Friday, February 13, 2009

Buffett's Bullish Advice a Bunch of Bull?

While a prudent student of finance ought to be skeptical of expert "advice" (after all, anyone willing to tell you their strategy is likely to gain on their own investments by doing so) Warren Buffett has long been a staple of the American investing community and has been considered an expert for decades. If you didn't know what to do, it couldn't hurt following Buffett's advice, or, if you had the means, investing alongside him directly. Then again, that's the same way many people felt about Bernie Madoff.

Buffett announced in mid-October that he was investing heavily in U.S. equities, particularly the stock market. He rationalized his contrarian move by quoting one of his principle investing philosophies: "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful."

Not convinced? You shouldn't be.

Buffet had another tidbit of investing advice which he imparted on us back in 2001: When the relationship between the stock market's value as a percent of U.S. GNP is close to 70%, it's time to buy.

If you bought in 2000 right before the tech bubble burst, when this ratio was 190%, you got murdered; Likewise in late 2007 when the stock market reached its peak of 14,000. But look at the chart historically before 2000 and his target ratio doesn't hold water. In 1929, the ratio was around 75%. I wouldn't exactly call the eve of the Great Depression a good time to buy. In 1972 the ratio was also around 75%, only to dip below 50% a year later. Considering the ratio has never been below 40% in the 85 year history of the Dow Jones, I would say 50% is a much safer threshold.

After all, does anybody really believe that now is a good time to invest heavily in the stock market as opposed to waiting a few more months? After all, Buffett invested heavily in October, and the Dow has slid an additional 10% since then. Some analysts suggest that the Dow could easily dip below 7,000 before we see a sustained turnaround.

If Buffett ends up being wrong about his timing, its a minor blip on his financial radar screen. If you end up being wrong, you might lose your house....that is of course if you haven't lost it already.

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