Every Rose Has Its Thorn

I want to kill myself for incorporating anything written by Bret Michaels or recorded by rock band Poison into this blog, however, the 80s hair band's biggest hit is simply the perfect analogy for the year that investing's biggest hit, Warren Buffet, just had.

Earlier this month, Buffett, the head of Berkshire Hathaway since 1965, addressed shareholders in his annual letter with not the greatest of news. Like almost every other investor, Berkshire Hathaway lost a considerable amount of money for its shareholders. Berkshire in 2008 lost 9.6% in book value per share, a common metric Berkshire uses to track performance. That marks the biggest decline since Mr. Buffett took over almost 45 years ago.

Berkshire shares fell nearly as much as the rest of the market last year, indicating that investors are worried about the company's ability to keep growing. In 2008, Berkshire's Class A stock fell 32%. This year, the shares are down nearly 19%, only slightly better than the Dow Jones Industrial Average.

Buffett, the proverbial investment rose, surely and self-admittedly did some pretty stupid things. He bought a significant number of shares in oil giant ConocoPhillips when the price of oil was near its record high, only to see the price of a barrel of sweet crude tumble almost $100 dollars a barrel, and Conoco's share prices tumble right along with them. He also invested almost a quarter billion dollars in a pair of Irish banks that hit subprime trouble, which resulted in an 89% loss.

Some wondered if the investment guru's run was over, with his inability to stave off steep losses like the rest of the market. Yet while Buffett certainly has had his thorns the last 18 months, he is still a rose.

He took a $400 million dollar loss when he pushed General Re, his big insurance company acquisition in 1998, to disentangle itself from over 23,000 derivatives contracts it had on its books at the time. Buffett was notorious for claiming in 2002 that derivatives were "financial weapons of mass destruction." He has always thought they were unnecessarily complicated risks, not worthy of taking. While on the surface, a $400 million dollar loss is no prize, first consider what the exposure could have been now had he not begun to take action to unburden General Re of them almost a decade ago. $400 million could have ballooned into a double digit number with a "B" on the end of it rather than an "M." How many other investment managers do you know who had the foresight to avert such a monumental disaster? Buffet knew when to cut his losses, and in this environment, losing less than the next guy is actually perceived as winning.

Which brings Buffett to his next (not so) rosy outlook. Losses have been so endemic and persistent across all investment strategies over the past year, that an incredible phenomenon began to occur in the U.S. Treasuries market. People became so scared of investing, that the mass flock to the security of U.S. Treasury Bonds pushed their yield to zero, and even into negative territory, and yet people continued to invest. It turns out that people would rather take a minor, but guaranteed loss, than risk a much bigger loss in the market, trying to make a gain. Or as Buffett specifically noted himself, "the investment world has gone from underpricing risk to overpricing it," which he said is reflected by investor appetite for Treasury bonds. Future historians will comment on the Internet bubble of the 1990s and the housing bubble of the early 2000s, he said, but "the U.S. Treasury-bond bubble of late 2008 may be regarded as almost equally extraordinary."

Possibly the biggest thing that makes Buffett smell rosy through all of this turmoil is all the work he had done prior to this mess to be able not only to weather the storm, but comeback with ferocity. We all know that in this environment, cash is king. Buffett has $24.3 billion in cash that can be used to find bargains in a distressed market. How much do you have?