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Buffett says Investors are Playing with Fire

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The Wall Street Journal reported last week that the proportion of money-losing companies that have gone public so far this year was 83%. The record (for now) is 81% from back in 2000. That was the year the Tech Bubble peaked. The current stock market has at least one other commonality with the Tech Bubble. Consider what the Oracle of Omaha, Warren Buffett, said before (1999) and after (2001) the Tech Bubble collapsed.

Investing Requires Zero Qualifications

Warren Buffett made a speech at the Allen & Company Sun Valley Conference in 1999. Those who attended were some of the world’s elites. They comprised of leaders in business, politics, philanthropy and art. With 1999 being a memorable year for dot-com driven stock market, attendees also include many young tech entrepreneurs. They amassed vast paper profits from taking their fledgling internet companies public. In Buffett’s speech, he was remembered for preaching to the tech entrepreneurs about how extravagantly overvalued their company stocks were. He started his speech by saying (emphasis added):

“I will be talking about pricing stocks, but I will not be talking about predicting their course of action next month or next year. Valuing is not the same as predicting. In the short run, the market is a voting machine. In the long run, it’s a weighing machine. Weight counts eventually. But votes count in the short term. And it’s a very undemocratic way of voting. Unfortunately, they have no literacy tests in terms of voting qualifications, as you’ve all learned.” – Warren Buffett (July 1999)

After going into some lessons in market history and a joke about killing aviation pioneer Orville Wright, Buffett’s message was clear. Despite hopes for a new paradigm driven by the internet, the value of the stock market could only reflect the output of the economy. According to Buffett’s biographer (emphasis added):

“The audience took his point, which was that people who bought Internet stocks were about to get screwed. They sat in stony silence. Nobody laughed. Nobody chuckled or snickered or guffawed.” – Alice Shroeder, Warren Buffett’s biographer (September 2008)

The lack of financial literacy qualifications required to be an investor during the Tech Bubble proved devastating. After peaking in March 2000, the S&P 500 crashed by 50% over the next 31 months. The technology-heavy NASDAQ fared worst.

Playing with Fire

As the Tech Bubble collapsed, Buffett shared in a Fortune magazine article he co-authored in December 2001 how he values the stock market. As indicated above, he believes the value of the stock market is best compared to the output of the economy. He does this by calculating the ratio of the market value of a county’s stock market against its gross national product (“GNP”). According to Buffett (emphasis added): “The ratio . . . is probably the best single measure of where valuations stand at any given moment.” This is illustrated in the graph below.

Warren Buffett, Charlie Munger, valuation, stock market, GNP, gross national product, equities, equity, Tech Bubble, Subprime Bubble, Subprime Mortgage Bubble, Quantitative Easing, QE, Fed, Federal Reserve, monetary policy

The Tech Bubble peaked in early-2000 when the ratio reached as high as 190%. According to Buffett, this was much too high a level fraught with risk. He wrote (emphasis added):

If the ratio approaches 200% – as it did in 1999 and a part of 2000 – you are playing with fire.” – Warren Buffett (December 2001)

Fast forward to the present. Buffett’s valuation ratio was most recently at 191%, exceeding the height of the irrationally exuberant Tech Bubble. This suggests the current stock market is not only in a bubble, but possibly in a bigger one. Given the Tech Bubble was once the biggest stock market bubble ever, the current stock market may have raised the standard for bubbles and forever changed history.

Summary

Buffett told the crowd at the Allen & Company Sun Valley Conference in 1999 that the stock market is a voting machine in the short run that could be run afoul by financially illiterate investors. He also said it is a weighing machine in the long run that is grounded by economic output. Fast forward to the present, valuations are once again approaching 200%. It sure looks like a another generation of inexperienced and financially illiterate investors are playing with fire.

Whether or not you believe investors are once again playing with fire, please consult an investment fiduciary before making any investment decisions. Should you be in search of an investment fiduciary, Meritocracy Capital Partners Inc. would welcome the opportunity to serve as your partner.

Meritocracy Capital Partners Inc. is a boutique investment management firm & portfolio manager that aligns itself with its clients. We build trust & accountability by providing a fee structure driven by performance and by having our money invested right alongside our clients’ money. As a result, we treat our clients’ money like our very own.

We work with growth-oriented professionals and entrepreneurs that seek a value-focused and performance-driven approach to how their wealth is managed. You can reach us at (778) 807-8560 or on our Contact page.

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