On Saturday, Berkshire Hathaway hosted its annual shareholder meeting, which had a different feel, taking place in an empty auditorium, and without the great Charlie Munger being by his side. Despite that, the meeting had a lot of great information, during these immensely precarious times. Overall Buffett, is always bullish long-term on America, and on stocks in general. However, he realizes that the current pandemic and the unprecedented response of shutting down economies across the globe creates a spectrum of outcomes that is difficult to quantify.
Berkshire’s operating businesses are being negatively impacted just like most companies not named Amazon, Microsoft, or Gilead. Many of these companies require considerable cash in reserves to deal with problems that could potentially arise from the pandemic, such as litigation etc. While stocks tanked at the most rapid rate in history, Berkshire was unable to secure any purchases of whole companies, which are its preference at this point in time. Even special financing deals like the company executed with Goldman Sachs, Bank of America and GE during the Financial Crisis, were not needed because of the rapid intervention of the Federal Reserve. These actions allowed companies to access capital far more rapidly and at better rates than what Buffett was comfortable doing.
Berkshire sold 100% of its airline stakes, which were huge positions, owning nearly 10% of the big 4. The rationale behind this was that he can no longer predict with good precision what the business looks like in 3-4 years. He also probably would rather not be associated with businesses that were in dire need of government intervention, but those are my words and not his. We sold most of ours early into the crisis, as these are not companies that can deal with 95% revenue losses, due to their immense fixed costs. In fairness, few businesses can, which is why this crisis is so unique. Airlines are an example of a true destruction of value due to this crisis, where other stock fluctuations are more reflective of noise.
Berkshire did not buy much stock in the quarter, which disappointed many. Buffett is extremely close friends with Bill Gates, who has publicly been very worried about the pandemic, especially in the early stages. While the data on the virus and health crisis has gotten materially better in my opinion; with the serology tests that have been done that likely show the virus to be far more prevalent, and hence far less deadly than believed, I think naturally it impacted Buffett’s willingness to allocate more capital into equities than he already has, which is substantial. When I point stuff like this out, please don’t think I’m downplaying impact of virus, or its potential consequences. I worry greatly about it for many that are vulnerable including my parents, older clients, and anyone else really. I do also realize that the virus isn’t going away so we have to make the best decisions factoring in as many consequences as we can quantify, all of which entail hugely negative dynamic. I’d argue it would be a better response to target the focus on the most vulnerable, but obviously that is above my pay grade.
Many of Buffett’s positions were similar to the stocks we own. He has big insurance operations, his largest allocations are to banks, and he has some select large technology stocks. Of course he also has major railroad, utility, and manufacturing/retail operations. Berkshire posted a first-quarter net loss of $49.75 billion, including $54.52 billion of investment losses, offset by roughly $5 billion in operating profits. The big numbers are reflective of the accounting dynamics which mark to market most of the investment portfolio, so I wouldn’t overreact to any one quarter, as the changes are always pretty large. Berkshire is trading at some of its cheapest levels relative to book value in its history, and book value per share has likely risen over the last two months.
Buffett specifically talked about his confidence in the banks. Many of the banks he owns, we own, and have the potential to post massive returns and dividends from current levels. I’d personally rather own them than Berkshire based on current valuations but we have stakes in both of course.
Warren Buffett: (04:02:56)
“How you spot the people that are doing the dumb things is not easy because… Well, sometimes it’s easy, but I don’t see a lot that bothers me, but banks are in the end, institutions that operate with significant amounts of other people’s money, and if problems become severe enough in an economy, even strong banks can be under a lot of stress, and we’ll be very glad we’ve got the federal reserve system, standing behind them. I don’t see special problems in the banking industry now. I could think of possibilities, and Jamie Diamond referred to this a little bit in the JP Morgan report. You can dream of scenarios that puts a lot of strain on banks, and they’re not totally impossible, and that’s why we have a [inaudible 04:03:58]. I think overall the banking system is not going to be the problem. I wouldn’t say that with a 100% certainty because there are certain possibilities that exist in this world where banks could have problems. They’re going to have problems with energy loans. They’re going to have problems. Some, they’re going to have extra problems with consumer credit. They’re going to have that. But they know it, and they’re well reserved. Well, they’re well capitalized for it. They were reserved building in the first quarter, and they may need to build more reserves. But they are not a primary worry of mine at all. We own a lot of banks. Or, we own a lot of bank stocks.”
I talk a lot about how important it is to keep your investment time horizon in mind during major selloffs. Most funds you have invested will stay that way, even when you begin taking distributions. Time allows for a recovery and growth, which is why it is almost always the most toxic move to panic. Buffett got into this a bit with these comments:
Warren Buffett: (02:13:39)
“And I pointed out, I think a year, maybe two years ago on the annual report… Just the one before this most recent one, I pointed out that there had been three times in Berkshire’s history when the price of Berkshire stock nt down 50%. Three different times. Now if you hold it on borrowed money, you could have been cleaned out. There wasn’t anything wrong with Berkshire when those three times occurred. But if you’re going to look at the price of the stock and think that you have to act because it’s doing this or that, or somebody else tells you, “How can you stay with that,” when something else is going up or anything. You’ve got to be in the right psychological position. And frankly, some people are not really careful. Some people are more subject to fear than others.”
Over the weekend I talked with quite a few business owners and had mixed discussions and emotions. Nearly everyone I talked to has been devastated in some way and is hurting financially from this massive crisis. Employees of larger companies might not be as impacted, but most business owners certainly are. On the positive side, that PPP money for small businesses is starting to come through for more companies. This is a significant influx of capital that was desperately needed to help bridge the gap until the economy opens up. China’s economy has ramped up a lot and is getting close to prior levels, so hopefully in a few months we see something similar here, and states are beginning to open. The enhanced unemployment benefits really increased the relative attractiveness of layoffs for many lower paying jobs, as the income is actually higher than their salaries in some cases. That won’t last forever, but not all unemployment numbers are created equal. If someone is making more on unemployment, it probably isn’t entirely rational to expect them to start defaulting on their obligations.
Some major companies, including some large retailers, are opening up this week in various states, which will mean a lot of people will be brought back on. It will take several more months at least for this to offset the layoffs, but there is a brighter side that is closer than most would believe just reading the news. It is very likely even more stimulus is coming. We have never seen stimulus like this so fast. The Fed has been clear, low interest rates will last until employment normalizes. This means that risk assets should be pushed higher, and long-term inflation risks likely go up. You want to own stocks in that type of environment, but like Buffett would say, we have no clue what that means for the next 3 months or 3 weeks. Let’s see where things stand when the economy gets closer to normalized and the health crisis stabilizes. I suspect things will look far better for all of us, but the key is to not panic and let fundamentals play out. Earnings season has been encouraging in that business fundamentals and values are far better than current prices would indicate. That is what will drive future investment returns!