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Wednesday, September 22, 2021

Changing your mind

I recently stumbled upon a transcript from the 2013 Berkshire Hathaway meeting. It is in response to the Stock Market Capitalization to GDP indicator, which Buffett had used in 1999 to state that the stock market is overvalued. 

Here’s the transcript:

In 1999, Buffett said that corporate profits are 6% of GDP in the US and that is not sustainable. Today, corporate profits are 10% of GDP (including profits generated outside the US by US corporations). Buffett said that over the last decade business has come back much stronger than he expected in terms of profit [is it because Buffett did not anticipate the gains technology can add to a firm’s profitability?] but employment has lagged behind. 

Munger’s response to the relationship between GDP and corporate profits was, "just because Warren thought of something 20 years ago, it does not become a law of nature. There is no natural correlation between the two [GDP and corporate profits]"

This is just fascinating. Basically, Buffett and Munger end up destroying their best ideas as they keep learning. This is why they have been so successful, and have managed to adapt to changing market conditions for 50 – 70 years.

They’ve also managed to adapt to an environment where they managed a few hundred thousand dollars in the 1950s to an environment where they manage hundreds of billion of dollars in 2020s.

They’ve done that by unlearning old ideas, and learning new ideas, after careful observation of their environment.

I will include a few other quotes on the topic, which I have found to be helpful:

Winston Churchill once said to a woman berating him for changing his position, “When the facts change, I change my mind. What do you do, madam?”

Charlie Munger has stated that: “Any year that you don’t destroy one of your best-loved ideas is probably a wasted year.”

It looks like the most difficult part of investing is unlearning.

Contrast this to perma-bears, who have been forecasting doom and gloom for years. In fact, many perma-bears have used the Market Capitalization to GDP as a reason to sell US stocks for over a decade. As a result, they missed out on one of the biggest and longest bull markets in US history.

Anyone that listened to them has missed out on one of the greatest bull markets in US history – the one since 2009. Many are still using this as an excuse to avoid US stocks. This goes hand in hand with folks who are proclaiming that stocks are in a bubble, by looking at Schillers CAPE. This indicator has been bearish on US stocks for decades as well. I would argue that investors are better off using forward earnings estimates, in an effort to value equities. The CAPE pays too much attention to past earnings, and also could be facing downward pressure on earnings due to one-time events that only temporarily depress earnings in a recession ( write-offs).

For example, Schiller's CAPE seems very high at 37 today. But it has been at an elevated level for over 30 years.

There was a brief exception between 2009 - 2012.  It was high in 2013 too, when I warned investors about the dangers of CAPE and using GDP to Market Capitalization.

Translation: If you listened to the Schiller CAPE, you would have been out of stocks for most of the past 30 years, with the exception of 2 years after the Global Financial Crisis.

Source: Multipl


People who relied on CAPE would have been out of the market for over 30 years.

By contrast, these are the forward earnings estimates for S&P 500. It looks like S&P 500 is expected to earn $201/share in 2021, and $220.35/share in 2022. At a current price of around $4,500, it does not look as expensive at 22.50 times forward earnings as the CAPE at 37 suggests.


Source: Yardeni

This is the total return performance on S&P 500 since January 1, 1990. If you thought that "stocks are high" for the past 31 years, you missed out on over 2,300% increase in equities. This is the difference between being able to retire and potentially provide for the next generations, and working all your life.

If you are wrong for so long, you should stop and try to understand what happened. That could help in learning from the mistake.

This is a good thing for me to worry about too. 

We all have some ideas that are probably plain wrong. We need to evaluate our investments in a cool manner, in order to identify opportunities for improvement. This is an ongoing process of course. If you plan to invest for the next 30 - 40 years for example, then you need to plan to try and improve over the next 30 - 40 years as well.

This means to keep learning and keep improving over time. A large part of the learning process would be discarding old beliefs, which are proven to be wrong. Holding on to them for too long would be costly.

Relevant Articles:

- These three ideas can jeopardize your investing success

- The work required to have an opinion