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But do you think a recession is more likely now than you might have said 6 months ago? Okay, today I have a really special video for you. Warren Buffett is 92 years old and rarely gives interviews, but luckily for us, he recently agreed to a conversation where he talked about everything from the future of Berkshire Hathaway to the aftermath of the banking collapse.
But it was his comments on the economy that really caught my attention. As CEO of Berkshire Hathaway, Buffett has access to an overview of the economy that is unparalleled in the world. Berkshire Hathaway, of course, is a holding company that owns over 65 different businesses in a wide variety of industries around the world.
Buffett sees how these companies perform monthly, weekly, and perhaps even daily, which allows him to have a deep understanding of what is happening in the economy at any given time. So in this video, we'll hear what Buffett sees in the economy, his thoughts on a potential recession, but most importantly, what you can do to protect yourself from what's coming.
So, let's move on to the video. We recently heard from Jamie Dimon in his annual letter at JP Morgan. He says a recession is now much more likely. Janet Yellen has just spoken, it seems, within the last 24 hours, although it's hard to keep track of when what's happening from here. Just saying in the last 24 hours, I think the US is in better shape now than it was six months ago.
Which of these camps would you classify yourself in? Well, I know a lot of different businesses do, and I just got a report from one of them, because he happens to be in retail . And anyway, you know, in February it was minus 22% compared to last year. They did n't think this would happen. Sales, do you mean profit?
In terms of sales, profits fell significantly more than that. On the other hand, some of our businesses are still doing well, but they're all reporting that, well, you know, some of them are living off orders placed months ago and all that. But, but, it's a tougher world for a lot of businesses, not just the insurance business.
Well, the insurance business should be better this year than last. This does not mean that it will be so , because we cannot predict everything that will happen. But from a probability perspective, it should be better than last year, although the railway business has declined in terms of transportation volumes, but not critically.
And, of course, we have a utility company, and it is almost independent of such things. So overall, I think our business leaders, who are sensitive to the state of the economy, are surprised by where they are now compared to where they expected to be 6 months ago. It doesn't mean the world is ending or anything, because I've been running Burke for 58 years.
We face all kinds of challenges, but that's the essence of business. And we do things in a way that doesn't depend on everything always being perfect. We work to be the last ones standing . And if millions of people trust me with their money to manage it, we will try to take care of it. And if we earn less than we could have if we had taken out more loans or chosen a different strategy, so be it .
But do you think a recession is more likely now than you might have said six months ago? I think most of our managers would say they are surprised by their current situation compared to what they expected six months ago in many areas, but not in insurance. But I think people on the railway are a bit surprised that the transportation volumes are not a little higher, but on the contrary, a little lower.
Most of the goods we transport are essential, but this reflects the current situation. And, of course, the logistics chains were so disrupted a year or two ago that no economic indicators are pure. But I'm just expressing my impression, I look at the numbers every day. I can track our Easter candy store sales day by day, comparing California, Washington, and Oregon, and see the data the next day.
I really like numbers. You could say that I don't have much use for such data right now, but I just like seeing it. So, it's no secret that the US economy has been growing rapidly in recent years, and things have been going great. In fact, the economy was so “ hot” that it became overheated, causing inflation to soar to a 40-year high.
One of the biggest factors in why the economy became so overheated was ultra-low interest rates. So imagine you are a business owner. Your small company makes quality custom furniture , and you have been developing this business for several years. At first you just worked out of your own garage, but the business has grown steadily, and now you have several employees and rent a warehouse with other small businesses.
The business is growing so fast that you need to hire more employees to fulfill all the orders. But the only problem is that you don't have enough space on the current object to do this. And then one day, returning home from work, you see a vacant plot of land. And an idea strikes you. This will be the solution to your problem of lack of space for your business.
You decide to build a beautiful, brand new building on this piece of land. Finally, you will have a facility large enough to hire all the workers needed to fulfill all the orders you receive. However, there is one big problem. You don't have the money needed to build the facility. Your business is profitable, but all of that profit goes back into business development.
Therefore, to get the money needed for construction, you will have to go to the bank and take out a loan. In exchange for lending money, the bank will charge interest . Probably the biggest factor determining the size of this interest rate is the current level of interest rates in the economy. If we use the federal funds rate as a gauge, we see that interest rates have been at 0% for most of the last 15 years.
And this was especially true during 2020, 2021, and even the first half of 2022. At this time, it was extremely cheap for companies and individuals to borrow money. So if we go back to our example of building a factory , the interest rate will have a big impact on how successful this project will be .
Let's say you were able to get this loan to build a factory. The loan is $3 million and you have to pay it back within 30 years . If you have a 7% interest rate, that means your monthly payment to the bank will be around $20,000. $19,959 to be exact. So, with a monthly payment of $20,000, you're wondering if you should take on this project .
I mean, that's a lot of money. What if the business stops growing? You are unsure whether to implement the project. However, let's see how a lower interest rate will change the situation. For example, instead of 7%, you can lower the interest rate to 3%. This lower rate reduces the monthly mortgage payment from $20,000 to $12,648.
So that's about 37% savings just from the lower interest rate. Now this project seems much more feasible to you because of the cheaper cost of borrowing funds. You decide to start construction. To correctly assess the viability of a project, you need to think like an investor. By the way, I'm currently working on creating a comprehensive course on value investing and would love to hear your thoughts on what should be included in it.
I would be very grateful if you could fill out the short 2- minute survey in the description of this video. And as a thank you, I'll send you a completely free value investing cheat sheet that will help you better understand key investment terminology and how to apply these concepts. If you are one of the 400 people who have already filled out the survey, don't worry.
The PDF file will be sent to your email shortly. You are wonderful. Now let's get back to the video. The construction of this factory itself will have a ripple effect on the entire economy. Think of all the people and companies that will work in this factory and make money from it. You need to pour concrete, install the frame, and hire plumbers and electricians to work on the building.
Then drywall and painting, and a roof. And that's not even counting all the companies that supply materials for construction, not to mention all the workers you'll hire for the factory once it's completed. Although this is just an example, similar logic applies throughout the economy. Interest rates have a huge impact on whether a new factory opens, a new house is built, and whether startups get the financing they need to grow.
Low interest rates stimulate economic activity, and if the demand for goods exceeds their supply, we get inflation. When inflation is too high, the US Federal Reserve is forced to raise interest rates. The expectation is that economic activity will slow down and supply and demand will balance out, eventually returning inflation to a more normal level.
So, let's go back to the factory example we looked at earlier. We saw that at an interest rate of 3%, the monthly payment was $12,648. At 7%, this payment increased to almost $20,000. But if we raise interest rates to 12%, the monthly payment will increase even more—to $30,858. If the business owner doubted whether this project was possible at a rate of 7%, then at a rate of 12% he would definitely abandon it.
The monthly payment is now over 50% higher, and all the companies that were supposed to benefit from the project now have fewer orders. Demand for goods falls , and inflation begins to slow. At least, that's the goal. The Fed is raising interest rates at perhaps the fastest pace in history. The consequences of this are starting to be felt throughout the economy.
While you may not have access to private sales data from 65+ companies like Warren Buffett, there is one real- time metric you can track yourself to gauge the state of the economy. Weekly rail traffic volumes of public railway companies . Before you decide I'm crazy, hear me out. Buffett called this rail transportation metric his so- called “ desert island indicator.” This means that if he could only monitor one indicator to assess the state of the economy, it would be him.
This metric essentially measures the volume of goods transported by rail. The logic is that when the economy is growing, more goods are transported through the country due to high economic activity. On the other hand, if the economy slows down, businesses transport fewer goods by rail . through Berkshire.
Buffett owns BNSF, one of two railroad companies serving the entire western United States. Because BNSF is owned by Berkshire and is not a separate public company, there is little data about it. However, BNSF's largest competitor, Union Pacific, is a public company and is required to publish its figures.
Here is Union Pacific data for the first week of April. We can see the number of rail cars that were shipped, broken down by category. This is extremely informative for a better understanding of what is happening in the economy. For example, we see that volumes of lumber and wood products have fallen by 27% compared to the same week last year.
The demand for wood is closely linked to construction. So, given rising interest rates, it makes sense that construction is slowing down. We also see that transportation of vehicles and equipment has increased by 19% compared to last year. This indicates that automotive companies continue to increase production of new vehicles .
As for the state of the economy in general, we see that the total number of rail freight movements has decreased by 6% compared to the same period last year. This means that 6% fewer goods moved through the economy. While 6% doesn't seem like a big number, it's actually quite significant and aligns with Buffett's comments that the economy is weakening.
So, all of this brings me to the question I want to answer in this video. With the economy clearly slowing, how can you follow Buffett's principles to protect yourself from what lies ahead? The main reason Buffett is n't too concerned about the state of the economy is that he provides Berkshire Hathaway with what's known as a " fortress" balance sheet.
This means that no matter what happens in the economy, Berkshire will be able to successfully navigate through these difficulties. Buffett said that he runs his company so that it will be the last one standing. A useful analogy here might be the Egyptian pyramids. The pyramids still stand, even though they were built 4,500 years ago.
The reason for this lies in how they were built and what materials were used. Buffett is taking the same approach to Berkshire, building a business capable of weathering any storm it may face. But you don't have to be the CEO of a $ 700 billion company like Buffett to benefit from understanding the concept of a " fortress" balance sheet.
Although the “fortress” balance sheet is often used to describe a company’s financial health, I believe the concept is equally relevant for individuals. You can approach your own finances with the goal of building the same “fortress ” balance sheet. People can learn from Berkshire's example and apply some of these methods to their own lives.
Here are three things Berkshire does to stay resilient regardless of the current state of the economy. First, operate with a large cash balance. Berkshire has more than $100 billion in cash and cash equivalents. Second, avoid borrowing large amounts of money. Berkshire has only a fraction of the debt that a comparable company of the same size would have.
And finally, thirdly, keep operating costs low. Buffett and his staff work in the same office where the company has been based for decades. If you looked at this office, you would think it belonged to a small business barely surviving, not a company with a market cap of 700 billion. All of these lessons are applicable to you as an individual .
First, keep a large cash reserve. In the personal finance community, this is called a " reserve fund." This is money set aside to cover your expenses in the event of job loss. If you are worried about a recession and possible job loss, you should make sure you have a large emergency fund. Second, avoid borrowing large amounts of money.
In general, the more debt a person has , the more money they have to spend each month servicing it. This increases the so-called money "burn" rate, or, in other words, the amount a person has to spend each month just to meet their obligations. Reducing debt also reduces your monthly expenses. This allows you to live longer on your reserve fund.
And the longer you can weather a financial storm, the higher the chances that you will survive it. And third, keep operating costs low. The largest budget item for most people is housing. Buying a luxury house or apartment can increase your status in the eyes of friends and family, but it can significantly limit your financial flexibility.
If the economy slows down and you lose your job or take a pay cut, a large mortgage or rent will make your situation much more difficult. One of the ways I personally limit my financial expenses is by living in the duplex I own. This is a property I own that has two separate apartments in the same building.
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 cover most of my housing costs and provides greater financial flexibility in the event of an economic downturn. That's all. I hope you enjoyed the video, and don't forget to hit the subscribe button, because my goal is to make you a better investor by learning from the experiences of the world's greatest investors. See you next time.
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