Becky Quick had another CNBC interview with the Warren Buffett and Greg Abel of Berkshire Hathaway, likely as a preview to the annual shareholder meeting that is coming up soon in May. You can watch a replay of the interview via this CNBC YouTube playlist and/or read the full text transcript. I appreciate that CNBC provides the transcripts, and they are the most efficient way for me to digest the information and take notes. Below are a few highlights (bolded emphasis is mine).

With higher interest rates upon us, Buffett reminds us that those 30-year fixed rate mortgages at 3% or 4% were and are a great deal for the borrowers, but not great for the banks (or investors in those mortgages). This is one of the reasons I don’t own mortgage-backed securities (MBS) or a Total US Bond index fund, which many people don’t know consist of roughly 25% mortgage-backed securities.

WARREN BUFFETT: I think that they that there will be problems when and, you know, people had anybody that’s got a fixed rate in, locked in for a while when the fixed rate goes away and they gotta reprice it now has got a problem. And the holder of a 30-year Freddie Mac or Fannie, they’ve got the best deal in the world. And they should. I love the program. But—

BECKY QUICK: You mean somebody who has their 30-year mortgage—

WARREN BUFFETT: Yeah, who has the mortgage. But the reason it’s for the very fact that it’s very advantageous. The person who has the mortgage means it’s a very dumb holding for banks. But I also believe in the system that produces I think net the country is better off because it but I don’t wanna hold any 30-year mortgages myself. And the idea that if you’ve got a 30-year mortgage, you personally, you can call off the deal 10 minutes later, and if, and if the banks got a bad deal they’re stuck with it for 30 years. Berkshire cannot make the deal with our credit than you can make if you qualify for making a Freddie or Fannie Mae. I think that’s a good thing for society. I don’t think it’s a very good investment for banks.

Regarding FDIC insurance, Buffett is willing to bet anyone a million dollars that not a single US depositor will lose a penny of money within the next year due a bank failure. The media likes to stoke the fear. Buffett is realistic and is willing to put his money where his mouth is. I don’t lose sleep about my cash in any bank with FDIC insurance that is under the $250k limits ($500k for a joint account, by the way).

WARREN BUFFETT: But I will be glad to put a million dollars of my own money in the bank that or any place else actually that anybody takes a differing view takes and have them put a million dollars in, and at the end of the year from when we do it if any American depositor has lost money from a bank failure, the other fellow gets to name where the $2 million goes to what charity.

In many ways, the world is better today than it was for previous generations. It’s trendier to complain the other way, but that is human nature.

I think I was very, very, very lucky that Berkshire happened to be in America and I happened to be an American. And I was born in 1930 and I’ve been in a golden age ever since I was born. The GDP per capita’s up, like, six-fold or seven-fold. In one person’s lifetime there’s never been anything like that in the history of mankind. And so and, you know, we love to complain about wherever we are, but, you know, most people don’t work on Saturdays and don’t work on Sundays and when I was a kid everybody worked on Saturdays. And I mean, it the world has changed so much for the better in terms of, you know, how well off people are compared to any other time in history. If I’d been born 150 years ago and I went to the dentist, I mean, you know, they’d pour whiskey down me and all kinds of things. There’s just all kinds of improvements. And but it’s man nature to be dissatisfied. And politics does stir that up. And you’ve gotta say, if you’re out of power, that the other guy’s screwing up and you could do better. And that’s just built into the system. But that was the case when I was a kid, and it’s the case today.

Ignore economic forecasts and interest rate predictions. I’m always amused when Warren Buffett sits there and says “I ignore the noise” and all around him on the screen is all this… noise. S&P 500 up 5 points since 10 minutes ago! DOW down 10 points! 5-year yield up 8 points!

WARREN BUFFETT: I would say that I’ve been in business, running Berkshire for 58 years, and I’ve never opined an economic forecast of any use to the company. And all you have to do is keep running every business as well as we can, and we got to keep plenty of cash on hand so that people are going to keep making intelligent decisions, rather than those forced upon them. And that’s all we know how to do. And if I depended in my life on economic forecasts, you know, I don’t think we’d make any money. I don’t know how to do it. And, you know, people want to get them, so they get them. But it has no utility.

And but we haven’t changed our course, you know, in 58 years. And we just wanna buy good businesses run by people we like and trust and at a decent price. And we’ll keep doing that. And we’ll keep buying Treasury bills every Monday, and we haven’t missed a Monday yet. And we keep all our money short. We keep it in Treasuries.

And we were getting four basis points, which was $40 million on $100 billion worth. And now we get almost 5%, which is $5 billion. So we’ve got 100 times the earnings. But it doesn’t make any difference. I mean, that is there to be the strongest company you can imagine. And also, to take opportunities when they come along.

Warren Buffett buys US Treasuries because they are the absolute safest and most liquid instrument available to him. Notice he has never kept Berkshire Hathaway’s cash in a bank, even a huge megabank like Bank of America or Chase (and certainly not Silicon Valley Bank), because he KNOWS he is not covered by FDIC insurance. As an individual investor, I also KNOW that I am different that I am covered by FDIC insurance up to clear limits. Buffett cares about the interest earned on his cash, but not at the expense of safety. There is a big gap between safe 99% of the time and safe 100% of the time. Any time you have to multiply by zero, you get zero. It sounds stupidly simple, but zero happens.

The Morningstar article Why Investment Complexity Is Not Your Friend points out that out of the thousands of available ETFs and mutuals available, most of them are so narrowly-focused that you really don’t even need to consider them.

What asset classes do you really need to own? Here is their no-nonsense list broken down by “definitely need”, “probably need”, and “don’t need”.

Agree? Disagree? I do believe you can still do quite well over the long run even if keeping things very simple.

The 15th edition of the Credit Suisse Global Investment Returns Yearbook is available for free download in a 54-page PDF Summary Edition version on the Credit Suisse website. This publication provides a nice “big picture” overview of the long-term performance of global financial assets:

The Credit Suisse Global Investment Returns Yearbook is based on a unique database that offers a historical record of the real returns from equities, bonds, cash and currencies for 35 countries. The data spans developed and emerging markets, and stretches back to 1900. As well as being an important source of rich data on long-term investment returns, the 2023 edition contains analysis on topical issues that investors face today.

(You may be more familiar with the collapse of Credit Suisse and it’s government-brokered rescue and takeover, but this is more of a collaboration with market historians than investment bankers. I do hope that they keep publishing it in the future.)

I recommend scrolling through just to look at the cool charts with data from 1900. Here are just a few quick examples. Here is a chart that tracks the relative market capitalizations of world equity markets since 1900.

Then there the differences in the historical annualized real returns for equities, long-term government bonds, and US Treasury bills (very short-term government bonds).

Here are the annualized real returns of those three asset classes over three different periods for the United States:

Here are the annualized real returns (in USD) of those three asset classes over three different periods for the rest of the world (World ex-US):

You can see that the “equity premium” is very significant (on average) worldwide over the history that we have available, and of course that is why most of us invest at least partially in stocks today.

Per Wikipedia, a financial “hedge” is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. Wouldn’t be nice if for every Investment A, there was another Investment B that would always move in the opposite direction? Unfortunately, things aren’t so easy.

Here a reader e-mail that I definitely empathize with:

While I understand the dangers of performance-chasing, I’m getting more and more annoyed that bonds don’t do their jobs at stabilizing my portfolio. Last few years, they seem to have a positive correlation with stocks.

Things I’d love to better understand:
– say an ETF like BND, wouldn’t the fact that we know interests will be high for some foreseeable future already baked in the price of BND?
– Moving away from bonds at this point seems “late to the party” and market-timing…but like I said, I’m getting increasingly annoyed
– What could be good alternatives? What about dividend stocks such as the VIG ETF or some REITs?

Here’s a related excerpt from the Institutional Investor article Here’s Proof That Stocks Were Never an Inflation Hedge (emphasis mine):

Years of outsize returns also lulled investors on the correlation between stocks and bonds. Fixed income has historically acted as a portfolio stabilizer when markets are declining. When stocks tank, bonds have done well. But that correlation has changed over time.

From 1900-1949, Marsh explained, Credit Suisse found that the average correlation between stocks and bonds globally was 0.45, while from 1950 to 1999, the relationship had a correlation of 0.34.

As the authors wrote in the report: “The recent fortunes of 60/40 equity/bond strategies are a painful example of this, having trusted too heavily in the recent negative correlations between the two assets rather than properly consulting the history books.”

Here’s a direct quote from the Credit Suisse Global Investment Returns Yearbook 2023 (emphasis mine):

Many investors were caught off balance by the simultaneous fall in stocks and bonds and the poor performance of a classic 60:40 equity-bond portfolio (see Chapter 4). Over the previous two decades, investors had grown used to stocks and bonds providing a hedge for each other. However, we cautioned last year that this had been exceptional in the context of history. The negative correlation had been associated with a period of falling real interest rates, mostly accommodative monetary policy and generally low inflation, and we pointed out that “change was in the air.”

While bonds have had short periods of negative correlation with stocks, unfortunately the long term correlation is still moderately positive. In other words, bonds still tend to move in the same direction as stocks, just not as much. Bonds do have a stabilizing effect, but aren’t always an offsetting hedge to stock market drops.

I like to keep in mind that as interest rates rise, that means that the Fed has more room to cut rates quickly if a true recession occurs again and inflation cools. The Vanguard Total Bond ETF (BND) covers nearly the entire taxable bond universe and thus includes lots of different maturities with an average effective duration of about 6.5 years.

A useful rule of thumb is that for every 1% change in interest rates, the value of the bond will either increase or decrease by the same amount as its duration. So a 1% rate hike and it will go down 6.5%, and a 1% rate cut and it will go up 6.5%. If you want things more chill, you may want to pick a short duration and accept the lower returns.

If you zoom out on the Growth of $10,000 chart for the Vanguard Total Bond ETF, you can see it going up from the rate cuts and back down with the rate hikes. $10,000 invested in 2013 is worth about $11,000 today. That’s not a great rate of return but the ride was smooth compared to other asset classes, and with shorter-term bonds, it would have been even milder.

Higher yields also mean higher future returns. You may want to reconsider bailing out of bonds now. The Morningstar article The Return of the Bond Market summarizes the dynamic well:

Bonds have been painful and frustrating and have required a ton of patience.

But now the market has recalibrated, and yields have reset higher. Higher yields mean higher future returns. And for the first time in a while, you can make the argument that bonds provide true competition to stocks.

But a key aspect of the bond market is interest rates adjusting higher from zero, hurting most at the beginning. An increase in rates from 4% to 5% will be much less dramatic than the move from 1% to 2%, for the simple fact that if you’re getting paid a coupon of 4% to 5% and you reinvest, it has a tremendous compounding effect that isn’t replicated with 1%–2% yields.

In the end, I can’t predict future interest rates. If you want less sensitivity to interest rates, you should own shorter-term bonds or even just money market funds. Just know that if/when rates go down again, then BND will go back up a lot more than the money market fund. I personally hold a mix of cash/money market, short-term, and intermediate-term US Treasury bonds, CDs, and cash. I keep my overall average duration to less than 5 years. My overall yield is now close to 4%, rather than than 2%. These particular assets have a job in my portfolio as stabilizers, and I see them as still doing their job despite the losses when rates go up.

Per Wikipedia, a financial “hedge” is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. Wouldn’t be nice if for every Investment A, there was another Investment B that would always move in the opposite direction? Unfortunately, things aren’t so easy.

A common question: Should we own stocks as a hedge against inflation? The Institutional Investor article Here’s Proof That Stocks Were Never an Inflation Hedge provides a little of clarification:

“Equities are not an inflation hedge. When inflation is high, they tend to do poorly. But in the long run, they have beaten inflation, so a lot of people claim they’re an inflation hedge, but [that claim is the result of confusion]. In the long run, stocks beat inflation, but they do it because of the equity risk premium. They are not an inflation hedge. They have a negative correlation with inflation,” said Marsh.

Historically, stocks actually tend to go down when inflation goes up.

Here’s a chart of the correlations between inflation and various asset classes over the last 120+ years from the Credit Suisse Global Investment Returns Yearbook 2023:

Here is Warren Buffett in his 2022 Berkshire Shareholder letter (emphasis mine):

During the decade ending in 2021, the United States Treasury received about $32.3 trillion in taxes while it spent $43.9 trillion.

Though economists, politicians and many of the public have opinions about the consequences of that huge imbalance, Charlie and I plead ignorance and firmly believe that near-term economic and market forecasts are worse than useless. Our job is to manage Berkshire’s operations and finances in a manner that will achieve an acceptable result over time and that will preserve the company’s unmatched staying power when financial panics or severe worldwide recessions occur. Berkshire also offers some modest protection from runaway inflation, but this attribute is far from perfect. Huge and entrenched fiscal deficits have consequences.

We can’t predict inflation, and we can’t expect stocks to go up when inflation does hit. However, we depend on businesses as a whole to continuously adapt (raising prices, lowering input costs, switching to alternative products, etc), so our best choice is to hold stocks and hope they continue to adapt through capitalism. If we only hold cash, we can only expect to break even after inflation at best, and usually go negative after taxes.