QUALIPORT
Buffett: Making Fortune Tellers Look Good

By Maynard Paton (TMFMayn)
January 8, 2001

Carburton Street, London -- In my book, one of the most pointless exercises within equity investment is predicting the direction of the stock market. It really is a mug's game.

Trouble is, given the current time of year, and especially with the recent cut in US interest rates, no end of pundits feel qualified to give their opinion on the how the market will perform in 2001. Fools should read our New Year Share Tip before swallowing any of those year-end forecasts published over the past weekend or two.

Buffett in Fortune

But that's the short term. What about the long-term direction of the market? While many commentators venture their thoughts on the shorter term, few, if any, will give their view on the long term. However, Warren Buffett has occasionally expressed his stock market thoughts for the years to come.

Buffett's latest market musings were published in Fortune in November 1999. Here are the significant paragraphs from that article, summarising his somewhat bearish stance:

"I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like -- anything like -- they've performed in the past 17."

"The increase in equity values since 1981 beats anything you can find in history. This increase even surpasses what you would have realized if you'd bought stocks in 1932, at their Depression bottom -- on its lowest day, July 8, 1932, the Dow closed at 41.22 -- and held them for 17 years."

"If I had to pick the most probable [long-term future] return, from appreciation and dividends combined, that investors in aggregate -- repeat, aggregate -- would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more."

Buffett's estimate of an average return of 6% for US equity investors over the next seventeen years has worried a few Fools, given that equities have historically returned around 12%. But will Buffett be proved right on this 6% prediction?

An earlier bearish warning

To help judge Buffett's form, it's worth looking back to an earlier attempt at predicting long-term market returns. His only (as far as I'm aware) other market forecast was given in his Shareholder Letter of 1992. Here are the important paragraphs, with Buffett, once again, delivering a familiar bearish tone:

"The third point [concerning this year's performance] incorporates two predictions: Charlie Munger, Berkshire's Vice Chairman and my partner, and I are virtually certain that the return over the next decade from an investment in the S&P index will be far less than that of the past decade..."

"Making the first prediction goes somewhat against our grain: We've long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children. However, it is clear that stocks cannot forever overperform their underlying businesses, as they have so dramatically done for some time, and that fact makes us quite confident of our forecast that the rewards from investing in stocks over the next decade will be significantly smaller than they were in the last."

So, how is that ten-year S&P 500 prediction looking at the moment?

Buffett's above comments were written on March 1st 1993, a day when the S&P 500 closed at 442.01. Exactly ten years prior, the S&P 500 closed at 150.88. The performance during the intervening years equates to a rise of 2.93 times, or an average annual growth rate of 11.35%.

Now remember that Buffett declared back in March 1993: "...the rewards from investing in stocks over the next decade will be significantly smaller than they were in the last." He didn't say "equal to" or "slightly less".

With that in mind, it's quite surprising, with Buffett's experience and all, to discover that he got his 1993 forecast badly wrong. As at last Friday's close, the S&P stood at 1298.35. Over the seven years and nine months since Buffett's remarks, the S&P 500 has increased 2.94 times, equating to an average compound return of 14.93% over that time.

Thus, consider those investors who opened an S&P 500 index tracker in March 1993. They could liquidate their investment today, then put the proceeds under a mattress until March 2003 and still equal the performance of the preceding decade, a decade that Buffett claimed had little chance of being matched.

And significantly, we're not talking about this S&P index investor cashing in on a select few days to equal that preceding decade either. At any time during 2000, the same investor could have cashed in their S&P tracker, put the proceeds under a mattress for another two or three years and beaten Buffett's "unrepeatable" decade.

He still has time, though...

Of course, there are another two years and three months before we can draw a definite conclusion over Buffett's ten-year prophecy. If we assume that by "significantly smaller", Buffett had expected an 8% average annual return over the ten years to March 2003 (as opposed to the 11.35% average annual return for the ten years to March 1993), we could see the S&P 500 stand at 954 in just over two years' time. That level would mean a 26% drop in the S&P 500 index from today's mark.

But even at this stage of the ten-year forecast, three-quarters of the way in, the 1993 prophecy is not looking one of Buffett's best calls. In fact, after peering at this chart, it has hardly ever looked a prescient projection.

As Buffett commented in his 1992 Shareholder Letter: "short-term market forecasts are poison and should be kept locked up in a safe place". Should we add long-term forecasts too? To a certain extent, Buffett himself has proved his own adage, that of "the only value of stock forecasters is to make fortune tellers look good."

Action for possible lower returns

So let's get back to that 6% projected annual average return from the S&P 500 between now and 2016. After the dreary market performances of 2000 gave Buffett a little credibility to his latest forecast, what should UK investors do, given that the London market is tied to Wall Street?

Well, if you're a fan of index trackers, then the answer is "not a lot". Given that shares continue to outperform all other investments steadily over the long term, there would be no real need to deliberate diverting your regular tracker contribution to some alternative form of investment.

On the other hand, if you are the individual stock picking type, then the answer is the same: "not a lot". Far more important than the analysing the market as a whole, your efforts should be directed towards analysing the prospects and valuations of individual companies. Buffett introduced the aforementioned Fortune article by stating:

"Though I will be talking about the level of the market, I will not be predicting its next moves. At Berkshire we focus almost exclusively on the valuations of individual companies, looking only to a very limited extent at the valuation of the overall market. Even then, valuing the market has nothing to do with where it's going to go next week or next month or next year, a line of thought we never get into. The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts."

Where Next?

Discover how shares continue to outperform all other investments steadily over the long term
Discover why index trackers are the no-brain investment
Visit the Fortune website where Buffett tells of his latest market forecast
Visit the Berkshire Hathaway website for all of Buffett's Shareholder Letters.