Friday, March 14, 2014

A Sage Can Get Away With This: Warren Buffet’s Predictions

A Sage Can Get Away With This:  Warren Buffet’s Predictions

Warren Buffet was on CNBC this morning.[1]  He gave the host, Joe Kiernan two predictions.  First, he said it is unlikely the market will fall by more than 50% any time soon.  Second, he told Mr. Kiernan, age 58, that he could expect to see the Dow Jones Industrial Average hit 100,000 in his lifetime.  Mr. Buffet’s comments made headlines, only because he’s Warren Buffet.
Investment Math (2002)
The biggest drop in the DJIA occurred in 1930-1932, when the venerable average dropped 86%.  After the credit crisis, the DJIA fell 53%.  Other than those two horrific instances, the Dow has never fallen by more than 50%.  So Mr. Buffet isn’t telling us much when he says the chances of a 50% drop are remote.  It would be far more interesting to know what Mr. Buffet thinks is the likelihood of a 25% correction.  However, Mr. Buffet is too smart to try to predict something that is both more likely and extremely hard to predict.

Turning to Mr. Buffet’s long-term prediction, if we assume that Mr. Kiernan lives for another 30 years, the DJIA would only have to appreciate by little more than 6% per year to reach 100,000.  Mr. Buffet isn’t going too far out on a limb in making this prognostication.  Given the DJIA’s current yield of about 2.8%, the total return on Mr. Kiernan’s 88th birthday would simply be about average, based on historic data since 1928, or around 9.5%.

It’s wise of Mr. Buffet to make innocuous predictions, because he knows better than anyone that short and intermediate–term market swings are impossible to forecast. In addition, Mr. Buffet understands that all too many investors would take his guesses as gospel and act on his predictions.  Nonetheless, the Wizard of Omaha makes headlines no matter what he says.


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