Buffett and Munger on How We Got to Stock Market Mania

At Berkshire's annual meeting, the legendary investors highlighted the rise of speculation and other factors driving widespread overvaluation

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Margaret Moran
May 03, 2021
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On Saturday, May 1, Berkshire Hathaway (

BRK.A, Financial) (BRK.B, Financial) had its 2021 annual meeting, in which Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) addressed investors around the world regarding the conglomerate's business and investment decisions as well as a variety of other investing-related topics.

This year, the event took place in a hotel conference room in Los Angeles rather than on Buffett's home turf in Omaha, Nebraska. After sitting out the event in 2020 due to the pandemic, Munger returned to the stage this year, and the legendary investors were also joined by Berkshire's Vice Chairmen Gregory Abel and Ajit Jain, providing a telling clue on the conglomerate's potential succession plans.

Berkshire's top executives had a wealth of advice to offer their audiences on everything from first-time investing to the current economic situation. However, despite once again spending a significant chunk of the event praising the historical success of American corporations and capitalism, Buffett also honed in on how the current stock market environment has increasingly become more about gambling than long-term investing.

In an economic situation where decreased supply is meeting increased demand, Federal Reserve policies are also acting as a double-edged sword by feeding widespread mania, not just in stocks but in the broader markets as well. Buffett warned investors that the top stocks of the world are all but certain to be different in a couple of decades than they are today, and that regardless of how stock prices pan out, they are ultimately entirely different things from the companies that they represent.

The picture is always changing

Buffett started out the meeting by showing the 20 current largest companies in the world by market cap, and then the 20 largest from 1989. Among the 20 largest companies from three decades ago, not a single one has remained on that enviable list to this day. Three decades ago, the list was dominated by Japanese companies that were at the height of a stock market mania, with stock prices running rampantly higher than the value of the companies they represented.

The main lesson here is that times of rampant speculation are never a good entry point into stocks. Buffett quoted John Maynard Keynes to drive this point home:

"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."

An increasingly attractive market for speculators

History is full of up-and-coming industries that produced a handful of long-term winners among a sea of wannabe competitors that fell flat before ever really getting off the ground. Buffett identified the rise in special purpose acquisition companies and the increase in popularity of speculative trading made possible through commission-free platforms like Robinhood as hotbeds for speculation.

SPACs had a record-breaking year in 2020 in terms of the number of companies that went public via this method, and the number of SPAC public offerings in the first quarter of 2021 alone surpassed the entirety of 2020. These companies have no operations of their own and instead seek to merge with a private company to take it public. Buffett weighed in on SPACs, saying:

"The SPACs generally have to spend their money in two years, as I understand it. If you have to buy a business in two years, you put a gun to my head and said you've got to buy a business in two years, I'd buy one but it wouldn't be much of one If you're running money from somebody else and you get a fee and you get the upside and you don't have the downside, you're going to buy something."

One of the touted benefits of SPACs is that they take companies public that would have otherwise not been ready for a public offering for years to come. One of the main issues is that, precisely because these companies are mostly newer and untested, there is a much higher chance they will not be one of the long-term winners. Moreover, the SPAC's managers are incentivized to pay whatever it takes to seal some sort of deal, so there is a very high chance of overpaying.

Another driver of increased speculation that Buffett highlighted was trading apps like Robinhood and other commission-free brokers, which make it easier for those who are more interested in gambling than investing to take part in the stock market:

"It's become a very significant part of the casino aspect, the casino group, that has joined into the stock market in the last year, year and a half. There's nothing, you know, there's nothing illegal about it, there's nothing immoral. But I don't think you'd build a society around people doing it.

I think the degree to which a very rich society can reward people who know how to take advantage, essentially, of the gambling instincts of the American public, the worldwide public it's not the most admirable part of the accomplishment."

Imagined value

Rampant speculation happens in the markets when investors (both the long-term kind and the gambling kind) attribute far more value to a stock than what anyone in their right mind would actually pay to buy the company. Buffett and Munger have always done their best to avoid over-paying for businesses, focusing on obtaining good companies at fair prices in order to limit downside risk while still having upside potential.

Thus, it's no secret that the legendary value investors have a lot to lament about the current overvalued market situation. Munger in particular seems to despise the fact that many seemingly worthless companies and other assets have been bid up to exorbitant prices on the basis of hopes and dreams rather than anything concrete.

This viewpoint becomes especially clear when the topic of bitcoin comes up. Cryptocurrency by definition is the exact opposite of the investment style that Berkshire's top brass has always exemplified and, as a result, neither Buffett nor Munger is particularly fond of it. As an asset class, the only value it has lies in what people are willing to pay for it, and that aspect is no different from extremely overpriced speculative stocks.

While Buffett did not offer a direct opinion in response to a question about bitcoin that came up during the event, he has previously likened the cryptocurrency to "rat poison squared." As always, Munger was more direct in his attack, saying that bitcoin was made "out of thin air" and is "contrary to the interest of civilization."

The double-edged sword

In addition to speculation, SPACs and the other factors that typically bear the brunt of the "blame" for the current stock market overvaluation, Buffett also addressed the biggest driving factor of market mania that others are often keen to ignore the Federal Reserve's easy-money policies.

"The economy went off a cliff in March [2020]," Buffett said. "It was resurrected in an extraordinarily effective way by Federal Reserve actions and, later, on the fiscal front, by Congress." He also praised the Fed's backstopping of the corporate debt market, which has allowed for record issuance of corporate debt so that even companies that were already deep in the red could remain in operation. The Oracle of Omaha added that such actions have helped the economic rebound.

The bottom line is that investors love when stock prices go up, for obvious reasons. Even if it means stocks become massively overvalued, no one is going to complain too much about the value of their holdings going up. From this perspective, there's actually a lot to thank both the Fed and the crowds of Robinhood speculators for.

However, the Fed's easy-money policies are a double-edged sword. Now that continued low interest rates are meeting a growing economy and significant backlogged demand, prices are going up for just about everything, not just stocks.

"We're seeing substantial inflation," Buffett said. "We're raising prices, people are raising prices to us. And it's being accepted We really do a lot of housing. The costs are just up, up, up. Steel costs. You know, just every day they're going up It's an economy really, it's red hot. And we weren't expecting it."

"Because with everything boomed out so high and interest rates so low, what's going to happen is, the millennial generation is going to have a hell of a time getting rich compared to our generation," Munger said.

While low interest rates have given equity investors an opportunity to grow their wealth, this has resulted in consolidation of wealth in the hands of those who own assets already, whether it be stocks or companies or property or anything physical. The value of everything has skyrocketed, meaning the "haves" have more and the "have-nots" (mainly young people) have a steeper hurdle to clear if they want to own anything.

What many people tend to gloss over is that things such as inflation and housing bubbles and the like are very similar to stock market mania. Inflating a bubble intentionally means more profits in the short term for those who are blowing it up, but someday, the bubble is going to burst.

Companies and stocks are two different things

Despite the current market overvaluation and inflationary pressures, Buffett once again recommended the S&P 500 Index over any other investment, including Berkshire itself, due to the difficulty of achieving any level of market-beating success when picking stocks.

"I recommend the S&P 500 index fund I've never recommended Berkshire to anybody because I don't want people to buy it because they think I'm tipping them into something," Buffett said. "On my death there's a fund for my then-widow and 90% will go into an S&P 500 index fund I do not think the average person can pick stocks."

Does such a recommendation mean that Buffett considers the S&P 500 stocks to be better investments than Berkshire? Not necessarily. After all, the index contains many individual stocks that Buffett has never added to Berkshire's equity portfolio.

On the same topic, Munger said, "I personally prefer holding Berkshire to holding the market I'm quite comfortable holding Berkshire. I think our businesses are better than the average in the market."

The main takeaway here is that stock prices are entirely separate things from the underlying businesses they represent, and while the two can correlate or be roughly equal at times, they can also become severely disconnected at other times. Good businesses can and often do trade at much lower stock prices than flashy but poorly-run companies, but the stock price affects almost nothing about the operations of the business itself (unless said business is so desperate for funding that it needs to sell more stock in order to avoid bankruptcy).

Conclusion

Berkshire's annual meeting this year contained a lot for investors to digest. While they lamented the increased speculation supporting companies and driving up equity and asset prices, Buffett and Munger also praised the Fed stimulus that helped support companies and drive up equity and asset prices. The difference between the two is that Fed stimulus mainly helped larger and more established companies, while speculative investing mainly helped new companies that have yet to prove themselves. Regardless of the driving factors, though, it is clear that Buffett and Munger consider most things in the U.S. that are worth buying to be overvalued at this point. Whether that overvaluation will continue is a matter that is entirely out of investors' hands.

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