Whither Warren Buffett (And The Market)
In recent years, the conventional wisdom about Warren Buffett’s Berkshire Hathaway investment vehicle was that it had become increasingly paralyzed by its own past success. Not only had it become too large to buy any but giant companies. In addition, it could not possibly reduce its overall stock position without destroying the value of its own stocks.
In particular, Buffett seemed trapped by past success with Apple, which had appreciated seven times over the years and come to represent half the portfolio. Surely Buffett did not feel comfortable running what had become an Apple fund, especially as Apple began to run into serious problems in China and elsewhere.
In 2024, Buffett managed to pull off the near impossible. He sharply reduced his Apple position. Much of the Apple was sold into an Apple rally which in turn was partly fueled by massive company stock repurchases, repurchases that leave Apple with far less cash than it once had. Buffett also sold Bank of America.
By the next Berkshire Hathaway report, it seems likely that it will be holding more treasury bills than stocks. Buffett said at the May shareholder’s meeting that he found cash more attractive than stocks in general. He added that he would prefer treasury bills even if they paid little or no interest, as they had until recently.
What exactly is Buffett thinking? Stock valuation is surely on his mind, since U.S. stocks cost more today than at any prior time in history and now represent 70% of world indexes, also an all-time high. But he also knows that valuations do not themselves move markets.
If the market remains optimistic, valuations can advance further. If the market becomes pessimistic or frightened, then high valuations can make the subsequent fall far steeper.
As the legendary Merrill Lynch market strategist Bob Farrell noted in Rule 4 of his celebrated 10 Rules: “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.” This presents a dilemma, whch Buffett is resolving by focusing on the second half of the rule.
U.S. retail investors are not frightened today. They hold 42% of their wealth in stocks, which stands at the high end of history. The % allocation to stocks has been the most reliable long term market indicator, with high indicating negative and low indicating positive forward returns.
What is likely to frighten investors enough to get them selling? Inflation and recession qualify. There is, however, a more subtle potential trigger to fear. That is when expectations for earnings begin to diverge too far from reality or even to enter fantasy land. When perfection is not realized, panic ensues.
Today we have the highest multiples paid for the highest earnings. Over the years, those earnings have steadily risen as a percent of sales, driven by global trade depressed inflation and wage rates, falling tax rates, falling interest rates engineered by central banks, and most recently by huge government deficits. It is not always appreciated how government deficits feed right into corporate profits and thus tend to make the rich richer rather than helping the poor or middle class.
Today Wall Street expects earnings to keep growing and even to grow much faster than the underlying economy. FactSet reports expectations for the fourth quarter of 15% earnings growth versus 4.9% revenue growth and for 2025 of 15.2% earnings growth versus 5.9% revenue growth. To meet these targets, return on sales must keep heading higher.
The little recognized truth is that even if business is able to deliver these ambitious numbers for a while, any reversal of a rising ROS will not be well received.
Nor will it be easier to keep ROS heading higher when 43% of S&P 500 market capitalization is now under FTC/Justice antitrust investigation.
That is the problem with a bubble. It cannot be stabilized. It must grow exponentially or eventually collapse.
Could this be why the truest corporate insiders, the actual managers of public businesses, continue to sell shares at such a high rate?
WRITTEN BY:
HUNTER LEWIS | CHIEF INVESTMENT OFFICER
Hunter Lewis is Chief Investment Officer of Hunter Lewis LLC, as well as a co-founder and former CEO of global investment firm Cambridge Associates. Learn more about Hunter Lewis.