To Make Money, You have to do Better than Warren

It is almost blasphemous to even think that you can do better than Warren Buffet, perhaps the best investor of all times. But if your portfolios are down and you wish you had Warren's skills, you would not be much better off. Right up to mid September, the year to date performance of the DOW and Berkshire Hathaway (BRK.B) was nearly identical, down by about -16%. Then the word came that big banks and brokers were in trouble and BRK zoomed higher while DOW tanked. As of the end of last week, DOW is down over -30% while Berkshire has recouped some and is down only -17%. Of course, if you were lucky enough to hold some bonds and cash (which most of my clients do), the performance was nearly the same. By the way, this happens most of the time; when markets drop people park their money into Warren's care.

But the point is, even Warren would not have spared your loss, at least up to this point. If the rout continues, it is quite likely Warren will keep getting money from losing investors and will keep outperforming. Note however that the reversal in Berkshire shares is also swift, i.e. if for some strange reason there is a market rally, people will ditch Warren and pile into the DOW.

So to make money in this market you will have to outdo Warren. One way is to get out to of the market altogether and wait for the wind to blow over. A better way is to do what he is doing, i.e. buy preferred shares in the same or similar companies like Goldman Sachs, US Bancorp and GE. In Canada, you could buy pref's from the banks like CIBC, Royal, BNS, TD and National.

What are the odds of you beating Warren? Not great, given that he is best. The best strategy is to follow his words not his stock, i.e. buy when others are selling like he is doing NOW.

What to do in a Market Meltdown?

In my 30 year investment career, I have seen several meltdowns; some rapid crashes like the ones in 1987 and 2001 (following the 9/11 attack) and slow torturous declines like in the late seventies due to inflation and in the early nineties caused by the last real estate collapse in North America. Some of these were local problems in America or Asia (1998 currency crisis) while others were global. In several of these, the problems were likened to the 1929 crash followed by a depression. The most ironical example of this was a book written by Prof Ravi Batra, "the coming depression of 1990". The wise Prof followed his own medicine and sold his NY condo for $200K in 1990 and moved to a rental. His Condo recently sold for over $2.5 Million. Similar calls are being made today.

I too was shaken out of some of my positions during some of these; like the Multi Unit investment real estate I held, had to be liquidated to balance my debt equity ratio back in 1994 and disposed of Nortel at around $48 in 1998 before it went up to over $120 in 2000. Some of these turned out to be a fortuitously good decision like Nortel but majority of selling after a market has collapsed, was simply a bad idea.

My lesson was simply that given time assets you hold will come back and go higher as long as they can avoid bankruptcy.

So, today I go through my portfolios again and again and ask the question whether the holdings can last the down cycle. If yes, I hold. If doubtful I sell and hold on to cash until there is good reason to buy. There is no scarcity of things to buy, like Warren Buffet has declared by spending his hard cash into the likes of General Electric, Goldman Sachs and Constellation Energy. First two of these are also on my buy list and so are Caterpillar, 3M, Deere, Exxon, to name just a few. But the real opportunity lies in income producing preferred shares and bonds as there is considerable market inefficiency in this group due to credit concerns. These can yield as high as 8% while government bonds offer less than 4%.

700 Billion Doesn't Buy You Much

Yes, the market as represented by Paulson and Bernanke wanted 700 billion to thaw out the frozen credit market. They did get it albeit a few days and a couple of failed institutions like WaMu and Wachovia later. So, why did the market actually go down further?

It would be presumptuous of me to give you an answer as there are hundreds of explanations out there and I would have to pick one. The problem is that the stock market is an illusion, a show based on all of those factors. Here is a list of reasons;

• 700 billion isn't enough, lack of funding is not the problem,
• bad banks will fail no matter how much money you throw at it,
• a bigger problem may be lurking out in Europe where there is no concerted bail out fund,
• stock market has less to do with failing banks and more with the upcoming slow down in the global economy,
• even the developing world like China, India and Russia is slowing down which means there will be less income for the companies like GE, Caterpillar, Deere, JNJ and so on,
• US unemployment is rising and
• there is a good chance Obama will be the president and he would raise taxes making it difficult for the stocks to rise.

I think it is all of the above. I only wish I had known this yesterday or day before but then I wish I had the winning numbers for the $35 million lottery ticket as well.