Five Charts to Start the Week
Berkshire Hathaway Annual Letter Edition
Some quick reminders before we get into it since there are more of you reading this now than there were last week. First, this is my diary on the market. It is in no way shape or form investment advice. These are the conversations that I am having with myself as I take in all that is happening in the market while trying to square it with the prevailing narratives and fundamentals. I do this to give some clarity to my thoughts. If you like what you are reading, please consider passing it along to others who might like it as well.
Next, if you have an opinion, I would love to hear it, especially if you disagree with something that I am thinking. I promise you that after starting in this business as a summer intern at the New York Stock Exchange when I was 16 years old, I have extremely thick skin.
Finally, nothing I write here should be considered investment advice. It is highly likely that I have a different timeframe and risk profile than you do.
As I mentioned last week, over the weekend, the Berkshire Hathaway Annual Letter was published on Saturday. As I do every year, I printed it out, grabbed my coffee and gave it a read. Grabbed a second cup of coffee and gave it a second read and then I gave a third read just for good measure. There were a few things that jumped out at me and they will be the focus on my five charts to start the week.
1. "Fixed-income investors worldwide - whether pension funds, insurance companies or retirees - face a bleak future." That is a direct quote and it says a lot. Many model portfolios have some mix of fixed income products in the them as a diversifer to equity volatility. This is often in the form of treasuries. For a long time it has worked, treasuries have been moving higher for 40 years and have provided a cushion when stocks have become volatile. The question is, does this still make sense? Will models adjust? My guess is that if they do, they will do so slowly because many are based on historical data. The 10-year Treasury Bond yields 1.38%. The Fed has told us that they are willing to let inflation run at over 2% to help the economy. Some portfolios have 40% or more of their assets in fixed income products. What happens if rates move higher? Forty percent or more of some portfolios will start to become a performance drag on top of not keeping up with inflation.
2. The Family Jewels. Buffett laid out what he thinks of as the four pillars of the Berkshire portfolio. The largest, he says is their insurance business. In particular property and casualty. GEICO falls into to this group. Done properly, insurance is a great business. People pay you premiums which you can invest. It’s a free float and Buffett is a great investor, as we know. Here is the Power Shares KBW Property & Casualty Insurance Portfolio ETF (KBWP). Not quite a record high, but a solid rebound from the COVID lows and a steady uptrend on the monthly chart since 2011.
3. The Family Jewels, Part 2. Of the four family jewels, three are wholly owned by Berkshire so investing in them is by proxy, such as the P&C ETF above. One of the family jewels is publicly traded. Berkshire Hathaway owns 5.4% of Apple. The stake cost Buffett $36 billion between 2016 and 2018. That stake is worth ~$120 billion today. Here is the weekly chart since 2016. The stocks is wavering in the near-term but that is still in an uptrend.
4. Other Public Companies. Berkshire owns 18.8% of American Express (AXP). If there was a company that is in a position to benefit from the global economy reopening, it’s probably AmEx. I think that here in the US we take it for granted. I remember the “don’t leave home without it” adds when I was a child. But outside the US, AmEx is considered somewhat of a luxury brand. People in developing parts of the world with a rising middle and upper class view it as aspirational. AXP, the stock, traded to new highs last week before pulling back.
5. What was missing? This year there was not talk of “big game hunting” as Buffett usually describes the process of looking for a company to buy. Noting at all. That is likely a function of an expensive market environment. Buffett’s favorite way to determine if the market is cheap (good for deal making) or expensive (bad for deal making) is by looking at the Wilshire 5000 (all US stocks) relative to GDP. Here is a good way to think about the market in this context:
Right now, this metric is at 1.89 or 189%…significantly overvalued. At the lows of the pandemic, many wondered why Buffet didn’t act. Now we know. This ratio only made it down to 120%, or modestly overvalued. contrast that to the Global Financial Crisis, when Buffett did act as the ratio was less than < 60%. It didn’t feel like it at the time, but 2009 was a generational buying opportunity but we only know that with the benefit hindsight.
While the letter is always full of insights, here is one that we can all take to heart. We are going to make mistakes. Admit them, take responsibility and move one. The last big deal that Buffett did do was to buy Precision Cast Parts in 2016. This year Berkshire took an $11 billion write-down on that purchase….it was a flop. Here is what Buffett had to say:
“The final component in our GAAP figure – that ugly $11 billion write-down – is almost entirely the quantification of a mistake I made in 2016. That year, Berkshire purchased Precision Castparts (“PCC”), and I paid too much for the company.
No one misled me in any way – I was simply too optimistic about PCC’s normalized profit potential. Last year, my miscalculation was laid bare by adverse developments throughout the aerospace industry, PCC’s most important source of customers.
In purchasing PCC, Berkshire bought a fine company – the best in its business. Mark Donegan, PCC’s CEO, is a passionate manager who consistently pours the same energy into the business that he did before we purchased it. We are lucky to have him running things.
I believe I was right in concluding that PCC would, over time, earn good returns on the net tangible assets deployed in its operations. I was wrong, however, in judging the average amount of future earnings and, consequently, wrong in my calculation of the proper price to pay for the business.
PCC is far from my first error of that sort. But it’s a big one. “
I did the bolding on the two middle paragraphs because they are the lesson. Buffett takes all of the blame for the deal and then goes on to praise the management team. This is why the man is a legend!