Charlie Munger: The Stock Market Will Return 0% For Decades
– Warren Buffet's right hand man, Charlie Munger, is well known as one of the legends of investing. Through the Daily Journal portfolio, he outperformed the market
by almost 2000% since 1986. Munger recently spoke
at the Daily Journal's Annual Conference about the serious issues in the economy and the financial markets. This video will explain how Munger is preparing his portfolio to drastically outperform the market in the coming years. In order to understand how Munger plans to make large sums of
money from the economy, we have to analyze the
macroeconomic environment. Due to COVID-19, the Federal
government had to step in to provide support as consumer spending came to an abrupt halt.
There are two different
types of unemployment. U-3 Unemployment tracks
all unemployed people who are looking for a job. U-6 Unemployment is a broader measurement that also includes discouraged workers and part-time workers. In April 2020 U-3
Unemployment exceeded 14% and U-6 Unemployment exceeded 22%. That is a substantial amount, as almost one out of every
four people were unemployed or underemployed. As a result, Congress sent
stimulus checks to the people and provided various lending
facilities and grants to state and local governments. These checks also provided
COVID relief funds that helped businesses. On the monetary side, the Federal Reserve
lowered interest rates, which made it cheaper to borrow. The target interest rate
went from roughly 1.5% at the end of February 2020 to about 0.06% in April 2020. Today that rate is 0.08%, but is expected by everyone to increase. As we'll cover soon, these policies are setting the stage for a terrifying economic crisis. While the Federal Reserve lowered rates, it ramped up treasury bond
purchases in the market place, or quantitative easing. During the pandemic, the
Federal Reserve purchased in excess of $4 trillion of debt, which had the effect of pushing money out into the economy.
M2 is the measurement
of money in the economy, which measures cash on hand,
savings accounts, money market and certificate of
deposits under $100,000. The law of supply and demand eventually found its way into inflation. More money available to everyone led to an increase in the demand for goods, but that alone did not drive the inflation we are seeing today. Munger is keenly aware of the increase in M2 money, inflation and the implications: an asset bubble. The problems tied to the supply chain have also continued to
exacerbate the situation. You have probably noticed the shortage of items in the stores and the price increases of various items such
as consumer electronics. Most of this is due to the inability to get products off the
boats into the marketplace.
The basics of the issues
started prior to COVID, but were pushed forward by the pandemic. The underlying issues are vast. First of all, there is a limited
capacity to offload ships and a lack of chassis
to expand that capacity. The limited number of
truckers that are authorized to work at the ports has declined due to a lack of wage increases. The US warehouse technology, which is behind in
technology compared to Japan, Korea and China also
exacerbated the issue. Similarly, warehouse worker pay has not necessarily kept up and attracting good
warehouse workers is harder. The shortage of warehouse workers has also further constrained supply chains. Ryan Johnson, an experienced truck driver, wrote a post that went viral explaining some of the issues from his point of view.
He likens the current supply issues to a store like Costco or
Walmart having one cashier for hundreds of customers. Truckers like him have to go
through three separate lines for multiple hours on end to then pick up a container to transport it across the country. Goldman Sachs, along with a
few other investment firms, track the supply chain. Goldman recently lowered the
stress to a nine out of 10, with 10 being the highest stress. According to the Marine
Exchange of Southern California and Goldman Sachs, the number of vessels
at the LA port waiting to unload goods has declined to 89 from a high of over 100. That is a significant amount, when you consider that 20 months ago, there were zero vessels. That might sound horrifying, but there may be light
at the end of the tunnel. The expectation for when
this economic problem will be resolved varies, but it seems to be closer to
the end of 2022 to mid 2023. The key here is that essentially
all this pressure results in a lack of supply of goods.
This pressure, in
conjunction with the increase in the money supply, has pushed consumer prices to new highs. The consumer price index
recently accelerated to an annual increase of 7.5%. An important relationship
to understand here is that inflation and
interest rates are linked. In the 1980s inflation soared
to unprecedented heights. Fed Chairman Paul Volker
raised rates numerous times to get ahead of inflation. While the result was a win for the economy in general, increasing rates is usually not a politically favored action. Charlie Munger stated the likelihood of having someone such
as Paul Volker being able to raise rates in today's
political environments as unlikely even though the Fed is supposed to be outside the reach of politicians. He also said this could
lead to new troubles and could be worse than those we saw in the late seventies and eighties.
The late seventies and
eighties were terrible times to invest in the market. From 1965 to 1980 the market returned 0% when adjusted for inflation. Munger is warning of a similar outcome and the market may actually
have negative returns over the next decade. – Well, there's never been anything quite like what we're doing now. And, we do know from what's
happened in other nations. If you try and print too
much money it eventually causes terrible trouble. And we are closer to terrible trouble than we've been in the past, but it may still be a long way off. I certainly hope so. – The first result that we talked about is a decade of high inflation and low inflation adjusted returns for the stock market. There could also be a second outcome that Munger's potentially
even more frightened about.
The Fed obviously does not want a repeat of the 1970s to happen again and has already stated that it will be moving
the interest rate higher. The world's largest Futures
Exchange, CME Group, recently published a report that reviews the market expectations and how accurately investors tend to forecast rate hikes. Currently the expectations are for four to six Fed rate hikes in 2022 and two to three more in 2023. Normally these increases
occur at 25 basis points each. One basis point is 0.01%. So a 25 basis point increase would be an increase of 0.25%. Thus a 25 basis point hike from 2% would result in a rate of 2.25%.
The expectation is for
the target interest rate to end up at 1.625% versus todays 0.08%. In addition to the
increase in interest rates the Federal Reserve is
reducing asset purchases, specifically treasury bonds,
also known as treasuries. Such an action has the effect of lowering the available supply of money. In January 2022, the Fed reduced purchases to $60 billion, which was down $30 billion from December and down $60 billion from November. Note that the Fed is
still purchasing bonds, resulting in increasing the
supply of money in the economy and creating an artificial
demand for treasuries. There would have to be
an equivalent amount of new demand stepping in as the fed reduces its purchases to key price and yields level. This new demand would have
to balance out the lack of bond purchases from the Fed. In order to have a net
zero effect on the market the treasuries would have
to find outside investors adding 60 to a $100 billion
a month to their portfolios.
That is extremely unlikely. Thus, the tapering will also
result in lower bond prices. Bond yields and bond prices
are inversely correlated so that would equate to
higher US Treasury yields. So while the media focuses on the fed increasing interest rates, the tapering of bonds will
also have a substantial impact on bond yields and therefore interest rates as well. Charlie Munger is hesitant to state that the low rate asset
bubble will be popped as a result of the increase in rates. He believes the lower rates were done as an extreme measure during the onset of the COVID pandemic.
The US is flirting with
trouble that will end badly the longer we stay with low
rates and high inflation, especially now that we are past COVID and need to live with it. – Conventional economic theory argues that excessive monetary
and fiscal stimulus over the last two years has triggered the highest
inflation in 40 years. Do you broadly agree with this thesis? And more importantly, do you think there will be
a high economic price to pay as the Fed attempts to bring
inflation back under control? I guess the reasons for it- – Well, the first part I agree, I agree with it. We've done something but, we've done something pretty extreme and we don't know how
bad the troubles will be. Whether we're gonna be like Japan or something a lot worse. And, what makes life interesting
is we don't know how it's gonna work out. I think we do know we're flirting with serious trouble.
I think we also know that some of our earlier fears were, were overblown. – So now that we know that the economy is in serious trouble what should investors do? Munger's bearish on commercial
property in offices, but he recommends owning
stocks in apartment buildings. – The Mungers have Berkshire stock, Costco stock, Chinese
stocks, through Li Lu, a little bit of Daily Journal stock and a bunch of apartment houses. Do I think that's perfect? No. Do I think it's okay? Yes. I think the great lesson
from the Mungers is you don't need all this
damn diversification. That's plenty of.. You're lucky if you've
got four good assets. I think the finance professors and the, that sell the idea that perfect diversification is professional investment.
If you're trying to do better than average you're lucky if you
have four things to buy and to ask for 20 is really
asking for egg in your beer. It's, very few people get, have enough brains to
get 20 good investments. – Contrary to most invest
professional advice in business classes Munger argues that
diversification beyond around four to six investments is not a good idea. While he does not give a specific number he does argue that adding
too much diversification has diminishing returns. His argument is well grounded in Markowitz's Modern Portfolio Theory or MMT in short form. This theory states that adding a stock reduces the swings of the portfolio.
And as you add more stocks the swings become less and less. However, this trade-off is
not historically one to one as each additional investment
has a decreasing impact on the portfolio. Of course, this assumes that each investment is proportionately the same as the others. With 10 stocks each stock
would be 10% of the portfolio. With five stocks each stock would be 20% and with 100 stocks
each stock would be 1%. As you would expect with 100 stocks, one stock doubling would
have minimal impact, but with five stocks one stock doubling would have a much greater impact.
Munger believes that the
current market is ripe with gambling and speculation. As an example, he talked
about the SPAC space, which raises money prior
to having investments. – Well, certainly, the Great Short Squeeze in Gamestop was wretched excess. Certainly the Bitcoin
thing is wretched excess. I would argue that venture capital is throwing
too much money too fast and and there's a considerable wretched excess in venture capital and other
forms of private equity. And so, we have a stock market, which some people use
like a gambling parlor and the transactions of the people who love
the gambling parlor aspect of the business and those who want to
make long term investments to take care of their
old age and so forth.
I mean, model that in one market and it goes outta control, because the stock market becomes an ideal gambling parlor activity. I don't think that ought to
have been allowed either. If I were the dictator of the world I would have some kind of
a tax on short term gains that made the stock market
very much less liquid. And drove out this marriage of gambling parlor and legitimate capital development of the country. It's not a good marriage. And I think we need a divorce. – Other signs that Munger points to, besides the 850 SPACs, include the Great Short Squeeze and high multiple valuations. The S&P 500 is currently trading at a 20 times forward PE based on Bloomberg estimates'
consensus earnings. While this is down from the recent peak of 27 times in August 2021 such frothiness has not
been seen in 20 years. Similarly, the NASDAQ has declined to a 28 times Bloomberg consensus for PE, also down from its recent
December peak of 40 times.
These levels have not
been seen since 2003. Diversification outside the
US could be a positive thing given the current macroeconomic situation. Munger has invested in
China through stocks such as BYD and Alibaba. BYD has been one of Munger's
best picks of all time, which has also led to his
more recent investment in Alibaba. In both this year's and
last year's interview he revealed his reasoning
behind investing in China despite the major risks.
There are many inherent
risks to investing in China, which I'm sure many of you are aware of with the news over the past year. However, Charlie Munger believes that while these risks exist, including regulatory, economic
and delisting concerns, the value is substantially better in China's financial market when compared to the US. – Well, we did it for
a very simple reason. We got more strength per dollar invested. In China the companies we invest in are stronger relative to their competition and priced lower.
That's why we're in China. – Munger went on to state that China and the US have bad tensions, and has stated that it continues to occur because the US does not seem to understand that the variations in
government are appropriate. While China's system and
policies would not have worked in the US, these policies were needed for China. – Well, the Chinese government is worrying all the capitalists in the world, way more than it used to. And of course we don't like that. And we wish that China and the United States got along better. And if you stop to think about it, think about massively stupid both China and the United States have been to allow the existing tensions to arise.
What bad is ever gonna happen to China or the United States if we two are close. If we make good friends out of the Chinese and vice versa who in the hell is ever gonna bother us? 'Course we should make friends with China. And of course we should learn to get along with people who have a different system of government. We like our government
because we're used to it and it has advantages of personal freedom.
China could never have handled its life with a government like ours. They wouldn't, they wouldn't be in the
position they're in. They had to prevent 500
million or 600 million people from being born in China. They just measured the
women's menstrual periods when they came to work and aborted those who weren't allowed to have children. You can't do that in the United States. And it really needed doing in China. And so they did what they had
to do using their methods. And I don't think we should be criticizing China, which has terrible problems 'cause they're not just
like the United States. They do some things better than we do. They should like us and
we should like them. So I'm totally, I think nothing is crazier than people who foment resentment. So I'm either side of that one – Alongside Munger, plenty of top investors have continued to invest in China. Some of these include Ray Dalio, venture capital powerhouse,
Sequoia Capital, and Mohnish Pabrai. Munger believes that the two countries, the US and China, with reasonable honor, will continue to maintain
stable relations, which decreases the risk.
Munger's presentation provides us with a backdrop of his thoughts. Higher inflation, Fed tightening, supply chain issues and stretched valuations and speculation have placed the markets
in a dangerous position. Munger has adjusted his portfolio to survive these macro-economic trends by allocating his funds
to robust companies. His portfolio primarily
consists of five companies. Bank of America, Wells Fargo, Alibaba, US Bank and a south Korean company called Posco. Munger is not a fan of diversification and has chosen these three
companies as his stocks that will succeed over the long term.
Let me know whether you
agree with Munger down below. If you enjoyed this video,
please hit the like button and subscribe, and I'll see you in the next one..
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