Concerns of a recession are once again gripping the stock market. After a relatively peaceful few years, volatility has returned to the market with a vengeance, and equity prices are taking a battering as investors try to position themselves for the upcoming storm.
While the economy is only showing slight signs of an upcoming downturn right now, the stock market tends to be a leading indicator, giving its opinion before the data confirms it.
There's also a risk that the tail could end up wagging the dog. Market volatility will impact the wealth effect among consumers, who will, in turn, put the breaks on consumer spending, the engine of the U.S. economy.
In times like this, when worries about the state of the economy are starting to grow, and volatility is building, looking back at past scenarios can be helpful. History does not repeat itself, but it does rhyme. And if we want to become better investors, studying past market cycles is essential.
Buffett's advice before recessions
In 2007, the world was only just starting to wake up to the idea that there could be a recession on the horizon. While few anticipated how bad the economy would become over the next few years, investors wanted to know how to position themselves ahead of a market downturn.
At Berkshire Hathaway's 2007 annual meeting of shareholders, one investor took the opportunity to ask Chairman Warren Buffett (Trades, Portfolio) what he thought of the market environment. His answer is just as relevant today as it was 12 years ago.
Buffett began by saying:
"Charlie and I haven't the faintest idea where the stock market is going to go next week, next month, or next year. We never talk about it. You know, it never comes up."
Buffett then went on to explain that when he views the market, he ignores 99.9% of the information out there, because most of it is not relevant. However, "every now and then" Buffett and Munger "see something that looks like it's attractively priced to us, as a business."
The key words here are "as a business." Buffett recommends that investors "Forget about the word 'stock'" and concentrate on the underlying business instead. By using this approach, "We would be happy with that stock if they told us the market was going to close for a couple years. We look to the business." The Oracle of Omaha went on to add:
"It's exactly the same way as if you were going to buy a farm a few miles here outside of Omaha. You would not get a price on it every day, and you wouldn't ask, you know, whether the yield was a little above expectation this year or down a little bit.
You'd look at what the farm was going to produce over time. You'd look at expected yields. You'd look at expected prices, the taxes, the cost of fertilizer, and you would evaluate the intelligence of your purchase based on what the farm produced relative to your purchase price.
Quotes would have nothing to do with it. That's exactly the way we look at stocks. We look at them as businesses. We make judgments about what the future of those businesses will be. And if we're right about — in those judgments, the stocks will take care of themselves."
This simple advice can help any investor ride out market turbulence. As volatility returns, it seems sensible to keep this advice from Buffett in mind over the next few days, weeks or even months to make sure you don't do anything stupid and stay focused on the long term. After all, successful investing is not a sprint; it is a marathon.
Disclosure: The author owns shares in Berkshire Hathaway.
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