Is Choosing Appreciation over Dividends Risky Business?
Board: Macro Economics
Warren Buffett was Charlie Rose's guest for the first portion of the September 30, 2011 show.
A couple of highlights:
In response to a question about the European Union, Buffett said the root problem Europe faces is that it attempted to bring multiple economies together without a common economic culture and budgeting process. (Not exactly a novel thought...) He then said the only cure is to either iron out those variances in budgeting control and economic policy or disband. Rose didn't exactly press him on which one he thought was more effective or likely but Buffett's tone seemed to make it clear he thought at some point the Euro experiment would fail.
Rose asked Buffett what he saw in 2010 when he unwound most of his positions in assets exposed to the Euro crisis that no one else saw. Buffett said the 2010 situation for the Euro was very similar to the domestic situation in 2006. It's not like we were totally caught unaware about what happened in 2008. Even in 2006, "Everybody sorta saw it..." Basically, many people came to the same realization at the same time but once they realized how out of kilter the system had become, many basically said to themselves, "well, no one predicted we could survive at this point so maybe the system won't totally crash to a halt, maybe when things go wrong it will just slow down and give me a chance to get out."
On another topic regarding individual and corporate taxes, Rose asked if a reduction in corporate tax rates (one-time or permanent) would actually encourage firms to "repatriate" over-seas profits back to America. Buffet's response addressed two key macro concepts:
1) any encouragement to return profits back to the US resulting from a lower tax rate might be counter-balanced by the increased incentive to try the same thing again -- outsource MORE production overseas at lower wage rates and bring it back again
2) the main reason firms are accumulating HUGE stockpiles of cash is that a) big business is actually doing quite well and b) regardless of whether the dollars are earned here or overseas, businesses are NOT identifying any NEW avenues of investment in which to "spend" those profits -- it's not uncertainty over taxes or regulation, IT'S A LACK OF DEMAND.
Earlier in a discussion about housing, one of them cited a statistic that said at the peak of the housing bubble, America had nearly $22 trillion "invested" in housing. When asked how long the housing "hangover" of inventory homes would last and continue weighing down the economy, Buffett responded that the only way the hangover will abate is by the number of households producing the demand rising to a point to absorb the current inventory glut. Again, DEMAND (or lack thereof).
Pretty obvious point.
Maybe the larger point is not so obvious. There are circumstances in which it is possible for all of the following to happen simultaneously:
* local aggregate production / demand remaining flat
* high unemployment contributing to reduced demand and downward price pressure
* communication technology, outsourcing (off-shoring) and high unemployment producing flat / downward wage trends
* high corporate profits
The key is for the downward pressure on wages to outweigh any drop in demand produced by the high unemployment. Firms making goods that either sell to segments of the economy not affected by job losses or amount to essentials (gas, electric, basic communications) can continue to do well. Firms selling goods and services that are first on the mental "cutting block" for those facing reductions in income will have a very rough go of it and certainly won't expand production or employment.
That's exactly the situation we're in now. Virtually zero GDP growth, virtually zero job growth as a function of the population, flat or falling wages and a few large companies making huge profits and accumulating piles of cash with no where to invest -- they can meet demand with the people and equipment they have.
And that's the "sorta saw it" takeaway... Equity investors focused primarily (or exclusively?) on growth through stock price appreciation rather than dividends may expose their nest egg to a great deal of risk with little upside for the foreseeable future.