The Big Picture

Briefing.com Summary:

*The Buffett Indicator suggests investors may be "playing with fire" at current valuations.

*Berkshire Hathaway's cash position is at a record high alongside the S&P 500.

*Warren Buffett values patience over fear-driven investing in overheated markets.

Coming out of the COVID nightmare, people were spending like crazy, motivated by stimulus checks, cabin fever, and an unprecedented joie de vivre. There was at least one person, however, who did not join the spending party. In fact, this person saved even more, so much so that he became the largest private holder of U.S. Treasury bills.

To be fair, this person did not become the largest holder of Treasury bills, but the company he oversees did. That person, Warren Buffett, oversees Berkshire Hathaway (BRK.B).

We have touched on this point before, but we are revisting it again today because Berkshire Hathaway's cash and short-term investment position has risen to record highs alongside the S&P 500. What this means only Warren Buffett and Berkshire Hathaway truly know, yet that won't stop us from surmising that the greatest value investor of all time is struggling to find value in this market.

Comfortable, yet Agitated

Warren Buffett doesn't buy stocks; he buys businesses. If there was a business he liked and aimed to acquire at a fair value, he would put that cash to work. 

Berkshire Hathaway took a baby step in that direction recently, with its $9.7 billion cash acquisition of Occidental Petroleum's chemical business, OxyChem. Based on the company's second quarter 10-Q filing, that is slightly less than 10% of Berkshire Hathaway's cash-only position. The cash used to buy OxyChem, though, will be recovered in short order when a sliver of Berkshire's $243.6 billion in T-bills matures.

To say the least, Berkshire Hathaway sits in a comfortable, albeit agitated, cash equivalent position. We say comfortable because that is a ton of liquidity at the ready; we say agitated because the company would presumably prefer to earn a higher return on that capital.

The amazing quality Warren Buffett has is that he does not let that agitation translate into malinvestment. In other words, he doesn't chase performance. He is patient and disciplined and would prefer to sit on a mountain of cash, like he is currently doing, than put it to work simply because he doesn't know what else to do with it. A boring T-bill is just fine, particularly in markets trading with rich valuations.

Don't Forget the Sunscreen

We observed last week that the S&P 500 is trading at 23x forward 12-month earnings. That is a 24% premium to the 10-year average of 18.6x and a 36% premium to the 25-year average of 16.9x, according to FactSet. 

That is, historically, a very high valuation. History, though, isn't the market's guide at this time. The future is, and there is an enduring belief in that premium valuation that the future is bright. The price action leaves no doubt that things are burning bright in the market's mind.

Every dip gets bought; every piece of bad economic news gets spun as good news for rate cuts; the AI trade is indefatigable; highly shorted stocks are crowd favorites; the IPO market is revving up; and there is a lot of speculative energy in profitless corners of the market like quantum computing.

There are UV rays galore shining down on equity portfolios and 401(k) accounts, so much so that investors should apply sunscreen before looking at their statements. But is it a warm glow or the heat being thrown off by a fire? It feels like a warm glow in the moment, yet the future just might reveal that it is the heat of a fire.

The ratio of the Wilshire 5000 market capitalization to nominal GDP—a valuation measure popularized by Warren Buffett—is at a record high of 219%. He said in 2001 that "if the ratio approaches 200%—as it did in 1999 and a part of 2000--you are playing with fire."

Briefing.com Analyst Insight

If you are not invested in this stock market or you are sitting on a fair amount of cash, it can be mentally painful watching stock prices appreciate nearly every session, and even when they don't, not pulling back much before the dip is bought.

There is an understandable tendency to want to put that cash to work in the stocks and sectors that keep running for fear of missing out on further gains. Buying at a record-high level in a richly valued market requires conviction that your reward will be greater than the risk.

That could end up being the case, but the bar for that tradeoff is so much higher when the market's valuation is so much higher from which to begin. Fear can be a motivating factor, but it is not a virtue. Patience is a virtue, and Warren Buffett is perhaps the most virtuous of them all.

He knows value when he sees it, and he is okay sitting on a lot of cash, ready to strike when the iron is hot, as he did so adeptly during the financial crisis. From our vantage point, he and Berkshire Hathaway look to be in a strike position, ready to deploy cash opportunistically to extinguish fires in the stock market that lower asset values.

His approach may just be one worth copying for holders of cash feeling the heat of a stock market that seems to think nothing will go wrong.

--Patrick J. O'Hare, Briefing.com