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Why Warren Buffett Could Be Back on the Money

Stock-Markets / Investing 2009 May 21, 2009 - 10:55 AM GMT

By: MoneyWeek

Stock-Markets

Best Financial Markets Analysis ArticleHas Warren Buffett lost the plot?

The Sage of Omaha’s recent track record hasn’t been too hot. And he’s had a fair amount of flak for getting some things wrong.
Now, reports Bloomberg, his Berkshire Hathaway holding company is cutting back on buying shares, after the firm’s cash levels have fallen to their lowest in more than five years. Will this prove to be another mis-step? Or is Buffett back on form?


The Sage of Omaha's wobble

Even the mighty fall occasionally. Warren Buffett, whose name alone has been known to move markets, has rather gone off the boil performance-wise recently. And more unsettling for his legions of supporters was that he did so for entirely the ‘wrong’ reasons.

Remember how he used to call derivatives “Financial Weapons of Mass Destruction”? Well, unfortunately for Berkshire investors, Mr Buffett had a bit of a brainstorm. He made a $37bn punt on selling ‘put’ contracts, i.e. betting on stock markets rising, which didn’t exactly work out as planned. Buying dodgy Irish banking shares and oil stocks when the price was well above $100 a barrel didn’t help either.

So he’s seen his halo dim somewhat, as his firm made a $1.5bn first-quarter loss. Berkshire’s shares are now 37% below last September’s level, and the company has been stripped of its ‘triple–A’ status – i.e. the top-notch credit rating’s gone. Meanwhile Buffett has lost his crown as the world’s richest man.
But surely, we’re all allowed the odd wobble. After all, the guy’s long-term track record is just about second-to-none – and it’s not as if everyone else did stupendously well last year. So it’s still worth watching what he’s been up to.

Warren Buffett hasn't lost his touch

Berkshire Hathaway’s first quarter filing shows that he bought into two of his favourite banks, Wells Fargo (NYSE:WFC) and US Bancorp (NYSE:USB). Indeed, in March, Buffett said that if he had to put all his net worth into a single stock, it would be the former when it slipped below $9/share.

Well, Wells Fargo is now $25 a throw, while US Bancorp has doubled from its March lows. So it seems the Sage hasn’t lost his touch. But I wouldn’t rush to copy him now - Wells is on a current price to earnings ratio (PER) of 17 times and yields below 2%, while US Bancorp looks even pricier. But both stocks could be worth keeping an eye on for the future.

A third notable Buffett buy is healthcare product giant Johnson & Johnson (NYSE:JNJ). It’s in an area we like – nice and ‘defensive’, i.e. less dependent on the economic cycle - and what’s more, the stock price has risen less than 20% from its low. On a PER for next year of just 11.5 times and a yield of around 3.5%, J&J still looks reasonable value. This looks a good one to pick up, though we’d wait for the next pullback.

But what about the bigger picture – why’s he cutting back on buying stocks now? Buffett says it’s because he wants to maintain a $10bn ‘calamity’ cash pot, and that his available funds are shrinking towards this level. But we wonder if he’d be so keen to cut back if stock markets had slid rather than rallied in the past two months. The key thing to remember about ‘value’ investors like Buffett is that when they’re buying fewer shares, it’s because they don’t think there’s much value around.

Three warning signs that the rally's nearly over

We’ve been getting increasingly wary of the stock market rally in both Britain and the States – though not Japan, as my colleague John Stepek explained both in Money Morning recently (Japan is a mess - but it's still a buy) and in the magazine this week.

And I’ve seen three more troubling signs over the last few days.

Firstly, the professionals have gone bullish again. It seems that “experts around the world believe the global economy has turned, with a sizeable majority now saying it will improve in the next 12 months”, says The Times’ Helen Power. The Merrill Lynch May fund manager survey found that seven out of ten investment managers are now buying cyclical stocks “that will gain fastest when the economy picks up”.

Even more concerning, that’s a total turnaround from last October when a net 60% of those surveyed reckoned the outlook was worsening. And the sentiment swing has been most pronounced in Europe, where a net 35% of respondents say the economy will improve over the next year, compared with a net 26% who said – as recently as April – that it would get worse!

Why’s this sudden optimism such a worry?

Whenever the professionals turn this bullish, it normally means it’s too late for the rest of us – they’ve already piled in. As Michael Hartnett at Bank of America Merrill Lynch says, “this rush to take on risk is reminiscent of bubble-like behaviour”. I’d go further than that - it looks like a sell signal.

Secondly – and in the light of the above, no surprise - everyday my inbox gets bombarded with press releases from more fund managers proudly announcing they’re launching new funds. Note this didn’t happen at the bottom of the market, but only after prices have risen by a third or more from their lows.

It looks like the classic case of trying to pull in the mug punters after the action has largely happened. And to make even more money for those fund managers.

Thirdly, this has just crossed my desk from Societe Generale’s James Montier, one of those analysts who’s not afraid to tell investors what they don’t want to hear: “Has the market rallied too far, too fast? The swift rebound in the markets is leading to rapidly vanishing deep value opportunities”. In other words, the bargains have pretty much gone. As Montier says, “I’ll soon be worrying about a value drought”.

That could be Warren Buffett speaking. The London/Wall Street rallies may continue for a while on herd-following panic buying. But when Mr Buffett starts hoarding cash, we’d be inclined to do the same.

By David Stevenson for Money Morning, the free daily investment email from MoneyWeek magazine.

© 2009 Copyright Money Week - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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