A 31-Year Old Buffett Discusses the Stock Market

Posted on Posted in Warren Buffett

I came across this video that I’ve never seen before. It’s a video of a young 31-year old Warren Buffett giving an interview to a journalist about the stock market decline that occurred in the first half of 1962:

Buffett’s comment at the very beginning of the video regarding President Kennedy’s “actions on steel” referred to this press conference on April 16, 1962.

Basically, JFK announced that the Department of Justice was opening an investigation into the pricing strategies of the major steel companies. Steel prices and steel company profit margins had been rising despite excess capacity, lower input prices (steel scrap and coal), stable labor costs (according to the BLS). Steel company dividends exceeded $600 million in each year between 1957 and 1961. These facts, along with the 100,000 steel workers that lost their jobs in the three years leading up to 1962 was too much for the populist president to take.

I haven’t investigated this, but I wouldn’t be surprised if the steel industry made more money in 1961 than it did in most years of the recent decade or two.

The Difficulties of Investing in Highly Regulated Businesses

Buffett just referenced the steel industry, and although he has made investments in cyclical businesses at times, he has often talked about the headwinds an investor faces when doing so. JFK’s 1962 press conference is an example of one such headwind that recurs over and over again in highly regulated industries.

I heard someone talking about the cyclicality of the airline business and how regulators and lawmakers are constantly trying to balance the opposing desires of customers (who desire low prices) and airline companies (who desire high profitability). Throw in a third party with a third desire (labor unions who desire higher wages) and you have a never ending tug-of-war.

Regulators and lawmakers generally desire to pass legislation designed to keep prices low for consumers, which has the side affect of curbing airline revenue–often to the point at which airlines collectively lose money. Inevitably, it dawns on the bureaucrats that it’s good to have airlines around, and so mergers are allowed and airlines are once again allowed to make profits. For a time the airlines are allowed to make money, but inevitably the profits once again attract the attention of the lawmakers and regulators (not to mention labor unions), who begin looking for ways to tilt the scales back in favor of customers, and the cycle repeats.

The same cyclical battle between lawmakers (who supposedly have a proxy for consumers) and corporations (who supposedly want to make money for their owners) have existed since the days of John Sherman and more specifically, since 1909 when the Justice Department sued John D. Rockefeller’s Standard Oil Company for running an illegal monopoly.

Halfway in between that time and now, JFK was griping about the excess profits and dividends that the US steel industry was making, and he vowed that the Justice Department and Congress would do something about that.

1962 Stock Market Decline

According to Buffett, the JFK press conference precipated the stock market decline (which was presumably top-heavy with steel companies at the time).

However, Buffett seemed a) like he couldn’t care less, and b) like he had no idea where the market would go next.

His apathetic attitude toward general stock market prices should be put into context. Interestingly, in 1962 the Dow dropped from a high of 731 to a yearly low of 535 (a decline of 27% in the span of a few months)! And everyone was panicky over the 12% decline we just had over the summer…

I went back and looked at the history books, and it appears that the Dow had dropped 15% or so when Buffett gave this interview and then went on to drop another 10% for a total top to bottom drawdown of more than 25%. The 1962 Dow rallied strong to close the year down 7.6%. Buffett meanwhile finished the year up 13.9% after being down 7% at the halfway point, a result he was quite pleased with given the sizable margin he achieved over the market.

Although the interview is very brief, it provides a glimpse into how Buffett thought about stock price movements even in his early days. I don’t think much has changed for him, as 53 years later he again is talking about how macroeconomic and geopolitical events (like the horrific terrorist attack this weekend in Paris) do not influence his investment decisions.

But, I started the post with a point about the difficulties of investing in highly regulated businesses. I would say that it helps to think independently, and I would never say never (after all, one could argue that airlines have provided some of the greatest returns over the past four years), but I think as a rule of thumb, it’s helpful to consider why Buffett has often guided investors away from investing in these cyclical businesses.

There are probably easier places to make money.

6 thoughts on “A 31-Year Old Buffett Discusses the Stock Market

  1. Hi John,

    I can’t say I’m convinced that a regulated industry is as simple as “good” or “bad.” For example, banking is an industry that you and I are invested in that is highly regulated but has delicious economics. Of course, Buffett is also invested in it.

    In my view, regulation is “good” for a business that has a moat and “bad” for a business that doesn’t (this is, by the way, the same way Buffett views technology). Banking has one of the longest histories of regulation, which has been persisting and unrelenting. The end result? Persistent consolidation within the industry. From FDIC data: between 1934 and 2014, the total number of banking institutions decreased from 14,146 to 5,646. The underlying driver of this has been regulatory costs being uneconomic for smaller banks, and heightened barriers to entry. The bigger banks get an advantage in that regulatory committees offer scale. Yet, despite increased regulation, excess returns have been generated for shareholders.

    Mr. Buffett has also made it very clear he doesn’t care about cyclicality, as long as there are excess returns generated to shareholders over the long run.

    The contents of this post are terrific, and you’ve clearly outlined your thinking, but I’m going to have to disagree with you on this one.

    Respectfully,

    J

    1. Those are good points. And as I said at the end of the post, I would “never say never” when investing in cyclical businesses. I think of banking as much less cyclical than the regulated businesses in the commodity space, but yes, there are extreme opportunities in cyclical businesses. Airlines in 2011 after the merger boom is one example. They have produced excess profits for years now. I have my doubts whether this continues for the reasons I laid out in the post, but it has certainly been a boon for investors in recent years. Steel is a business that is very cyclical. Banking is a business that is highly regulated, but as I pointed out in my last post on WFC, I think banking is a great business, and I agree with your point about regulation creating a moat for the bigger businesses. Thanks for reading!

    2. Hi J.,

      I see two large differences between banking and airlines that distinguish their situations. First, airlines are capital-intensive. Second, airlines are easy to understand and therefore easier to regulate, both in fact and politically. (The fact that the cost that the public sees is hundreds or thousands of dollars does not help their reputation with the average voter, whose vague impression of profitability is driven by such numbers.) A possible third difference would be the fungibility of the stuff of their profit. Airlines have only one way to operate, while banks can respond to regulations with many accounting and operational moves (a la the “Dutch sandwich”) by directing capital elsewhere. What I mean by this, I suppose, is that banks are certainly regulated, but that the Byzantine yet fluid nature of the business lends itself to regulation much less than does that of airlines (or automobiles, or computers, or refining, or any other necessary technological commodity).

      Parenthetically, I would add that the nature of consumer products like Coca-Cola would similarly be regulatable, but they cost so little to the customer that there’s no populist push to do so, and regulators would probably feel a bit silly regulating something that seems so unimportant.

      1. Thanks for your responses. Matt I think you’ve misunderstood me: I believe there are many differences between banking and airlines. What I’m saying is that regulation and cyclicality, in and of themselves, are not primarily important to the economics of an industry. You’ve mentioned several factors of airlines that make them generally a poor business independent of regulation. To address your parenthetical, there have been attempts at regulating sugared beverages with a “fat tax,” so Coca-Cola is not immune to regulation either. But that’s not my point. My point is that regulation and cyclicality are secondary considerations.

        To address some comments you two have mentioned about the airline industry. I am perhaps a bit more skeptical that the boon to airlines is sustainable. The biggest cost in the industry is fuel (even bigger than labor). In 2000, total fuel cost was $15.1B. It peaked in 2008 at $54.9B. Since then, it has been on a steady decline until it plummeted this year to $24.3B. So I’m not entirely surprised that since 2008 the profits seem to be pointing directly upwards. But, in my view, people are assuming the airline industry is profitable when in fact it’s a change in commodities that’s driving it.

        Delta Airlines is the oldest operating U.S. airline, founded in 1924. On September 14, 2005, they filed for Chapter 11 bankruptcy. By the way, it’s no coincidence that bankruptcies occur during rising oil prices. From Delta’s inception until bankruptcy they had retained earnings of -$14.4B. After emerging from bankruptcy on April 30, 2007, they have retained earnings of $6.7B. Hardly anything I would call impressive.

        In fairness, there are certain airlines that have done well over time. Southwest airlines, with their novel point-to-point model of operation, and Ryanair with their barebones model have done well. But that is because their business models have succeeded in spite of poor industry economics.

        By the way, ironic to the thesis of John’s post, regulation was what protected the airline industry. Prior to 1978 airlines were given government-dictated monopolies over particular air routes. Much like utilities, they agreed to fixed profitability in exchange for monopolies. After deregulation the industry went in a downwards spiral. There was fierce competition for different routes, and the incentive to sell an incremental seat was incredible because fuel is more or less a fixed cost. Prior to deregulation, there were no major airline bankruptcies in the United States. In the period following deregulation, from 1979 to 1991, there were 29 major bankruptcies. Then there was a quiescent period from 1991 to 2002 (surprise, surprise. The 90s was a period when oil prices dropped).

        In my opinion, an investment in airliners is playing with fire. If someone held a gun to my head and forced me to pick one, though, I’d go with Southwest Airlines or Ryanair.

        I get that the purpose of John’s post isn’t to suggest that airlines are a great business, so I won’t ramble on about this. It was brought up, however, and I’ve studied airlines for some time now and am left underwhelmed. On the contrary to the suggestion that regulation can destroy an industry, airlines actually serve as a great example of one that thrived under heightened regulation.

        Keep up the good work. If you want to discuss more about the industry in private please send me an e-mail at jathinb@gmail.com

        Regards,

        J

  2. Hi John,

    Thanks for posting this; it’s absolutely fascinating to see and hear him back then. I can now almost imagine his meeting with Charlie Munger only three years before this, or his early work with Ben Graham a decade or so earlier. I’m only sorry there isn’t more of the interview online (if more was taped). Perhaps more early interviews will be dug out of archives and such. I sure hope so.

Leave a Reply

Your email address will not be published. Required fields are marked *