Oct 17 2008

Advice from an economic oracle – buy American stocks now!

Op-Ed Contributor – Buy American. I Am. – NYTimes.com

So Wall Street has recently experienced its worst shocks since the great depression. Every day the Dow Jones is like a roller coaster, DOWN 800 points, then  UP 500 points, then DOWN 200 followed by another rally of 600! In just three weeks the Dow has gone from 11,500 to below 900 points. Surely, the wise thing to do is get OUT of the stock market, right? WRONG! At least, so says the richest man in the world, Warren Buffet, someone who should know a thing or two about smart investing.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Discussion Questions:

  1. Why does holding cash seem like the smart thing to do during periods of volatile stock prices like the last month or so? Why does Mr. Buffet think that holding cash is NOT so smart?
  2. Mr. Buffet’s advice is counter-intuitive to some. Buying more of something that is falling in value (American stocks) may appear unwise… but what is Buffet’s rationale for why buying now may in fact be the smartest thing for an investor to do?
  3. Does the behavior of investors on the stock market reflect the behavior of consumers in a typical product market? In other words, do the laws of supply and demand apply to the stock market? Discuss…

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

12 responses so far

12 Responses to “Advice from an economic oracle – buy American stocks now!”

  1. Laura Perezon 19 Oct 2008 at 11:20 pm

    It’s impossible to know which turn the market is going to take in the next few weeks or months, and the company Dow is a perfect example of it. Warren Buffet said it himself, ‘I can’t predict the short-term movements of the stock market’. Investors are fearful and do not want to take chances with their stocks. Mr. Buffet, however, has a very different philosophy; ‘Be fearful when others are greedy, and be greedy when others are fearful’. By looking back on past events where there have been major economic drops, such as Dow during the depression in 1932, Mr. Buffet has seen that the long term effects are always positive and investors who only bought stocks when they were absolutely sure the economy was safe and sold them as soon as something started to go out of line were the ones to lose more money.

    By buying stocks now at times when the economy is most unstable, Mr. Buffet predicts that the long term effects will bring record profits in 5, 10 or 20 years from now. He is basing his rationale on the rise of Dow from 66 to 11, 497 during the two World Wars, the Depression, recessions and financial panics, oil shocks, the flu epidemic, etc.

    The stock market works exactly the same as the product market. Here are several examples: If there is high demand for a certain stock the price of that stock will increase, similarly to the product market. If there is high demand for a certain good the prices will go up. Another example; if there is a lot of supply but not enough demand, the price will decrease to get the investors to buy more of that stock.

  2. Maren Rackebrandton 22 Oct 2008 at 2:11 am

    It's smart to hold cash because nobody knows what is going to happen. If the banks can't give out any money or the stocks are so low that by selling them the buyers are not getting enough out of them, people are left with what they have at home. If everybody runs to the banks and want to get their money then soon there will be no money left.

    Mr. Buffet on the other hand thinks though that it's not smart to keep cash. He thinks that the stocks will go up again, but when he can't exactly say. If people have enough monet to keep their stocks I also think this would be a smart way to do it. Because why buying stocks that are basically worth nothing when there's a possibility that they can be up again in a period of time?

    He also says that buying stocks now that are rapidly falling is a smart thing to do. They are now falling, but he predicts that they are going to have "new profit records" some time and will be worth even more then.

    I also think that the product market works like the stock market. And Laura explained this very well I don't think there's anything to add.

  3. Thibault De Keersmaeon 22 Oct 2008 at 3:00 am

    I completely agree with Warren Buffet, when he says that people shouldn't be so fearful. The market will go back up, as it has done before, and right now it's a roller coaster because people don't trust the market and are afraid. Actually, the market might be going down, but as Mr. Buffet even said it, "most major companies will be setting new profit records 5, 10 and 20 years from now."

    Buying something that is losing is value might be unwise to some, but it is actually smart, since the market will come back up, and it is just like buying a stock at a discount, and you will actually make more profit from it later. The stocks have already gone down a lot, and the might still keep going at the moment, and no one can predict for how long, but they will eventually gain in value, and if one would buy them now at a lower price, the profit would be larger than buying something at a normal price and hoping for a profit.

    I completely agree with what Warren buffet says, and I think he is a very reliable person in this situation. I say this because he is the richest man in the world, and because "while 17 billionaires on Forbes list lost more than $1 billion in the past month, Buffett managed to boost his wealth by $8 billion to $58 billion, pushing him ahead of Gates, whose fortune fell to $55.5 billion from $57 billion." (http://tech.yahoo.com/news/nm/20081010/tc_nm/us_buffett_forbes)
    He knows what to do, that is for sure, but I still think he deserves a lot of respect for getting his wealth up by about 8billion dollars, while most people actually lost a lot of money.

  4. moritzreithmayron 22 Oct 2008 at 4:33 am

    Keeping cash during times like these seems like a smart idea because you don't risk any money by investing in stocks which could possibly fall in value over the next few weeks, months or even years. Buffet's point is that holding money instead of investing it during times where stocks depreciate in value is unwise because right now you can buy stocks at a very cheap price which allows you to buy even more of them. The value of those stocks will increase by a higher precentage over the next 5, 10, 20 years than the value of cash. Hence, regarding the long-term effects, buying stocks right now is a good idea in Buffet's eyes.

    Buying now not only allows you to buy more for the prices are low but also the value of those stocks will increase over the next decades.

    The behaviour of investors in the stock market, as the example of Warrren Buffet shows, is sometimes different to the behaviour of buyers in a product market. The article shows that successful investors will buy more stocks as prices decreases; thus, the law of demand is reversed: Ceteris paribus, within a certain time, as the value of stocks decrease, the quantity demanded increases. However, following this principle is probably something which distinguishes a clever investor and because there are lots of not so wise investor involved in the stock market, this reversion doesn't always take place or it just takes some time before it occurs. The law of supply for the stock market, too, is the reversion of the law of supply for other product markets for a good investor. The stock market in general doesn't need to follow this rule because people react in different ways to changes in the stock market. People might for example not be able to take the risk of short-term losses because they can't afford it and therefore sell their stocks

  5. Helen Poxonon 22 Oct 2008 at 6:56 am

    During volatile stock prices holding on to your money seems to me to be a good idea. You're not going to be benefitting from it anytime soon and your not going to be selling any stock shares as people wont want them. This is because the amount of money in the world has decreased becuase of increase or the beginnings of inflation caused by the debt in banks and large companies. The lack of people having money has lead to people being fearful and therefore the stock markets become even lower. Holding onto you money means that you won't be losing anymore but it also means you won't be gaining more than your income.

    Warren Buffet the worlds richest man believes that putting your money into stock (meaning not holding onto money) during volatile stock prices is the best time to do so. I can see the logic of this idea but who knows how reliable it is and how long we have to wait to see the markets go up and stay up. Buffet believes the following quote "Be fearful when others are greedy, and be greedy when others are fearful." He is saying that when the markets are high and people are constantly able to buy (if wealthy enough) shares and sell them for even more we should start to be careful with our money(fearful). But when people can easily buy shares they should because once they have hit rock bottom the only way to go is up. Therefore people can make a large amount of money (profit). I think that this all sounds amazing believable but what happens if you buy shares and after 2 years nothing much has happened then your going to start to be more fearful. no? I think that if we knew that the market was going to rise with the next months or year this would be more beneficial for people who are into shares and the stock market.

    I think that the laws of supply and demand does take affect to the stock market. Examples being that when the demand for a good or service increase then the market in the same area increases. When there is an increase in supply and a decrease in demand then the price of the share goes down. Depending on the actions on supply and demand depend on the shares and the stock market. Depending on the stock market depicts weather people buy shares. Depending on the demand and supply of a good or service depicts weather the people are going to want more or less of it.

    Overall i agree and disagree with Marren Buffet. I think he has a nice idea to believe and it makes sense to buy shares when they are cheaper. But i wouldn't want to know that i have my money waiting in the market and dependant on worlds actions weather it goes up. This to be doesn't seem so reliable to me. I would have to know roughly when the market would go up. Maybe im just being to fearful (as Mr. Buffet says we become naturally fearful when we should be taking advantage).

  6. KReminon 24 Oct 2008 at 6:51 am

    For people who have some extra cash to invest into stocks, it is the best thing to do! The prices for these american stocks are very low due to what is going on right now and you can therefore buy more. Although you might not see any gains from your investments in the near future ( a couple of months let's say), one knows that the economy will always fix itself after some time and you will therefore profit from buying extremely low and selling for way higher…

    Keeping your money and saving it for the hard times MIGHT seem like a smart idea, but in my opinion, it is not the right thing to do when 'times get really tough'. This is because if hyperinflation takes place, the money you have saved becomes practically worthless (one example: '29 stock market crash eventually led to hyperinflation [although the crash wasn't the only cause, it certainly was a major one]. Hyperinflation made the peoples money worthless and the prices of things literally rose within in a couple of minutes by huge amounts. However, the value of goods did not go down and you were therefore way better off having a lot of goods instead of having a lot of money.

    To some extent, the laws of supply and demand take effect in the stock market as well as discussed by the previous people that commented. However, MOST people don't want to buy stocks in times like these when they are cheaper because they perceive them to be worthless and are scared of investing their money in the wrong place. Therefore, demand is not always higher when prices are lower for stocks, and thus the law does not always apply.

  7. Nicon 28 Oct 2008 at 10:08 pm

    'To some extent, the laws of supply and demand take effect in the stock market as well as discussed by the previous people that commented. However, MOST people don’t want to buy stocks in times like these when they are cheaper because they perceive them to be worthless and are scared of investing their money in the wrong place. Therefore, demand is not always higher when prices are lower for stocks, and thus the law does not always apply.'

    Is this not the introduction to behavioural economics? People are naturally going to act irrationally and base most decisions on unpredictable instincts. The only way that people like Warren Buffett can save the economy is to advise people to buy. Given the current government intervention, the dollar is most likely going to depreciate.

    Warren Buffett naturally makes a clever point. People should invest and gain assets, rather than live solely on money. But this may pose a problem to a consumer based economy such as the United States.

    However, he has been known to be a bit early on his calls. With the financial problems in 2003, Buffett advised the people to invest roughly 8 months too early. NBC's 'street talk' programme thinks that investors should wait until the economy falls a bit more before they invest.

  8. Eithanon 03 Nov 2008 at 2:39 am

    Thibault, you claim that: "I completely agree with Warren Buffet, when he says that people shouldn’t be so fearful. The market will go back up, as it has done before, and right now it’s a roller coaster because people don’t trust the market and are afraid. I have to disagree with you, and with Warren Buffet for that matter. It's true, the market will eventually go back up. However, how long will that take? Ten years? Fifty years? Warren Bufft gives this as an example to support his argument: "In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." If I am fifty years old with a family to support, I cannot afford to wait a century (for obvious reasons), or even twenty years, for the market to recuperate. If am Warren Buffet, however, I can easily afford to wait, and wait, and wait…

  9. Bjorn Borgerson 03 Nov 2009 at 1:05 am

    People act rationally. When money seems scarce, they save it… when it flows like water, they spend it. In the stock market however, people have a tendency to panic, when the market goes down. Many seem to want to cut their losses by selling in times of dispair, whilst only the opposite seems logical. If we wait long enough, in theory those stocks are more likley to be higher than they are at that point (o.k. maybe not for Lehmann Brothers).

    The issue with what Buffet is saying is that people simply dont trust eachother. If nobody else decides to spend their money as well, those spending are poorer, and the economy has not actually improved. It needs to be a combined effort from many consumers; yet many people are simply not secure enough financially to spend their savings.

    What Buffet presents, seems to defy the law of demand. When prices are low, so is the quantity demanded, whilst normally there should be an inverse relation between the two. This is also the essence of why Buffet suggests that we buy in hard times. If we buy now, when prices are low, and nobody else is doing so, we are likely to make a large profit, when prices go up again, and we own what others demand… (sorry if that sounds a little complicated:)

  10. Bjorn Kvaaleon 04 Nov 2009 at 1:23 am

    The economy is currently still in a recession. Many people are rather reluctant to invest their money in the stock market because they do not trust the market now. They believe they will lose money. But Mr. Buffet says now is the time to invest. The economy has slowly reached its trough and therefore economic growth is coming nearer every day. If we invest now when the prices are low, we are creating profit because we assume that a period of economic growth will come sometime soon.

    As the price of the stocks are low, the quantity demanded for the stocks are higher, or at least, should be higher. This is the law of demand. This is true for Mr. Buffet because as the price declines, he is more willing to buy stocks and then sell them sometime in the future when the price has risen.

  11. axelon 05 Nov 2009 at 1:11 am

    As holding cash may seem like the thing to do during this recession, it is in fact not. It might be the safer way of not loosing in the short run but worse off in the long run. The stocks may be going crazy at the moment, going up and down spontaneously. But all the prices are still very low. If you buy a stock now you may lose a thousand dollars since the stock went down unexpectedly but the stock will then rise again. As Mr. Buffet said, the complanies will be making record profits in 5, 10, or 20 years. this means that you would have bought when the stocks are extremely low, and then can sell when the prices are at its highest again. I do not believe that Mr. Buffet's advice is counter-intuitive i believe it is just that people only fear what will happen with their money in the short term.

    I believe that what Bjorn says is correct and that as the price of stocks are low, the quantity should demanded should be higher. it is only peoples fear of in vesting in stocks that makes it a little different. Mr. Buffet is just telling the people to follow the law of demand.

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