Last Saturday was the Berkshire Hathaway annual shareholder meeting and there was an interesting quote from Warren Buffett, after selling a chunk of his Apple stock.
“I don’t mind at all, given current conditions, building our cash position. When I look at the equity markets and the composition of what’s going on in the world, we find cash quite attractive.”
Buffett knows that his words can move the market and from decades of studying him, this is about as bearish as he talks publicly. The fact of the matter is that equity valuations as a whole are quite expensive. Stocks such as Apple, which are showing very little actual growth, are trading at more than double their historical valuations. This doesn’t mean that they are bad investments necessarily, but it does show that there isn’t the same margin of safety, which we as value investors look for to ensure we are complying with rule number one, not to lose money!
When Buffett says he is raising cash, what is he is mostly saying is that he is buying short-term debt securities, including Treasuries. We haven’t had yields like this in over 20 years, so it makes a lot of sense to buy debt here. At T&T Capital Management, we’ve been building bond ladders. As part of that, we have been investing in AAA loan security structures that have been yielding nearly 6.5%. These loans are short-term and are adjustable rate, so they are extremely low risk when it comes to interest rates, or credit quality. If rates go down, the yields will go down, which is why we also like buying debt with longer maturities. In combination with short-term debt, we’ve been buying investment grade and some high yield debt with yields to maturity from 6.5-9%. These bonds lock-in attractive yields for a longer duration, and they provide further upside if the Federal Reserve does indeed start cutting interest rates. This is a fantastic time to own bonds and they should dramatically outperform stocks in the next bear market, cushioning portfolios, especially for those close to retirement, or already retired.
Real estate investment trusts are another asset class that is very attractive in the current environment. Prices are down 40-50% from their highs on many of them, but the cash flows are stable to growing. Leases have rent escalators that are either fixed or linked to CPI, so over time, they are a great hedge against inflation. Many of the REITs that we have been buying have yields near 6%, to upwards of 8%, and we expect these yields to grow at attractive rates over the next 3-5 years. Once again, REITs would likely perform even better if the Fed does cut rates.
Part of Buffett’s trepidation towards stock valuations are the geopolitical and economic risk factors that are staring at us in the face. Western economies are drowning in debt and deficits, which are being exasperated from higher rates to the point where debt service is becoming the largest part of many economic budgets. There are two major wars with few signs of ending, and with material potential for escalation. We have an election in the United States, which is likely to be among the most contentious and vitriolic that we have ever seen. I don’t blame Buffett for not wanting to bet the house on an expensive equity market, when frankly there are way easier and more durable ways to make money.
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