Thursday, March 10th, 2016
Once again Warren Buffett has presented a compelling long term view of the growth potential of the US economy. In doing so he draws upon his long lifetime experience to explain that betting against the USA was and remains a foolish investment endeavour – “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs. America’s social security promises will be honoured and perhaps made more generous. And, yes, America’s kids will live far better than their parents did.”
However, there were notes of caution in his letter as well and one was significant for the insurance sector of the equity market.
“The prolonged period of low interest rates the world is now dealing with also virtually guarantees that earnings on float will steadily decrease for many years to come, thereby exacerbating the profit problems of insurers. It’s a good bet that industry results over the next ten years will fall short of those recorded in the past decade, particularly for those companies that specialise in reinsurance.”
Buffett’s acknowledgement of sustained lower interest rates and the extension of low yields across the maturity curve of the bond market is a reminder as to why equity investment can now only be assessed on a long term basis. Further, it suggests that companies that rely on real positive interest rates to generate a return on equity, will certainly be challenged. Thus, investments in listed insurance companies should be continually reviewed against their intrinsic value with the assumption that their returns will remain challenged and possibly decline.
Buffett comments on the slowing growth trajectory of the US economy, but he explains that the effect of compounding growth and the productivity enhancements of this technology era will ensure that wealth creation will be sustained – but at a slower rate.
The following few sentences, from his introduction, make some telling observations about the last 80 years and the future of the USA.
“It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do. That view is dead wrong: The babies being born in America today are the luckiest crop in history. American GDP per capita is now about $56,000. As I mentioned last year that – in real terms – is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well.”
“Today’s politicians need not shed tears for tomorrow’s children. Indeed, most of today’s children are doing well. All families in my upper middle-class neighbourhood regularly enjoy a living standard better than that achieved by John D. Rockefeller Sr. at the time of my birth. His unparalleled fortune couldn’t buy what we now take for granted, whether the field is – to name just a few – transportation, entertainment, communication or medical services. Rockefeller certainly had power and fame; he could not, however, live as well as my neighbours now do. Though the pie to be shared by the next generation will be far larger than today’s, how it will be divided will remain fiercely contentious. Just as is now the case, there will be struggles for the increased output of goods and services between those people in their productive years and retirees, between the healthy and the infirm, between the inheritors and the Horatio Algers, between investors and workers and, in particular, between those with talents that are valued highly by the marketplace and the equally decent hard-working Americans who lack the skills the market prizes. Clashes of that sort have forever been with us – and will forever continue. Congress will be the battlefield; money and votes will be the weapons. Lobbying will remain a growth industry.”
Figure 1. Either Donald or Hillary will be the next POTUS
Photo. Donald Trump, Hillary Clinton
Overall Buffett remains upbeat on the US economy although he acknowledges, if only in passing, that the distribution of wealth across the population is not fair.
In our view it is the distribution of wealth that is now dragging down the growth trajectory of the US. While we agree that the US economy will sustain real growth, we do not believe that this currently makes the US stock market compelling value. Indeed, the next quarter’s financial results from S&P 500 companies will be telling. The December quarter results revealed negative moves in earnings across the index. Should this be repeated in the March quarter, then it would represent a significant flattening of earnings in the face of historically high PERs.
As Buffett has often stated – price and value periodically disconnect. The time to aggressively buy is when the disconnection is in the investor’s favour and that is when price is well below value. Notably Buffett did not claim that he was seeing immense value in the US market today, and that is support for the contention that investors should be patient in this volatile period.