While in Omaha for the Berkshire Hathaway annual meeting a couple of weeks ago, I participated in an investment panel hosted by a local chapter of the Young Presidents’ Organization. I had the privilege of sharing the stage with such industry giants as Tom Russo, a partner of Gardner Russo & Gardner (famous for knowing more about consumer stocks than the management that runs them), and Tom Gayner, president and CIO of Markel Corp., a specialty insurance company that on many levels resembles the Berkshire of 30 years ago.
Macro Forecasting
We were asked how much time a value investor should spend on macro forecasting. Usually macro forecasting is frowned upon in the value investing community, and Berkshire CEO Warren Buffett has everything to do with that. He is famous for saying (and I am paraphrasing), “My decision making would not change even if I knew what the Federal Reserve will do with interest rates next month.” There is sound logic behind this: Forecasting the economy is incredibly difficult in the short run. The economy is not unlike a black box with hundreds of gauges on it that in the near term give you conflicting readings about what’s inside it.
For this reason macro forecasting was disapproved of by value investors, and for 20 years this attitude paid off. The economic climate was favorable, the stock market was in overdrive, price-earnings ratios were expanding. Macro did not matter — until the housing bubble and financial crisis. Value investors who had had their heads in the sand got annihilated.
Things in life often swing pendulumlike, from one extreme to another. Right after a crisis every investor is a macro expert. It’s kind of hilarious: Investors who just a few years earlier didn’t even know the names of most economic indicators are now spitting them out in conversations as though they had absorbed them with their mother’s milk. So what should investors do — become macro experts or economic ignoramuses?
Believe it or not, there is a logical and, more important, a practical answer to this question. As an investor you want to spend very little time on forecasting the weather (that is, what the Fed will do with interest rates next month or the rate of growth of the economy). Weather forecasting, first of all, is not always accurate, but it will certainly consume a lot of time and energy, and the forecasts have a very finite shelf life. Yesterday’s weather is irrelevant today. As long as you own companies that can survive rain without catching pneumonia — even a few weeks of rain — weather forecasting is a waste of time. This is what Buffett was implying by saying he didn’t want to be a macro forecaster.
However, instead of being a weatherman (or weatherwoman), as an investor you want to pay serious attention to “climate change” — significant shifts in the global economy that can impact your portfolio. This is exactly what Buffett did over the past few decades — he was warning about the weak dollar because of trade-deficit imbalances (he even put on a trade that bet against the dollar). He also warned about derivatives — “weapons of mass destruction” — and tried to cleanse them from the portfolio of General Re (an insurance company Berkshire acquired) as fast as he could.
Though he underestimated the housing bubble, he was acutely aware of it. Alice Schroeder, author of The Snowball: Warren Buffett and the Business of Life, recently answered questions on Reddit about Buffett (it’s a must-read). This excerpt on housing caught my eye: “I bought a house in 2004, and when I told him, he was aghast. That’s when I knew we were in a serious housing bubble. Finally, he said, ‘Well, don’t worry; you’ll be able to sell it in ten years, so just hold on until 2014.’”
There is a significant difference between being a meteorologist and a climatologist, but unfortunately in investing, both activities fall under the rubric of macro analysis, and little distinction is made between the two.
By Vitaliy Katsenelson, CFA / Institutional Investor Magazine
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Musical Note: This improvisation by Oscar Peterson, “Just a Gigolo” (listen here), is very special to me. I used to listen to it together with my son Jonah as I drove him to daycare on my way to work. It was our song. We had our favorite part (at the 1:54 mark). We loved it so much, we’d turn up the volume and listen to it several times each trip. It is still our song, but Jonah turned thirteen a few days ago and will have his bar mitzvah next week. According to Jewish tradition he is a man now. I want my little Jonah back. Music is almost like an amplifier of memories.
As I write this I realize that five years from now I’ll be remembering the time I spent with the five- and the thirteen-year-old Jonahs. And I’m thinking that maybe we live too much in the past and future and not enough in the now. I am off to pick up Jonah from his bar mitzvah lesson and drive him home. Enjoy the song. Live in the now.
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley) and The Little Book of Sideways Markets (Wiley).
His books were translated into eight languages. Forbes Magazine called him "The new Benjamin Graham". To receive Vitaliy’s future articles by email or read his articles click here.
