Warren Buffett: How Long Can This Stock Bubble Last? (2021)

It's no secret that stock prices have continued to hit all-time highs. All three major American stock market indices, the S&P 500, the Dow Jones Industrial Average, and the Nasdaq, all are at record highs. That has led to some very prominent and highly respected people in the financial community calling the stock market a bubble and predicting a stock market crash is right around the corner.

However, I think it is important to note that while stock valuations may be high relative to historical norms, that doesn't mean that stock prices can't get even higher or stay at these elevated levels for a long time. In this video, we're going to watch a clip of Warren Buffett talk about stock market bubbles and how long they can last. Then we're going to discuss what exactly is causing these high stock prices that Buffett is referring to, and what investors can do to avoid losing money if and when the bubble decides to burst.

But first, make sure to like this video and subscribe to the channel if you aren't already because it is my goal to make you a better investor by studying the world's greatest investors. Even more importantly, I want to help you avoid becoming like this unfortunate guy. Without further ado, let's dive in.

Investors behave in very human ways, which is they get very excited during bull markets and they look in the rearview mirror. They say, "I made money last year; I'm going to make more money this year." So this time I'll borrow. You know, or the neighbor says, "You know, I wasn't in last year when that neighbor was dumber than I made a lot of money, so I'm going to go in this year." So they're always looking to the mirror, and when they look in the rearview mirror and they see a lot of money having been made in the last few years, they plow in and they just push and push and push on prices.

When they look in the rearview mirror and they see no money having been made, they just say, "This is a lousy place to be." So they don't care what's going on in the underlying business, and it's astounding. But that makes for a huge opportunity—just a huge opportunity. I mean, I've lived through roughly half, in an investing sense, about half that period, and I've had that long period of stagnation from '48—I mean from '65 to '82—17 years.

I wrote an article for Forbes in 1979. I just said, "How can this be?" Pension funds in 1970 put a hundred and some percent of their new money in stock because they were wild about stocks. Then they got a lot cheaper, and they put a record low, in nine percent of their net new money, and in 1978, when stocks were way cheaper, people behave very peculiarly in terms of their reactions.

Because they’re human beings, and they get excited when others get excited, they get greedy when others get greedy, they get fearful when others get fearful, and they'll continue to do so. You will see things you won't believe in your lifetime, and securities markets and the country will do very well over time. But you will see these huge waves, and if you can stay objective throughout that, if you can detach yourself temperamentally from the crowd, you get very rich.

And you won't have to be very bright. I mean, I'm sure you are, but it doesn’t take brains; it takes temperament. It takes the ability to sit there and look at something. When I started out in 1950, I would go through and find things at two times earnings, and they were perfectly decent businesses.

People wanted jobs at those companies, and everybody knew they were going to be around, and they wouldn't buy them at two times earnings, and that's when interest rates were two and a half percent. You know, I went to the—I started selling securities when I was 21, and a Kansas City Life Insurance Company happened to be a fairly prominent company in Omaha. The policies they sold you, if you were buying life insurance from them, had a built-in assumption of two percent interest.

The stock of Kansas City Life was selling at less than three times earnings. You’re getting 35% if you bought the stock. No question about the soundness of the company. I went to the local agent. I thought, "Hell, I'll be able to sell him a few shares of stock." I mean, the guy would understand him; he's got his whole life invested in this company.

I went to the local agent who'd been with him for twenty years, and his name was Moose. I said, "Mr. Moose, I said you know you're selling these policies with two percent. You may even have a few members of your own family, and you can buy into this company whose paycheck you depend on every month and whose future your beneficiaries of these life policies depend on."

And who you're selling them, you know, two percent investment on, and you get 35 percent on your money? He said, "Yes, and you know stocks aren't any good." And I couldn't sell; you know, I was a lousy salesman, I mean, well you have to start with that. But it just blew me away.

It blew me away; sometimes I used to wonder if I was nuts, you know. But those things—the same thing happened. I mean in 1964 the Dow closed at 864. At the end of 1981, 17 years later, it closed at 865. It moved one point in 17 years. Now that's not a big move, and you can't believe how discouraged people were by that during that period.

But you know, people were living better, so things can go on a long time that don't make sense. But they do come to an end. I mean the internet thing, I mean you had these companies selling for many billions of dollars that had no, really frankly, no prospects of making any money. That's a bubble.

But Herb Stein one time said, "Anything that can't go on forever will end." Now that seems pretty good, but think about that. Particularly think about it next time you're trying to do something just because the stock's gone up a whole lot, you know, and your neighbors make money or something. You’ve got to be—you just have to sit and think objectively and think about, "Would I buy this whole business?"

It's an internet company that's got 100 million shares out and selling at 100. That's 10 billion. Is it worth 10 billion dollars? If it's worth 10 billion dollars, it's got to be able to give you, you know, seven or eight hundred million next year, and if it doesn't give you seven or eight hundred million next year, it has to give you maybe ten percent more than that the year after, and continue.

There aren't a lot of businesses that can do that, and people just go crazy. To truly put Warren Buffett's comments into context, I think it's important to take a second to understand how we got to where we are today in the stock market. It's no secret that valuations in the stock market are high relative to where they have been historically.

Look no farther than this chart, the S&P 500 index price-to-earnings ratio over the past 90 years. But why is this? It is because the higher interest rates are, the less investors are willing to pay today for a dollar in the future. That is the fundamental idea of what investing is: laying out cash today to buy stocks to hopefully get more money in the future.

I know that sounds complicated, but this simple example should make a ton of sense. Take two hypothetical situations—one where interest rates are five percent and one where interest rates are ten percent. Under these different scenarios, how much would you pay today for one dollar a year from today?

With an interest rate of 5%, a rational investor would pay 95.2 cents. This is calculated by taking the amount you would receive in the future, one dollar, and dividing it by one plus the interest rate, so in this case, 1.05. In the other scenario, with a 10% interest rate, the amount a rational investor would pay for the same dollar would decrease to 90.9 cents.

Using this simple example, it is easier to see how lower interest rates can easily increase the amount investors are willing to pay today for stocks for those future cash flows from the profits of the underlying company an investor purchases stock in.

Now that we understand more about how we got here, that raises the next important question: How should you go about investing in a period of high stock prices? Here are the three main takeaways from a video that all investors should remember.

One: Do not try to time the market. Buffett is clear that forecasting stock prices in the short term is virtually impossible. Even though a stock price may be high, that doesn't mean it can't go even higher. In other videos, Warren has made it clear that he's a huge fan of dollar-cost averaging for the normal investor, being that investor invests a specific dollar amount and sets time intervals such as every week, two weeks, or months to invest.

That leads us to the second takeaway: Bubbles in the stock market can last a long time. That is part of the reason why it is so risky betting on a market crash. While an investor that is betting on a market crash may eventually be right, it can take such a long time for that prediction to play out.

There's an old saying in the investing business: Being too early is indistinguishable from being wrong. And the final point: Invest for the long term. If you know anything about Warren Buffett, you know that he is the ultimate long-term focused investor. He makes it clear that there are going to be ups and downs in the stock market, and an investor needs to keep that in mind.

Most importantly, investors shouldn't necessarily be trying to predict what's going to happen to the market over the next year, but rather focus on investing for decades, allowing compound interest to work its wonders.

So there we have it! I hope you enjoyed the video. Make sure to like the video and subscribe to the channel if you aren't already because it is my goal to help make you a better investor by studying the world's greatest investors. See you next time!