how to become part of the problem

Warren Buffett says people like him are the problem with the U.S. economy.

With a net worth of more than $75 billion, Buffett is currently the second richest man alive, according to Forbes. As the CEO of investing house Berkshire Hathaway, he is hallowed as the Oracle of Omaha. But for all his personal success, Buffett says the issue really is the 1 percent.

Part of the reason some are struggling, says the octogenarian investor, is that the automation and digitization of the U.S. labor force is happening faster than employees can be retrained.

"We always see shifts in employment. If you think about it, if you go back to 1800, it took 80 percent of the labor force to produce enough food for the country. Now it takes less than 3 percent. Well, the truth is that market systems move people around," says Buffett.

Buffett made his extreme wealth by investing in the stock market, an interest that took hold young. Buffett bought his first stock when he was 11 and has been in the market for 75 years. He recommends others do the same.

"They should just keep buying and buying and buying a little bit of America as they go along. And 30 or 40 years from now, they will have a lot of money," he says.

In an effort to compensate for the wealth inequality that he himself has benefited from, Buffett and his billionaire buddy Microsoft co-founder Bill Gates co-founded the Giving Pledge, a voluntary commitment by the richest people in the world to give away at least half of their wealth. The goal of the Giving Pledge is not only to help those in need but to encourage others to do the same.

The Witch of Wall Street

[6/23/17] How Hetty Green acquired all that money

[6/7/06] So was Anne Scheiber.

[6/15/05] Hetty Green was a miser.

the only game in town?

The easiest way to understand why you don’t want to make money from the late stages of an expensive/futuristic stock boom is to look at what were considered the lowest-risk ways to play the 1990s boom. Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC) and Cisco (NASDAQ:CSCO) were considered “pickaxe” companies to that boom because they were not dotcom flashes in the pan and were drafting on all the activity requiring their software, chips and routers created by the “internet revolution.”

Microsoft’s high stock price in 2000 was $58.38. It bottomed at $17.10 in early 2009. Today, Microsoft is projected to earn $3.02 in 2017 (Value Line). This means the stock sold in 2000 at 19 times 2017 earnings per share. Is it any wonder that investors have only seen 20% appreciation from the height of the Tech Bubble?

Intel and Cisco are even worse. Intel peaked at $66.75 in 2000, and it is projected to earn $2.80 in 2017 (Value Line), which means it traded at 23.8 times 2017 earnings back then. Cisco traded at $77.31 per share at its 2000 peak and bottomed two years later at $10.49. It was projected to earn $2.40 per share (Value Line). It traded for 32 times what it would earn 17 years later. This only happens when you are “the only game in town!”

Are we doing something very similar today? Here are the P/E ratios of the FANG stocks, Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOGL), based on Value Line estimates:

• Facebook – $4.75 in 2017, P/E ratio 32.
• Amazon – $7.95 in 2017, P/E ratio 125.
• Netflix – $1.10 in 2017, P/E ratio 148.
• Alphabet – $35.00 in 2017, P/E ratio 29.

A quick glance at these numbers shows that Amazon and Netflix are certainly as expensive as Cisco and other glamour large cap stocks were in 1999. Facebook and Alphabet are less expensive – or like what Microsoft, IBM and Hewlett Packard were in 1999. Therefore, as we consider how this might play out, we will ask how the FANG stocks became “the only game in town.” FANG dominance is best represented by their gains since the beginning of 2015 as compared to the gains in the remaining stocks in the Standard & Poor's 500 Index. The chart below shows that the FANG stocks gained 48.92% while the remaining stocks gained 4.96% on an equally weighted basis (1):

...

We have no idea when this euphoria episode will end. However, we believe we know what to do with it. When a group of stocks gets mega-popular, we must avoid the area the same way we would avoid Palm Beach during a Miami hurricane alert. This is especially true when it is “the only game in town.”

-- Smead Capital Management

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[P.S. I personally own every stock mentioned above -- in varying degrees, with no immediate plans to sell.]

patience

"The big money is not in the buying and selling … but in the waiting"   Charlie Munger

I predict...

Making bold predictions is a fool’s errand. I think Yogi Berra summed it up best when he spoke about the challenges of making predictions:

“It’s tough to make predictions, especially about the future.”

While making predictions might seem like a pleasurable endeavor, the reality is nobody has been able to consistently predict the future (remember the 2012 Mayan Doomsday?), besides perhaps palm readers and Nostradamus. The typical observed pattern consists of a group of well-known forecasters bunched in a herd coupled with a few extreme outliers who try to make a big splash and draw attention to themselves. Due to the law of large numbers, a few of these extreme outlier forecasters eventually strike gold and become Wall Street darlings…until their next forecasts fail miserably.

Like a broken clock, these radical forecasters can be right twice per day but are wrong most of the time. Here are a few examples:

Peter Schiff: The former stockbroker and President of Euro Pacific Capital has been peddling doom for decades (see Emperor Schiff Has No Clothes). You can get a sense of his impartial perspective via Schiff’s reading list (The Real Crash: America’s Coming Bankruptcy, Financial Armageddon, Conquer the Crash, Crash Proof – America’s Great Depression, The Biggest Con: How the Government is Fleecing You, Manias Panics and Crashes, Meltdown, Greenspan’s Bubbles, The Dollar Crisis, America’s Bubble Economy, and other doom-instilled titles.

Meredith Whitney: She made an incredible bearish call on Citigroup Inc. (C) during the fall of 2007, alongside her accurate call of Citi’s dividend suspension. Unfortunately, her subsequent bearish calls on the municipal market and the stock market were completely wrong (see also Meredith Whitney’s Cloudy Crystal Ball).

John Mauldin: This former print shop professional turned perma-bear investment strategist has built a living incorrectly calling for a stock market crash. Like perma-bears before him, he will eventually be right when the next recession hits, but unfortunately, the massive appreciation will have been missed. Any eventual temporary setback will likely pale in comparison to the lost gains from being out of the market. I profiled the false forecaster in my article, The Man Who Cries Bear.

Nouriel Roubini: This renowned New York University economist and professor is better known as “Dr. Doom” and as one of the people who predicted the housing bubble and 2008-2009 financial crisis. Like most of the perma-bears who preceded him, Dr. Doom remained too doom-ful as the stock market more than tripled from the 2009 lows (see also Pinning Down Roubini).

Rather than paying attention to crazy predictions by academics, economists, and strategists who in many cases have never invested a penny of outside investor money, ordinary investors would be better served by listening to steely investment veterans or proven prediction practitioners like Billy Beane (minority owner of the Oakland Athletics and subject of Michael Lewis’s book, Moneyball), who stated the following:

“The crime is not being unable to predict something. The crime is thinking that you are able to predict something.”

-- Wade Slome, CFA, CFP