The church of Warren Buffett: Faith and fundamentals in Omaha - By Mattathias Schwartz

Thanks to Lincoln for passing this Harper's article along.

Link to: The church of Warren Buffett: Faith and fundamentals in Omaha

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Sprott December Comment: Is it all just a Ponzi scheme?

In the latest Treasury Bulletin published in December 2009, ownership data reveals that the United States increased the public debt by $1.885 trillion dollars in fiscal 2009. So who bought all the new Treasury securities to finance the massive increase in expenditures? According to the same report, there were three distinct groups that bought more than they did in 2008. The first was “Foreign and International Buyers”, who purchased $697.5 billion worth of Treasury securities in fiscal 2009 – representing about 23% more than their respective purchases in fiscal 2008. The second group was the Federal Reserve itself. According to its published balance sheet, it increased its treasury holdings by $286 billion in 2009, representing a 60% increase year-over-year. This increase appears to be a direct result of the Federal Reserve’s Quantitative Easing program announced this past March. Most of the other identified buyers in the Treasury Bulletin were either net sellers or small buyers in 2009. While the Q4 data is not yet available, the Q1, Q2 and Q3 data suggests that the State and Local governments and US Savings Bonds groups will be net sellers of US Treasury securities in 2009, while pension funds, insurance companies and depository institutions only increased their purchases by a negligible amount.

So who was the third large buyer? Drum roll please,... it was “Other Investors”. After purchasing $90 billion in 2008, this group has purchased $510.1 billion of freshly minted treasury securities so far in the first three quarters of fiscal 2009. If you annualize this rate of purchase, they are on pace to buy $680 billion of US treasuries this year - or more than seven times what they purchased in 2008. This is undoubtedly the group that made the US deficit possible this year. But who are they?

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Hussman Weekly Market Comment: Bayes' Rule (January 29, 2007)

Fun with Bayes' Rule: Birds and Hamsters

Suppose that you've got a truckload of animals in boxes, but you can't actually see the animals. If the animal is a hamster, there's an 80% chance the box is green. If it's a bird, there's only a 20% chance the box is green. You're given a green box. How likely is it that the animal inside is a hamster?

Though it's tempting to answer that a hamster is most likely, we need more information. We have to know what proportion of the animals are hamsters.

Suppose that only 10% are hamsters. Then given it's a hamster (10%) there's an 80% chance the box is green. So 10% x 80% = 8% of the time we'll have a hamster and a green box. However, we'll also have a green box in 20% of the cases where the animal is a bird (90% of the animals). So 20% x 90% = 18% of the time we'll have a bird and a green box.

Bayes Rule says that the probability it's a hamster when you're handed a green box is:

8% / (8% + 18%) = 31%.

Most likely, there's a bird in the green box. Notice that choosing a green box increases the probability it's a hamster (which you would expect just 10% of the time if you had no information about the box), but it's not enough to make a hamster the most likely expectation.

Steve Jobs' 2005 Stanford Commencement Address

Grant's Winter Break 2009 Issue

This compilation of recent articles, the first annual Grant’s Winter issue, is for you. And it's for your friends, co-workers, clients, classmates, shipmates, brothers-in-law and maids-of-honor, too. Please pass it along, with our thanks, to any and all prospective members of the greater Grant’s family.

Click here for PDF
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Hussman Weekly Market Comment: Clarity and Valuation

So overvalued, check. Overbought, check. Overbullish, check. Upward pressure on yields, check. Market internals? – certainly mixed, but not bad – and there's the wild card. Historically, markets featuring a combination of these other risks have been vulnerable even without clear deterioration of internals. What the mixed internals (rather than clearly negative) buy you is variability in the timing of subsequent weakness. Sometimes the market plunges immediately, but often it bounces around for a while and continues to make marginal new highs. More often than not, what the syndrome produces is an abrupt plunge within a window of about 10-12 weeks. Not a forecast, just a regularity. This time might be different, but we wouldn't risk a great deal hoping it will.

It's important to recognize that when I quote probabilities, I am generally using a form of Bayes' Rule. So when I say, for example, that I estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year, that figure is based on various combinations of historical evidence, and what has (and has not) happened afterward, and how often. As a side note, a “market plunge” in this context need not be a “crash.” In the context of a credit-driven crash and rebound (which is what I believe we've observed), a typical post-rebound correction would be about -28%, but even that would take stocks to less than 20% above the March lows.

Probabilities, however, are not certainties. If the probability of a given event is “p”, then the probability of “not that event” is (1-p). This, in my view, is what makes probabilities and average outcomes different from forecasts. When people forecast, they say “this or that is going to happen,” and very often they establish investment positions that will do them a great deal of harm if they are incorrect. What we try to do is say, “on average, these conditions have been associated with this typical outcome, as well as a range of other possible outcomes (risk) that is this wide.” The larger the typical outcome is, compared with the possible range of outcomes, the larger a commitment we are willing to make. But if the average outcome is weak, and the range of outcomes is wide, we'll defend against the risk.

Ben Stein: My dinner with Warren

Sunday, December 13, my pal Phil DeMuth and I flew into an unbelievably cold Omaha to meet and eat the next day with the maestro, Warren E. Buffett. The next day was even colder, but Warren greeted us in his trademark folksy manner at the door to Berkshire Hathaway's old fashioned, but solid, offices in downtown Omaha. I know that space is limited so I will get right to what went on.

First, his office had changed a little bit since I was there a couple of years ago. He now has model trains everywhere, emblematic of his recent buy of Burlington Northern Santa Fe -- apt gifts, because Warren has been a model train collector since his childhood. Phil had brought him a 1930s Lionel catalog, which Warren read eagerly, Citizen Buffett with his Lionel trains Rosebud.

I asked him why he thought Burlington Northern was such a great buy and he answered in characteristic fashion...with numbers. He explained that Berkshire had gotten so big that even a very successful small purchase would hardly affect earnings at all.

But a medium successful large purchase would be more helpful. (He explained this with numbers in such a rapid fashion that it was as if a computer were spitting out the analysis, which, in a way, it was. He is so astonishingly facile with numbers that it is almost eerie.)

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I did not have the wit to ask him how one defined value in a constantly shifting world. We all agreed that interest rates would change towards the upside at some point, although we did not know when or by how much (of course).

Buffett, like everyone else, is mystified by the Japanese example of super high deficits, a huge national debt, and no inflation and ultra-low interest rates. Something like that is apparently happening here, he suggested, which we would all agree is true (although this week's producer prices number was worrisome and had not come out as of our dinner). But why it is happening now and did not happen in the past (there was inflation between 1933 and 1937, in a far worse economic environment), no one knew.

Scientists spot nearby 'super-Earth'

Astronomers announced this week they found a water-rich and relatively nearby planet that's similar in size to Earth.

While the planet probably has too thick of an atmosphere and is too hot to support life similar to that found on Earth, the discovery is being heralded as a major breakthrough in humanity's search for life on other planets.

"The big excitement is that we have found a watery world orbiting a very nearby and very small star," said David Charbonneau, a Harvard professor of astronomy and lead author of an article on the discovery, which appeared this week in the journal Nature.

The planet, named GJ 1214b, is 2.7 times as large as Earth and orbits a star much smaller and less luminous than our sun. That's significant, Charbonneau said, because for many years, astronomers assumed that planets only would be found orbiting stars that are similar in size to the sun.

Because of that assumption, researchers didn't spend much time looking for planets circling small stars, he said. The discovery of this "watery world" helps debunk the notion that Earth-like planets could form only in conditions similar to those in our solar system.

"Nature is just far more inventive in making planets than we were imagining," he said.

2001 Jim Grant Article: Sometimes the Economy Needs a Setback

This 2001 article was written in regards to the Internet bubble, but it has some timeless insights about booms and busts.

The weak economy and the multi-trillion-dollar drop in the value of stocks have raised a rash of recrimination. Never a people to suffer the loss of money in silence, Americans are demanding to know what happened to them. The truth is simple: There was a boom.

A boom is a phase of accelerated prosperity. For ignition, it requires easy money. For inspiration, it draws on new technology. A decade ago, farsighted investors saw a glorious future for the personal computer in the context of the more peaceful world after the cold war. Stock prices began to rise -- and rose and rose. The cost of financing new investment fell correspondingly, until by about the middle of the decade the money became too cheap to pass up. Business investment soared, employment rose, reported profits climbed.

Booms begin in reality and rise to fantasy. Stock investors seemed to forget that more capital spending means more competition, not less; that more competition implies lower profit margins, not higher ones; and that lower profit margins do not point to rising stock prices. It seemed to slip their minds that high-technology companies work ceaselessly to make their own products obsolete, not just those of their competitors -- that they are inherently self-destructive.

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Booms not only precede busts; they also cause them. When capital is so cheap that it might as well be free, entrepreneurs make marginal investments. They build and hire expecting the good times to continue to roll. Optimistic bankers and steadily rising stock prices shield new businesses from having to show profits any sooner than ''eventually.'' Then, when the stars change alignment and investors decide to withhold new financing, many companies are cash-poor and must retrench or shut down. It is the work of a bear market to reduce the prices of the white elephants until they are cheap enough to interest a new class of buyers.

George Soros Lectures

I finally got around to reading the transcripts from the lectures given by George Soros at the end of October. They certainly made me think.

Link to the five-part lecture series:

George Soros: Open Society,

the Financial Crisis, and the Way Ahead

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