Tuesday, May 6, 2008

Even Buffett Isn’t Perfect

"The idea of financial panic -- that has been pretty much taken care of,"
Warren Buffett

“Economy May Face Prolonged Pain, History Suggests”
Greg Ip, Wall Street Journal

Mr. Buffett may be technically correct but that won’t help investors who come to the mistaken conclusion that further economic pain has been averted.

The argument being made in my previous reports and on the blog point to a painful adjustment process that the US and world economy will likely undergo as it suffers through the withdrawal pains of deleveraging. Yes, the panic may be over (for now), but the adjustment is not.

A changed credit creation process will impact the real economy overall (through lower credit availability) but will also hit the Financial sector directly through a changed business model. The originate to distribute model is broken and whatever will replace will very likely not be anywhere near as lucrative as was witnessed over the past decade.

Investment Strategy Implications

The recent return to risk (I say complacency) by many market participants ignores the longer term shifts underway in the US economy. Moreover, in the near future there is a rising likelihood that the US consumer, particularly the baby boomers, will come to realization that their dependence on a rising net worth to provide for a retirement lifestyle that equates to something close to their current lifestyle (replete with high degrees of indebtedness) is no longer valid. Accordingly, a shift away from shop ‘til I drop to saving for that inevitable rainy day will contribute to the transformation of the US economy.

Offsetting the downward economic pressure from a higher saving rate by the US consumer will be an expanded US export market. Global growth, if managed properly by emerging economies (not a guarantee by a long shot), can enable the world economy to navigate through the deleveraging process of the financial industry and a shift to savings by the US consumer.

These factors are what await investors. And they should not be underestimated. Whether another credit crisis shoe will drop will only exacerbate the situation.

The situation is highly fluid. Therefore, the assumptions that the markets and economy are out of the woods seems premature, at best.

As the book title of my recent "Beyond the Sound Bite" guest, Vahan Janjigian, puts it – “Even Buffett Isn’t Perfect.”

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