This was a section of a recent Saber note to clients that I wanted to post here for BHI readers as well.
This is another Lincoln post (coming in slightly over the 700 word goal but still hopefully quite readable).
Our next couple posts will have investment updates on some of our stocks as well as a new idea. This post has some thoughts on tariffs, trade and the opportunities from short-termism:
Read more hedge fund letters here
Trade and the Economy
“We have been trying for many years to engage in reciprocal tariff reductions… on the whole, it has been a very unsuccessful policy.” – Milton Friedman, 1978
Milton Friedman was a full-throated advocate of free trade (and was no fan of tariffs). He felt free trade is the best way to not just give consumers the lowest prices but also give producers (as a whole) the most jobs and the highest aggregate income. He viewed trade as just one side of the coin. The other side was the capital account surplus – foreign owned US dollars coming back home to be invested in the US. Limiting trade meant not only higher prices for consumers but perhaps fewer jobs since the foreigners wouldn’t have the funds to invest here.
I tend to agree with Friedman’s view on free trade, but it’s possible that this is an ideal viewpoint. As Yogi Berra said, “in theory, there is no difference between practice and theory; in practice, there is”.
For those of us who need an economics refresher, a trade deficit simply means we consume more than we produce. It’s not all bad, but it does effectively mean we need to borrow from our trading partners to fund this overconsumption. It’s possible that too much debt owed to our trading partners could lead to inflation.
Buffett (who is a man in the arena) talks about America as a massively wealthy family that owns a farm that is so vast that the edges of it can’t even be seen. Each year, the harvest shows up at the family’s doorstep. The family consumes 100% of what its farm produces, but wants even more, so it imports food from a neighboring land, paying for this additional consumption by selling off a piece of its farm. Since the farm is so vast, no family member notices that it has a little bit less than it did the year before. After all, they’re eating as much as they want without seeing any near-term consequences. This can go on for years, even decades, but eventually, the rich family might begin to notice that their farm is much smaller than it once was, and the neighboring land owns an uncomfortably large portion of what used to belong to the family.
This is the trade deficit. Instead of selling off a piece of our land, though, we’re mortgaging it. We give the neighboring lands an IOU (Treasury bonds) which are claims on our nation’s future earnings. We’re trading future earnings so we can consume more today.
Thankfully, as the world’s reserve currency, we have a never-ending lineup of lenders. As such, it’s highly unlikely that we’ll ever see any sort of dramatic debt default that worried commentators often suggest. We have the safest house in the neighborhood and as long as that remains true, the neighbors will always seek shelter here whenever there is trouble in the streets.
But I do wonder what happens if foreign trading partners become adversaries? What level of foreign ownership of US assets would be concerning, or even unstable? Foreign ownership of publicly traded American corporations has grown from 9% to 18% in just the last decade. At this same rate of acceleration, foreigners would own more than a third of America’s publicly traded equity a decade from now. Will the next generation be comfortable sending 1/3 of their earnings overseas?
Milton Friedman said that this trade deficit isn’t a problem (he looked at the capital account surplus – the other side of the trade deficit coin – as a glass half full, not half empty). And I think he’s right that if we all get along, it wouldn’t be a problem. But alas, human beings are involved, and life gets messy. What happens if we don’t get along? What if foreigners ultimately want to be repaid?
These are questions I don’t know the answers to. Deficits (both budget and trade) are currently very high. As a risk manager, I think inflation is a possible outcome that we need to be prepared for. This is not a prediction, but simply a risk to be mindful of. To defend against this risk, we want to own companies with an ability to increase returns on capital, which is the only way to mitigate inflation (more on this in another post).
For those interested in hearing two different views from two very smart economists (one of which is the world’s greatest investor), I’d recommend this Friedman talk on trade and this Buffett article from 2003 where he outlines his concerns about trade deficits and inflation, and recommends a surprising solution – essentially tariffs! (with a free market twist). Buffett also gives a nice 2 minute summary here.
Short-termism & Opportunities for the Patient
One thing I can say with certainty is that the last few weeks have displayed how little appetite we have for pain in this country. It took just 3 down days in the stock market and the 10-year Treasury yield to spike to 4.5% (the horror!) for people to panic. This is an indication to me that the expedient and easier route is almost always likely to be taken over the difficult and responsible one. It’s harder to cut spending, easier to run budget deficits. It’s harder to raise interest rates; easier to provide stimulus, etc…
The good news is the short-termism creates all kinds of opportunities for long-term investors like us. American corporations were valued at $6 trillion less on April 8th than they were on April 2nd. On April 9th, they were offered at $4 trillion more at 3pm than they were at lunch time. Perhaps either price didn’t reflect the right value, but I’m positive that the present value of all future cash flows coming from American business didn’t change by 10% in mere hours.
We’ve discussed before how frequently these opportunities present themselves. Being able to look past this noise is a major edge for long-term investors, and the longer we look, the more pronounced the opportunities.
JP Morgan is the world’s largest and most well-followed bank, and the stock is worth over 100% more than it was 3 years ago. This doesn’t happen because analysts misjudge the quality of the business or its long-term earning potential. It happens because investors fear what might happen to earnings next year. They are often directionally correct, but the pessimism pendulum often swings too far. This provides a steady stream of opportunities for patient investors and since human nature doesn’t change, I expect these opportunities to persist indefinitely.
The next few posts will discuss some of these specific opportunities and provide some updates on our stocks.
About the Author
John Huber is the founder of Saber Capital Management, LLC. Saber manages an investment fund modeled after the original Buffett partnerships.
John can be reached at [email protected].
