and beat, castrated, and lynched an elderly black man who had been accused of rape. Afterward they dragged his body through the streets, shot bullets into it, lynched it again, and set it afire. The Courthouse Riot became the most shameful episode in Omaha’s history. Howard missed seeing much of the violence, but witnessed the lynch mob turning a streetlamp into an improvised scaffold, and the mayor of Omaha hanging by a noose around his neck before being rescued in the nick of time. The memory haunted him for the rest of his life. He had seen with his own eyes the speed with which ordinary people, formed into a mob, could act out the lowest depths of human nature. – Pg 186

[viii] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; King’s warning earlier that year about mass social unrest potentially leading to fascism required no explanation to Warren Buffett. His own commitment to siding with the underdog went beyond instinct and rested partly on this train of logic. Many people thought such a thing was inconceivable in the United States, but the seemingly impossible happened time and again. The law is not to change the heart, King said, but to restrain the heartless. And who are they, the heartless? That he did not say. A few weeks later, King flew to Memphis to speak at the Masonic temple. He reflected on a woman who had stabbed him in New York City and the persistent rumors that an assassin was waiting for him. “I don’t know what will happen now,” he told the audience. “We’ve got some difficult days ahead. But it really doesn’t matter with me now, because I’ve been to the mountaintop.” The next day, April 4, as he stood on the balcony of the Lorraine Motel preparing to lead a march of sanitation workers, he was fatally shot in the neck. Grief, rage, and frustration poured out of black communities across America, turning urban centers into fiery combat zones. – Pg 186-187

[ix] This is our team’s view based on extensive, independent empirical analysis of historical market behavior as well as peer review research by academics.

[x] This is our team’s view based on reading extensively the writings of Warren Buffett.

[xi] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Inflation on everyone’s lips quotes below. By 1967 Chace and McKenzie had managed to pull the hapless maker of men’s suit linings back to breakeven. But the term “inflation”—moribund since the Second World War—was again on everyone’s lips. The costs of wages and raw materials were rising like silt in a river, and both foreign and southern textile mills with cheaper labor were drying up Berkshire’s sales. – Pg 180

[xii] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; He had an idea that he thought would be helpful to politicians, about what he called the “discomfort index”—the inflation rate plus the unemployment rate—which he passed on to Harold Hughes of Iowa, to whom Rosenfield had introduced him. – Pg 211

[xiii] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; A new breed of men, who had come of age after World War II without the lessons of the Crash and the Great Depression seared into their brains, had risen on the Street. As they pushed stocks to never-before-seen values, Buffett began selling down his American Express position, which by now was worth $15 million more than the $13 million that it had cost, partnership’s gain. But he didn’t want to plow that money back into Berkshire Hathaway. – Pg 180

[xiv] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Hundreds of millions of dollars had been poured into it by people mindlessly coattailing so-called experts, who themselves had no more than a couple of years’ proven ability to make money. More than fifty new investment funds had come to market, with nearly sixty-five more waiting in the wings.3 For the first time in U.S. history, it became fashionable for a broad group of individuals to own stocks.4 Buffett would describe this phase as resembling “an ever-widening circle of chain letters,” even a “mania,” populated mostly by “the hopeful, credulous, and greedy, grasping for an excuse to believe.” – Pg 189

[xv] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; In a business that was still transacted through paper trade tickets and physical delivery of stock certificates, trading volume had reached such a level that the market was nearly crushed under the weight of paperwork. – Pg 189

[xvi] “The Snowball,” Warren Buffett and the Business of Life, by Alice Schroeder; Huge numbers of orders were duplicated or never executed, the tickets misplaced or simply thrown in the garbage, while file rooms worth of stock certificates disappeared, presumed stolen, amid rumors that the Mafia had infiltrated the market. – Pg 189

[xvii] “Partnership Letter,” January 1967, Pgs 4&5, Warren Buffett; At that time, and for some years subsequently, there were substantial numbers of securities selling at well below the ”value lo a private owner” criterion we utilized for selection of general market investments. We also experienced a flow of “workout” opportunities where the percentages were very much to our liking. The problem was always which, not what. Accordingly, we were able to own fifteen to twenty-five issues and be enthusiastic about the probabilities inherent in all holdings. ln the last few years this situation has changed dramatically. We now’ find very few securities that are understandable to me, available in decent size and which offer the expectation of investment performance meeting our yardstick of ten percentage points per annum superior to the Dow. ln the last three years we have come up with only two or three new ideas a year that have had such an expectancy of superior performance. Fortunately, in some cases, we have made the most of them. However, in earlier years, a lesser effort produced literally dozens of comparable opportunities. It is difficult to be objective about the causes for such diminution of one’s own productivity. Three factors that seem apparent are: (1) a somewhat changed market environment; (2) our increased size; and (3) substantially more competition. It is obvious that a business based upon only a trickle of fine ideas has poorer prospects than one based upon a steady flow of such ideas.

[xviii] “Partnership Letter,” May 1969, Pg 4, Warren Buffett; Quite frankly, in spite of any factors set forth on the earlier pages, I would continue to operate the Partnership in 1970, or even 1971, if I had some really first-class ideas. Not because I want to, but simply because I would so much rather end with a good year than a poor one. However, I just don’t see anything available that gives any reasonable hope of delivering such a good year and I have no desire to grope around, hoping to “get lucky” with other people’s money. I am not attuned to this market environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.

[xix] “Partnership Letter,” May 1969, Pg 3, Warren Buffett; I find “selective reporting” even more distasteful. Our poor experience this year is 100% my fault. It did not reflect bad luck, but rather an improper assessment of a very fast-developing governmental trend. Paradoxically, I have long believed the government should have been doing (in terms of the problem attacked – not necessarily the means utilized) what it finally did – in other words, on an overall basis, I believe the general goal of the activity which has cost us substantial money is socially desirable and have so preached for some time.

[xx] “Partnership Letter,” October 1967, Pgs 3&4, Warren Buffett; Any form of hyper-activity with large amounts of money in securities markets can create problems for all participants. I make no attempt to guess the action of the stock market and haven’t the foggiest notion as to whether the Dow will be at 600, 900 or 1200 a year from now. Even if there are serious consequences resulting from present and future speculative activity, experience suggests estimates of timing are meaningless. However, I do believe certain conditions that now exist are likely to make activity in markets more difficult for us for the intermediate future.

The above may simply be “old-fogeyism” (after all, I am 37). When the game is no longer being played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were – not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing large and apparently easy, profits to embrace an approach which I don’t fully understand, have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital.

[xxi] “Partnership Letter,” January 1969, Pgs 3&4, Warren Buffett; The investment management business, which I used to severely chastise in this section for excessive lethargy, has now swung in many quarters to acute hypertension. One investment manager, representing an organization (with an old established name you would recognize) handling mutual funds aggregating well over $1 billion, said upon launching a new advisory service in 1968:

“The complexities of national and international economics make money management a full-time job. A good money manager cannot maintain a study of securities on a week-by week or even a day-by-day basis. Securities must be studied in a minute-by-minute program.”

Wow! This sort of stuff makes me feel guilty when I go out for a Pepsi. When practiced by large and increasing numbers of highly motivated people with huge amounts of money on a limited quantity of suitable securities, the result becomes highly unpredictable. In some ways it is fascinating to watch – and in other ways it is appalling.

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