Was that a Dow Theory sell signal?

That's because both the Dow Jones Industrial Average and the Dow Jones Transportation Average broke below their respective Jan. 20 lows. In the case of the Dow Transports, furthermore, Monday's closing represents a new closing low for the bear market that began 18 months ago .

The Dow Theory is the oldest stock-market-timing system in widespread use today. Its author was William Peter Hamilton, who introduced it in a series of editorials in The Wall Street Journal over the first three decades of the past century.

Hamilton argued that it is bullish if both the Dow Industrials and the Dow Transports jointly reach significant new highs. Similarly, the market is likely to continue falling if both Averages jointly reach significant new lows. Potential turning points are signaled when only one of the two Averages reaches a new high or a new low--"non-confirmations" in Dow Theory parlance.

It is just this sort of non-confirmation on which at least some Dow Theorists were recently pinning their bullish hopes. Last Friday, when the Dow Transports fell below their Jan. 20 low, the Dow Industrials did not.

This non-confirmation lasted just one market session, however, and was eliminated on Monday. After the close, Jack Schannep, editor of TheDowTheory.com, wrote to subscribers: "Yes, today the Dow Jones Industrials and the Transports closed below the January lows. That is a Dow Theory Sell signal ... Therefore, I suggest lightening up."

Also bearish is Richard Moroney, editor of Dow Theory Forecasts, the second of the three Dow Theory newsletters I monitor. However, on his interpretation the Dow Theory turned bearish at the end of t September; he did not feel as though Monday's action merited any special communication to his subscribers.

To be sure, careful followers of the Dow averages will note that there is an additional non-confirmation in the charts that might have bullish significance: Though the Dow Transports have broken below their Nov. 20 lows, the Dow Industrials remain nearly 400 points above their low of that day.

Interestingly, however, the editor of only one of the Dow Theory newsletters I track is placing much importance on whether the Dow Industrials remain above their Nov. 20 low. He is Richard Russell, editor of Dow Theory Letters.

Russell says that he won't turn bearish on the stock market's major trend "unless or until the Dow [Industrials] violates its Nov. 20 closing of 7,552.29, thereby confirming the Transport action ... I [therefore] decided to hold off on placing the bear on the site until we receive a bearish confirmation by the Industrial Average."

Russell's refusal to declare the Dow Theory as outright bearish is not much for the bulls to hang their hats on, however. Russell wrote Monday night that he wasn't turning officially bearish "despite the fact that I don't like the market action."

Fed prepared to buy Treasuries

Pulling out all the stops to try to break the downward spiral of the economy, the Federal Reserve on Wednesday said it would continue to flood the financial system with money and moved a step closer to purchasing longer-term Treasury securities.

The Federal Open Market Committee kept its interest rate target in a range of zero to 0.25%, as expected. Rates will need to stay close to zero for "some time," the statement said.

The lack of action on interest rates was expected, as was the FOMC's statement that rates were likely to stay low for a considerable length of time.

The Fed said the economy was weak but still held out hope for a second-half rebound. Deflation became the primary worry on the price front.

All of the action in the statement was related to the Fed's continuing effort to support credit markets. The Fed has stepped in to keep some markets functioning.
In essence, the Fed has adopted a "throw the kitchen sink" approach to supporting the fragile financial system, which is dragging the economy lower.

"The Fed stands ready to buy anything that anyone suggests might help. The sky is the limit," said Mike Englund, chief economist at Action Economics.

Buying longer-term Treasurys would be a new tool in the Fed's arsenal to repair financial markets. Some economists worry that buying Treasurys would cause foreign investors to lose their appetite for the securities.

"If the Fed commits itself to a policy of artificially depressing the returns on Treasury securities for an extended period, it will force investment committees around the world to reconsider their portfolio allocations to the U.S. Treasury market as an asset class," wrote Lou Crandall, chief economist at Wrightson ICAP in a note to clients.

The Fed said was "prepared" to buy Treasurys "if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."

In December, the central bank just said it was mulling over the option.

Still, Treasurys were still down after the Fed statement was released. Analysts said that some investors were disappointed that the purchases didn't start at once.
There was some sense of "holding back," Englund said.

The Fed is already buying commercial paper and mortgaged backed securities and is about to start a program to buy AAA rated consumer loans.

The Fed said it was going to continue these efforts.

"The Fed will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the statement said.

"The focus of the FOMC's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Fed's balance sheet at a high level."

Some good results seen

Although tangible results are slim, the Fed said that "some" financial market conditions have improved.

For instance, the Fed has a plan to buy $500 billion in mortgage securities. This has already driven down rates on mortgages.

Marvin Goodfriend, an economics professor at Carnegie Mellon University, said there will be an economic benefit from the Fed moves, which essentially boil down to writing checks on itself virtually without limit.

Even though the banks are not lending the reserves that the Fed is creating, it is helping, Goodfriend said.

The broad money is making investors and companies more liquid.

If the Fed can convince investors that the economy will avoid deflation, "the private economy will repair itself if we have patience," Goodfriend said.

Richmond President Jeffrey Lacker dissented from the decision. He wanted the Fed to stop other programs and concentrate on buying Treasurys.

Englund said Lacker doesn't really want to buy Treasurys. Instead, the dissent shows that some Fed officials are "uneasy" about all of the mortgage and consumer loans the Fed intends to purchase.

Many economists are waiting for the more nuanced discussion of Fed "credit easing" policy in the minutes of the meeting to be released on Feb. 18.

The Fed is also working closely with the new Obama administration on new approaches to save banks. Although it was not the focus of the FOMC meeting, the Fed presidents were likely interested in discussing the proposals.

One approach on the table is the Treasury putting up a portion of the $350 billion of the bailout funds and the Fed using its balance sheet to leverage the money.

Grim economy but 2nd half recovery

In the statement, the Fed admitted that the economy was in worse shape than in its prior meeting in December.

"Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending.," the statement said.
Global conditions are also slowing and credit conditions for households and firms remain extremely tight

Despite these worries, the view remains that a "gradual recovery...will begin later this year," the statement said, although there are "significant" downside risks to this outlook.

The central bank stressed that deflation was the biggest concern. Deflation is the general decline in prices. One of the worst effects of deflation is that it makes debts more expensive.

"The Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term," the statement said.

Goodfriend of Carnegie Mellon said convincing financial markets that the Fed could ward off deflation was the top job of the central bank in coming months.

Warren Buffett: Credit Crunch "Getting a Little Better" But Business Is Getting Worse

Buffett and Gharib cover a number of other subjects, including how much advice he's giving President Obama, the government's attempts to stimulate the economy, and the Bernard Madoff scandal.

In the conversation, Buffett says the credit crunch is easing but business conditions are getting worse. He also hints Berkshire Hathaway might buy back some of its stock since it has fallen so sharply from its highs.

SUSIE GHARIB, ANCHOR, NIGHTLY BUSINESS REPORT: Are we overly optimistic about what President Obama can do?

WARREN BUFFETT, CHAIRMAN, BERKSHIRE HATHAWAY: Well, I think if you think that he can turn things around in a month or three months or six months and there’s going to be some magical transformation since he took office on the 20th, that can’t happen and wouldn’t happen. So you don’t want to get into Superman-type expectations. On the other hand, I don’t think there’s anybody better than you could have had, have in the presidency than Barack Obama at this time. He understands economics. He’s a very smart guy. He’s a cool rational-type thinker. He will work with the right kind of people. So you’ve got the right person in the operating room, but it doesn’t mean the patient is going to leave the hospital tomorrow.

GHARIB: Mr. Buffett, I know that you’re close to President Obama. What are you advising him?

BUFFETT: Well, I’m not advising him really, but if I were I wouldn’t be able to talk about it. I am available any time. But he’s got all kinds of talent right back there with him in Washington. Plus he’s a talent himself so if I never contributed anything for him, fine.

GHARIB: But I know that during the election that you were one of his economic advisors, what were you telling him?

BUFFETT: I was telling him business was going to be awful during the election, period, and that we were coming up in November to a terrible economic scene which would be even worse probably when he got inaugurated. So far I’ve been either lucky or right on that. But he’s got the right ideas. He believes in the same things I believe in. America’s best days are ahead and that we’ve got a great economic machine, it's sputtering now. And he believes there could be a more equitable job done in distributing the rewards of this great machine. But he doesn’t need my advice on anything.

GHARIB: How often do you talk to him?

BUFFETT: Not often, not often, no, no, and it will be less often now that he’s in the office. He’s got a lot of talent around him.

GHARIB: What’s the most important thing you think he needs to fix?

BUFFETT: Well the most important thing to fix right now is the economy. We have a business slowdown, particularly after October 1st, it was sort of on a glide path downward up til roughly October 1st, and then it went into a real nosedive. In fact, in September I said we were in an economic Pearl Harbor and I’ve never used that phrase before. So he really has a tough economic situation and that’s his number one job. Now his number one job always is to keep America safe. That goes without saying.

GHARIB: But when you look at the economy, what do you think is the most important thing he needs to fix in the economy?

BUFFETT: Well, we’ve had to get the credit system partially fixed in order for the economy to have a chance of starting to turn around. But there’s no magic bullet on this. They’re going to throw everything from the government they can in. As I said, the Treasury is going all in, the Fed, and they have to, and that isn’t necessarily going to produce anything dramatic in the short-term at all. Over time, the American economy is going to work fine.

GHARIB: There is considerable debate, as you know, about whether President Obama is taking the right steps so we don’t get in this kind of economic mess again. Where do you stand on that debate?

BUFFETT: Well, I don’t think the worry right now should be about the next one. The worry should be about the present one. Let’s get this fire out and then we’ll figure out fire prevention for the future. But really, the important thing to do now is to figure out how we get the American economy restarted and that’s not going to be easy and it's not going to be soon, but it's going to get done.

GHARIB: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?

BUFFETT: The answer is nobody knows. The economists don’t know. All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are. Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake or to follow Hoover-like policies would be a mistake and we don’t know how effective, in the short-run, we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.

GHARIB: But are we creating new problems?

BUFFETT: Always.

GHARIB: How worried are you about these multi-trillion dollar deficits?

BUFFETT: You can’t just do one thing in economics. Anytime somebody says 'I'm going to do this', you have to say, 'And then what?' And there is no free lunch, so if you pour money at this problem, you do have aftereffects. You create certain problems. I mean you are giving a medicine dosage to the patient on a scale that we haven’t seen in this country. And there will be aftereffects and they can’t be predicted exactly. But certainly the potential is there for inflationary consequences that would be significant.

GHARIB: We all know that in the long-run everything is going to work out, but as you analyze President Obama’s economic plan, what do you think are the trade-offs? What are the consequences?

BUFFETT: Well, the trade-off, the trade-off basically is that you risk setting in motion forces that will be very hard to stop in terms of inflation down the road and you are creating an imbalance between revenues and expenses in the government that is a lot easier to create than it will be to correct later on. But those are problems worth taking on, but you don’t get a free lunch.

GHARIB: What about the regulatory system? Is it a matter of making new rules or simply doing a better job at enforcing the rules we already have?

BUFFETT: Well, there are probably some new rules needed, but the regulatory system, I don’t think, could have stopped this. Once you get the bubble going, once the American public, the U.S. Congress, all the commentators, the media, everybody else, started thinking house prices could go nothing but up, you were creating a bubble that would have huge consequences because the asset class was so big. I mean, you had 22 trillion dollars, probably, worth of homes. It was the biggest asset of most American families and you let them borrow 100% of, in many cases, of the price of those and you let them refi up to where they kept taking out more and more and treating it as an ATM machine. The bubble was going to happen.

GHARIB: But everybody is talking about, OK, we need more rules, we have to enforce them, we need to go after every institution, every financial market. Do you think that new rules will do the trick or do we have enough rules, we just have to police better?

BUFFETT: Well, you can have a rule, for example, to prevent another real estate bubble. You just require that anybody bought a house to put 20% down and make sure that the payments were not more than a third of their income. Now we would not have a big bust ever in real estate again, but we also would have people screaming that you’re denying home ownership to all these people, that you got a home yourself and now you’re saying a guy with a 5% down payment shouldn’t get one. So I think it’s very tough to put rules out. I mean, I can design rules that will prevent it but it will have other consequences. It’s like I say, in economics you can’t just do one thing. And where the balance is struck on that, will be a political question. My guess is that it won’t be struck particularly well, but that’s just the nature of politics.

GHARIB: You’ve said that we’re in an economic Pearl Harbor, so how bad are things really?

BUFFETT: They’re bad, they’re bad. The credit situation is getting a little better now. Things have loosened up from a month ago in the corporate debt market. But the rate of business descent is at a pretty alarming pace. I mean, there is no question things have really slowed down. Peoples’ buying habits have changed. Fear has taken over and fear is a tough thing to fight because you can’t go on television and say don’t be afraid, that doesn’t work. People will get over it. They got greedy and they got over being greedy. But it took a while to get over being greedy and now the pendulum has swung way over to the fear side. They’ll get over that and we just hope that they don’t go too far back to the greed side.

GHARIB: What’s your view on the recession? How much longer is it going to last?

BUFFETT: I don’t know. I don’t know. I don’t know the answer to these things. The only thing is I know that I don’t know. Maybe other people think they know, but I have no idea.

GHARIB: The last time we talked, you said back in the spring, you said the recession is not going to be a short-haul thing. What is your feel for it right now?

BUFFETT: It isn’t going to be short, but I just don’t know, Susie. If I knew that. There’s no way of knowing.

GHARIB: Berkshire Hathaway is in a lot of businesses that are economically sensitive, like furniture, paint, bricks. Do you see any signs of a pick-up?

BUFFETT: No. No. The businesses that are either construction or housing-related, or that are just plain consumer businesses, they’re doing very, very poorly. The American consumer has stepped back, big time, and it’s contagious and there’s a feedback mechanism because once you hear about this then you get fearful and then don’t do things at all. And that will end at a point, but it hasn’t ended at this point. Now fortunately our two biggest businesses are not really tied that way - in insurance and in our utility business we don’t feel that, of course, those are different things. But everything that’s consumer related feels it big time.

GHARIB: My question to you is, do you think that the psyche of the American consumer has changed, becoming more savers than spenders?

BUFFETT: Well, it certainly has at this point and my guess is that continues for quite a while. What it will be five years from now, I have no idea. I mean the American consumer when they’re confident they spend and they’re not confident now, and they’ve cut it back. But who knows whether.. I doubt that that’s a permanent reset of behavior, but I think it’s more than a one-day or one-week or one-month wonder in that case.

GHARIB: Is that a bad thing?

BUFFETT: Well, it just depends who the consumer is. I mean, consumer debt within reason makes sense. It makes sense to take out a mortgage and own a home, particularly if you aren’t buying during a bubble. You are normally going to see house price appreciation if you don’t buy during a time when people are all excited about it. So I don’t have any moral feelings about debt as to how people should.. I think people should only take on what they can handle though and that gets to their income level.

GHARIB: Let me ask it this way, Americans saving more may be good for consumers, but is that bad for business?

BUFFETT: Well, it’s certainly bad for business in the short-term. Now whether it’s better for business over a 10 or 20 year period... If the American public gets itself in better shape financially that presumably is good for business down the road, but while they’re getting themselves in better shape, it isn't much fun for the merchant on Main Street.

GHARIB: One thing that Americans aren’t buying these days are stocks. Should they be buying?

BUFFETT: Well, just as many people buy a stock everyday as sell one so there are people buying stocks everyday and we’re buying stocks as we go along. If they’re buying into a business they understand at a sensible price they should be buying them. That’s true at any time. There are a lot more things selling at sensible prices now than there were two years ago. So clearly it’s a better time to buying stocks than a couple of years ago. Is it better than tomorrow? I have no idea.

GHARIB: This financial crisis has been extraordinary in so many ways. How has it changed your approach to investing?

BUFFETT: Doesn’t change my approach at all. My approach to investing I learned in 1949 or ‘50 from a book by Ben Graham and it’s never changed.

GHARIB: So many people I have talked to this past year say this was unprecedented, the unthinkable happened. And that hasn’t at all impacted your philosophy on this?

BUFFETT: No, and if I were buying a farm, I wouldn’t change my ideas about how to buy a farm or an apartment house or a business, and that’s all a stock is, it’s part of a business. So if I were going to buy stock in a private business here in Omaha, I’d look at it just like I would have looked at it two years ago and I’ll look at it the same way two years from now. I look at how much I am getting for my money, how good the management is, how the competitive position of that business compares to others, how durable it is and just fundamental questions. The stock market is, you can forget about that. Any stock I buy I will be happy owning it if they close the stock market for five years tomorrow. In other words I am buying a business. I’m not buying a stock. I’m buying a little piece of a business, just like I buy a farm. And that doesn’t change. And all the newspaper headlines of the world don’t change that. It doesn’t mean you can’t buy it cheaper tomorrow. It may turn out that way. But the real question is did I get my money’s worth when I bought it?

GHARIB: One of your famous investing principles is, “Be fearful when others are greedy and greedy when others are fearful.” So is this the time to be greedy, right?

BUFFETT: Yeah. My greed quotient has risen as stocks have gone down. There’s no question about that. The cheaper something gets that you’re going to buy, the happier you feel, right? You’re going to buy groceries the rest of your life; you want grocery prices to go up or down? You want them to go down. And if they go down you don’t think, gee, I got those groceries sitting in my cabinet at home and I’ve lost money on those. You think I am buying my groceries cheaper, I am going to keep buying groceries. Now if you’re a seller, net, obviously you like prices higher. But most people listening to this program, certainly I, myself, and Berkshire Hathaway, we’re going to be buying businesses over time. We like the idea of businesses getting cheaper.

GHARIB: So where do you see the opportunities in the stock market right now?

BUFFETT: That one I wouldn’t tell you about.

GHARIB: Let me throw out some sectors and you just tell me quickly how you feel about these sectors.

BUFFETT: Susie, I am not going to recommend anything.

GHARIB: Even in general? For example, a lot of people now are looking at infrastructure companies. Is that a sector that you find attractive?

BUFFETT: I wouldn’t have any comment. What they ought to do is look at businesses that they understand, they‘d be happy owning for years if there was never a quote on the stock. Just like they buy in privately into a business in their hometown, they ought to forget all about what somebody says is going to be hot next year or the year after, whatever. Because what’s going to be hot, you may be paying twice as much for as something that’s not going to be hot. You don’t want to think in terms of what’s going to be good next year, you want to think in terms of what’s a good business to be in and then buy it at an attractive price. And then you can’t lose.

GHARIB: Do you see more opportunities in the U.S. compared to overseas?

BUFFETT: Well, I am more familiar with the U.S. We have such a big market. I see lots of opportunities here and I see lots of opportunities around the world.


GHARIB: Let me ask you a little bit about investor confidence. Investor confidence was so shattered last year. What do you think it's going to take to restore confidence?

BUFFETT: If people were dependent on the stock market going up to be confident, they’re in the wrong business. They ought to be confident because they look at a business and they think, I got my money’s worth. They ought to be confident if they buy a farm, not on whether they get a quote the next day on the farm, but they ought to look at what the farm produces, how many bushels an acre do they get out of their corn or soybeans and what prices do they bring. So they ought to look to the business as to whether to be confident compared to the price that they paid and they ought to forget about what anybody is saying, including me on television, or what they’re reading in the paper. That’s got nothing to do with whether they made a good decision or not. What’s got to do with whether they made a good decision is what kind of business they bought and what they paid for it.

GHARIB: People are reeling from this whole Bernie Madoff scandal. What would you say to people who have lost trust in the financial system?

BUFFETT: They shouldn’t have lost, you don’t need to lose trust in the American system. If you decide to buy a farm and you pay the right price for it, you don’t need to lose faith in American agriculture, you know, because the prices of farms go down.

GHARIB: But you know what I’m saying. This was on top of everything else. People lost money last year in companies that they thought were rock solid. As I said, the unthinkable happened, and then on top of it, this whole Bernie Madoff scandal. It has undermined people’s sense of well-being about our system. So what do you say to people who have lost trust?

BUFFETT: Well, they may be better off not being in equities. If they’re really depending on somebody else and they don’t know anything about the somebody else, they’ve got a problem. They shouldn’t do that. I mean there are going to be crooks out there and this guy was a crook on a scale that we’ve never seen before. But you ought to know who you’re dealing with. But if you’re going to buy a stock in some business that’s been around for a 100 years and will be around for 100 more years and it’s not a leveraged company and it sells some important product and it’s got a strong competitive position and you buy it at a reasonable multiple of earnings, you don’t have to worry about crooks, you’re going to do fine.

GHARIB: Is there any take away lessons from the Bernie Madoff story?

BUFFETT: Well, he was a special case. I mean here is a guy who had a good reputation for 30 years or something, and the trust of a lot of people around him. So it’s very easy to draw assurances from the fact that if fifty other people that are prominent and intelligent trust the guy, that maybe you should trust him too. But I wouldn’t put my trust in a single individual like that. I would put my trust in a very good business. I would want a business that was so good that if a so-so guy was running it, it would still certainly do well and there are plenty of businesses that are like that.

GHARIB: So, are you saying that investing has gotten so complicated that investors should stick to what they know? Is that the take-away lesson?

BUFFETT: You should always stick to what you know. I say the 'know-nothing investor' and there’s nothing wrong with being a 'know-nothing investor.' I mean, I spend 60 hours a week thinking about investments, and most people have got jobs and other things to do. They can buy index funds. And they’re not going to do better than an index fund if they go around and trust some guy that's promising them very high returns. If you buy a cross section of American business and you don’t buy it during a period when everybody is all enthused about stock, you’re going to do fine over 10 or 20 years. If you buy something with the idea that you’re going to do fine over 10 months, you may or may not. I do not know what stock is going be up 10 months from now, and I never will.


GHARIB: What about Berkshire Hathaway stock? Were you surprised that it took such a hit last year, given that Berkshire shareholders are such buy and hold investors?



BUFFETT: Well, most of them are. But in the end, our price is figured relative to everything else. So the whole stock market goes down 50 percent, we ought to go down a lot because you can buy other things cheaper. I‘ve had three times in my lifetime, since I took over Berkshire, when Berkshire stock’s gone down 50 percent. In 1974, it went from $90 to $40. Did I feel badly? No, I loved it. I bought more stock. So, I don’t judge how Berkshire is doing by its market price, I judge it by how our businesses are doing.

GHARIB: Is there a price at which you would buy back shares of Berkshire? $85,000? $80,000?

BUFFETT: (Laughs.) I wouldn’t name a number. If I ever name a number, I’ll name it publicly. I mean, if we ever get to the point where we’re contemplating doing it, I would make a public announcement.

GHARIB: But would you ever be interested, are you in favor of buying back shares?

BUFFETT: I think if your stock is undervalued, significantly undervalued, that a management should look at that as an alternative to every other activity. That used to be the way people bought back stocks, but in recent years, companies have bought back stocks at high prices. They’ve done it because they like supporting the stock. They don't ever say it.

GHARIB: In your case, with Berkshire. I mean, it's down a lot. It was up to 147-thousand last year. Would you ever be opposed to buying back stock?

BUFFETT: I’m not opposed to buying back stock.

GHARIB: OK, I'm going to move on. Everyone wants to know your plans. What you’re going to do with all of Berkshire Hathaway’s cash, some 30 billion dollars? Is this now the right time to do a big acquisition?

BUFFETT: Well, we’ve spent a lot of money in the last four months. We spent five billion on Goldman Sachs, three billion on GE, 6.6 billion on Wrigley, we’ve got three billion committed on Dow. We’ve spent a lot of money. We’ve got money left, but I love spending money. Cash makes me very unhappy. I like to always have enough and never way more than enough, but I always want to have enough. So we would never go below $10 billion of cash at Berkshire. We’re in the insurance business - we got a lot of things. We’re never going to depend on the kindness of strangers. But anything excess in that, I love the idea of buying things and the cheaper they get, the better I like it.

GHARIB: You’ve been talking about doing a big acquisition for a while now. What are you waiting for?

BUFFETT: Well, we’ve spent 20 billion dollars. (Laughs.) That might not be ..

GHARIB: I mean in terms of a company, buying …

BUFFETT: Well, we’ll wait for the right deal. We had a deal to buy Constellation for roughly five billion and then events with the French coming in meant that we didn’t do it. But I was delighted to commit for that five billion dollars for Constellation Energy. And it could happen tomorrow. That one happened on a Tuesday afternoon. I mean, it happened like that. Constellation was in big trouble and we flew back that day, the people at (Berkshire Hathaway subsidiary) MidAmerican, met on Tuesday and made them an offer that night.

GHARIB: It seems that you’re pretty optimistic about the long-term future of the American economy and stock market, but a little pessimistic about the short term. Is that a fair assessment of where your head is right now?

BUFFETT: I am unquestionably optimistic about the long-term. I’m more than a little pessimistic about the short-term, but that doesn’t mean I am pessimistic about the stock market. We bought stocks today. If you tell me the economy is going to be terrible for 12 months, pick a number, and then if I find something that is attractive today, I am going to buy it today. I am not going to wait and hope that it sells cheaper six months from now. Because who knows when stocks will hit a low or a high? Nobody knows that. All you know is whether you’re getting enough for your money or not.

GHARIB: All right, I want to move on to our 30th anniversary and wrap-up some of your reflections and thoughts on that. As you know, it’s the 30th anniversary of Nightly Business Report. As you look back on the past three decades, what would you say is the most important lesson that you’ve learned about investing?

BUFFETT: Well, I’ve learned my lessons before that. I read a book, what is it, almost 60 years ago, roughly, called The Intelligent Investor, and I really learned all I needed to know about investing from that book, and particularly chapters 8 and 20. So I haven’t changed anything since. I see different ..

GHARIB: Graham and Dodd?

BUFFETT: Well, that was Ben Graham’s book The Intelligent Investor. Graham and Dodd goes back even before that, which was important, very important. But, you know, you don’t change your philosophy, assuming you think have a sound one. And I picked up, I didn’t figure it out myself, I learned it from Ben Graham. But I got a framework for investing which I put in place back in 1950, roughly, and that framework is the framework I use now. I see different ways to apply it from time to time, but that is the framework.

GHARIB: Can you describe what it is? I mean, what is your most important investment lesson?

BUFFETT: The most important investment lesson is to look at a stock as a piece of a business, not as some little thing that jiggles up and down, or that people recommend, or people talk about earnings being up next quarter, something like that. But to look at it as a business and evaluate it as a business. If you don’t know enough to evaluate it as a business, you don’t know enough to buy it. And if you do know enough to evaluate it as a business and it's selling cheap, you buy it and you don’t worry about what it does next week, next month, or next year.

GHARIB: So if we asked for your investment advice back in 1979, back when Nightly Business Report first got started, would it be any different than what you would say today?

BUFFETT: Not at all. If you’d ask the same questions, you’d have gotten the same answers.

GHARIB: Thank you so much Mr. Buffett. Thank you so much, always a pleasure talking to you.

BUFFETT: Thank you, been a real pleasure.

Obama's first 100 days

The Super Contango Puzzle

"I would say, the long-term demand for oil is there. The supply won't be there. So, long-term, I think the price will be much higher than it is today" ~ Marc Faber, 2009 Outlook on Crude Oil.

Billionaire oil tycoon Boone Pickens, chairman of BP Capital, predicts oil will reach $75 a barrel within a year and go back up to $140 a barrel when the global economy turns around. ~ CNBC Interview, 13 Jan 2009

The oil market is currently in super-contango. That is the forward prices are much higher than current prices. Normally, it costs more to buy a barrel of oil for delivery six months from now than it does to buy a barrel of oil today. Sounds nice, but since this profit opportunity is so obvious it should get arbitraged away almost instantly by speculators. In short, a situation like this should never happen — certainly not for long periods, anyway. But it has:

So what's going on? One possible explanation is that most of the easy storage is already full. But even if that's the case, there's yet another option: oil producers can pump less oil now (essentially "storing" it in the ground) and then pump it out in July for delivery at the higher price. But apparently they're not doing that.

There are two possible explanations:
(1) the oil producers are already pumping at full capacity, so they can't promise to pump extra oil in July even if they want to therefore the very sharp forward prices, or

(2) oil producers are so desperate for cash that they're willing to take money now even if it's way less than they could get for the same stuff six months from now.

---> #1 doesn't seem to be true. So that leaves #2: thanks to plummeting oil prices, OPEC countries are in serious economic turmoil and desperate for any cash they can get their hands on right now.

I have no third explanation - other than the government is selling front month oil to drive down prices. Possible given rising inventories? But in summary either the oil exporters are desperate for cash or OPEC is lying about oil capacity and they are really constrained – or a combination of the above.

Hyperinflation - Zimbabwe unveils $100 trillion banknote

Zimbabwe unveiled a 100 trillion dollar note Friday in the latest grim measure of its staggering economic collapse, heightening the urgency of a new round of unity talks set for next week.

Veteran leader Robert Mugabe and opposition chief Morgan Tsvangirai are set to hold talks Monday with key regional leaders in a bid to salvage a four-month-old unity accord, which has yet to be implemented.

The stalemate over disputed elections last year has only fuelled the economic and humanitarian crisis that has impoverished the country, leaving nearly half the population dependent on food aid as a cholera epidemic sweeps the country.

The Reserve Bank announced in the government mouthpiece Herald newspaper a series of trillion-dollar denominations to keep pace with hyperinflation that has left the once-dynamic economy in tatters.

The new 100,000,000,000,000 Zim-dollar bill would have been worth about 300 US dollars (225 euros) at Thursday's exchange rate on the informal market, where most currency trading now takes place, but the value of the local currency erodes dramatically every day.

The move came just one week after the bank released a series of billion-dollar notes, which already are not worth enough for workers to withdraw their monthly salaries.

Inflation was last reported at 231 million percent in July, but the Washington think-tank Cato Institute has estimated it now at 89.7 sextillion percent -- a figure expressed with 21 zeroes.

When Mugabe took power at independence from Britain in 1980, the Zimbabwe dollar was equivalent to the British pound.

For years, the nation's farms, schools and health care were considered a model for Africa. Now 80 percent of the population is in poverty, 1.3 million are living with HIV, five million depend on food aid, and more than one million others have fled overseas.

A breakdown in basic sanitation and water has spawned a cholera epidemic that has killed 2,100 people since August and shows no sign of slowing.

Despite the ever-worsening crisis, Zimbabwe is locked in a political limbo following elections last March, when Tsvangirai won a first-round presidential vote and his Movement for Democratic Change (MDC) seized a parliamentary majority for the first time.

The MDC victory was greeted with a wave of political attacks that Amnesty International says left more than 180 people dead -- mostly opposition supporters.

Citing the violence, Tsvangirai pulled out of a run-off election in June, allowing 84-year-old Mugabe to claim a one-sided victory condemend by western powers.

Former South African president Thabo Mbeki brokered a power-sharing deal signed September 15, but the rivals have yet to agree on how to form a unity government, while attacks and arrests of MDC members have continued.

Hoping to salvage the deal, South Africa's new President Kgalema Motlanthe plans to fly to Harare on Monday with Mbeki and Mozambican President Armando Emilio Guebuza to mediate new talks.

"They will focus their discussions on the outstanding matters in the implementation of the global agreement," Motlanthe's spokesman Thabo Masebe told AFP in Johannesburg.

Tsvangirai told reporters Thursday that he remained committed to the unity accord. "All I lack is a willing partner," Tsvangirai said.

But he said he was not willing for talks to drag on indefinitely.

"At some point we will have to decide whether it is worth going into this government or not," he said.

How Porsche took Volkswagen shorts for a 7 Billion Euro Ride‏

This real life story took place recently has proved that shorting is a very dangerous game. Even Merckle, whose estimated $9.2 billion fortune put him 94th on Forbes’ list of the world’s richest people, was caught in a so-called short squeeze after betting Wolfsburg, Germany-based Volkswagen’s stock would fall.

Adolf Merckle, one of the world's richest men, committed suicide yesterday by throwing himself under a train, Bloomberg reports. Financial difficulties, and particularly great losses he suffered on Volkswagen stock, are being cited as the key reason he ended his life:

[Merckle's company] VEM was caught in a so-called short squeeze after betting Wolfsburg, Germany-based Volkswagen's stock would fall. Merckle lost at least 500 million euros on the bets on VW stock, people familiar said on Nov. 18. VEM lost "low three-digit million euros" on VW stock, the company said in November.

A "short squeeze" sounds inconspicuous enough; you wouldn't tell it by Bloomberg's language, but Merckle's Volkswagen bet lost out to one of the most masterful hacks of the financial system in history.

For those of us who don't live and breathe finance, this is that story.

In 1931, Austro-Hungarian engineer Ferdinand Porsche started a German company in his own name. It offered car design consulting services, and was not a car manufacturer itself until it produced the Type 64 in 1939. But things got interesting for Porsche long before then.

In 1933, he was approached by none other than Adolf Hitler, who commissioned a car designed for the German masses. Porsche accepted, and the result was the iconic Beetle, manufactured under the Volkswagen (lit. "people's car") brand. Today, Porsche's company is one of the world's premier luxury car brands, while Volkswagen (VW) is itself the world's third-largest auto maker after General Motors and Toyota.

Three years ago, Volkswagen found itself fearing a foreign takeover. Porsche, the company, decided to step in and start buying VW stock ostensibly to protect the landmark brand, widely fueling market expectations that it would eventually buy Volkswagen outright. Of course, this isn't quite what came to pass.

For three years, Porsche kept accumulating VW stock without telling anyone how much it owned. Every time it purchased more, the amount of free-floating VW stock would decrease, driving the stock price up slightly; your basic supply and demand at work.

Eventually the share price became high enough that, to outside observers, it wouldn't have made any sense for Porsche to buy Volkswagen. It would simply have cost too much.

To explain what happened next, I'm going to first tell you about a financial maneuver called shorting.

At any given point, only a certain amount of a publicly traded company's stock is floating freely in the market. The rest is held in various portfolios, funds, and investment vehicles. Now, everyone's familiar with the basic idea behind the stock market: you buy stock when it costs little, and you sell it when it costs a lot, profiting on the difference.

But that assumes a company's value is going to increase. What if, instead of betting a company will go up, you want to make money betting the company will go down? You can — by selling stock you don't own.

Say you borrow a certain amount of stock from someone who already owns it. You pay a fixed fee for borrowing the stock, and you sign a contract saying you will return exactly the same amount of stock you took after some amount of time. So, you might borrow a thousand shares of Apple stock from me (I don't actually own any, but play along), pay me $100 for the privilege, and sign an obligation to return my stock in 3 months. At the time, Apple stock is worth $10 per share.

After you borrow the stock, you immediately sell it. At $10 a share, you get $10,000. Two and a half months later, another rumor about Steve Jobs' health sends AAPL crashing to only $6 per share for a few hours, so you buy a thousand shares, costing you $6,000. You give me back those shares. Because you successfully bet the company would go down in value, you earned $4,000 minus the borrowing fee. This is called short-selling or shorting the stock, and the downside is obvious: if your bet was wrong, you would have lost money buying back the shares that you have to return to your lender.

Now things get kinky.

When Volkswagen's share price exceeded the point where it made sense for Porsche to buy the company, a number of hedge funds realized that Volkswagen shares have nowhere to go but down. With Porsche out of the picture, there was simply no reason for VW to keep going up, and the funds were willing to bet on it. So they shorted huge amounts of VW stock, borrowing it from existing owners and selling it into circulation, waiting for the price drop they considered inevitable.

Porsche anticipated exactly this situation and promptly bought up much of these borrowed VW shares that the funds were selling. Do you see where this is going? Analysts did. According to The Economist, Adam Jonas from Morgan Stanley warned clients not to play "billionaire's poker" against Porsche. Porsche denied any foul play, saying it wasn't doing anything unusual.

But then, last October 26th, they stepped forward and bared their portfolio: through a combination of stock and options, they owned 75% of Volkswagen, which is almost all the company's circulating stock. (The remainder is tied up in funds that cannot easily release it.)

To put it mildly, the numbers scared the living hell out of the hedge funds: if they didn't immediately buy back the Volkswagen stock they were shorting, there might not be any left to buy later, and it isn't their stock — they have to return it to someone. If their only option is thus to buy the VW stock from Porsche, then the miracle of supply and demand will hit again, and Porsche can ask for whatever price it wants per VW share — twenty times their value, a hundred times their value — becuse there's no other place to buy. They're the only game in town.

And that, my friends, is called a short squeeze.

Porsche's ownership disclosure sent the hedge funds on such a flurry of purchases for any Volkswagen stock still in circulation that the VW share price jumped from below €200 to over €1000 at one point on October 28th, making Volkswagen for a brief time the world's most valuable company by market cap.

On paper, Porsche made between €30-40 billionin the affair. Once all is said and done, the actual profit is closer to some €6-12 billion. To put those numbers in perspective, Porsche's revenue for the whole year of 2006 was a bit over €7 billion.
Porsche's move took three years of careful maneuvering. It was darkly brilliant, a wealth transfer ingeniously conceived like few we've ever seen. Betting the right way, Porsche roiled the financial markets and took the hedge funds for a fortune.
Betting the wrong way, Adolf Merckle took his life.

How a Ponzi scheme can make you a smarter investor

Unless you've been living on the dark side of the moon, you're aware that New York trading firm owner and sometime investment manager Bernie Madoff by his own admission bilked investors out of an estimated $50 billion.

You're also probably aware that the media is using his record-breaking Ponzi scheme to explain what's wrong with everything from Wall Street to capitalism to Social Security to the Bush Administration -- namely "if it sounds too good to be true, it probably is" (more on that later).

The truth is that the Madoff case, and the circus that's surrounding it, does offer some lessons that can make us smarter about financial advisers and personal finance in general. In my experience, professional investors aren't any smarter than financial consumers, but they do have a much better perspective of how the financial game really works.

So, much as I abhor following the herd, here's my take on Bernie Madoff, why he matters to you, and what you can learn from all this to better protect whatever investment portfolio you have left.

First, let's talk a little bit about Madoff's record-breaking Ponzi scheme. Charles Ponzi was a notorious swindler, who, in the early 1920s, perpetrated one of the most famous financial frauds in history, bilking would-be investors out of millions of dollars (back when $1 million was real money) before he got caught. Today, almost 100 years later, in an ignominious claim to fame, similar cons, such as the one Madoff allegedly ran, are called Ponzi schemes.

Circle game

Brilliant in its simplicity, someone running a Ponzi scheme simply pays his or her investors' a "return" out of the principal he or she takes in from new investors. Since the money isn't really being "invested" in anything at all, the con-person can make the "returns" what ever they want, and pocket the rest

Typically, the returns are attractively high, which enables the cheat to attract new investments, some of which he uses to pay the older investors. The flaw in a Ponzi is that eventually, they can't bring in enough money to pay the returns and the con is revealed. This appears to be what happened to Madoff: when the credit crunch drove the market south, his new investment money dried up, some existing "investors" wanted their principal back, and the whole scheme collapsed.

We may never know why Madoff started his fraud. What we do know is that in early December, he admitted to his partners (who are his sons) and then to the FBI, that his "highly successful" investment management business was a "fraud," that he couldn't keep it going any longer, and that would probably cost his investors around $50 billion.

We also know that those investors read like a Who's Who of savvy institutions and private investors around the globe: The Royal Bank of Scotland, The Royal Bank of Canada, UBS Bank, The Thyssen family, Liliane Bettencourt (heiress to the L'Oreal empire), Mort Zuckerman, and Henry Kaufman, to namedrop a few.

The attraction of Madoff's investments is that apparently over the past 20 years or so, he paid out returns of between 1% to 2% each month -- month in and month out. No bad months, no bad quarters, no bad years. Just 10% to 20% a year for nearly a quarter of century, including the recession of 1991 and the dot.com crash. Does that sound too good to be true? Of course it is.

But here's the punch line: His investors knew it, but they didn't care.

Why? Because they assumed he was illegally using inside information from his stock trading business (one of the largest in the world) to the benefit of his investors.

Too good to be true

So, despite red flags dating back at least to Erin Arvedlund's May 7, 2001 Barron's article "Don't Ask, Don't Tell," (a Google search will reveal a list of cautionary pieces on Madoff and whistleblowers longer than your arm), investors kept pouring money into Madoff's investment funds.

Don't believe it? Here's what Henry Blodget on clusterstock.com recently reported: "For years and years I've heard people say that [Bernie's] investment performance was too good to be true... ...and too high given the supposed strategy.

One Madoff investor, himself a legend, told me that Madoff's performance 'just doesn't make sense. The numbers can't be straight.' So why did these smart and skeptical investors keep investing? They, like many Madoff investors, assumed Madoff was somehow illegally trading on information from his market-making business."

So, the first lesson from the Madoff mess is that just because something sounds "too good to be true," or actually is too good, doesn't mean you won't be tempted to invest in it anyway. Many sophisticated investors did. But the bigger problem with the too-good-to-be-true advice is that most con men know the "too good" thing, too -- so they tailor their pitches to sound just good enough to be true. (Madoff is the exception because he knew that knowledgeable but greedy investors would assume he was cheating someone, just not them.)

The second takeaway here is that when someone is delivering substantially better returns than everyone else, you'd better know exactly how they're doing it.

Contrary to the impression we often get in the media that Wall Street is a good ol' boys club with everyone scratching each other's financial backs, it's far more like a swimming pool filled with sharks who would eat each other in a second, given the chance.

There are tens of thousands of very smart, highly compensated folks out there managing investment portfolios. Sure, a few of them are smarter than the others, but even then, it's only by a very small margin, which then compounds over time. And chances are, the very smartest guys aren't going to be telling you about it; why would they need to?

When you see someone generating investment returns that are a lot better than everyone else, be afraid, be very afraid. A while back a mutual fund manager told me why his fund didn't invest in the Enron disaster: "We have a guy on staff with 20-years experience in the oil business, but we just couldn't figure out what Enron was doing better than everyone else to make those high returns. So we passed." That's a good mantra for all investors -- amateur or professional.

Treasury Bills - why invest in them

Why Invest in Treasury Bills?

Why leave the rest of the money in your savings deposits when you could earn higher interest investing in T-Bills? The current yield for a 3 month T-Bill is better than the local banks' savings rate1.

T-Bills offer flexibility with no lock-in period; thus you will be able to liquidate your investment whenever you need the money. You can even choose to liquidate just part of it (in multiples of 1000 units).

While some fixed deposits might offer higher interest as a promotion, they usually require you to lock up your deposit for the entire tenure, and require a minimum investment of quite a significant sum. Unlike those, T-Bills only require a minimum investment of less than $1000. If you are unwilling to lock-up a huge chunk of your funds in fixed deposits, T-Bills could be suitable for you.

For equities investors, T-Bills could come in useful during occasions when you are standing on the sidelines and waiting for the next opportunity. Make your money work harder for you by parking your spare cash in T-Bills to earn some interest.

How do Treasury Bills work?

T-Bills have a fixed maturity date and have zero coupons. During the tenor, the owner of the T-Bills will not receive any interest payments. Instead, the T-Bills are sold at a discount and redeemed at par value upon maturity.

For example, if you purchase 1000 units of a 1-year T-Bill at a yield of 1% per annum, you will only need to pay $990 and you will receive $1000 upon maturity a year later.

Similarly for 1000 units of an 86-day T-Bill at a yield of 1% per annum, you will need to pay $998 and you will receive $1000 upon maturity 3 months later.

Stagflation

Stagflation is a "Sluggish economic growth coupled with a high rate of inflation and unemployment. ".

In other words, in stagflation prices are going up while the economy is going down. The word was coined during the inflationary period of the 1970's.

Under normal conditions one would expect inflation to heat up the economy. That is one reason the FED generally increases interest rates during periods of higher inflation. This helps to cool the economy and prevent inflation from spiraling out of control.

Of course ,if you have read other articles on this site, you will know that the primary cause of inflation is an increase in the money supply.

So clamping down on interest rates is kind of like stomping on the accelerator with one foot (increasing the money supply) and stomping on the brakes with the other (increasing interest rates).

The net effect is not good for your car. In the same way it doesn't help the economy either. But we digress (back to stagflation).

Remember, under normal circumstances increasing inflation equals an increasing economy as all that new money begins flowing around.

But in the 1970's we saw something unusual, inflation and a recession at the same time. This was so unusual that they coined a new term "stagflation" to describe the situation.

Basically, what happened in stagflation was that there was plenty of liquidity in the system and people were spending money as quickly as they got it because prices were going up quickly, (price inflation).

But the rapid price increases in the price of oil caused many businesses to become unprofitable, so they began laying off workers. This threw the economy into a tailspin as unemployment grew in spite of an increase in the money supply.

The end result was stagflation, i.e. price inflation and high unemployment and a disastrous economy. Finally, the FED cut the money supply, oil prices moderated, and the economy was able to get back on it's feet.

The major problem with stagflation is that the normal methods of increasing interest rates doesn't help the situation. The only reason it helps in times of high economic activity is because it slows the "velocity of money" or the speed at which it changes hands.

In contrast, when the economy is weak the standard medicine administered by the FED is to lower interest rates to stimulate the economy. Unfortunately, it is impossible to stimulate the economy by lowering rates while simultaneously fighting inflation by raising rates.

So there is the catch. What do you do in Stagflation? Well at this point the Government is forced to face the real problem (which isn't interest rates at all but the money supply). It has to reduce the money supply and get the economy back on a firm footing.

That is what finally happened in the early 1980's and that is what is happening now, although not by choice as the market collapses and banks fail the money supply and the velocity of money is contracting.

The current situation is a result of years of inflation because low foreign wages and high demand for US paper debt, were able to keep a cap on our inflation. But finally higher oil prices are igniting the old fires of inflation while the sub-prime mess is unraveling the economy placing us in much the same situation as in the 1970s.

Unfortunately, currently the FED is still in denial about the stagflation situation and is trying to lower interest rates and increase the money supply by using massive bailouts, to fight the stalling economy and it isn't doing very well.