Warren Buffett, out of sample
By Scott Sumner
In a recent post I discussed a couple of arguments against the Efficient Market Hypothesis, which I used to hear a lot when I first started blogging in early 2009. One had to do with the outperformance of hedge funds, and the other was the so-called “inevitable” housing crash in the US (which never occurred in lots of other “bubble” economies, and is reflating again in America.)
Another argument was that people like Warren Buffett would persistently outperform the market. This was supposed to violate the EMH. It doesn’t—the EMH predicts that out of every 50 million stock investors, about 49 will beat the market in 20 consecutive years. Buffet never came close to that, but he had some years with huge outperformance, and thus his overall record is amazing. But did it violate the EMH? Maybe, but I was skeptical. In economics we often do “out of sample tests”. That is, when someone published a theory years ago, we return to the data to see how it held up using more recent data.
This article lists the annual return for Warren Buffett’s Berkshire Hathaway, ever since 1965, as well as the annual return on the S&P 500. Over the past 51 years, Buffett averaged a 20.8% rate of return while the S&P 500 only averaged 9.7%. But how about since the beginning of 2009, when I started blogging?
Warren Buffett: 10.8%
S&P 500: 14.8%
It’s quite possible I’ve made an error here, either in my computation, or in my interpretation of the article. A footnote suggests that because of tax factors, the Buffett return would have been lower than the S&P 500, even if he had done equally well in picking stocks. But I also recall that his insurance company gave him some leverage. If any commenter can help me out here I’d appreciate it. My guess is that any mistakes would make the figures more equal, but not affect my qualitative claim that Buffett has not significantly outperformed since early 2009.
PS. Buffett did make one good investment in 2009, the Burlington Northern Railroad, which has benefited hugely from President Obama’s decision not to approve the Keystone Pipeline. Buffett and Obama have been friends going all the way back to when he was a Senator from Illinois. I actually don’t think there was any corruption here, either in terms of inside information on the decision, or Obama making the decision to benefit Buffett. But I also think this shows the danger of drawing inferences about corruption. Most people know that Buffett lives very modestly and plans to give away most of his wealth and also favors higher taxes on the rich. So he’s trusted, and I think justifiably so. But imagine someone with a poor reputation in the same situation—what would people think?