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Warren Buffett is not buying into this bullishness

By David Scott | Monday 5 June 2017


 


Over recent years Warren Buffett has been hoarding dollars at a colossal rate. This was first really noticeable in August 2014. At that time, Buffett was holding about $50 billion and he was already 83 years old. Even then his hoard of dollars was already the largest of his entire career. But over the last three years this sum has swelled to $100 billion in size.

The Berkshire chief executive officer spoke at length recently about his failure to pounce on opportunities in tech stocks, the challenge of lining up large deals, and his frustration with a cash pile that’s approaching US$100 billion. “We shouldn’t use your money that way for long periods,” Buffett said of the cash during his meeting in Omaha, Nebraska. “The question is, ‘Are we going to be able to deploy it?’ I would say that history is on our side, but it’d be more fun if the phone would ring.” Currently Buffett's equity portfolio is valued at $135 billion. With $100 billion in cash, that means more than a 40% cash element, an unprecedented mountain of cash in the history of Berkshire Hathaway.

When the world’s most successful investor is so defensively positioned, should you not be thinking why that maybe and should you not be considering emulating him with your current investments. This is especially true if retirement is coming into focus. A reduced pension pot could seriously affect your standard of living in retirement.

Ultimately it's not that Warren Buffett can't find any companies in which he would like to deploy some of Berkshire Hathaway's (and his own) money. It's that Buffett doesn't want to and never has paid bubble prices for his investments. In the past, like in 2008, he pounced when the bargains were to be had. In the depths of the last financial crash one of those bargains happened to be Goldman Sachs - one of the current cheerleaders of this current equity bubble. Then Buffett bought $5 billion worth of perpetual preferred stock in Goldman in a private offering on the 22nd September 2008. For that, he got a 10% dividend and warrants to buy $5 billion of common stock with a strike price of $115 a share, exercisable over a five year period. Goldman's stock closed on Sept. 23 2008 at $125 they are now $213.


The problem with overvaluation and investor exuberance is they are clear hallmarks of historical bull market peaks. This is particularly the case when there is a central asset, or asset class, that investors are piling headlong into without regard to the consequences. Virtually every class of US debt — sovereign, corporate, unsecured household/personal, auto loans and student debt — is at record highs. Americans now owe $1tn in credit card debt, and a roughly equivalent amount of student loans and auto loans which, like the subprime mortgage quality that set off the 2008 financial crisis, are of largely low credit quality (and therefore high risk). US companies have added $7.8tn of debt since 2010 and their ability to cover interest payments is at its weakest since 2008, according to an April International Monetary Fund report. With total public and private debt obligations estimated at 350 per cent of gross domestic product, the US Congressional Budget Office has recently described the path of US debt (and deficits) as almost doubling over the next 30 years.

But this is not just a US phenomenon. In November last year, unsecured household debt in the UK passed pre­ financial crisis highs in 2008. In the UK, debt excluding student loans crept up to £192bn, the highest figure since December 2008, and it continues to rise this year. Meanwhile, in the Eurozone, debt­ to ­GDP ratios in Greece, Italy, Portugal and Belgium remain over 100 per cent. As of March there were more than $10tn negative yielding bonds in Europe and Japan.

There is also the constant risk and market concern that debt levels in China will at some point rise swiftly to the top of the country’s economic woes in a very damaging way. Among the most risky are non­performing loans of state-owned enterprises, and mismarked and therefore not properly accounted for debt obligations in the over­heated real estate market. More broadly, emerging market borrowing is surging. Sales of EM corporate dollar ­denominated notes have climbed to about $160bn this year, more than double offerings at this point in 2016 and the fastest annual start on record, according to data compiled by Bloomberg going back to 1999. The total stock of foreign currency EM debt stands at more than $15tn.

Globally, the picture is precarious, with debt stubbornly high in Europe, rising in Asia and surging across broader emerging markets. A decade on from the beginning of the financial crisis, the world has the makings of a fresh debt crisis. When debt-asset bubbles expand at rates far above the expansion of earnings and real-world productive wealth, their collapse is inevitable. There is a staggering amount of debt instruments owned by central banks. As of the latest data, central banks own just over a third of the global tradable bond universe of $54 trillion, or roughly $18 trillion. How this amount of debt on Central Bank balance sheets is ever unwound, that is sold - even with central banks' best intentions - without crashing the global bond markets, nobody knows and that includes those supposedly in charge of this experiment.

 

A status quo in which "emergency measures" have become permanent supports is by very definition a failure. The "emergency" responses to the Global Financial Meltdown of 2008-09 are, eight years on, permanent fixtures and if the deficit spending, money-printing, zero interest rates, shadow banking and the asset purchases by central banks stopped the status quo falls apart rapidly and this scares our Central Banks witless. In their heart of hearts they know they have failed, but will not admit publicly this error. Preferring instead to continue to kick the can down the road rather than face the truth. Unfortunately they have now nearly run out of road.

“In the long run, we are all dead,” said 20th Century economist, John Maynard Keynes. This, in a nut shell, was Keynes’ rationale for why governments should borrow from the future to fund economic growth today. Why wait for recessions to do the work of equilibrating the economy when a little counter-cyclical stimulus can push growth onward and upward? Keynes is certainly dead, but we are still alive and can rightly be referred to as his victims. Continuing to attempt to spend a nation to prosperity using borrowed money is not without consequences. In the short run, an illusion of wealth can be erected, but eventually this illusion will turn nasty. The hangover of excessive credit expansion is brutal, as lenders go bankrupt, wiping out their owners, and borrowers go bankrupt as they are unable to make their payments or sell the collateral to pay off the loan.

The Chairman of EOG Inc. in the USA said that 10 years ago it was necessary to invest $48 billion to extract a million barrels a day. Today it can be done with under $7 billion, thanks largely to new shale fracking technology. Ten years ago it costs $55m to build a 15 megawatt solar plant. Today it costs $15m and it produces 40% more electricity. Disruptive technologies are everywhere and anyone who invested and built significant capacity in these areas 10 years ago using huge amounts of debt is in trouble. The bull market in equities has hidden the scale of this trouble. It will not just be a reduction in credit flows that undermines this artificially lengthened business cycle and multiple asset bubbles, disruptive technologies will do significant damage too.

Every stock market bubble of the current magnitude in history has ended in a spectacular reset back to normality, and this one will not be any different. We can argue about the exact timing of the next reset, but what everyone should be able to agree on is that is all is not well economically nor politically in the world.

You only make good long term generational money out of the equity markets if you get out at the right time. When asked how he had made so much money out of the 1929 Wall Street cash, a seasoned investor said, ‘by getting out too early.’ Historically many of those that timed things well have made a tremendous amount of money, but most investors will be entirely caught off guard by the economic implosion that is rapidly approaching.

As I have said repeatedly, markets tend to go down a whole lot faster than they go up, and in the not too distant future we are going to see trillions of dollars of investor wealth wiped out very, very quickly. Let’s hope that the coming crisis will not be as bad as 2008, but I have a feeling that it is going to be much worse. Tesla which burns a billion per year in cash, sold only 76,000 cars last year against 10 million worldwide for General Motors. Yet Tesla’s market cap is $51.7 billion against $48.8 billion for GM. This insanity is the surest sign that the US stock market bubble is getting ready to pop.

David Scott is an Investment Manager & Market Commentator at Andrews Gwynne


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