Warren Buffett's 2023 Recession Prediction (Recent Interview)

But you think a recession is more likely now than maybe you would have said six months ago.

Okay, I have a really special video for you guys today. So, Warren Buffett is 92 years old, and it's extremely rare for him to give interviews. But luckily for us, he actually recently sat down for an interview where he talked about everything from the future of Berkshire Hathaway to the fallout from the banking collapse.

But it was actually his comments around the economy that really got my attention. As CEO of Berkshire Hathaway, Buffett gets a look into the economy that is unparalleled by anyone in the world. Berkshire Hathaway, of course, is a holding company, and they own over 65 different companies in a complete variety of industries across the world. Buffett gets to see exactly how these companies are performing on a monthly, weekly, but probably even daily basis, which allows him to have a deep understanding of what's happening in the economy at any given period.

So, in this video, we're going to hear what Buffett is seeing in the economy, his thoughts around a potential recession, but most importantly, what you can do to protect yourself from what's coming. So, let's get into the video.

We have heard recently from Jamie Dimon in his annual letter at JP Morgan. He says a recession is much more likely now. Janet Yellen was just speaking, I think in the last 24 hours, although it's hard to track from here when things are happening. She has just said in the last 24 hours that she thinks that the U.S. is in better shape now than it was six months ago. Which of those camps would you put yourself in?

Well, I know what a lot of different businesses are doing, and I just got a report from one of them that happens to be in the retail role in their business. In any event, you know, it was minus 22 percent in February from a year ago, and they didn't think that was going to happen. Sales and sales problems are down a lot more than that.

On the other hand, some of our businesses are still doing fine, but they all are reporting that the new, you know, some of them are living off of orders placed months earlier and that sort of thing. But, uh, it's a tougher world out there in a great many businesses—not in the insurance business. The insurance business should be better this year than last year. That doesn't mean it will be, because we can't predict everything that happens, but on a probability basis, it should be better than last year.

And the railroad business is down, uh, and carloads are down. But it is dramatic. And, of course, we've got a utility business, and that doesn't really vary much of a thing. So, but overall, I think people that run our businesses that do have any sensitivity to the economy are surprised at where they are now compared to where they thought they were going to be six months ago.

That doesn't mean the world is coming to an end or anything, because, because, uh, for 58 years I've been running Berkshire. I mean, we've run into all kinds of problems, but that’s what business is about. And we run our business so that we don't depend on everything being perfect. We might have said that we will be the last man standing. And that’s the way, if millions of people are going to give me their money and help me to take care of it, we're going to try and take care of it.

And if we don't make as much money as we might have, we leveraged more or done other policies—so be it. But you think a recession is more likely now than maybe you would have said six months ago? Well, I think most of our managers would say that they are surprised at where they are now compared to how they thought they were going to feel six months ago at this point in a lot of businesses.

But not in the insurance business, you know, and, and, uh, uh, but I think the people of the railroad are somewhat surprised that car loadings aren't a little higher rather than a little lower, you know, somewhat lower. But most of the stuff we carry is is essential. But it reflects what's happening.

And, of course, supply lines were so disrupted and everything a year or two ago that, uh, you know, no economic figures are pure. But I'm just telling you my impression. I look at the numbers every day. I mean, I can, I look at our Easter sales today, day by day, the candy store, and I, you know, I can look at California versus Washington versus Oregon, and I can get them the next day. I mean, so I—I love figures, you know, and you say that it doesn't really do me that good to be such a figure or not, but I just like it when I see them.

Okay, so it's no secret that the U.S. economy was absolutely booming these last couple of years, and things had been going great. In fact, the economy was actually so hot that it became overheated, which resulted in inflation skyrocketing to a 40-year high. One of the biggest drivers as to why the economy became so overheated was ultra-low interest rates.

So imagine you're a business owner. Your small business makes high-quality custom furniture, and you've been building that business for a few years now. At first, you were just working out of your garage, but the business kept growing and growing, and now you have a few employees and share a warehouse space with a few other small businesses. The business is growing so rapidly that in order to keep up with all of the orders, you need to hire more employees.

But the only problem is that you don't have enough space at your current location to do so. So one day, you're driving home from work and you see an empty piece of land, and you have an epiphany. This is going to be the solution to your problem of not having enough space for the business. You decide you're going to build a beautiful brand-new building on this piece of land.

Finally, you'll have a location large enough to hire all the employees you need to produce all the orders you're getting. There's one big problem, though. You don't have the money needed to actually build the property. Your business is profitable, but all of those profits are going back into growing the business.

So, in order to get the money you need to build that property, you have to go to the bank and get a loan. In exchange for lending you money, the bank is going to charge interest. Likely, the biggest detriment of what that interest rate will be is the current level of interest rates in the economy.

So if we use the federal funds rate as a proxy, we can see here that interest rates for the better part of the last 15 years or so were zero percent. And this was especially true during 2020, 2021, and even the first half of 2022. It was extremely inexpensive for companies and people to borrow money during this time.

So if we go back to our factory construction example, the interest rate is going to have a big impact on how successful this project will actually be. So let's say you're able to get that loan to build the factory. The loan is for three million dollars, and you have to pay it back over a term of 30 years. If you have a seven percent interest rate, that means your monthly payment to the bank is going to be around twenty thousand dollars—nineteen thousand nine hundred and fifty-nine to be exact.

So with that twenty thousand dollar monthly payment, you are hesitant to do the project. I mean, that's a lot of money, and what if the business stops growing? You're on the fence about doing the project. However, let's see how a lower interest rate changes things.

Let's say instead of a seven percent interest rate, you're able to lower it to three percent. That lower interest rate takes the monthly mortgage payment down from twenty thousand dollars a month all the way to twelve thousand six hundred and forty-eight dollars. So that's a roughly 37% reduction just from the lower interest rate. This project now starts to make a lot more sense for you because of the cheaper cost to borrow the money. You decide to move forward with construction.

In order to properly evaluate the viability of the project, you need to think like an investor. Speaking of which, I'm currently in the process of building out a comprehensive course on value investing and would love to hear your thoughts on what you think should be included. It would mean the world to me if you could fill out a brief two-minute survey in the description of the video, and as a thank you, I will send you a completely free value investing cheat sheet that will help you better understand key investing terminology and how to apply these concepts.

If you're one of the 400 people that have already filled out the survey, don't worry—the PDF will be hitting your email inbox shortly. You guys are great, and let's get back into the video.

Just building this factory is going to have ripple effects throughout the economy. Think about all the people and companies that work in this factory and make money from it. There's the concrete that needs to be poured, framing that needs to be done, plumbers and electricians that are going to be working on the building.

Then there's drywall and paint and also the roof. And this doesn't even include all the companies that send the materials that will be used for construction—not to mention all the workers you'll be hiring to fill the factory after it's built. While this is just an example, similar logic applies throughout an economy.

Interest rates have a massive impact on whether a new factory gets opened, a new house is built, and whether startup companies get the funding they need to grow. Low interest rates encourage more economic activity, and if demand for goods outpaces the supply of them, we get inflation. When inflation is too high, the U.S. Federal Reserve has no choice but to raise interest rates. The hope being that economic activity will slow and supply and demand will become more aligned, ultimately bringing inflation down to more normalized levels.

So let’s go back to the factory example from earlier. So we saw at a three percent interest rate that the monthly payment was twelve thousand six hundred and forty-eight dollars. At seven percent, that payment shot up to nearly twenty thousand dollars. But if we raise interest rates all the way to twelve, the monthly payment goes up even more, all the way to thirty thousand eight hundred and fifty-eight dollars.

If the business owner was questioning whether this project was possible at a seven percent interest rate, there’s absolutely no way they’re going to do it at a twelve percent rate. The monthly payment is now over 50% higher, and all the companies that were poised to benefit from the project now have less business. Demand for goods decreases and inflation begins to moderate—well, at least that’s the goal.

The FED has raised interest rates at probably the fastest clip ever, the impacts of which are starting to be felt throughout the economy. While you may not have access to private sales data on the 65 plus companies Warren Buffett does, there is one real-time metric you can track yourself to get a sense of the current health of the economy—weekly carloads of publicly traded railroad companies.

So before you call me crazy, hear me out. Buffett has referred to this car load metric for railroads as his so-called desert island indicator, meaning if you could only look at one piece of information to judge the health of the economy, this would be it.

This metric essentially measures the amount of goods that are being moved by rail. The logic here being that when the economy is growing, more products are being moved throughout the country as economic activity is high. But on the flip side, if the economy is slowing, businesses will be moving fewer things on rail. Through Berkshire, Buffett owns BNSF, which is one of two railroad companies that serves the entire Western United States. Because BNSF is owned by Berkshire and is not a publicly traded stand-alone company, there aren't a lot of numbers for the company out there.

However, BNSF's biggest competitor, Union Pacific, is publicly traded and is required to disclose their numbers to the public. Here are Union Pacific's numbers for the first week of April. We can actually see the number of carloads that moved on the railroad broken out by category. This is super insightful to get a better understanding of what's happening in the economy.

For example, we can see that lumber and wood products are down 27% compared to the same week last year. Lumber demand is closely tied to construction, so given the rise in interest rates, it makes sense that construction is slowing down. We also see that motor vehicles and equipment are up 19% compared to last year, and this shows that automotive companies are still ramping up production of new vehicles.

In terms of how the overall economy was doing, we can see that total carloads and intermodal were down six percent compared to the same time last year, and this means that there is six percent less goods being moved throughout the economy. While six percent doesn't seem like a whole lot, that's actually pretty sizable and lines up with Buffett's comments around how the economy is weaker.

So all of this leads me into the question I want to answer in this video: given that the economy is definitely slowing down, how can you follow Buffett's principles to protect yourself from whatever is ahead? A big reason why Buffett isn't overly concerned with the economy is because he ensures Berkshire Hathaway has what is referred to as a fortress balance sheet.

What this means is that no matter what happens in the economy, Berkshire is going to be able to successfully make it through to the other side. Buffett has said that he runs his company to ensure it will be the last man standing. A helpful analogy here would be the pyramids in Egypt. The pyramids are still standing after being built 4,500 years ago, and the reason for that has to do with how they are built and what materials were used.

Buffett takes the same approach with Berkshire, building a business built to withstand whatever bad weather it may encounter. But you don't have to be the CEO of a 700 billion dollar company like Buffett to benefit from understanding the concept of a fortress balance sheet.

While a fortress balance sheet is often used to describe the financial health of a company, I think the concept is just as relevant for individuals. You can approach your own finances with the goal of building that fortress balance sheet. People can learn from the way Berkshire operates and apply some of those methods to their own life.

Here are three things that Berkshire does to be resilient regardless of the current state of the economy. Number one, operate with a large cash balance. Berkshire has over 100 billion dollars in cash and cash equivalents. Number two, avoid borrowing large amounts of money. Berkshire has just a fraction of the debt that a comparable company of its size would have. And then number three, keep operating expenses low.

Buffett and his employees work out of the same office space that the company has been in for decades. If you were to look at the office space, you would think that it belongs to a struggling small business and not a 700 billion dollar market cap company. All of these lessons are applicable to you as an individual.

Number one, operate with a large cash balance. Within the personal finance community, this is referred to as having an emergency fund—money set aside to cover your expenses in the event that you lose your job. If you're worried about a recession and potentially losing your job, you're going to want to make sure you have a large emergency fund.

Number two, avoid borrowing large amounts of money. Generally speaking, the more debt a person has, the more money that person has to spend each month servicing that debt. This increases a person's so-called burn rate, or put another way, how much money they have to spend each month just to meet their obligations. Reducing your debt also reduces your burn rate. This allows you to live off your emergency fund for longer, and the longer you can weather the financial storm, the greater your odds of making it through to the other side are.

And number three, keep operating expenses low. The biggest budget item for most people is their house. Buying that fancy house or apartment might make you look better to your friends and family, but it can significantly limit your financial flexibility. If the economy slows down and you lose your job or have to take a pay cut, that big mortgage or rent payment is going to make things a lot more difficult.

One thing I personally do to limit my own financial operating expenses is live in a duplex that I own. So this is a property I own that has two separate apartments within the same structure. I live in one of them and rent out the other. The rent I receive covers my mortgage payment, property taxes, and home insurance. This strategy allows me to have the majority of my housing expenses covered and provides me more financial flexibility in the event of a slowdown.

So there you have it. I hope you enjoyed the video and make sure to hit that subscribe button because it's my goal to make you a better investor by studying the world's greatest investors. Talk to you again next time.