The huge cash pile at investing legend Warren Buffett’s holding company Berkshire Hathaway, which crossed the $50 billion mark in June 2014, points simply to one fact about the current market: the scarcity of undervalued securities that could be profitably exploited. The American markets, like many others around the world, have enjoyed a tremendous bull run since 2009. This has largely been due to the flood of cheap money pouring into the markets through the US Federal Reserve that has lowered bond yields (by bidding up their prices), and succeeded in squeezing investors to chase equities and other risky assets—in an attempt to reach for higher yield.
Be it the cyclically adjusted Shiller PE, level of margin debt, ratio of bears to bull, yield on junk bonds, Fed’s purchases of mortgage bonds, number of IPOs (initial public offerings), leveraged buyouts, or the credit quality of borrowers, all point to an imminent bubble fuelled by credit from the Fed.
In such a bullish climate, conservative investors are left with the option of either being fully invested in the market and take part in the speculative rally—one hardly warranted by fundamentals—or simply hold cash and wait for the markets to correct and return to sanity. The former offers the thrill of quick profits while exposing the investor to the risk of capital loss, while the latter assures safety of capital and the opportunity to pick up bargains when the market eventually corrects and returns to fundamental value. Buffett, like a truly conservative investor concerned more with the return of capital than return on capital, has chosen the latter course of action.
This, however, is not the first time Buffett has chosen to pick the unpopular decision of holding cash over staying invested in the market, thus missing one of the most lucrative bull markets in years. In 1969, Buffett closed his investment partnership and returned money to investors citing a market that he found to be fairly valued. In a letter to investors in the partnership, Buffett noted, “The investing environment […] has generally become more negative and frustrating as time has passed […] it seems to me that opportunities for investment that are open to the analyst who stresses quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years”. That was after delivering magnificent returns to investors, well above the general market, for 13 years beginning 1956.
Years later, in 1973 and 1974, the Dow Jones Industrial Average sank by over 40%, giving Buffett the opportunity to return to the markets to shop for cheap stocks with cash he held on the sidelines. This led to his investment in winners like The Washington Post, Geico, etc. Buffett, along with his partner Charlie Munger, chose again to remain out of the market between 1984 and 1987 and increase their cash pile before picking Coca Cola shares in 1988.
The decision to hold cash, let alone for a period of years, is often considered a losing proposition, considering how inflation erodes the real value of cash, and, even more so, when the general market witnesses a historic rally. But in the absence of undervalued securities, unfortunately, that may be the only prudent course of action available to the conservative investor to achieve stable, superior returns in the long run. This is more the case as bonds no longer offer an alternative safe investment. Bond yields have been crushed by the Fed’s intervention in credit markets. Buffett cut down Berkshire’s allocation towards bonds to a decade low, citing low yields. Remember, bond prices can only go down from the current artificially high prices once the Fed’s distortion to the market ends.
Of course, if one is a “momentum” investor from Wall Street permanently bullish over the prospects of the stock market and confident about timing the markets, this would sound foolish—until markets teach a lesson or two on the impossibility of perfect timing.
At the moment, Buffett is not the only investing legend cashing out of a market that is overvalued by all measures. Seth Klarman of the Baupost Group, and author of the book Margin of Safety, is another value investor who has chosen to pile up his fund’s cash holdings—representing about half (or even more) of the total value of assets under management. Hedge fund investor Stanley Druckenmiller, with an impressive investment track record of returning 30% annually since 1986 and previously part of George Soros’ Quantum fund, shut operations as early as 2010 citing lack of opportunities in the current bloated market. Legends of the investment world clearly understand the froth in today’s market—one that is totally distorted by the Fed—and hence bailed out early on the market. These conservative investors loading up on cash give themselves the opportunity to take advantage of value bargains when the market eventually faces a painful correction.
Read more at: http://www.livemint.com/Opinion/DKXzoTbEAXWr2qUpKOEj7L/When-the-market-gets-frothy-Warren-Buffett-sits-on-cash.html?utm_source=copy
Be it the cyclically adjusted Shiller PE, level of margin debt, ratio of bears to bull, yield on junk bonds, Fed’s purchases of mortgage bonds, number of IPOs (initial public offerings), leveraged buyouts, or the credit quality of borrowers, all point to an imminent bubble fuelled by credit from the Fed.
In such a bullish climate, conservative investors are left with the option of either being fully invested in the market and take part in the speculative rally—one hardly warranted by fundamentals—or simply hold cash and wait for the markets to correct and return to sanity. The former offers the thrill of quick profits while exposing the investor to the risk of capital loss, while the latter assures safety of capital and the opportunity to pick up bargains when the market eventually corrects and returns to fundamental value. Buffett, like a truly conservative investor concerned more with the return of capital than return on capital, has chosen the latter course of action.
This, however, is not the first time Buffett has chosen to pick the unpopular decision of holding cash over staying invested in the market, thus missing one of the most lucrative bull markets in years. In 1969, Buffett closed his investment partnership and returned money to investors citing a market that he found to be fairly valued. In a letter to investors in the partnership, Buffett noted, “The investing environment […] has generally become more negative and frustrating as time has passed […] it seems to me that opportunities for investment that are open to the analyst who stresses quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years”. That was after delivering magnificent returns to investors, well above the general market, for 13 years beginning 1956.
Years later, in 1973 and 1974, the Dow Jones Industrial Average sank by over 40%, giving Buffett the opportunity to return to the markets to shop for cheap stocks with cash he held on the sidelines. This led to his investment in winners like The Washington Post, Geico, etc. Buffett, along with his partner Charlie Munger, chose again to remain out of the market between 1984 and 1987 and increase their cash pile before picking Coca Cola shares in 1988.
The decision to hold cash, let alone for a period of years, is often considered a losing proposition, considering how inflation erodes the real value of cash, and, even more so, when the general market witnesses a historic rally. But in the absence of undervalued securities, unfortunately, that may be the only prudent course of action available to the conservative investor to achieve stable, superior returns in the long run. This is more the case as bonds no longer offer an alternative safe investment. Bond yields have been crushed by the Fed’s intervention in credit markets. Buffett cut down Berkshire’s allocation towards bonds to a decade low, citing low yields. Remember, bond prices can only go down from the current artificially high prices once the Fed’s distortion to the market ends.
Of course, if one is a “momentum” investor from Wall Street permanently bullish over the prospects of the stock market and confident about timing the markets, this would sound foolish—until markets teach a lesson or two on the impossibility of perfect timing.
At the moment, Buffett is not the only investing legend cashing out of a market that is overvalued by all measures. Seth Klarman of the Baupost Group, and author of the book Margin of Safety, is another value investor who has chosen to pile up his fund’s cash holdings—representing about half (or even more) of the total value of assets under management. Hedge fund investor Stanley Druckenmiller, with an impressive investment track record of returning 30% annually since 1986 and previously part of George Soros’ Quantum fund, shut operations as early as 2010 citing lack of opportunities in the current bloated market. Legends of the investment world clearly understand the froth in today’s market—one that is totally distorted by the Fed—and hence bailed out early on the market. These conservative investors loading up on cash give themselves the opportunity to take advantage of value bargains when the market eventually faces a painful correction.
Read more at: http://www.livemint.com/Opinion/DKXzoTbEAXWr2qUpKOEj7L/When-the-market-gets-frothy-Warren-Buffett-sits-on-cash.html?utm_source=copy
No comments:
Post a Comment