Charlie Munger sees our current market environment to be much like the 1970s when inflation was running high and the Federal Reserve had to get inflation down at all costs, even if it led to a recession.
“Well, when Volker, after the seventies, took the prime rate to 20% and the government was paying 15% on its government bonds, that was a horrible recession. Lasted a long time, caused a lot of anger and agony. And I certainly hope we’re not going there again. I think the conditions that allowed Volcker to do that without any interference from the politicians were very unusual, and I think in 20/20 hindsight, it was a good thing that he did it. I would not predict that our modern politicians will be as willing to permit a new Volcker to get that tough with the economy and bring on that kind of a recession. So I think the new troubles are likely to be different from the old troubles. You may wish you had you had a Volcker style recession instead of what you’re going to get. The troubles that come to us could be worse than what Volcker was dealing with. And harder to fix.” – Charlie Munger[1]
Munger questions if the long-term political will is there to allow the Federal Reserve to do what needs to be done with monetary policy to bring down inflation. Senators Elizabeth Warren and Bernie Sanders are already criticizing Fed Chairman Powell for the financial pain he is bringing on people with the quick and massive interest rate hikes. Powell is openly saying he wants to see the asset bubble come down in real estate and stocks along with an increase in unemployment to help tame inflation.
Here are some of the recent quotes by the Fed Chairman explaining his monetary policy moves,
“If we want to light the way to another period of a very strong labor market, we have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.” – Jerome Powell
“We certainly haven’t given up the idea that we can have a relatively modest increase in unemployment. Nonetheless, we need to complete this task.” – Jerome Powell (September 2022)[2]
“Coming out of the pandemic, [mortgage] rates were very low, people wanted to buy houses, they wanted to get out of the cities and buy houses in the suburbs because of COVID. So you really had a housing bubble, you had housing prices going up [at] very unsustainable levels and overheating and that kind of thing. So, now the housing market will go through the other side of that and hopefully come out in a better place between supply and demand.” – Jerome Powell [3]
“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said at Jackson Hole in August 2022. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.” – Jerome Powell [4]
Is a recession coming in 2023?
The U.S. did have two back to back negative quarterly GDP results in 2022 before rebounding for a positive GDP due primarily to the high price received from energy exports. Whether experts or the government will agree that we had a recession or are in one now their is a very high probability that the U.S. will see a recession in 2023 based on many factors.
High interest rates, high bond yields, high inflation, increasing lay offs, and decreasing corporate sales and profits all lead to a recession. Less discretionary spending money for consumers creates a chain reaction in the economy decreasing the velocity of money into discretionary spending channels as it’s depleted into the first level of consumer needs like energy bills, food, and rent or mortgages. Corporate profit margins are also depleted by high labor costs, wholesale costs of goods, materials, and energy bills leaving little money for capital expenditure for upgrading equipment and facilities along with company growth.
These are all heavy factors weighing on the economy that present us with a high probability of a recession along with the past GDP and job data presenting us with the same high probability.
What should I invest in when a recession hits?
This high probability recession will likely be occurring while the effects of inflation are still going on, so how people invest needs to take an inflationary environment into account as well.
CNBC interviewer: “How will this all play out and what’s the best advice you have for individual investors to optimally deal with the negative impact of inflation other than owning quality equities?”
Charlie Munger’s response: “It may be that you have to choose the least bad of a bunch of options that frequently happens in human decision making. The Mungers have Berkshire stock Costco stock Chinese stocks a little bit of Daily Journal stock and a bunch of apartment houses. Do I think that’s perfect? No. Do I think it’s okay? Yes. The great lesson from the Mungers is you don’t need all this damn diversification. You’re lucky if you’ve got four good assets. If you’re trying to do better than average you’re lucky if you have four things to buy. To ask for 20 is really asking for egg in your beer, Very few people can have enough brains to get 20 good investments.”
Munger’s advice is to concentrate your capital into just a few of your very best investment ideas. He doesn’t wait for macroeconomic conditions to reallocate his capital, he builds his investments with everything in mind to start with. His small portfolio is already optimized for inflation, recession, and a good economy as well.
What products sell best during a recession?
The products that sell best during a recession are consumer staple items like food and cleaning supplies, think about things carried in a basic grocery store. During a recession or high inflation people will pay for the basic budget items first like food, shelter, transportation, utilities, and insurance and not have money left over for bigger discretionary purchases like appliances, new cars, or home improvements. People also shift from restaurant food to buying groceries and eating at home.
The bigger problem is when the economy has high inflation during a recession and it creates stagflation. Persistent high inflation combined with high unemployment and stagnant demand in a country’s economy creates the worst of both worlds. Companies revenues are down but their expenses remain high destroying profit margins of even grocery stores and dollar stores as high labor cost and the wholesale cost of products destroys their tiny profit margins.
Charlie Munger’s portfolio is built with companies that can withstand much of these pressures.
Berkshire-Hathaway owns many companies that sell goods consumers need repeatedly and has some pricing power. Berkshire’s biggest primary business is insurance which is recession proof as people need to stay insured regardless of the larger economic conditions. Berkshire also uses its cash flow from the insurance businesses to raise capital and buy value stocks during bear markets or even whole businesses. The company has the greatest stock picker in history with Warren Buffett.
Costco is primarily a recession proof business as it sales large quantities of products for the best prices anywhere. They’re profits primarily come from membership fees, they try to break even for their retail operation. They do have the pricing power to raise their membership fees as needed.
His Chinese stocks are a bet on the fast growing economy of China, his stocks were doing great before the pandemic and political tensions with the U.S. started.
His apartment houses are a good hedge against inflation because real estate investments tend to go up, and at a minimum keep pace with inflation in value. Apartment rentals are good during a recession because people must still have somewhere to live and pay their rent.
His newspaper holding may be a legacy investment. This is a terrible business model in 2022.
Three out of five great investments in the short-term isn’t bad and he played the long-game so he’s already a billionaire. Investors would be wise to learn from his principles for success.
