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The Daily Reckoning | Monday, April 4, 2011 Chris Mayer's take on Berkshire's latest annual letter, The sometimes-brilliance of simply doing nothing, Bill Bonner on out-earning Bernanke Down Under, PLUS, a review of Bill's new book: Dice Have No Memory... ------------------------------------------------------- The Rich, the Smart and the Lucky Demystifying the Legend of Warren Buffett Eric Fry Reporting from Laguna Beach, California... Warren Buffett is a smart guy. Warren Buffett is a rich guy. Most folks assume a connection between the two...and that's probably true. But Warren Buffett is also a lucky guy. Even though luck is not a feature of the officially sanctioned Buffett mythology, good fortune has certainly contributed to his large fortune. Buffett has referred to himself alternately as a winner of the "Ovarian Lottery" and a member of the "Lucky Sperm Club." In other words, he was lucky to have been born in the United States in 1930. But after that, his genius took over. At least that's the myth. He is rich because he is smart. End of story...beginning of myth. Warren Buffett may - or may not - be a genius, but he did at least one very smart (or lucky) thing: He stopped buying stocks when he could not find anything to buy. Buffett operated a partnership from the late 1950s until 1969. During those 13 years that partnership delivered almost a 30% annualized return and made him his first $25 million. And then he just shut it down. He said that he couldn't find any investing opportunities that appealed to him. So he just shut down the partnership and sent the money back. "I didn't know how to be a hero anymore," Buffett said at the time. "I had been a Niagara Falls of new ideas. But I became an eyedropper." Not knowing what to do, he did nothing...and that was brilliant. Much of Buffett's wisdom stems from this one investment trait: when you don't know what to do, don't do anything. Most of the rest of his "wisdom" is just the effluent of a successful guy processing his popularity. Warren Buffet is probably rich because he is smart. But maybe he is rich simply because he was lucky and is not stupid. We'll probably never know. What we do know is that the entire world - including Warren Buffett - considers Warren Buffett an investment genius. The man does not merely tolerate adulation, he relishes and embraces it. Accordingly, the "Oracle of Omaha" regularly dispenses wisdom and witticisms to his adoring public. Berkshire Hathaway's annual report, for example, is famous for its faux-folksy investment observations. To his legions of disciples, each annual letter is a sacred addition to the Holy Writ. To the rest of us, Warren's musings are just that - the musings of a successful investor. Often insightful; always drenched in a "gee-whiz," "aw shucks," tone. Read through an annual letter and you just might feel like you've consumed a marshmallow casserole, topped with honey, maple syrup and brown sugar. Be that as it may, the man knows a few things about investing. Buffett is a legend...and deservedly so. Even if he isn't a genius, he is at least a very successful investor with a lot of miles on his odometer. No matter how nauseating his prose and pronouncements may be, he has some very unique and worthwhile insights to share. Chris Mayer, editor of Mayer's Special Situations, sifted through Buffett's most recent annual letter and extracted a few worthwhile tidbits. Read on... EXPOSED: The Biggest Scam In American History! Mad men drunk on power and driven by greed are robbing YOUR retirement! Most sickening of all, Washington fully endorses this bold-faced assault on your wealth. But Chris Mayer is exposing this scam in his brand new video presentation. PLUS, he'll show you how you could protect and even grow your wealth in spite of this scam, virtually spitting in the face of these elitist thieves. Don't be a helpless victim... Click here to act right now. The Daily Reckoning Presents Cash on Hand...An Investors’ Best Friend Chris Mayer Warren Buffett's annual letter to shareholders came out recently. This is probably one of the most anticipated shareholder letters in the financial world. Everyone wants to know what the Oracle's take on the world is. Also, because Berkshire is so large and spread across so many sectors - it owns 80-plus businesses now - his thoughts may give some insight into how the economy is doing. His letter was the most optimistic letter we've seen in awhile - and maybe ever. Buffett said things such as "There is an abundance of [opportunity] in America" and its "best days lie ahead." Looking at his businesses, you can see from where that optimism might spring. Iscar, which makes metal tools, enjoyed a 41% increase in sales from a year ago. TTI, an electronics distributor, saw sales jump 45%. Burlington Northern, the railroad, reported a 43% jump in profits. And on and on it goes. Forced to pick one indicator to judge the health of the economy, Buffett said it'd be rail car loadings. In 2010, rail car loadings were up 7.3% over 2009, which was the largest percentage increase since we have data (1988). He also offered up the prediction that the housing market would recover within a year. A few of his businesses, such as carpet maker Shaw, are still way below where they were a few years ago. So there you go. The Oracle is optimistic. Now, I've learned a lot from Warren Buffett over the years. Studying his career is a must for investors. After all, he may be the greatest investor of all time. But this cheerfulness doesn't sit well with me. I'm seeing too much of it everywhere. Perhaps Buffett will be right when looked at over a period of years. But in the near term, I see a lot of things that give me pause. Some of these are just unassembled fragments, but consider... The IPO market is off to its best start ever, according to Dealogic. So far, there has been $26 billion raised in new listings. And there is a backlog of $48 billion. So essentially, insiders are selling stock to public shareholders, who, so far, have lapped it up like hungry dogs. Insiders are also selling stock of already public companies at a brisk rate. Insider selling itself is not a profitable signal to follow. In fact, academic studies have shown time and again that insider selling is not a worthy predictive signal. That makes sense because insiders can sell for all kinds of reasons. (This is in contrast to insider buying, which is a profitable signal to follow.) And we did get a very bearish level of insider sales last November, which did not materialize into a market correction of any kind. But it is unsettling, nonetheless. Insider sales outnumber insider buys by a ratio of nearly 40-to-1. Bad. If things were so rosy, would that ratio be so high? Then, there is the surging price of grains and oil. The high price of food is a major destabilizing force in emerging markets, where there are large pools of poor people who spend a great deal of their income on food. When food prices rise 25% in India over a few months, that's going to have an outsized effect. This matters for investors because the market so far has floated on a sea of good earnings. And if you dig into those earnings, you can't help but notice how many companies are reporting wonderful results because of booming business in Brazil or Russia or China or some such place. Emerging markets helped drive earnings. By contrast, the results from the US and Europe and Japan have enjoyed more muted recoveries. I worry that the rising cost of food and raw materials will dampen those results in the coming quarters. So that's bad. So I think it's a good time to be careful. In fact, Buffett had some very good advice in his letter when he started to talk about the effects of borrowed money. "The fundamental principle of auto racing is that to finish first, you must first finish," he writes. Using lots of debt makes finishing iffy. The Oracle continues: "Unquestionably, some people have become very rich through the use of borrowed money. However, that's also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you're clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade - and some relearned in 2008 - any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people." Of course, this math applies to investing in stocks, which is why it is important to look at financial strength and balance sheets, as we do. Maybe we haven't made as much money as we might have in the past two years if we had bet on more speculative, less ably financed companies. But over the long haul, we're following a surer path. (And we've done pretty darn well as it is.) Buffett also writes about a letter he found written by his grandfather to his son in 1939. "Ernest never went to business school - he never, in fact, finished high school - but he understood the importance of liquidity as a condition for assured survival," Buffett writes. Old Ernest gave his son Fred very good advice. He writes: "Over a period of a good many years I have known a great many people who at some time or another have suffered in various ways simply because they did not have ready cash... Thus, I feel that everyone should have a reserve." Buffett says Berkshire customarily keeps at least $20 billion on hand, "so that we can both withstand unprecedented insurance losses...and quickly seize acquisition or investment opportunities, even during times of financial turmoil." It's a good way to run a business. It's a good way to run your personal finances. And it's a good way to run a portfolio. So my advice to you is to keep a cash reserve. As a long-term investor, I might share some of Buffett's optimism. When I look over our names, I see a lot of people doing great things that could create substantial wealth this year and in the years to come. At the same time, I think this market has a little air under it. I would never advocate selling simply because of a guess about the market's direction. Calling tops and bottoms is a fool's errand. But I do know that finding bargains is getting harder. Many valuations are full. Keep a cash reserve so that you are ready to take advantage of new opportunities when we get the inevitable dip in the market. Regards, Chris Mayer, for The Daily Reckoning Joel's Note: Of course, keeping a cash reserve is not the same as simply "doing nothing." There's always plenty to read, plenty of wise old market veterans with secrets to share and tales to tell. As an avid student of market history, Chris is seldom without a dusty old book in front of him. Part of his success as an investor stems, surely, from his encyclopedic knowledge of this market history and of the many lessons to be learned form it...lessons others too-often ignore. One such lesson that ought to entice Fellow Reckoners is the lesson of printing too much money. Chris' review of Adam Fergusson's book, When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany, gives us a great primer on this important and timely subject. If you haven't read it yet, feel free to do so here. Ex-Lawyer Invents Method for Making 1,329% Four-Day Gains in the Market Now you can use his method for the chance at gains like 178% in four days, 369% in 48 hours - even 545% and 1,329% gains in less than a week! Get started right now with this new video presentation. Bill Bonner Falling Unemployment: Blind Optimism in the “Poor” Economy Bill Bonner Reckoning from Delray Beach, Florida... Let's see...what's new? Bloomberg reported last week that thanks to the mining boom, uneducated Aussie crackers earned more than Ben Bernanke. "Travis Marks, a 24-year-old with no college degree, is hitting pay dirt as Australia's mining bonanza fuels demand for workers," says Bloomberg. "Already making triple the nation's average salary, he expects to get even richer... "Marks, who earns A$220,000 ($227,150) a year - more than Federal Reserve Chairman Ben S. Bernanke's $199,700 - is a rigger for a company providing construction and maintenance services to the resources industry. '[This job] is a really good way to get ahead as a young bloke,' Marks said." Well, of course Mr. Marks should earn more than Bernanke. He's not destroying the world's financial system. He's doing something useful. As we've said many times, modern academic economics is a knowledge- subtracting discipline. It's full of bad ideas and misleading theories. The more you study it, the more you know that isn't so. Mr. Bernanke proves it. He's a smart guy. But with so much training in economics he's worth less than an Outback truck driver. But this story has a sunny side to it. Turns out, there's opportunity Down Under. "Prime Minister Julia Gillard said in February the resource industry could be short 36,000 workers in the next four years," Bloomberg continues, "and the government will have to introduce measures to encourage older Australians and parents to rejoin the workforce. She also plans to relax restrictions on skilled migration." Did you see that last sentence, dear reader? Maybe this is part of the answer to America's job shortage - export workers to the sunburnt country on the other side of the world. They just have to learn to wrestle crocodiles and to speak Strine. But let's turn back to the main story we're following: There are now two economies in America. There's the "rich," recovering economy, floating on $2 trillion in excess cash pumped in by the feds. And there's the "poor" economy, with millions of people drowning in all that Fed-fed inflation. But wait, what's this? Unemployment is down to 8.8%. Here's the report: "The unemployment rate fell to a two-year low of 8.8 percent in March," says Bloomberg, "capping the strongest two months of hiring since before the recession began. "The economy added 216,000 jobs last month. Another month of brisk hiring provided the latest sign that the economy is strengthening nearly two years after the recession ended. Still, a surprisingly large number of people who stopped looking for work during the downturn have yet to start looking again. Private employers, the backbone of the economy, are driving the gains. They added more than 200,000 jobs for a second straight month. It was the first time that's happened since 2006 - more than a year before the recession started. "Economists predict employers will add jobs at roughly the same pace for the rest of this year. That would generate about 2.5 million new positions. Still, that would make up for only a small portion of the 7.5 million jobs wiped out during the recession." Well, at least that's progress...but read the next two paragraphs carefully: "A big factor in the lower unemployment rate is that the proportion of people who either have a job or are looking for one is surprisingly low for this stage of the recovery," Bloomberg winds up. "People who stopped looking for work during the downturn are not counted as unemployed. If many out-of-work people start looking for work again, they will be counted and the unemployment rate could go up. That could happen even if the economy is adding jobs." Let's see, the economy has to create 125,000 jobs per month just to stay even with population growth. Even so, this isn't bad. Net, nearly 100,000 jobs to the good. Hmmm... With 7 million officially unemployed...and maybe another 5 million who stopped looking for work...that makes 12 million or so without jobs. If we can sustain this rate - recovering about 100,000 jobs per month - how long will it take for your laid-off nephew to find a new job? Maybe only 10 years! And more thoughts... Here's another thing to be gloomy about: Workers' paychecks were flat in March. Average hourly earnings held steady at $22.87, unchanged from February. Over the past 12 months, wages have lagged behind inflation. In other words, even if you have a job, you're likely to earn less real money. Uh oh... And here's former Labor Secretary, under Bill Clinton, Robert Reich. He says job growth is not likely to continue. Instead, we're headed for another dip into recession. Says Reich: Consumers are 70 percent of the American economy, and consumer confidence is plummeting. It's weaker today on average than at the lowest point of the Great Recession. The Reuters/University of Michigan survey shows a 10-point decline in March - the tenth largest drop on record. Part of that drop is attributable to rising fuel and food prices. A separate Conference Board's index of consumer confidence, just released, shows consumer confidence at a five-month low - and a large part is due to expectations of fewer jobs and lower wages in the months ahead. Pessimistic consumers buy less. And fewer sales spells economic trouble ahead. Add two other ominous signs: Real hourly wages continue to fall, and housing prices continue to drop. Hourly wages are falling because with unemployment so high, most people have no bargaining power and will take whatever they can get. Housing is dropping because of the ever- larger number of homes people have walked away from because they can't pay their mortgages. But because homes [are] the biggest asset most Americans own, as home prices drop most Americans feel even poorer. There's no possibility government will make up for the coming shortfall in consumer spending. To the contrary, government is worsening the situation. State and local governments are slashing their budgets by roughly $110 billion this year. The federal stimulus is ending, and the federal government will end up cutting some $30 billion from this year's budget. ..Watch out. We may avoid a double dip but the economy is slowing ominously, and the booster rockets are disappearing. *** Booster rockets? He must mean the popular QE2 program that expires in June. It's done wonders for the rich - boosting stock market prices and business profits (largely in the financial sector). But it's a curse on the poor and lower middle classes. Gasoline has just registered its highest price ever for the month of March. ABC is on the story: The weekly national average gas price showed the highest price ever during the month of March and the seventh consecutive increase this week, according to the Department of Energy. Prices are at their highest level since 2008, in part because of the Japan earthquake and turmoil in the oil-producing Middle East. But analysts say the price of oil and gas would still hover at a surprisingly high level despite geopolitical concerns. The feds wanted inflation. They got it. Now what? David Rosenberg says that when oil shoots up it always bring on a recession. 1974, the early '80s, '93, 2001 - each of the previous 4 recessions came with a big rise in oil. Regards, Bill Bonner, for The Daily Reckoning Joel's Note: A special thanks to one "long suffering" reader, as Bill likes to say, who visited Amazon over the weekend to pen a few kind words about Bill's new book: Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas. Check it out: "Like P.J. O'Rourke, Bill Bonner has the entertaining ability to make us laugh at the stupidity we humans are capable of in large groups while teaching truths that we seem determined to forget. It is indeed a truth that the only animal capable of learning from the mistakes of others is so reluctant to actually do so. Thus we go round again. "As the Bible teaches: 'Professing themselves wise, they became fools', the sociopaths craving power that rise like pond scum to positions of authority and become the societal cancer known as government can only be exorcised through an informed populace. "Via the hard won truths of history, Mr. Bonner provides that necessary information. Exposing the intellectual dishonesty and moral bankruptcy of the 'wise' men, he delivers the education our government controlled school system totally abdicates - and he does it in a delightful way that will have you impatient for the next installment. "If you enjoy the sarcastic wit of O'Rourke or the finger pointing ridicule of Monty Python, you will love the quite real education Bill provides. We learn that, far from being doom & gloom, the cure for our economic ills is quite simple - shine the light of knowledge and reason through the fog between the ears of authority. "Through his writings, Bill Bonner hands you that flashlight." We couldn't have said it better. Thanks for that.