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Is the Warren Buffett way dead?

Posted by cij on Dec 10th, 2008

In a recent interview with Marc Faber, he said that

I think The Warren Buffett approach is dead, and it’s been dead for ten years, and it’s going to be dead for another ten years.

This statement lies in the context of extreme market volatility described in our earlier article, Real economy suffers while financial markets stuff around with prices,

Right now, deflationary forces are acting on the economy while at the same time, central bankers and governments are attempting to inflate. Consequently, the result is extreme volatility in prices.

In Marc Faber’s latest Gloom, Boom & Doom report, he wrote

In the next few years I expect asset markets to favor aggressive traders and not long term investors…

In my life I experienced two major trading markets (1968 – 1982) and Japan post 1992 (see Figure 9). I can assure my readers that during these trading market conditions (no net gain for the indices and in the case of Japan new lows) hardly anyone except very smart (lucky) traders made any money.

Above I tried to show the existing connectivity between global liquidity (coming from the US current account deficit), asset markets, and currency movements. To navigate successfully between all these volatile and often unpredictable market movements you need to be a genius. And whereas I am sure that my readers are all above average investors (80% of investors think they are above average investors), I am not and, therefore, in very volatile periods I try to avoid losses and look for a safe heaven such as physical gold…

In the global stock, commodity, forex, bonds and credit markets, prices are very volatile and unstable. The sudden price deflation of commodities over the past few months caught many by surprise. What’s surprising is not just the fact that prices declined. The speed of price collapse is the phenomena that shocked many investors (even Jimmy Rogers admitted to not expecting that). It was only not long ago that oil was US$147 and the Aussie dollar close to parity with the US dollar. A 70% fall in oil prices in just a few months was something that we did not anticipate too.

In the real economy, many businesses, especially the resource companies, will fail because of this unexpected surprise. Therefore, the effects of such price volatility are still yet to be permeated to the rest of the economy.

Coming back to value investing, one of its root activity is business calculation. But if prices are unstable and unpredictable due to monetary deflation/inflation, this root activity cannot be performed reliably. As we said before in How is inflation sabotaging our ability to measure the value of things?,

If you want to measure the length of a box, you may use the ruler to do it. The reason why a ruler can do such a job is because its length is reasonably consistent for the foreseeable future. Now, imagine that ruler is as elastic as a rubber band. Do you think it is still a useful tool to measure the length of the box? An elastic ruler is useless because you can always make up the measurement of the box to whatever you please just by stretching the ruler such that the edge of the box is aligned to any intended measurement markings in the ruler.

Now, let come back to measuring the value of oil. Since oil is priced in US dollars and if the supply of US dollars can be expanded and contracted, how useful do you think it is as a calibration for measuring the value of oil?

If business calculations cannot be performed reliably, then business valuation cannot be ascertained reliably too. Without a reliable business valuation, long-term buy-and-hold value investors are investing in the dark.

That’s the dilemma facing value investors right now.