Charlie Munger: How to Invest During a Recession

You mentioned we're in a big bubble; can you elaborate on that and how is this likely to play out? Well, I think eventually there'll be considerable trouble because of the wretched access; that's the way it's usually worked in the past. But when it's going to come and how bad it will be, I can't tell you. That was Charlie Munger back in February 2022 at the Daily Journal shareholder meeting. He certainly picked it, didn't he? And it looks like he didn't have to wait too long for the considerable trouble to begin.

Year-to-date, the S&P 500 is down 20%, as interest rates continue to rise. In fact, just a few weeks ago we got the latest inflation data from the Bureau of Labor Statistics, which showed that in the last 12 months the Consumer Price Index is up 8.3 percent, with a seasonally adjusted month-over-month increase of 0.1 percent. And while that doesn't sound like a lot, think about this: that's a 0.1% increase month-over-month after factoring in the whopping 10.6% drop in gasoline and 5.9% drop in fuel oil. That's telling.

In fact, when we look at core inflation, which strips out energy and food, that index rose 0.6% in August, breaking the downtrend we'd seen since March. So all in all, despite the headline rate continuing its decline, the underlying core inflation data definitely put a damper on everybody's hopes that this inflationary period is on the way out, and definitely puts to bed the idea that interest rate hikes could have been relaxed. In fact, on that topic, it was just a few days ago that we saw Jerome Powell announce yet another 0.75% interest rate hike, also known as the 75 basis point rate hike. This is what he had to say during the press conference today:

“The FOMC raised its policy interest rate by three quarters of a percentage point, and we anticipate that ongoing increases will be appropriate. We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%. Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.”

Yeah, that doesn't sound like things are going to change anytime soon. In fact, it sounds like we could be in for some interest rate pain over the next year or two. So with that reality so joyfully presented by Jerome Powell, in this video I want to hone in on what you as an investor should expect during an inflationary period, with some help from our good friend Charlie Munger.

The reason Charlie Munger is such a good person to listen to on a topic like this is, well, because he's 98 years old. So he's seen the brutal inflation of the 70s, he's seen the non-existent inflation through the 60s, and heck, he was even alive during the Great U.S. deflation that occurred from 1930 to 1933. Fair to say, he's seen it all. But for sure, the last comparable period to what we're seeing today is definitely the 1970s, and worryingly, Charlie is actually nervous that what we're in right now could end up being worse than what went on before Paul Volcker came in and reset the system.

Take a listen. Steve Caskel writes in on this same subject. He says, “What are your current thoughts on the inflationary environment, and please compare and contrast it to the 1970s when Volcker, after the 70s, took the prime rate to 20 percent and the government was paying 15% on its government bonds? That was a horrible recession that lasted a long time, caught with a lot of agony, and I certainly hope we're not going there again. Conditions that allowed Volcker to do that without interference from the politicians were very unusual. In hindsight, it was a good thing that he did it. I would not predict that our modern politicians will be as willing to permit a new Volcker to get that tough with the economy and bring on that kind of a recession. So I think the new troubles are likely to be different from the old troubles. You may wish you had a Volcker-style recession instead of what you're going to get. The troubles that come to us could be worse than what Volcker was dealing with.”

I find that very interesting; reason being I kind of agree. Now, I'm not going to pretend I'm some political expert because believe me, I'm definitely not that. But I think one thing we've all noticed about politics lately is that everyone has a pretty strong opinion, and these days, literally everything political gets seriously scrutinized. So with political tension so high, yet the chair of the Federal Reserve being a position selected by the president, you could make the argument that it's quite unlikely that anyone that so much as read a book by Paul Volcker will be put in the top spot.

Paul Volcker is, of course, the chair of the Federal Reserve that raised rates decisively to 20% to break the Great Inflationary period of the 1970s. He did throw America into a painful recession by doing so, but ultimately, his decisiveness did rein in the inflation rate. But today, with recessions, stock market crashes, and economic indicators being so politicized, you could definitely argue that the political willpower to act decisively and stop inflation could be absent, as they fear the political side effects of deliberately causing a recession.

What that would all lead to is stagflation, which is what Ray Dalio thinks we will get—a sustained period of inflation remaining higher but economic conditions remaining poor. So, very interesting perspective from Charlie Munger, and hopefully not one we see play out this time around.

Conventional economic theory argues that excessive monetary and fiscal stimulus over the last two years has triggered the highest inflation in 40 years. Do you broadly agree with this thesis? And more importantly, do you think there will be a high economic price to pay as the FED attempts to bring inflation back under control?

“We've done something pretty extreme, and we don't know how bad the troubles will be here, whether we're going to be like Japan or something a lot worse. What makes life interesting is we don't know how it's going to work out. I think we do know we're flirting with serious trouble. Think of how seductive it is: you have a bunch of interest-bearing debts, and you pay them off with checking accounts which you're no longer paying interest. Think of how seductive that is for a bunch of legislators. You get rid of the interest payments, the money supply goes up, it seems like heaven. When things get that seductive, they're likely to be overused, and of course, that's exactly what's happened. COVID happened; the FED printed trillions of dollars, that kicked inflation into overdrive, and now we have to deal with the consequences.

Ultimately, the FED has to raise rates, and when you raise rates quickly, that frequently inhibits economic activity enough to cause a recession. But with that said, let's now turn our focus to how to best handle these economic periods as an investor. And let's be real here: inflationary periods, where interest rates are rising steeply, are really tough for investors. Staying in cash sucks as inflation erodes the value of your dollars, but being invested also sucks because the Federal Reserve puts the clamps on consumer spending and businesses' ability to borrow and service debt, so a lot of companies really struggle.

I mean, the safety of Treasury bonds could be an option, but again, that's nothing really to write home about. So what do we do? How will this all play out? And what's the best advice you have for individual investors to optimally deal with the negative impact of inflation?

Other than owning quality equities, it may be that you have to choose the least bad of a bunch of options. That frequently happens in human decision-making. The Mongers have Berkshire stock, Costco stock, Chinese stocks, a little bit of Daily Journal stock, and a bunch of apartment houses. Do I think that's perfect? No. Do I think it's okay? Yes. The great lesson from the Mongers is you don't need all this damn diversification. You're lucky if you've got four good assets, kids. If you're trying to do better than average, you're lucky if you have four things to buy. To ask for 20 is really asking for an egg in your beer. Very few people can have enough brains to get 20 good investments.

I really think that's a great bit of wisdom from Charlie. Sometimes you just have to choose the least bad option. I like this because it's a callback to Warren Buffett's rule number one of investing, which is: don't lose money. Sometimes market conditions are just not in your favor, and investing can be difficult. So in these times, it's almost worth accepting that we might not hit any home runs, so we shouldn't try and force it.

But what we can do is stay rational, think long term, as the questioner says, stay invested in high-quality equities, and think beyond the next one to two years. And I like Charlie's note to remember that you don't need to be buying and selling a million stocks all the time. All you need to do is find like the four or five golden opportunities over your whole investing career and just stick with the long-term mindset, and over the long run, you'll do just fine.

In the short term, you know, who knows? You might cop an inflationary period and lose 30% during a recession. But as Charlie said, the Mongers own Berkshire, Costco, a collection of Chinese equities, through Lilu, Daily Journal stock, and some apartment houses. Is it perfect? No. In hindsight, could you have made some epic trades and done a lot better? Of course, you could have. But for Charlie, it's a collection of high-quality investments that have proven reliable over a long period of time, and it's good enough for him.

I think nowadays, with copious amounts of stock market coverage in the media and so many publicly accessible statistics and numerous brokers trying to encourage trading activity all the time, most people really do feel like they always need to be doing something in the market. This is something that Charlie has spoken out about a few times already. And I think, particularly at times like this, it can be beneficial to just take a step back and review your portfolio with that classic long-term 10-year mindset.

We have a stock market which some people use like a gambling parlor, and the transactions are the people who love the gambling parlor aspect of the business and those who want to make long-term investments to take care of their old age and so forth. I mean, he modeled that in one market, and it goes out of control because the stock market becomes an ideal gambling parlor activity. If I were the dictator of the world, I would have some kind of a tax on short-term gains that made the stock market very much less liquid and drove out this marriage of gambling parlor and legitimate capital development of the country.

It's not a good marriage, and I think we need a divorce. What we're getting is wretched access and danger for the country, and everybody loves it because it's like a bunch of people get drunk in the party. They're having so much fun getting drunk that they don't think about the consequences. This is serious stuff, but a lot of people like a drunken brawl. So far, those are the people that are winning, and a lot of people are making money out of our brawl.

Overall, I think this highlights that we need to make sure we're not the ones falling into the trap of making rash decisions because we feel like we need to be doing something. Have a listen to this clip that Charlie delivered with absolute savagery more than 10 years ago: “How worried are you by the declines in the share price of Berkshire Hathaway? The difficulties? This is the third time that Warren and I have seen our holdings in Berkshire go down top tick to bottom tick by 50%. I think it's the nature of long-term shareholding with the normal facility attitudes and in worldly outcomes and in markets that the long-term holder has his quoted value of his stock go down by say 50%. In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century, you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get.”

I think that's a great clip. So all in all, we just need to stay rational, think long term, and above all else, avoid being sucked into a rash decision when the odds are against you. If you hold a few high-quality businesses with obvious moats that give them pricing power, then feel free just to go back to sleep until this whole thing blows over or, in the meantime, just sit and watch, waiting patiently in the wings for the short-term focused market to present you with a fantastic long-term opportunity.

And remember this: our old-school Ben Graham valuation methods—they'll never die. You can't—the idea of getting more value than you pay for, that's what an investment is. If you want to be successful, you have to get more value than you pay for, and so it's never going to be obsolete. Think of the past crazy booms and how they worked out: the bubble in the late 20s, so on and so on. We've had this since the dawn of capitalism; we've had crazy bubbles. There's always something going wrong or a bubble forming, but just remember, rational long-term value investing never goes out of style.

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