The news that could spoil Warren Buffett's 90th birthday celebrations
Warren Buffet turns 90 on Sunday. In a cruel twist of fate, his birthday coincides with the US Federal Reserve's historic announcement that it would relax its inflation target.
The Fed will now target an "average" inflation target of 2% compared to its previous 2% ceiling, giving it a more flexible range.
"It is hard to overstate the benefits of sustaining a strong labour market, a key national goal that will require a range of policies in addition to supportive monetary policy," says Fed chair Jerome Powell.
This news will be nails on a chalkboard for Buffet. He loathes inflation.
"The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital," he told Fortune Magazine back in 1977.
"If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker — but not your partner."
Much of Buffett's hatred for inflation centres on its impact on the real rate of return.
"A business earning 20% on capital can produce a negative real return for its owners under inflationary conditions.
"The inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) - can be thought of as an 'investor's misery index'. When this index exceeds the rate of return earned on equity by the business, the investor's purchasing power (real capital) shrinks even though he consumes nothing at all."
Inflation becomes a consumer of capital, or in Buffett's words, "a gigantic corporate tapeworm".
"[It] consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and fixed assets are continuously required by the business in order to merely match the unit volume of the previous year. The less prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm."
During high inflation, Buffet favours companies with strong cashflows that don't need to invest heavily.
"As inflation intensifies, more and more companies find that they must spend all funds they generate internally just to maintain their existing physical volume of business. There is a certain mirage-like quality to such operations. However attractive the earnings numbers, we remain leery of businesses that never seem able to convert such pretty numbers into no-strings attached cash."
In a further hit to the birthday celebrations, the so-called Buffett indicator is sitting at about 184%, an all-time high.
What does that mean?
It's a measure of market value. You take the total market capitalization and divide it by the most recent quarterly GDP figure. The Wilshire 5000 Total Market Index is valued at about $35.6 trillion at the time of writing, while the latest Bureau of Economic Analysis estimate puts second-quarter US GDP at $19.4 trillion.
So happy birthday Warren, wish it was better.
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