As central banks fight inflation, retail investors should think and act like Buffett and Munger

BILLIONAIRE investor Warren Buffett and his business partner Charlie Munger had harsh words during Berkshire Hathaway’s most recent annual general meeting for the way Wall Street firms encourage excessive risk taking when the market is hot.

“Wall Street makes money, one way or another, catching the crumbs that fall off the table of capitalism,” Buffett said, during the meeting held on Apr 30. He added: “They make a lot more money when people are gambling than when they are investing.”

Munger specifically took aim – and not for the first time – at online brokerage platform Robinhood, criticising it for having promoted “short term gambling” among small-time investors. “It was disgusting,” he said.

The comments from Buffett and Munger – who are chairman and vice-chairman of Berkshire Hathaway, respectively – did not surprise me in the least.

But the response from Robinhood did.

“It is tiresome witnessing Mr Munger mischaracterise a platform and customer base he knows nothing about,” said a spokesperson for Robinhood, in a statement widely quoted by news outlets.

“He should just say what he really means: unless you look, think, and act like him, you cannot and should not be an investor,” the spokesperson added.

Robinhood is perfectly justified in defending itself. And, Munger was kind of asking for it.

But Robinhood’s assumption that its “customer base” is some new group of investors misunderstood by the likes of Munger – or any other long-time market watcher – seems rather self-serving.

Retail investors were participating in the market long before Robinhood came along.

Some of these investors have a lot of experience, but many of them do not. As a group, they are arguably less savvy than professional money managers. And, they often become active when markets move dramatically.

This column highlighted back in July 2020 that retail investors in Singapore and across the world were big buyers when stock markets tanked at the onset of the pandemic. Retail investors in the United States also had a field day with meme stocks such as GameStop and AMC Entertainment.

Then, there was Bitcoin and other hot cryptocurrencies, which customers of Robinhood are also able to trade via its platform.

With the US Federal Reserve now aggressively raising interest rates and reducing the size of its balance sheet, global asset prices are under pressure.

The S&P 500 index was down nearly 21 per cent in H1 2022, which is reportedly its worst H1 performance since 1970. The Nasdaq 100 was down an even steeper 30 per cent. Bitcoin has fallen about 60 per cent.

As for Robinhood, its shares declined 54 per cent during the first 6 months of 2022. The loss-making company, which went public only last year, is now trading 78 per cent below its IPO price and is speculated to be a takeover target for privately held cryptocurrency exchange FTX.

Expect bear rallies

Many retail investors might now believe this to be an opportune moment to jump into badly beaten down stocks. China stocks, in particular, have been charting seemingly promising rebounds over the past couple of months.

Since the end of April, the CSI 300 index has climbed more than 11 per cent while the S&P 500 has fallen more than 7 per cent.

The Hang Seng Tech Index – which includes stocks such as Alibaba, Meituan, Tencent and Xiaomi – is up nearly 9 per cent during the same period.

The Nasdaq Golden Dragon China Index – which comprises US-traded China stocks – also seems to have regained its footing after massive volatility earlier this year, rising more than 20 per cent since the end of April.

By contrast, the Nasdaq 100 Index was down nearly 10 per cent during the same period.

The strength that China stocks are displaying comes after a long period of weakness, though. Even after their recent rebounds, the CSI 300 Index is more than 14 per cent below where it was at the beginning of 2021 while the Nasdaq Golden Dragon China Index is down more than 48 per cent.

The way I see it, China needs to lift its Covid-19 restrictions for economic activity and corporate earnings to really take off. But it is likely to face the same inflationary pressures as the rest of the world when it does.

The bottom line is that there may be intermittent bear rallies in the months ahead, but tightening monetary policy by major central banks will be a significant and persistent headwind for global markets.

Opportunities to come

This brings me back to Buffett and Munger, and how Berkshire Hathaway became the US$600 billion company it is today.

Berkshire Hathaway said in its most recent annual report that the market value of its stock grew at a compounded rate of 20.1 per annum from 1965 to 2021. This was nearly twice the S&P500’s return of 10.5 per cent per annum.

The story of how this was achieved is well known. Berkshire Hathaway invests in high quality businesses at reasonable prices.

What is a high quality business? As summarised in an episode of the Mark To Market podcast last year, it is a business with durable competitive advantages and robust profit margins that does not require much capital expenditure to keep growing.

This sounds simple enough. Yet, retail investors tend to get most excited about barely profitable companies in fast-growing sectors – such as e-commerce and electric vehicles. They often also lose interest in great companies just as they begin spewing cash.

Berkshire Hathaway’s purchase of its stake in Apple – one of its most significant moves over the past decade – is instructive.

It only began accumulating Apple shares in late 2016, when many people might have thought Apple’s best growth years were behind it. After all, this was 9 years after the first iPhone was launched and 5 years after Steve Jobs had died.

Yet, it was a very profitable move. In its 2021 annual report, Berkshire Hathaway listed the market value of its 5.6 per cent stake in Apple at US$161.2 billion, versus its cost of US$31.1 billion.

Buffett said in his 2020 annual letter to shareholders that Berkshire Hathaway had been collecting dividends from Apple that averaged US$775 million per year.

By the time central banks get inflation under control, investors will probably be presented with a wide range of interesting opportunities to deploy their funds. And, regardless of what their brokers might say, it will probably serve them well at that point to think and act exactly as Buffett and Munger would.