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Warren Buffett’s Peek Into the Financial Abyss
Berkshire Hathaway’s online annual meeting lacked analysts, a live audience and the venerable Charlie Munger, but the Oracle explained why he’s holding tight to cash amidst the pandemic that even he doesn’t understand.
The Woodstock of capitalism got a coronavirus makeover on Saturday.
Amid worries of unchecked contagion, Berkshire Hathaway CEO Warren Buffett held court on Saturday over a live-streamed annual shareholders meeting — without the usual crowds, promotions, or carnival atmosphere. Or his longtime friend and foil, Berkshire vice chairman Charlie Munger.
Viewers got something better, however: A firsthand explanation of why Berkshire continues to sit on top of some $137 billion in cash and Treasury bills following the steepest market sell-off since the 2008-09 financial crisis, rather than snapping up beaten down stocks or entire companies. The Oracle of Omaha told a spookily empty auditorium for the first time how credit markets had virtually seized up in March, as the Covid-19 pandemic and related economic shut down punished stocks — and sent companies scrambling to tap their credit lines, bringing markets to the financial edge.
“We came very close to having a total freeze of credit to the largest companies in the world who were dependent on it,” Buffett said. Chief financial officers were petrified. “Fear is the most contagious disease you can imagine,” he said.
The Federal Reserve, under chairman Jerome Powell, responded quickly and massively on March 23, rolling out its unprecedented stimulus package of unlimited debt buying. And it was that near-calamity, a banking system in extremis, that put the kibosh, at least temporarily, on Berkshire’s appetite for using its $137 billion in cash and Treasury Bills to buy up beaten down companies and stocks.
“We never want to be dependent, not only on the kindness of strangers, but the kindness of friends,” he quipped. That apparently includes the Federal Reserve and chairman Powell. “We prepare on the basis that we won’t have a chairman like that,” Buffett said.
The precarious state of the U.S. banking system was not widely known. “I had no idea how much we were up against it in terms of facing a banking crisis,” said Thomas Russo, managing member of Gardner Russo and Gardner, a money management firm in Lancaster, Pennsylvania, which has owned Berkshire shares since 1990. “We were near a precipice.”
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For those hoping for an all clear “buy” signal from Buffett at the annual meeting, well, there wasn’t one, given the swelling of the Fed’s balance sheet. “We don’t know the consequences of that,” Buffett said, between sips of Coke. “And we don’t know the consequences of what we will undoubtedly have to do.”
He pointed out how the 2008-09 financial crisis unfolded in stages. “You didn’t see all the problems the first day,” Buffett said. “There are things that trip other things and we take a very much worst-case scenario into mind.”
Despite the near cataclysm, it goes almost without saying that Buffett still served up his usual paeans to America’s economic resilience over the long term: “Never bet against America,” after all, is a mantra for him. There were plenty of data-driven observations, such as the growth of American wealth from 1789 to today, which he calculates was 5,000 to 1 explosion in real terms.
And Buffett peppered his presentation with witticisms from his value investing mentor, Benjamin Graham; former Chicago Mayor and White House chief of staff Rahm Emmanuel; and of course, the character Blanche DuBois from Tennessee William’s seminal play, “A Streetcar Named Desire.”
But Buffett’s relentless message was one of caution. “What we didn’t hear was ‘Jump right in because fear is dominating the market right now’,” said Meyer Shields, insurance analyst at Keefe, Bruyette & Woods. “[The question] appears to be in Warren Buffett’s mind, ‘Is there too much uncertainty?’”
Indeed, Buffett cited the 20-year-plus stretch, from 1929 to 1951, that it took the Dow Jones Industrial Average to regain its peak following the market crash and Great Depression.
“Anything can happen in the markets,” he warned, and then added a pointed qualifier to his ‘Bet on America’ mantra. “You can bet on America, but you better be careful how you bet.”
All this comes at a pointed time for Buffett, who turns 90 in August. For more than a decade now, value investors have grown increasingly frustrated as Berkshire Hathaway shares, along with value stocks in general, have trailed the Standard & Poor’s 500 stock index. In early afternoon trading Monday, Berkshire Hathaway class A shares were down $7,362, or 2.69 percent, at $265,900. Class B shares, which on an economic basis are worth one-fifteen-hundredth of the A class shares, were down $5.73, or 3.08 percent, at $177.12.
They likely remained frustrated as Buffett on Saturday pointedly suggested he did not necessarily expect Berkshire Hathaway to outperform the index going forward. “In my opinion, the best thing to do is own the S&P 500 index fund,” he said.
Statements like that irk Bill Smead, chief investment officer of value-focused Smead Capital Management in Seattle and a longtime Berkshire shareholder. “Does he work for State Street or BlackRock?,” he fumed. “If I was his board I’d fire him. This virus has got him scared.”
Others say a dose of realism may be in order. “We’re not seeing these phenomenal one-off investment opportunities,” said Shields. “I think expectations of outperformance were tamped down.”
As Buffett pointed out, with Fed spigots open and interest rates low, this is a poor time for Berkshire to be lending money, which he did to companies including General Electric & Co., Goldman Sachs Group, and Bank of America Corp. in the 2008-09 financial crisis, generating outrageous profit.
Today’s interest rates preclude that. “There is no shortage of funds at rates which we would not invest at,” Buffett said.
Nevertheless there are, Buffett argued, plenty of places to put Berkshire money to work going forward, especially at capital-hungry subsidiary companies like Berkshire Hathaway Energy, the utility operator.
“The internal opportunities for capital are there,” says Russo.
Still, Buffett is under scrutiny, if not criticism, by some investors for failing to buy back more Berkshire Hathaway shares. Since July 2018, the company has been authorized to buy back shares when they trade below either Buffett’s and Munger’s estimation of their intrinsic value, conservatively determined.
In the first quarter of 2020, as the price of the Berkshire A shares plummeted, the company’s 10-Q filing shows Berkshire bought back a relatively paltry $1.7 billion of its stock.
In the last week of December 2019, the company bought back 674 class A shares, for an average price of $333,298.06 each.
By the time Berkshire class A shares had tumbled to a low of $240,000 on March 23, the company had stopped buying them back altogether. The class A shares finished the quarter at $272,000 a piece.
“We were shocked to see that Buffett stopped buying back Berkshire's shares on March 10 and didn't repurchase any of the company's common stock between then and the end of April,” wrote Morningstar sector strategist Greggory Warren.
In response to a question at the meeting, Buffett said he doesn’t view Berkshire stock as a particular bargain. “I don’t think Berkshire shares relative to present value are at a significantly different discount that they were when we were paying somewhat higher prices,” he said.
“The value of certain things has decreased,” he added. “Keynes said, or whoever it was: ‘Facts change. I change my mind; what do you do, sir?’”