It's been quite a few weeks since my last post. I haven't really changed my thoughts since then, but maybe the economic impact of this will have more than a blip on the long term charts after all.
So far, the economy seems to be doing much worse (or will soon) than the stock market. The initial decline was shocking, but not at all unexpected. The recovery rally is kind of incredible too.
As I watch all these commentators, I realize nobody really has any idea. The commentators / pundits that survive a long time are masters at saying things that will make them look 'correct' in hindsight later on. You make enough calls and predictions, you will at least be able to pick one and say you were right. Also, they are very careful to word their comments so that they can't be called out for being wrong. 'If this happens, then this will happen, if that happens, then that might happen...' etc. You say enough of that, and you will be right about something, eventually... It's kind of a joke, but whatever.
Buffett and Airlines
A lot of things have happened since my last post, including the virtual BRK annual meeting. Nothing really new or unexpected, as usual, but one thing that may have shocked people was how Buffett dumped all his airline stocks. We are supposed to be long term investors, and are not supposed to be reacting to headlines, however scary.
But if you look at their income statements and realize that their revenues are down 90% and may be down for a year or more, it's hard to imagine them surviving. Most of them will be out of business by the end of the year or long before that. The government will have to bail them out, but that will be costly. Either they will have to take on a lot of debt that will take years to pay off, or they will have to issue a lot of equity, basically wiping out current shareholders.
Many businesses will not survive this, and even if they do, there will be big losses to equity investors.
A lot of restaurants will go out of business too, but mostly the independent ones. Major chains, especially fast food and fast casual should be fine.
Retailers are out too, for the most part. A lot of retailers should probably not even exist, and this pandemic is just accelerating what is going to happen anyway. The Micrsoft CEO, Nadella, said that there was two years worth of virtualization in two months since the pandemic. I think that's the case with retailers. This will just accelerate the demise of retailers with flawed (or out of date) business models.
One thing Buffett said was that he didn't really see any bargains during the decline in March. We know from the 2008-2009 crisis that Buffett is not really a trader, so he is not going to be buying the lows on big down days, necessarily. So on fast declines with quick rebounds, he is not going to get much done.
If you look at what's going on, the stocks that were really hit are the ones that you don't really want to own, necessarily. Airlines, real estate, retail, travel-related stocks etc. And the ones you want to own didn't really get cheap. I can see Buffett piling into things like Amazon or Google if they were dumped with the bath water, but they weren't, really. Neither was Microsoft. Not sure what he thinks of Netflix, but that wasn't dumped either.
So crappy stocks got cheap, but as Buffett said, the way to succeed in the stock market (or at least not lose money) is "don't buy crummy businesses". And there are a lot of them out there now.
People also view Buffett as being 'bearish' because he sold stocks, and he is still sitting on a growing cash balance. He did mention during the meeting that he has a lot of cash, but he has a lot of equity exposure too. I wrote about it a while back, but his equity exposure is not limited to his listed equity portfolio. Kraft is not included in his list of stock holdings, but he still owns it. Same with Burlington Northern, and his many other operating companies (some of which were listed until recently). If you add it all up, BRK is still fully exposed and is not as conservative as it seems if one were to look only at his listed equity portfolio and cash balance.
Which leads to the next thing being talked about a lot these days (as it has been for the last few years).
Value Investing is Dead?
One thing people need to keep in mind about value investing is that the way the general press talks about it and the way investors talk about it are completely different. The press just looks at nominal valuation and that's it. There is no concept of what something should be worth, and whether it is trading above or below that. They don't understand the concept of intrinsic value. Indexes split between growth and value don't help either.
Value investing used to be about low P/E's and things like that, I suppose, but the more modern approach is what something is trading at versus intrinsic value. This is not that modern, actually, as Buffett has been saying that for many decades.
Here is something from the second edition of Graham's Securities Analysis. This is in the section where he discusses the difference between investment and speculation.
It may be helpful to elaborate our definition from a somewhat different angle, which will stress the fact that investment must always consider the price as well as the quality of the security. Strictly speaking, there can be no such thing as an “investment issue” in the absolute sense, i.e., implying that it remains an investment regardless of price. In the case of high-grade bonds, this point may not be important, for it is rare that their prices are so inflated as to introduce serious risk of loss of principal. But in the common-stock field this risk may frequently be created by an undue advance in price—so much so, indeed, that in our opinion the great majority of common stocks of strong companies must be considered speculative during most of the time, simply because their price is too high to warrant safety of principal in any intelligible sense of the phrase. We must warn the reader that prevailing Wall Street opinion does not agree with us on this point; and he must make up his own mind which of us is wrong.Nevertheless, we shall embody our principle in the following additional criterion of investment:
An investment operation is one that can be justified on both qualitative and quantitative grounds
I would look at the opposite of this example and say that many cheap stocks may not necessarily be safe. Would you buy junk bonds just on yield? Nope. Someone showed me years ago a quantitative report basically showing that the valuation of a stock is pretty much determined by it's credit quality (I don't know if there was an adjustment for long-term growth or returns on capital), but it made sense to me. The industrial cyclicals were always 'cheap', like steel, auto manufacturing etc. And consumer stocks were always expensive.
Anyway, today, I think a lot of this gap between value and growth just may be reflecting huge secular changes in the economy. You can say AMZN is overpriced and BBBY is cheap. But really, who would short AMZN and go long BBBY?
MKL Dumping Stocks
On the 1Q earnings call, MKL said they dumped a few stocks they thought would be hugely affected by Covid-19. Here are the stocks they dumped:
|Anheuser-Busch Inbev ADR||0||0.00%||13,000||-13,000||-100%|
|CDK Global Inc||0||0.00%||176,897||-176,897||-100%|
|Dollar Tree Inc||0||0.00%||123,100||-123,100||-100%|
|Kraft Heinz Co||0||0.00%||68,000||-68,000||-100%|
|Rockwell Automation Inc||0||0.00%||140,100||-140,100||-100%|
|Scotts Miracle-Gro Co||0||0.00%||422,000||-422,000||-100%|
|Unilever PLC ADR||0||0.00%||1,527,600||-1,527,600||-100%|
|United Health Group Inc||0||0.00%||599,000||-599,000||-100%|
This is as of end the March, and they may have dumped more things in April. Buffett dumped airline stocks in April, so that dumpage doesn't show up on his 13-F, which is here, by the way:
BERKSHIRE HATHAWAY INC
Filing Date: 2020-05-15
|APPLE INC||62,340,609||35.52%||245,155,566|| || |
|BANK AMER CORP||19,637,932||11.19%||925,008,600|| || |
|COCA COLA CO||17,700,001||10.09%||400,000,000|| || |
|AMERICAN EXPRESS CO||12,979,391||7.40%||151,610,700|| || |
|WELLS FARGO & CO NEW||9,276,210||5.29%||323,212,918|| || |
|KRAFT HEINZ CO||8,056,205||4.59%||325,634,818|| || |
|MOODYS CORP||5,217,658||2.97%||24,669,778|| || |
|JPMORGAN CHASE & CO||5,196,030||2.96%||57,714,433||-1,800,499||-3%|
|US BANCORP DEL||4,563,233||2.60%||132,459,618|| || |
|DAVITA HEALTHCARE PARTNERS I||2,897,549||1.65%||38,095,570||-470,000||-1%|
|BANK OF NEW YORK MELLON CORP||2,686,487||1.53%||79,765,057|| || |
|CHARTER COMMUNICATIONS INC N||2,367,684||1.35%||5,426,609|| || |
|DELTA AIR LINES INC DEL||2,050,935||1.17%||71,886,963||976,507||1%|
|SOUTHWEST AIRLS CO||1,910,218||1.09%||53,642,713||-6,500||0%|
|VISA INC||1,701,823||0.97%||10,562,460|| || |
|GENERAL MTRS CO||1,551,872||0.88%||74,681,000||-319,000||0%|
|LIBERTY MEDIA CORP DELAWARE||1,446,433||0.82%||45,711,345||-240,000||-1%|
|COSTCO WHSL CORP NEW||1,235,572||0.70%||4,333,363|| || |
|MASTERCARD INC||1,192,040||0.68%||4,934,756|| || |
|AMAZON COM INC||1,039,786||0.59%||533,300||-4,000||-1%|
|PNC FINL SVCS GROUP INC||880,431||0.50%||9,197,984||526,930||6%|
|UNITED CONTL HLDGS INC||699,073||0.40%||22,157,608||218,966||1%|
|SIRIUS XM HLDGS INC||654,149||0.37%||132,418,729||-3,857,000||-3%|
|KROGER CO||570,475||0.33%||18,940,079|| || |
|M & T BK CORP||556,665||0.32%||5,382,040|| || |
|AMERICAN AIRLS GROUP INC||510,871||0.29%||41,909,000||-591,000||-1%|
|GLOBE LIFE INC||457,278||0.26%||6,353,727|| || |
|LIBERTY GLOBAL PLC||434,229||0.25%||26,656,968||-481,000||-2%|
|AXALTA COATING SYS LTD||415,689||0.24%||24,070,000||-194,000||-1%|
|TEVA PHARMACEUTICAL INDS LTD||384,248||0.22%||42,789,295||-460,000||-1%|
|RESTAURANT BRANDS INTL INC||337,782||0.19%||8,438,225|| || |
|STORE CAP CORP||337,425||0.19%||18,621,674|| || |
|STONECO LTD||308,410||0.18%||14,166,748|| || |
|GOLDMAN SACHS GROUP INC||296,841||0.17%||1,920,180||-10,084,571||-84%|
|SUNCOR ENERGY INC NEW||236,195||0.13%||14,949,031||-70,000||0%|
|OCCIDENTAL PETE CORP||219,245||0.12%||18,933,054|| || |
|RH||171,638||0.10%||1,708,348|| || |
|JOHNSON & JOHNSON||42,893||0.02%||327,100|| || |
|PROCTER & GAMBLE CO||34,694||0.02%||315,400|| || |
|MONDELEZ INTL INC||28,946||0.02%||578,000|| || |
|VANGUARD INDEX FDS||10,183||0.01%||43,000|| || |
|SPDR S&P 500 ETF TR||10,155||0.01%||39,400|| || |
|UNITED PARCEL SERVICE INC||5,549||0.00%||59,400|| || |
|TRAVELERS COMPANIES INC||0||0.00%||312,379||-312,379||-100%|
By the way, insurance companies are going to hurt for a while. People keep saying that business disruption doesn't cover pandemics, or that it requires physical damage etc. But the way things work in this country, that doesn't matter. We have enough lawyers with a poorly structured incentive system so insurance companies can get bogged down in years and years of lawsuits. Even if insurance companies win, who knows how much all of that is going to cost.
Plus, interest rates are now 0% all the way out to 5 years, and 1% to 20 years. That's going to be painful, and makes BRK's float basically worthless. Yes, this may be temporary, but we have been saying that for more than 10 years now. I have always suspected we will follow Japan in terms of interest rates. I didn't expect a pandemic to cause rates to go to zero, though.
I still think BRK, MKL and others are great investments for the long haul, but there are serious issues for them out there for sure.
JPM and other banks are going to take some huge credit losses. There is no way around that. One rule of thumb is that credit card losses will follow the unemployment rate. Unemployment got up to 10% during the financial crisis, and sure enough, JPM's credit card charge-offs peaked at 10% or so. Total charge offs were 5%, I think, back then.
Unemployment is now over 15%, and headed to 20%. JPM has $160 billion in credit card loans, so credit card charge-offs can get over $30 billion. Total credit losses may get to 10% and they have around $1 trillion in loans outstanding. Who knows, really.
JPM is still the best managed big bank and they will get through this for sure, but they face some very serious problems. I think the view expressed during the 1Q conference call (expecting rebound in second half of the year) is way too optimistic.
Even if we start to reopen the economy, we can't really have a real recovery as a lot of events won't come back, and restaurant / bars / retailers will run at 30-50% capacity.
An interesting thing to look at is Sweden. They didn't have a hard lockdown like the U.S. and European countries, but their economy is taking a hit anyway. Reopening the economy doesn't mean we are all going to go back to the way we were right away. Many people tell me that they won't change anything even if the economy reopens until they get a vaccine. This could be years away.
I tend to believe things will normalize when we get a treatment that makes Covid-19 far less fatal. If we take that off the table, people will start to get back to normal.
I have no idea about these things, but I tend to think the odds of us finding a treatment is far higher than us finding a vaccine (there is a chance we may never find a vaccine).
Anyway, the mitigating factor to the above bank credit disaster is the amount of money being injected into the economy. I don't know if people are going to use their stimulus / Covid-19 help checks to pay off their credit card (they seem not to be paying their rent), but it will have some positive impact on bank credit, I assume (and hope). Well, but don't assume because...
Is the Market Being Rational?
So, people are saying that the market is being too optimistic about a return to normal, but it's hard to tell. The market is full of stocks with different exposure. If the airline stocks got back to their highs, I would agree that the market is being too optimistic. But that hasn't happened; not even close. Same with retailers. And restaurant stocks. OK, Amazon, Netflix, and others are going to new highs, but I doubt that is reflective of the market's optimism about a return to normal.
So when the markets move, I think we have to look by sector, and by stock, to see what they're expecting. It makes no sense to look at the index itself.
What to do?When this started, I told people the same thing I always told them. Ignore the headlines and just think 3-5 years ahead. This works, though, for people with diversified portfolios. I wouldn't know what to say if they owned a lot of airlines, hotel and other travel related businesses, or other areas that may not recover so quickly. I have no idea.
I haven't owned any retail stocks in a long time (except BRK, which is the closest thing to a retailer I own), and the only restaurant stocks I own are CMG, QSR and SHAK. Well, SHAK was never cheap so it's a token position that is not significant; it's more of a moral support, I like this company, kind of position. CMG was a large position that I scaled back and had to do again as it went over $1,000. It's not a cheap stock, and I have no idea why it's above $1,000; maybe they are going to take market share after many of their competitors go out of business within a few months). Oops, after writing this, I just realized I do own Costco. So I lied. I own Costco and have no problem with it. I will hold on to it. Yes, it's expensive, but I really like the business for all the reasons we've all heard already a gazillion times.
If you own the S&P 500 index, it doesn't really matter. Many companies will go bust, but that happens all the time. Some big banks, AIG and FNM went bust (or was massively diluted) during the financial crisis and yet the S&P 500 index was fine. It should be fine over the long term this time too, but many of the components won't be.
As usual, just don't invest based on the headlines. OK, evaluating your holdings on long term potential incorporating Covid-19 might not be a bad idea (like Buffett's dumping of airlines), but I would be careful about that too.
One thing is for sure. You really don't want to go chase Covid-19 stocks. You can buy AMZN, NFLX, MSFT thinking these are the pandemic-proof stocks, but the worst time to buy stocks is when everyone piles into them for the same reason (I wouldn't short them either!). For example, I wouldn't touch Zoom stock, of course.
Things are Interesting
I have to admit I have sort of been lazy about my investments over the past few years, kind of just let it go... Looking for things to do wasn't all that interesting as things got expensive.
But things are getting interesting again. I haven't read through so many conference calls and 10-Q's in a long time, and it's been fun. I have to say, though, that the 10-Q's only reflect a small portion of what's happening as the 1Q included the relatively healthy January and February. NYC shut down in mid-March. So there was only 2 weeks of really bad data included in 1Q. The 2Q reports are going to be really scary, but I can't wait to sift through that stuff.
Maybe this will lead to more blog posts. That would be fun, as I do enjoy this process. Until now, though, things are more interesting, but nothing really stands out to me. The really devastated industries are just 'too hard' for now, like cruise lines, airlines, casinos, and the solid businesses that you want to own are not cheap (AMZN, MSFT, COST etc...).
So to those who feel that ETFs and the indexing bubble has lead to a lack of differentiation in the evaluation of individual stocks, it is quite obvious that this is not the case at all. I've always maintained that this is not the case. Sure, there may be excess valuation in some large cap index stocks where index funds are 'forced' to buy regardless. I think overall, crummy stocks are cheap and higher quality stocks are expensive.
OK, banks and insurance companies are cheap now, and not all of them are crummy. But there are massive uncertainties they are facing now. The market is probably wrong and these stocks are probably too cheap.