Wednesday, April 22, 2009

Blind Faith In Capitalism

When the rest of the market panics and a wild sell-off ensues, value investors calmly increase their market holdings. As the unemployment rate increases and more investors panic, value investors become giddy as they swallow up stocks at even more attractive prices. Is it blind faith? Where does this faith come from? As Buffett has said many times over the years...

"In the 20th Century alone, we dealt with two great wars; a dozen or so panics and recessions; virulent inflation that led to a 21.5% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25%."

Although there have been cyclical downturns in the past, how do we know that it's not "different this time", as doom and gloomers will assert in each and every downturn? Quite simply, it is an understanding of the effectiveness of the incentive system that is the basis of capitalism. As Buffett puts it in his 2008 letter to shareholders:

"Our economic system has worked extraordinarily well over time. It has unleased human potential as no other system has, and it will continue to do so. America's best days lie ahead."

Investors who study various economic measures through the course of history will find many of the recurring themes which make Buffett so positive. One is the positive effects that lower borrowing costs have on the economy. Another is the adaptive ability of businesses which react to shocks by eventually bringing supply and demand back in line with each other. Another is growth in productivity, as innovation drives increases in efficiency which allows workers to produce more per hour and thus become more valuable and thereby increase their standard of living.

While certain political leaders call for an end to capitalism, it is important to retain some perspective and consider how valuable this economic system has been and how valuable it will be in continuing to drive increases in our standard of living.


Anonymous said...

I think value investors are optimists who think that economic conditions will improve over time as more human potential is unleased. I guess the market is effecient, if you involve yourself in the daily fluctuations of the market what we see is more of irrational behavior as opposed to any kind of effeciency or growth in the markets.
I have read some of what Peter Lyynch has to say in his books and he believes in the power of capitilism and the good it can do. We have been put in this economic situation due to greed and if it is not dealt with properly, it could lead to more troubles in the future. Living on debt which cannot be paid back is living under a false illusion, not Capatilism.

Anonymous said...

Looking at the top 25 highest paying hedge fund managers from , it seems to me that many of them employ some type of mathematical model for investing/trading.

As us value investors, how should we better explain this phenomenon, especially considering some of these guys (i.e., james simons) have a long successful market beating record..


Manshu said...

I don't think the system is broke either. There will always be booms and busts, at least as long as humans experience greed and fear. There is no cause for worry, at least for someone who is in it for the longer run.