• Home
  • About
  • Team
  • Contacts
  • Blog

Build It and Money Will Come

  1. Home
  2. Blog
  3. Build It and Money W ...

Client Letter November 2000

Think about it. Every major correction in the stock market has been preceded a period cheap money.

  • 1929 The newly created FED spent most of the twenties expanding the money supply, and the NYSE was poring gasoline on the fire in the form of 10% margin requirements
  • 1973 – 74 Lyndon “Guns and Butter” Johnson spent the 1960s fighting both the war on poverty and the Vietnam War. “No problem we will just get the fed to pump up the money supply.”
  • 1989 Japan’s Central bank decides in the 1980 that they have discovered the Holy Grail of universal prosperity. “We will keep our interest rates at 2% until we liquefy the world”.

Cheap Money Means Poor Returns

This is one those fundamentals of market behavior that Charlie Munger, Would label as perfectly obvious but very little understood. It is something that Berkshire Hathaway’s Management understands very well, but seems to go over the heads of most Corporate Chief Executives.

Let me give you an example, last week the wall street Journal carried a Story about a Capacity Glut in for The Fiber Network stocks. It contains these figures on the capital spending of one of the smaller more obscure players in Fiber Optics.

“360networks, based in Vancouver, British Columbia, is spending some $5.7 billion – and has taken on more than $2 billion of debt-to develop its fiber network. Those are hefty figures for a newly public company that had just $234 million of revenue in the first half of this year and is expected to produce negative cash flow and losses for at least another year … There are now 14 big-capacity national networks operating or under construction in the US and the companies are “all burning cash at a pretty sharp rate”, says Paul Sagawa, a Sanford C. Bernstein analyst who recently became bearish on the sector”.

Greg Maffei CEO of 360networks justified his business plan with the following rational “I’m very optimistic about the long-term demand” for bandwidth, Mr. Maffei says. Just as lower mobile phone charges have greatly multiplied the number of customers, lower bandwidth prices will lead to many more bandwidth-hungry applications, he predicts. And 360networks says only a few networks can match its relatively low building costs and global scale.”

The Build it And Money Will Come Rule

In other words build it and money will come. This is the number one rule of Executive Behavior, and it is the main reason that cheap money always leads to poor returns. It is the same basic rule that has relied on by Iridium when they put up their satellites, Now their investors can experience the ecstasy of watching their $7 Billion burn up on reentry.

You give the typical CEO $5.7 billion and he will find something to spend it on. Will a good deal of this spending is well intentioned, cheap money invites abuse (“We need to buy a Gulfstream IV because the Boca office will need close supervision this winter”). The Typical CEO figures that he is smart enough to get hands on $5.7 billion, then he is smart enough to spend it.

(Ya, right!) The cheaper money is to get the more they spend. The further you get along in a positive economic cycle the better this rule works. It is the cheap money that creates the over capacity. CEOs do not know any better; they are just doing what comes naturally.

The interesting thing is that the cheap money does not have to come from a central bank, in our present circumstance most of it came from Wall Street, but the source does not matter. The cheap money will get spent. And the eventual result will be capacity is built that is not needed.

The Cheaper the Money the Bigger the Correction

So what happens now? How far down does the market have to go, to discount the consequences of Wall Street’s manic excesses? We are not all the way to low tide yet. So it is soon for a comprehensive bathing suit check, but if I had to guess I would guess that the size of the crash would be roughly proportional to the cause. In other words the easier the money the bigger the correction.

But, On the subject of the future consequences of this wild spending binge “Barton Biggs was quoted in Barons as saying, “the excesses (he) explains with a touch of regret, have not been completely purged, not by a long shot. In the fiercely damaged Internet section, for example, there remain, he notes, loads of companies whose stocks, bloody but unbowed, still sport market caps of well over a billion dollars “with nothing but dreams, mounting losses and fancy business plans.” In the monster bear market of the early ‘Seventies, he reminds the graybeards among us, the speculative junk, no matter how inflated it got, “all ended up selling for three bucks.”

(Personally, The way I remember it, it was more like a buck and half.)

But if it really is easy money that is responsible for the eventual carnage, logic would suggest that the damage might be very lumpy. The worst Damage will be limited to those areas that received the most cheap money. The manic dimensions of our recent tech bubble has produced prodigious sums for chief executives to piss away, But beneficiaries were limited to certain select market sectors, so the worst of the carnage may be similarly limited.

There is a real possibility that a sharp cut back in tech capital spending will drag the rest of the economy into the ditch. The sharp drop in growth of GDP in the fourth quarter raises the chances of recession to something above 50% in my opinion. But a lot of old economy stocks have already discounted a moderate recession. Retail and consumer stocks started correcting some time ago.

As far as our major holding of Berkshire Hathaway is concerned, insurance stocks, as everyone here already knows, started correcting two years ago and may have already seen their lows. The insurance industry received little if any benefit from the flow of funds into tech stocks. Retail and consumer stocks received the benefit of increased consumer spending, but have already corrected for a lot of problems.

Money has been getting more expensive for insurance companies (Combined ratios increasing) for quite a while. With no cheap money it may now be possible expect better returns from insurance stocks than from tech stocks in the next few years. That is a prediction that you probably have not seen before.This is wildly counterintuitive. Logic and math would suggest that cheap money would make corporations more profitable. The problem is that it does not work out that way, or least only for the short periods. Over the coarse of a long economic cycles cheap money destroys discipline in capital allocation, while expensive money demands it.

11/01/2000



Leave a Reply Cancel Reply

Your email address will not be published.


Comment


Name

Email

Url


Blog Archive

2020

  • The Stock Market

2019

  • Behavioral Investing

2018

  • Trumped
  • Warren Buffett vs Wall Street
  • Globalism, 1982-2000 Bull Market

2017

  • Volatility Underlying Calm Market
  • What’s new with CB&I?
  • Passive Investing
  • Economic Cycles
  • Current Stock Market 2017 Comment

2016

  • Global Plastics Summit Highlights
  • Value Investing vs Index Investing
  • How to Play an Index Bubble
  • Successful Investors
  • Is the Market Overvalued?
  • Operating Earnings
  • Article by investment manager in Bay Hill Living
  • Building Foundation

2015

  • 3G Culture – Dream Big
  • Myopic Loss Aversion
  • CBI Nuclear Energy
  • St Joe Company
  • What’s in a Word? Plastics.
  • Are Bonds Safer Than Stocks?

2014

  • Chicago Bridge and Iron
  • CAMEX 2014
  • Global Economy October 2014
  • Fluor Corporation
  • Interesting Quotes from Daily Journal Annual Meeting
  • The Daily Journal Annual Meeting
  • Albemarle Corporation
  • Triumph Group
  • The American Energy Revolution
  • Singapore

2013

  • St Joe Company Update
  • Hedge Fund Managers
  • Triumph Group Inc.
  • Bitter Brew
  • An Antifragile Portfolio

2012

  • Leucadia National Corporation
  • This Time it is Different
  • Successful traders psychology
  • St Joe Company
  • Learning from Pain

2011

  • Long Cycles – Part II
  • Long Cycle
  • Nasty Month for Market
  • Make a Buck with Fortescue Metals Group
  • Berkshire Hathaway Look Through Earnings
  • St Joe Company Inc
  • Successful Investment Management
  • A Look Into Latin American Market
  • The Mother of all Quarters
  • 2010 Investment year results

2010

  • Fault Lines
  • US Market 2010
  • Berkshire Hathaway Third Quarter 2010
  • The Stock Market 2010
  • Berkshire Hathaway Second Quarter 2010
  • Berkshire Hathaway Performance
  • Long Term Greedy
  • Goldman Sachs
  • Berkadia and Leucadia
  • USG corporation
  • Berkshire Hathaway 2009 2010
  • Why Capitalism Works

2009

  • The Lords of Finance
  • The $44 Billion Dollar Train Set
  • Berkshire Hathaway 3rd Quarter 2009
  • Career Risk for Investment Manager
  • Berkshire Hathaway financial statements
  • Berkshire Hathaway Preferred Stock
  • Moral Hazard
  • Credit Default Swap
  • The Shadow Banking System
  • Learning Things the Hard Way
  • Our C-System
  • 2008 Investment results

2008

  • Investment Risk
  • Bear Markets
  • Generational Events
  • Orange sheets – Money is doing better
  • Inflation Not The Problem
  • Tipping Point
  • Long Term Capital Management
  • Financial Insurance
  • Western Refining Inc
  • Berkshire Hathaway Year To Date
  • Berkshire Hathaway Cash Flow
  • 2007 investment results

2007

  • Investment results 4th Quarter 2007
  • Greenspan on Inflation
  • Berkshire Hathaway Third Quarter 2007
  • Berkshire Hathaway Operating income 2007
  • Berkshire Hathaway Hedge Fund
  • Leveraged Buyouts
  • Stability Unstable
  • Weak Dollar
  • Berkshire Hathaway Chairman’s Letter
  • Steel Dynamics
  • Breakwater Resources
  • 2006 Investment year results

2006

  • New Investment Stocks
  • Equitas
  • Berkshire Hathaway Third Quarter 2006
  • Hurricane Synergy
  • Berkshire Hathaway Second Quarter 2006
  • Fat Pitch
  • Perfectly Obvious
  • Berkshire Hathaway Growth Rate
  • Berkshire Hathaway First Quarter 2006
  • Berkshire Hathaway Annual Report 2006
  • Inflation Is
  • 2005 Investment year results

2005

  • Exogenous Events
  • The Easy Money
  • Look-Through Earnings
  • High-Risk Mortgages
  • Unintended Consequences
  • Rydex Ursa Fund
  • Warren Buffett Premium
  • Private Equity
  • Latticework Mental Models
  • Buffett’s Lackluster Performance
  • 2004 Investment year results
  • Professor Smith’s Second Bubble

2004

  • Hedging Currency Disaster
  • Risk Assessment
  • Too Many Bears
  • The Chinese Century?
  • Patterned Irrationality
  • Timber
  • Costco’s Cash
  • Physics Envy by Charlie Munger
  • Asset Allocation Berkshire Hathaway
  • The Balance of Payments
  • 2003 Investment year results

2003

  • Hedge Funds
  • The trade deficit is not debt
  • Secular Bear Market
  • Which Index Funds?
  • A Different Drummer
  • Costco’s Float
  • The Power of Float
  • Berkshire Hathaway Annual Meeting 2003
  • Psychology of Human Misjudgment
  • Sitting on the Sidelines
  • Berkshire Hathaway intrinsic value
  • 2002 Investment year results

2002

  • Insurance company Moats
  • Bond Bubble
  • Berkshire Hathaway Cash Flow 2002
  • Behavioral Economics
  • The Bear Market 2002
  • Greenspan Put
  • Second Quarter Cash Flow at Berkshire Hathaway
  • Berkshire Hathaway Annual Meeting 2002
  • Red Wire – Green Wire
  • Stupid FED Tricks
  • The Bottom Line
  • 2001 Investment year results

2001

  • Don’t Fight the FED
  • Buy and Hold? – It all Depends
  • Ben Laden and Berkshire Hathaway
  • The Dinosaurs Dance
  • Costco Moat
  • Bubble Watching
  • Sit on your Ass investing
  • Berkshire Hathaway Annual Meeting 2001
  • Carnival Cruise Lines
  • 450000 Square Ft Furniture Store
  • Lunch Money Indicators – Annual report
  • Other People’s Money

2000

  • Bear Tracks
  • Build It and Money Will Come
  • Efficient Stock Market
  • Style Drift
  • Lunch Money Indicators – Options
  • Identifying Problems
  • Small Retail Stocks
  • Charlie Munger comments
  • Big Al and the Bubble Machine
  • Berkshire Hathaway Cheap
  • Index Funds
  • 16 rules for investment success
Make an appointment or contact us by phone: +1 (689) 246 49 49
© 1999 - 2022 Losch Management Company
Support by Global AGM