Lessons from Warren Buffett

‘By year-end, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game’ – that is how Warren Buffett describes the recent market carnage in his latest 2008 Annual Letter to Berkshire Hathaway shareholders.

Buffett just recorded his worst annual performance in 44 years at the helm of Berkshire. Muni bonds, real estate, stocks, commodities …all have gotten hammered relentlessly and there have been relatively few places to hide throughout this downturn.

No matter what you think of Buffett, I think he is still worth listening to. Once the money floodgates have already been opened, so the only logical question left is, ‘What is the long-term consequences?’ Among the target size of US$1 trillion appears outsized relative to the underlying issuance capacity of the targeted market. Of the US$75bn directed towards the Homeownership Stability Initiative, under the best case scenario, US$44bn would go towards incentives leaving US$31bn left to fund interest rate reductions.

Deflation is in the driver’s seat for now and cash has been king. And there is no telling how long the trend will last. But when things do turn, I believe that central banks will remain behind the curve as they have all along. That means renewed inflation, possibly substantial inflation.

Now, it is the time to consider inflation protection. It is because as Buffett remind us …`Our country has faced far worse travails in the past…without fail, however, we’ve overcome them’. I doubt that any amount of economic damage will dampen the collective entrepreneurial spirit. Regardless, I don’t think this is the end of our great economic machine, nor do I think all stocks should be trading at doomsday-scenario prices.

In Buffett’s letter points out that two of Berkshire’s largest operations – utilities and insurance – remain economically insensitive, and delivered strong results in 2008. Right now, investors don’t seem to care. They are selling everything and asking questions later.

In Buffett’s words ….`When investing, pessimism is your friend, euphoria the enermy..whether we are talking about stocks, I like buying quality merchandise when it is marked down’.

If you believe in this philosophy, then this is the time to consider dipping a toe in the water. Heck, I have never seen such widespread pessimism in my last 15 years of investing. Some of it is well founded, but if you are not comfortable, you should do what allows you to sleep at night.