Thoughts through the cycle: W1 May ’20

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  • Even though he has only ever tweeted nine times, it would be hard to dispute that the person who sits at the top of the list of ‘influencers’ when it comes to markets – especially the US stock market – is Warren Buffett, Chairman / CEO of Berkshire Hathaway (BRK/B.US). Second place probably goes to Berkshire’s vice-Chairman, Charlie Munger. Following these two, third place is just a niche in obscurity. Given the extraordinary events of the past few months, hearing what Buffett had to say about the market at the Berkshire Hathaway Q1 results conference call on Saturday 2nd May probably therefore falls into the category of ‘getting a feel for what smart money is thinking’.
  • Did Warren buy the dip? No. Berkshire’s cash balance has risen to $137bn following equity sales in the airline stocks (United, Delta, Southwest, and American) where he exited positions entirely, not only admitting they were a mistake but adding that,  “I don’t know that 3-4 years from now people will fly as many passenger miles as they did last year …. you’ve got too many planes.” Not only is this clearly a negative comment on the likelihood of the much-hoped-for V-shaped recovery, but within the airline space, the Buffett-effect can clearly be seen below with Delta Airlines (DAL.US) trading down 12% on Monday 4th May following the meeting (the circle on 3rd April marks the day on which Berkshire announced its first sale, presumably the selling continued for most of April).

Source: Bloomberg, 4th May 2020

  • Berkshire also bought back only $1.7bn of its own stock in Q1 2020, less than in the last quarter of 2019. Buffett added, “The price has not been at a level where it really feels way better to us than other things, including the option value of money, to step up in a big way,”. It is interesting to consider S&P 500 valuation in this context given that the index has actually outperformed Berkshire’s B-shares year-to-date (graph below, Berkshire in red, S&P 500 in blue).

Source: Bloomberg, 4th May 2020

  • Famously in the post-Lehman banking collapse of 2008, Buffett’s company took a $5bn stake in Goldman Sachs (GS.US) with warrants to buy another $5bn of GS stock at a further discount. If there were a single investor whose reputation could save a company as beleaguered as Goldman in September 2008, then it was Buffett. While claiming his investments aren’t statements there clearly is an element of that, as can be seen below when asked on Saturday why Berkshire hadn’t done anything:

“Well, we haven’t seen anything attractive. And frankly, wasn’t predicated on this, but the Federal Reserve did the right thing and they did it very promptly, which they should have and I salute them for it. But that means that a lot of companies that needed money and probably should have done their financing a little earlier, but they’re perfectly decent companies, got the chance to finance in huge ways in the last five weeks or thereabouts.”

  • It is worth considering this statement in the light of the graph below which shows year-to-date S&P 500 performance (rising, white line) against average sell-side 12m forward-earnings estimates (falling, green line). If Buffett doesn’t see anything attractive in terms of valuation, what do recent buyers see that he doesn’t?

Source: Bloomberg, 4th May 2020

  • It is also worth noting Buffett’s mention of the Fed in the quotation above. He is clearly not blaming the Fed. His comment below makes this plain:

“I’ve always had Paul Volcker up on a special place, a special pedestal in terms of Federal Reserve chairmen over the years… Jay Powell in my view, and the Fed board, belong up there on that pedestal with him because they acted in the middle of March. Probably somewhat instructed by what they’d seen in 2008 and 2009. They reacted in a huge way and essentially allowed what’s happened since that time to play out the way it has. March, when the market had essentially frozen, a little after mid-month, ended up on March 23 — it ended up being the largest month for corporate debt issuance, I believe, in history… Every one of those people that issued bonds in late March and April ought to send a thank you letter to the Fed because it wouldn’t have happened if they hadn’t operated with really unprecedented speed and determination.”

  • Buffett is presumably being a little coy, even disingenuous here – while not getting involved in the market himself on what seems to be a valuation basis due to the Fed’s intervention, he nonetheless lauds the Fed’s actions as allowing companies to seek financing. Gold medal for this Fed-enabled refi goes to Boeing (BA.US) who have just issued $25bn of debt from 3yr to 40yr maturities largely on the back of the rally in credit induced by the Fed saying it would liaise with the Treasury through a special-purpose vehicle (SPV) to buy investment-grade and fallen-angel debt. Quite how strong Boeing’s order book will be from those airlines whose equities Buffett unceremoniously dumped in April remains to be seen. Buffett is also a long-term equity investor. One wouldn’t expect to see him in the order book for Boeing debt at a time like this either.
  • Shifting focus for a moment from Buffett’s thoughts on the Fed to the Fed itself, it is necessary to point out that even the central bank is starting to feel as though it has to explain a little about the limits to what it can do. At the beginning of the Fed’s FOMC press conference on the 29th April, Chairman Powell commented as follows with respect to the nature of Fed activity since the onset of the Covid-19 pandemic:

“I would stress that these are lending powers, and not spending powers. The Fed cannot grant money to particular beneficiaries. We can only make loans to solvent entities with the expectation that the loans will be repaid. Many borrowers will benefit from our programs, as will the overall economy. But for many others, getting a loan that may be difficult to repay may not be the answer. In these cases, direct fiscal support may be needed. Elected officials have the power to tax and spend and to make decisions about where we, as a society, should direct our collective resources. The CARES Act and other legislation provide direct help to people, businesses, and communities. This direct support can make a critical difference, not just in helping families and businesses in a time of need, but also in limiting long-lasting damage to our economy.”

  • While cautiously-phrased as ever, there are hints here that Powell is alluding to the difference between solvency and liquidity, and that just throwing money into the financial markets is not the same as saving companies from insolvency during a recession. Indeed, recessions may be characterised in text books as two successive quarters of negative GDP, but what really happens is balance-sheet repair, both by households and corporates – simply put, people save rather than spend, resulting in what John Maynard Keynes called the ‘paradox of thrift’ (economic contraction due to simultaneous, uncoordinated saving) which always leads to corporate casualties.
  • It is perhaps this that the wise old sage of Omaha was thinking when he said towards the end of Saturday’s earnings call with respect to what the immediate future holds:

“Well we don’t know. We don’t know how long this period lasts. And nobody knows. Most people think, and they know more about it than I do, that the virus will, to some extent, decline in its spread during summer months. And I would say a good many think, that it will come back at some later date. And how the American public reacts if they get their hopes up through some summer diminution and how they would react to a second attack, in effect by the virus…. And the unknowns that apply to the health aspect create unknowns in the economy. And we’ll have to keep evaluating things as we go along. I hope, like crazy obviously, that once suppressed that it doesn’t come back and that we readjust. But things don’t always work perfectly. That doesn’t mean there was a better course of action that would not… I would not go around criticizing people at all for what they’ve done or anything of the sort. I just think you’re dealing with a huge unknown. And I think that the degree to which it’s disturbed the world and changed habits and endangered businesses in the last couple of months indicates that you better, not be too sure of yourself about what it’ll do in the next six months or year or whatever.”

  • Clearly Mr Buffett is leaving the prediction of whether it will be a V-shaped, U-shaped, or W-shaped recovery to someone considerably smarter than himself.

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Thoughts through the cycle: W3 June ’20

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