It’s Only ‘Safety First’ That Will Make You Money: Part II

Billionaire investor Warren Buffett, on the heels of releasing his annual report, said that the stock market isn’t in a bubble and “measured against interest rates, stocks actually are on the cheap side compared to historic valuations.” In the same interview, he also warned “That doesn’t mean the stock market can’t go down 20% tomorrow.” A buying opportunity he’d welcome with open arms. It’s good to be Warren.

Believe me when I tell you that I appreciate the methods Warren Buffett deploys to make money. One big one being that at the core of his methods he’s America’s #1 stockbroker. Between the Woodstock for Investors annual meetings and the “Aw shucks” interviews on CNBC he’s Mr. ABC, always be closing. He’s the steely eyed operator behind that good ‘ole Warren veneer.

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That’s why when I hear that Warren Buffett is bullish on stocks I don’t jump right in with Zac Brown abandon. Instead, I begin the tedious work of determining margin of safety, whether it’s mine or my client’s. One thing I can assure you is that it’s different than Mr. Buffett’s.

Which brings me to Buffett’s statement that stocks, measured against interest rates, are on the cheap compared to historic values. It’s not surprising to me, by any stretch, that Buffett is pushing stocks. But he knows that gravity/interest rates are at unnatural lows and that we are, more than likely, living in a universe of reduced returns—investors be warned—in both bonds and stocks.

I learned early in my career from both Dick Young and Warren Buffett that interest rates are gravity.

Before jumping into stocks investors need to know that what lies on the other side of a stock trade, the Grand Canyon or terra firma, is unknown. And that the best way to determine your margin of safety is to follow Dick Young’s advice and locate the North Star and proceed with caution. Dick wrote in the July 2010 issue of his Intelligence Report:

The Real North Star is the inflation-adjusted rate of interest on three-month Treasury bills. The rate of return offered on the Real North Star is viewed as the risk-free rate of interest. The risk-free rate of interest is used as a benchmark to price all other asset classes. If real T-bill rates are low, you shouldn’t expect much from other asset classes.

Read Part I here.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West (RIP JB) and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.