Warren Buffett: Stop Listening to Economic Predictions

Given how crazy the economy, the stock market, and even the world has been over the past few months, there is a scary word that is appearing more and more often in headlines and in the news. This word is scary enough for some investors that even just the sound of this word is enough to convince them to sell all of their stocks and run for cover. That word is recession, and it's usually followed in news headlines and YouTube video titles by its close sibling, stock market crash.

In this video, we're going to discuss why Warren Buffett recommends that you should ignore these economic predictions, and who knows? Maybe we should listen to this guy, as he probably knows a thing or two about investing. Let’s listen to what Buffett had to say.

“So, uh, let's start off and talk about, uh, the economy a little bit. Obviously, we've been on a good long run here—a very long run. And yet does that surprise you? What would be the signs that you would look for to see that things were winding down?"

“Well, I look at a lot of figures just in connection with our businesses. I like to get numbers, so I'm getting reports in weekly in some businesses, but that doesn't tell me what the economy's gonna do six months from now or three months from now. It tells me what's going on now with our businesses, and it really doesn't make any difference in what I do today in terms of buying stocks or buying businesses. What those numbers tell me—they're interesting, but they're not guides to me. If we buy a business, we're going to hold it forever. So we're going to have good years, bad years, in-between years, maybe a disastrous year or something here. And, uh, we care a lot about the price. We do not care about the next 12 months. Economic predictions just don't enter into our decisions.”

“Charlie Munger, my partner, I—in, you know, 54 years now—we've never made a decision based on an economic prediction. We make business predictions about what individual businesses will do over time, and we compare that to what we have to pay for. But we have never said yes to something because we thought the economy was going to do well in the next year or two years. And we've never said no to anything because we were right in the middle of a panic, even if the price was right.”

“All right, so you don't pay much attention to the dismal scientists then, I guess?”

“Well, I pay none in the sense of as a guideline to doing anything. It's entertainment. I mean, you know, it's like going to a variety show or something like that. But, uh, and I just don't know of any economist that actually has bought businesses successfully or done well in stocks. Paul Samuelson may know; he was a big shareholder at Berkshire. But, uh, you know, they make guesses, and there are so many variables. I mean, in the hard sciences, you know that if an apple falls from a tree, that it is going to change over the centuries because of anything or political developments or 400 other variables that go in. But when you get into economics, there are so many variables. And the truth is you’ve got to expect good times and bad times in business. If you were to buy an auto dealership and you're, you know, wherever you live locally, or a McDonald's franchise, or anything like that, you wouldn't try and time the purchase. You try and make the right purchase at the right price, and you want to be sure you got a good business. But you wouldn't say, ‘I'm going to buy it because growth this year is going to be 3 instead of 2.8.’”

Knowing what's going to happen in the economy would obviously be helpful for us as investors; however, making economic predictions is not only difficult but almost downright impossible. The best example I have ever heard about the difficulty of predicting the economy comes from Buffett himself. At one of the legendary Berkshire Hathaway annual meetings, Buffett said that most people view the economy as a simple equation. Think back to algebra class for just a brief second. For the sake of this example, let's say we have an equation: x plus y equals z. This is how many people think about the economy. Under these circumstances, if you change one of the variables, you know how the overall equation would be impacted; pretty simple.

However, Buffett argues that instead the economy is a complex equation with hundreds of different variables. These variables are all changing, and it is impossible to change one of the variables without changing the others. That is why it is difficult, and arguably impossible, to know how something will impact the broader economy.

According to Buffett, in order for information to be relevant for investors, it must pass a simple two-part test. Listen to what he has to say. “We try to think about two things. We try to think about things that are important and things that are knowable. Now, there are things that are important that are not knowable, in our view. Those two questions that you raise follow that there are things that are knowable but not important. We don't want to clutter our minds up with those. So we say, what is important and what is knowable, and what among the things that fall within those two categories can we translate into some kind of an action that is useful for Berkshire?”

“And, and we really, there are all kinds of important subjects that Charlie and I—we don't know anything about, and therefore we don't think about them. So we have our view about what the world will look like over the next 10 years in business or competitive situations—we're just no good. We do think we know something about what Coca-Cola is going to look like in 10 years, or what Gillette's going to look like in 10 years, or what Disney's going to look like in 10 years, or what some of our operating subsidiaries are going to look like in 10 years. We care a lot about that. We think a lot about that. We want to be right about that.”

As Buffett puts it, investors must focus on what is: one, important; and two, knowable. He says that in order for a piece of information to be relevant for investors, it needs to meet two simple criteria. First, it has to be important—or, put another way, is this information going to affect how your investment is going to perform? Economic predictions definitely meet this criteria. I mean, who wouldn't want to be able to sell all of your stocks when the economy is great and stock markets are high, and then buy them back during a down economy and a down stock market? I know I would.

But there is a second criteria that needs to be met before you should incorporate that information into your investment process. That information also has to be what Buffett refers to as knowable. This is where economic predictions fail the test. History has shown that economic predictions are rarely accurate, and even some of the best economic minds are not good investors. Since economic predictions do not meet this two-part test, they shouldn’t be included as reasoning for making or not making an investment decision.

But this is the complete opposite of how most investors invest, professional investors included. I even see this at my job as an investment analyst at a large investment firm. Most professional money managers' thought processes go something like this: “I think for whatever reason the economy is going to be strong, so I need to buy ‘growth stocks.’” Or, “I think the economy is going to start to weaken, so I better sell my growth stocks and only buy ‘defensive stocks’ that perform well in a recession.” Or even, “Although I really like this company and think it is selling for a good price, the economy is a little shaky right now, so I’m not going to buy it.”

I’m not exaggerating on this either; this is how many people, professionals included, approach investing. I hope that after listening to Buffett, you now understand why this isn’t the best approach to investing. Buffett has said in countless interviews over the years that the secret to investing successfully in the stock market is to treat stocks as what they really are: little ownership pieces of a business. This means that by definition, when you own a stock of a company, you are essentially a part owner of that company.

Think about some of the business owners in the city you live in or your hometown. What if the owners of the local restaurants, car dealerships, or apartments sold their business every time they were worried about a recession or an economic slowdown? If you own the best restaurant in town that is always full of customers and has a waiting list, why would you sell that amazing business just because some person on TV or YouTube is predicting the economy is going to slow down?

Once you have this perspective, you will see how foolish it is to sell stocks, which again are just little pieces of businesses, based purely on economic predictions. Just because stocks are easier to buy and sell than entire businesses doesn’t necessarily mean you should.

There is another huge downside to this type of investing. That downside is taxes. In most countries, every time you sell a stock for a profit, you are taxed. Here in the United States, if you held that investment for less than a year, the tax rate you pay on that investment can be double what it would be if you had held it for longer than a year. So, if you’re constantly changing your view about the economy and constantly buying and selling stocks, be ready to pay a higher tax bill, assuming you even make money.

So this leads to the question I want to answer for you guys in this video. You may be saying to yourself, “Okay, I get it. Economic predictions are unreliable. So how should we be investing instead?” To answer this question, there are three specific pieces of advice from Warren Buffett I would point to.

The first piece of advice is to focus on microeconomics instead of macroeconomics. Put simply, microeconomics focuses on individual companies and particular industries, while macroeconomics focuses on the entire economy. When Warren Buffett invested in Coca-Cola, he was focused on the microeconomics of the business. He understood that consumers had very strong brand loyalty to Coca-Cola and customers would be glad to pay a premium to purchase Coca-Cola instead of a competing product. He also realized that people spent a very small percentage of their grocery budget on Coca-Cola. Put another way, Coca-Cola is relatively inexpensive relative to other goods and services consumers purchase. As a result, an increase in the price of Coca-Cola wouldn’t really negatively affect demand. And then finally, he realized that technology wouldn’t greatly impact Coca-Cola’s business model. All of these factors combined, and of course others, helped to make a confident assumption about the future performance of the company. Put simply, Coca-Cola’s business would look very similar 5, 10, even 20 years later. Notice here how Buffett’s analysis was at a microeconomic level, and his thoughts about the economy did not play into his decision-making process.

The next lesson would be to have a long-term perspective. I’m a big believer that no one can predict stock prices in the short term. When everyone is focusing on the short term, this creates an opportunity for long-term-focused investors. This is what investor Bill Ackman refers to as time arbitrage. There are times when a great business will see its stock price fall 10, 20, 30, even 40 percent based on short-term concerns. This creates a potential buying opportunity for a long-term investor. This is how Buffett was able to buy the railroad BNSF for a fraction of its current value. Buffett paid 26 billion dollars to purchase all of BNSF. This was in late 2009, when investors were deeply worried about the economy. As I’m sure you can imagine, a bad economy is not the best time to own a railroad as less goods are being shipped on the railroad. However, Buffett took a long-term perspective. He knew BNSF was an amazing business, and this was a buying opportunity, and he was right. BNSF’s value is now estimated to be somewhere between 150 billion dollars to 200 billion dollars. Having that long-term perspective can pay off quite nicely.

This leads us into the third point: Approach stock investing with what Buffett refers to as a business owner mindset. The value of any investment is the cash that investment will produce for its owners over the lifetime of the asset. The value of an investment is based on what the company will be making three, five, and even ten years from now, not how the company will perform over the next three months. In addition to investing in stocks, I also invest in real estate. When I'm analyzing a deal, am I concerned with how much rent the property will produce the first month I own it or even the first year? Honestly, not that much. I'm more concerned with how much rent the property will be generating five years from now, ten years from now, heck even twenty years from now. That same thing applies to when you are looking to buy a small business. You wouldn't buy the business for what it could make in the first month or even year you own it. You would buy it for how much cash it could generate for you over many years. Remember, stocks are just little pieces of businesses, so approach stock ownership with a business owner's mindset.

To recap this video: Predicting how the economy will look in the next year, two years, five years, or even ten years is incredibly difficult—so much so that virtually no one can predict the economy accurately and consistently. Because of this, Buffett doesn't factor economic predictions into his investment process. Remember the two-part test: Future economic conditions are important; it passes that part of the test, but it isn’t knowable—that’s where it fails the two-part test.

So how exactly should we be investing if it doesn’t include trying to predict the economy? There are three main takeaways from Buffett on this topic.
Focus on the microeconomics of the business, not the macroeconomics of the economy. Keep Warren Buffett and his investment in Coca-Cola in mind as an example. Next is to have a long-term perspective. When people are worried about a recession and stock prices are low, that can be a great investment opportunity. That’s how Buffett was able to buy the railroad BNSF, and it turned out to be one of his greatest investments ever. And then third, view stocks with a business owner mindset. The most successful business person isn’t going to sell the business he or she has spent years building because of economic predictions. So why should you sell a great stock because of economic predictions?

So there you have it. I hope you enjoyed this video. Make sure to like this video and subscribe to the Investor Center because it is my goal to make you a better investor by studying the world's greatest investors. Also, check out my Patreon, where I post the tools I use to analyze investments. You can access it through the link in my description. Talk to you soon.