Warren Buffet on International Investing

Each year I look forward to reading Warren Buffet’s annual report to the shareholders of Berkshire Hathaway. The 76 year old Buffet is the Chairman of Berkshire Hathaway, a holding company that owns a diverse group of subsidiaries.

With an estimated net worth of $28 billion, Buffet is one of the ten richest men in the world and considered by many to be the best investment analyst ever. In the past, he has stuck primarily with US investments, but as he says in his report to shareholders, things are changing.

In reference to the $2.2 billion dollars he made on currency exchanges and the nearly $3 billion earned on his investment in PetroChina, Buffet said, “As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. . . the U.S. had $.76 trillion of pseudo-trade last year - imports for which we exchanged no goods or services (only money).” By doing this, Buffet said, “the US necessarily transferred ownership of its assets or IOUs to the rest of the world. Like a very wealthy, but self-indulgent family, we peeled off a bit of what we owned in order to consume more than we produced.”

Buffet continued, ”The ‘investment income’ account of our country – positive in every year since 1915 – turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card.

And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay for ever-increasing amounts of interest on interest.” In addition to our trade imbalance, non-U.S. companies are gaining ground in areas traditionally considered U.S. based businesses. As an example, the world’s largest producer of steel and the largest supplier of beer are US Steel and Anheuser Bush, right? Wrong. Mittal Steel, owned by an Indian and headquartered in the Netherlands, is the world’s largest steel producer. U. S. Steel is the 7th largest producer of steel behind six other non-U.S. companies. InBev, the result of a merger of a Brazilian company AmBev and a Belgium company, Interbrew, is the largest producer of beer in the world. Anheuser Bush is the third largest, behind InBev and SAB/Miller, a South African company.

The world’s best companies continue to make huge investments outside the U.S. We must follow their example and do the same. Over the past 5 years, the EAFE Index, has had an annualized compounded return of 16% compared to a return of just 7% for the S & P 500. A balanced investment portfolio must include a heavy dose of non-U.S. investments.

Buffet summarized his thoughts on this issue by stating, “It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future, U.S. workers and voters will find this annual “tribute” so onerous that their will be a severe political backlash. How that will play out in the markets is impossible to predict – but to expect a “soft landing” is wishful thinking.”

Sector Performance Report 3-31-07

The utilities sector posted the strongest 12 month trailing return of nearly 28%, followed closely by the telecom sector at 24% annual return. The worst performing US sector in the past 12 months was the IT sector at just under a 3% total return.

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Market Summary

A recent Wall Street Journal article depicted investors riding on a rollercoaster called the “Volatiler”. Quite appropriate, since the S&P 500, like most roller coasters, ended in the same location it started. The first quarter of 2007 moved up over 2% and down over 3%, more than a 5% delta, much like the “Volatiler”. In contrast the EAFE Index (a market value weighted index of the largest companies in Europe, Australia, and the Far East designed to measure overall conditions of overseas markets) posted another excellent quarter, up 3.5%. Over the past 12 months, the S&P 500 and the EAFE were up 11.8% and 20% respectively.

Going forward, the market is likely to remain quite choppy. The housing market slowdown, which may be worsened by the growing debacle in the sub-prime mortgage market and tighter lending standards, is of chief concern to the market. Warnings by homebuilders and new federal investigations into lending practices have the market on edge as do concerns that these problems may spread into the broader economy. Further, a spike in oil prices amid growing Iranian tensions is adding fuel to the fire. These inflationary pressures are likely to keep the Federal Reserve in limbo in the short run but may allow for a drop in rates by the end of the year.

Volatility in the market creates ideal conditions for portfolio rebalancing. Make sure you do not have all your eggs in one basket or you may find yourself in the hole!