Warren Buffett’s Advice For Bear Markets

Guest post by Nick Ward

Image Source: Pixabay

As cliché as it might seem, when it comes to bear markets, I do my best to channel my inner Warren Buffett, to ensure that I take advantage of the rare opportunities that they present. 

I’m a huge fan of Buffett’s work, his philosophies, his general demeanor (frankly, he just seems like an all around good guy); however, I’ll be the first to admit that I often cringe when I see authors/analysts use the word “Buffett” in the headlines of their reports because what follows is generally haggard, shallow, and click-baity.  

I do my best to avoid falling into this mold; yet, I’m breaking my own rules here because during volatile times like this I think Buffett’s words of wisdom are worth reading (even if you’ve already read them a thousand times).  

Fear and greed drive markets.  Understanding these emotions is the key to success in the market over the long-term.  Investors need to know when it’s correct to act upon fearful and/or greedy urges and when to ignore them.  Oftentimes, doing so requires a contrarian mindset.  That’s especially the case during bear market environments.  

The fact is, bear markets can make or break investors.  Selling low can add years, or not decades, to an investors’ journey towards financial freedom.  On the other hand, capitalizing on the unique opportunities that they provide can accelerate one’s wealth generation process in a major way.  And, who better to have as a guiding force during such scary times as arguably the best investors of all-time?  

With this in mind, let’s hearken back to 1986 and Warren Buffett’s letter to Berkshire Hathaway shareholders, which included one of the Oracle of Omaha’s most timeless phrases.  

During that 1986 letter to shareholders, Buffett touched upon the investment options that Berkshire had for the floats generated by its insurance companies.  

He said, “as money comes in, we have only five directions to go: (1) long-term common stock investments; (2) long-term fixed-income securities; (3) medium-term fixed-income securities; (4) short-term cash equivalents; and (5) short-term arbitrage commitments.”

Buffett continued, “Common stocks, of course, are the most fun.”

I agree.  

Common equities are the most fun because they offer the most upside potential.  

To me, in terms of generating long-term wealth with my invested capital, it doesn’t get much better than owning bits and pieces of the world’s best businesses.  

Not only do these businesses generate rising fundamentals over time, which generally translate into higher share prices…but many of them…the dividend growth ilk…return some of the cash flows that their operations generate to shareholders in the form of reliably increasing dividends.  

As I’ve said before, no dividend is ever truly safe.  Simply put, there are no 100% guarantees in the equity dividend space.  When push comes to shove, equities are risk assets.  I want to hammer home this idea because it’s key to risk assessment as a portfolio manager.  However, even with that being said, I still love and adore dividends.  

What sets the dividends paid by common stocks apart from the fixed income securities that Buffett mentions above is dividend growth.  

Relative to the passive income provided by bond yields, dividend growth accelerates the compounding process and protects one’s passive income stream from being eroded away by inflation over time.  

In my opinion, these benefits outweigh the potential risks of dividend cuts (especially when we’re talking about blue chip equities with strong balance sheets and relatively predictable growth prospects).  

Therefore, when markets sell-off, I’m always looking to overcome the fear that inevitably pops up (I’m human and fear is an instinctual response to uncertainty) and buy the dips when it comes to wonderful companies that have historically paid rising dividends.  

And, as it turns out, Warren Buffett agrees.  

In that 1986 letter, he continued, “When conditions are right that is, when companies with good economics and good management sell well below intrinsic business value – stocks sometimes provide grand-slam home runs.”

In other words, when blue chips are trading at irrationally cheap valuations, they not only offer investors the opportunity to lock in abnormally high dividend yields, but they also bestow attractive total return prospects.  

When talking about the markets, Buffett is happy to admit that he has no idea what is going to happen in the short-term.  He is many things, but a soothsayer, he is not.  

He wrote, “we have no idea – and never have had – whether the market is going to go up, down, or sideways in the near- or intermediate term future.”

It might surprise you to hear that Buffett said that he and his partner, Charlie Munger, freely admit that they have no idea where the market is going to head in the short-to-intermediate term. 

These are two of the world’s all-time best investors, after all.  

This is why attempting to time the market in the short-term is a fool’s errand.    

But, to Buffett, short-term results are often inconsequential.  Instead, he’s interested in buying shares of very high quality businesses and reaping the shares that equity ownership offers over the long-term.  

As his mentor, Benjamin Graham taught him…in the short-term, the market is often a voting machine (meaning, it is dictated by investor sentiment), but over the long-term, it becomes a weighing machine (meaning that eventually, fundamentals matter and ultimately, determine the values of equity holdings).  

Therefore, with regard to using this sentiment (which is often irrational) to his advantage, Buffett discussed his strategy for overcoming uncertainty and hitting those proverbial “grand-slam home runs”.  

He wrote, “What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever  occur in the investment community.  The timing of these epidemics  will be unpredictable.  And the market aberrations produced by  them will be equally unpredictable, both as to duration and  degree.  Therefore, we never try to anticipate the arrival or  departure of either disease.  Our goal is more modest: we simply  attempt to be fearful when others are greedy and to be greedy only when others are fearful.”  

This phrase, “be fearful when others are greedy and to be greedy only when others are fearful” is the mantra that I repeat to myself (alongside many other value investors) when the market is volatile.  

The most basic tenant of successful investing is to buy low and sell high.  

As simple as this might seem to understand and conceptualize, it’s often difficult to put into practice, because those “super contagious diseases” – fear and greed – that Buffett refers to are doing their best to cloud our minds and persuade us to do just the opposite (sell low and buy high).  

Once these diseases spread across the investor base and influence the collective consciousness of the herd to make irrational decisions, it becomes very difficult to break out of this cycle.

Not only are human beings prone to irrational decision-making (driven by fear and greed), but we’re also a herd species, finding comfort in groups, and oftentimes unwilling to look past the accepted status quo, and eschew comfort to truly find reason.  

I recently broke down the downside of group-think in the markets in an article titled, “Don’t Be A Lemming.  You’re Better Than That”.  

I ended that article by saying: 

“In conclusion, don’t be like the average investor who makes disastrous decisions and destroys wealth with poor (irrational) investment decisions.  Don’t fall prey to those who are shilling fearful or greedy advice.  Don’t settle for a spot in the herd which is destined to run off of a cliff, over and over again.  Don’t be a lemming.  You’re better than that.  I know it!” 

This is what Buffett’s quote is all about…breaking out of the pack, producing above-average results, and frankly, outperforming one’s peers (and the market, at large) over the long-term, by simply using fear and greed to one’s advantage, as opposed to stumbling into the pitfalls that irrational thought presents.