Warren Buffett is indisputably the most successful investor alive today and one of the wealthiest on the planet. His investment vehicle, Berkshire Hathaway, has advanced from $150 a share in the 1960s to over $165,000 today. Using Berkshire’s book value as the best measure of its worth, it has outperformed the S&P by factor of 7 times; since 1964 it’s grown over 586,000 percent versus the S&P’s near 8,000 percent advance.
We can gain insight into his market outlook by piecing together a flurry of news from him this year, including his company’s Annual Report, its annual meeting in Omaha, plus his TV appearances immediately following the meeting.
Bonds are a “Terrible Investment”
Mr. Buffett minced no words when it came to the topic of bonds, labeling them “terrible investments” and singling out long term government bonds as especially toxic. Even casual market observers acknowledge that interest rates are close to their lowest in 50 years. What many don’t realize is the loss of principal that will result if rates rise. Expect a 6% principal decline for every 1% rise in rates on the 10 year Treasury. That bond yields 1.9% today, but it was nearly 16% in the early 1980s. You do the math.
Interestingly, many believe they have skirted this risk by investing in high yielding fixed income substitutes. But, Mr. Buffett made clear that such investor favorites as junk bonds and real estate investment trusts (REITS) could also deal investors a harsh blow in a rising rate environment.
There’s no question that yields on REITS have plummeted, now below 4% compared to 11% in February of 2009, thus offering far less value today. Meanwhile, high yield bonds are, well, no longer high yielding, with their rates below 5% for the first time ever.
Bottom line: Mr. Buffett is warning on bonds, and does not believe that the popular yield substitutes investors are flocking to today will escape the ultimate fate of longer dated government bonds.
Stocks Are “Reasonably Priced”
Despite being in the fifth year of a bull market, with the Dow and the S&P at all-time highs, Mr. Buffett still thinks stocks are “reasonably priced.” Of course, he admits that they aren’t the bargains they were several years ago. Nevertheless, in comparison to other investment vehicles, like debt, real estate and farmland, he believes stocks are the best home for your money.
That money should have a long term focus; Mr. Buffett says he has no idea where stocks are going in the next day, week, month or even year. His level of confidence only seems to rise when holding periods are a decade or longer.
Bottom line, Mr. Buffett likes equities’ present valuations, but recognizes that’s no guarantee against a bear market or worse in the near term.
Returning Money to Shareholders
Mr. Buffett continues to extol the virtues of companies’ returning money to stockholders, either via stock buybacks or dividends. He responded to questions on Apple by relating discussions he had with the late Steve Jobs, counseling Jobs that if he felt Apple’s stock was cheap and it had surplus cash, a stock buyback made sense.
Continuing his recurring theme that price is paramount when investing, he warns that companies that buy back stock at too high a price are simply destroying capital. That applies to even great companies; indeed, he made clear that if his own company were to buy back stock at the wrong price that would be a horrendous mistake.
Mr. Buffett explained in detail why he preferred stock buybacks to dividends. With a stock buyback the holder retains control over when and how much he might want to draw down on his investment by selling shares. This permits tax deferral that’s not possible with a dividend.
Bottom line, Mr. Buffett would counsel that after your research has uncovered a cheap stock, the company’s plan to buy back stock would increase the attractiveness. Further, despite the current mania for dividends, they are a less efficient way than stock buybacks to build wealth.
Consider Carefully the Counter Arguments
Mr. Buffett’s latest annual meeting made news because he invited a noted short seller and Berkshire bear, Doug Kass of Seabreeze Partners, to take the podium and make the negative case.
While Mr. Buffett didn’t concede (“nothing Kass has said makes me want to sell my shares”), the exercise was instructive. There’s always another side to any investment thesis; you’re not going to be able to buy an investment unless someone else sells it to you. Serious investors examine carefully the flip side to any investment thesis.
Hold Some Cash
Despite Mr. Buffett’s long term optimism (Heinz, a recent buy, will be a great brand for the “next 100 years”), a careful parsing of his comments makes a case for keeping some cash in your portfolio.
First, he extolled the advantages of Berkshire’s size in the event of a financial crisis, boasting that Berkshire will be the “800 number” because of its cash horde for those caught in the next financial storm. Mr. Buffett suggests there will plenty of financial panics in the years ahead, and those that have liquidity at those times will profit. Indeed, he cited what a great opportunity his own stock had been during the four times it had dropped 50% “if you had cash then.”
Second, while eschewing macroeconomic forecasts, there are clearly long term economic problems he worries about. He praises Ben Bernanke and the Federal Reserve for rescuing the global economy in the latest crisis. However, he has no idea how the Federal Reserve will reverse its historic bond buying, and what that may do to the economy.
Further, he raises real questions on our nation’s debt quagmire: “The amount of deficit spending in the last four years … has been quite appropriate in relation to the threat …..The question is, how do you get off that.”
Bottom line, while Mr. Buffett disdains big picture forecasting, the next crisis is simply a when, not an if, and the prescient investor will have some cash handy to scoop up the inevitable bargains!
Financials Still Attractive
Mr. Buffett loves brands; one of his biggest holdings is Coca Cola. He thinks Wells Fargo offers better opportunity today than does Coca Cola. Mr. Buffett underscored the value of its retail depositor basis, a source of long term cheap funding. Wells’ earnings were understated, as it reduced them to reflect the amortization of the value of those deposits; under general accounting rules deposits have a relatively short finite life. But, Mr. Buffett thought those rules understated their life; those deposits are unlikely to leave Wells anytime soon.
Similarly, Mr. Buffett waxed enthusiastic on Bank of America, for many of the same reasons. Investors failed to give due credit to its massive deposit base, on which they were paying little and had little risk of losing. As Buffett saw “some recovery” in housing, Bank of America is “making progress” with legacy problems in its mortgage portfolio inherited from Countrywide. As is his wont, he would not provide a timeline, but thinks Bank of America would ultimately be “significantly” higher.
Bottom line, Mr. Buffett remains very positive on both Wells Fargo and Bank of America. Financials remain cheap relative to pre-downturn levels. As Mr. Buffett believes that by the time of the next annual meeting the economy “will have moved forward,” bank investments have his clear endorsement.