I know I'm preaching to the choir here for the most part, and others will disagree completely and say that always being invested in stocks is reckless.
But still, I thought it would be interesting to look at how Buffett viewed the market over the years, and what he did about it. We can learn. And it's always fun to go back and read Buffett's writing whatever the reason.
Buffett on the Markets: The Berkshire Years
The first time I notice common stocks mentioned in the Berkshire Hathaway letter to shareholders is in 1966 (the earliest I have is 1965 from Berkshire Hathaway: Letter to Shareholders 1965-2012). This, by the way, is before the insurance acquisition. The letters from 1965 to 1969 are signed by Kenneth V. Chace, President of BRK, but actually written by Buffett.
All of the emphasis (italics) from the letters are mine.
BRK LTS 1966
It is these considerations which caused the Company at year end to include in its working capital $5.4 million of marketable securities, composed of short-term municipal bonds, commercial paper and common stock. Because of the uncertainties in knowing when the Company may be called upon to produce substantial sums of cash, and the possibility that this might not occur for a considerable period of time, your directors have felt that we should be as zealous to achieve a realistic return on this portion of our capital as we are on the funds that are at the time invested in plant, inventories, receivables etc. Accordingly, it is the present intention of the directors to proceed toward interim investment of a major portion of these funds in marketable common stocks. This should hold promise not only of greater income than can be achieved through alternative investment possibilities in the field of non-equity marketable securities, but also provides us with the opportunity to participate in earnings derived outside of our textile business, even if only temporarily and indirectly.This is very interesting because if you look at long term charts and valuations, the market is very pricey in the mid to late 1960's. And yet he has written the above paragraph. Others might be more cautious and say the exact opposite; that since markets are bubbly and prices high, they will put a major portion of funds in municipal bonds! But no. That's not Buffett. Or at least not yet.
BRK LTS 1967
1967 is the year they got into the insurance business by buying National Indemnity and the National Fire and Marine Insurance Company.
In the last paragraph, it says, "Our present liquid resources held in readily marketable common stocks are available for either acquisition of new businesses or for application toward greater profit opportunities in our present operations."
So even though it was harder for his partnership, BRK continues to keep their liquid resources in common stocks. Maybe this reflects the difference between trying to outdo the market by 10%/year (in the partnership) and just trying to get reasonable returns (in BRK).
BRK LTS 1968
So it looks like Buffett is selling some stocks in 1968, but still seems to own a bunch.
Marketable Securities and Acquisitions During 1968, we sold a portion of our marketable securities portfolio at a profit of approximately $1.5 million after tax. At the end of 1968, we had unrealized market appreciation of $6,400,000 in the balance of the portfolio. Such securities were held in marketable common stocks as a temporary investment, pending the utilization of the funds in acquisition or expansion of operating businesses consistent with our program for the development of greater and more diversified earning power.I wish we had complete annual reports for BRK available somewhere online (along with annual reports of every other company that ever existed!); then we can actually see how the balance sheet is allocated over the years.
Warren Buffett Library of Corporate Annual Reports
So here I go again on a tangent. What if there was a library funded by a really wealthy guy that wants to improve financial intelligence in this country? And what if this library contained the one thing this wealthy guy keeps telling people to read?
Yeah, wouldn't it be cool if there was "Warren Buffett Library of Corporate Annual Reports"? Imagine being able to go online and reading the Coca Cola annual reports (including the financials) in the 1920's and 1930's. Imagine reading Securities Analysis and then actually digging up the annual reports and financials of the companies mentioned?
If Google is scanning every book ever published (?), why can't the value investing community support a similar project for annual reports?
And Buffett would be a perfect sponsor of such a thing. He always tells people to read annual reports! He says that he has read the annual report of Bank of America every year for the past fifty years. What if there was such a place online that gives other aspiring value investors (and students) a chance to do the same? I'm sure the expensive business schools have extensive libraries of corporate reports, but why shouldn't kids (elementary, middle and high school) and others be able to access the same?
Imagine how convenient it would be if we could just pull up Enron or Merrill Lynch annual reports right away to learn from the mistakes of others. Imagine if we can do that for other 'bubbles' in the past. When people were getting excited about the internet, wouldn't it have been useful for people to be able to pull up the annual reports (and stock market data) of say, RCA in the 1920's? Someone says, "asset-lite" and we can hit up the Enron annuals (OK, there are some good businesses these days that use that term).
It would be great to learn from history and past mistakes, but the world is structured so that the mistakes tend to get buried; where can I get annual reports of Worldcom, for example? You can still get a lot of the SEC filings online, but that database doesn't go back too far. And companies like Wells Fargo and Markel have annual reports going way back, but companies that do that tend to be the ones that want people to see their past.
Anyway, I think this would be a huge asset to humanity.
But OK, let's move on.
BRK LTS 1970
The 1970 letter starts by explaining that,
Four years ago your management committed itself to the development of more substantial and more consistent earning power than appeared possible if capital continued to be invested exclusively in the textile industry. The funds for this program were temporarily utilized in marketable securities, pending the acquisition of operating businesses meeting our investment and management criteria.and it goes on to say that,
...We have liquidated our entire holdings of marketable securities over the last two years at a profit of more than $5 million after taxes. These gains provided important funds to facilitate our major purchase of 1969, when borrowed money to finance acquisitions was generally most difficult to obtain.The major acquisition, by the way, was their purchase of Illinois National Bank. So finally, BRK liquidates (or finishes liquidating) their entire stock portfolio. But it seems like that was done to acquire the bank. As BRK has been saying, the common stocks were a place-holder, temporary investment until they can deploy it in a business, and that's exactly what they did.
We anticipate no further purchases of marketable securities, but our search for desirable acquisitions continues. Any acquisition will, of course, be dependent upon obtaining appropriate financing.
The comment that they anticipate no further purchases of marketable securities can be construed as a market timing comment, I suppose. And it is early 1971 when the letter was written. I won't argue that.
But on the other hand, with the insurance business and now the bank, BRK has other areas to deploy capital. Back when they only had the textiles business, they had to either invest in the textile business or buy marketable securities. Now they have a choice of investing in the textile business, insurance business or the bank. So there is less need for the alternative of common stocks.
BRK LTS 1971
There is no mention of stocks in the 1971 report, but it seems capital is being deployed in the insurance business with an acquisition and expanding lines. The only mention of investments is:
...However, our large volume gains in 1970 and 1971 brought in additional funds for investment at a time of high interest rates, which will be of continuing benefit for years. Thus, despite unimpressive prospects regarding premium volume, the outlook for investment income and overall earnings from insurance in 1972 is reasonably good.This doesn't say anything about the stock market, though, as the 'float' of an insurance company is usually invested (and even currently at BRK) in fixed income securities.
BRK LTS 1972
Insurance Investment Results
We were most fortunate to experience dramatic gains in premium volume from 1969 to 1971 coincidental with virtually record-high interest rates. Large amounts of investable funds were thus received at a time when they could be put to highly advantageous use. Most of these funds were placed in tax-exempt bonds and our investment income, which has increased from $2,025,201 in 1969 to $6,755,242 in 1972, is subject to a low effective tax rate.There is no mention of stocks in 1972 either, but again, this is the investment of float, which even now is mostly invested in fixed income. We will find out later, though, that BRK bought Washington Post in 1972, and other stocks (presumably judging from the language in the 1973 letter). Also, Buffett seems very happy with the record-high interest rates (boy, he has no idea what's coming!).
Our bond portfolio possesses unusually good call protection, and we will benefit for many years to come from the high average yield of the present portfolio...
BRK LTS 1973
So for the first time since the 1970 letter, BRK mentions stocks:
On the investment side of our insurance operation, we made substantial additional commitments in common stocks during 1973. We had significant unrealized depreciation - over $12 million - in our common stock holdings at year-end, as indicated in our financial statements. Nevertheless, we believe that our common stock portfolio at cost represents good value in terms of intrinsic business worth. In spite of the large unrealized loss at year-end, we would expect satisfactory results from the portfolio over the longer term.So BRK was out of stocks completely in 1970 and started to get back into them in 1972. Market timer! OK. So not market timer, but exploiter of opportunities. It seems Buffett was happy with high bond yields during the early 1970's and as bargains started to appear in the stock market, he bought stocks.
You can certainly argue that Buffett is clearly a market timer as he was out of stocks and folded his partnership by 1970 only to start buying stocks again in 1972. But keep in mind that he was moving capital around to where he could get good returns. He thought bonds offered attractive yields for the insurance business until stocks started to become more attractive. So in that sense, it's not like Buffett was sitting in cash waiting for an opportunity to get into stocks at a cheaper price; if there was no bear market he would have enjoyed reasonable yields for a long time. This is also very different than 'hedging' or buying puts (OK, so there was no future markets, ETF's and options were unlisted OTC/private transactions with wide spreads so maybe this wasn't an option back then!).
BRK LTS 1975
In 1974 and 1975, BRK reports losses in the stock portfolio but expresses confidence that they are worth more than cost etc.
He says in the 1975 letter:
...Our equity investments are heavily concentrated in a few companies which are selected based on favorable economic characteristics, competent and honest management, and a purchase price attractive when measured against the yardstick of value to a private owner.He gets into a stock but doesn't really care what the stock does after he buys as long as the underlying businesses does well. I think he said somewhere that Washington Post stock went down 50% after he bought the stock, but he wasn't worried. He knew Washington Post was worth much more than his cost, so he didn't care what price Mr. Market put on it temporarily.
When such criteria are maintained, our intention is to hold for a long time, indeed, our largest equity investment is 467,150 shares of Washington Post "B" stock with a cost of $10.6 million, which we expect to hold permanently.
With this approach, stock market fluctuations are of little importance to us - except as they may provide buying opportunities - but business performance is of major importance. On this score we have been delighted with progress made by practically all of the companies in which we now have significant investments.
Also, keep in mind what was happening in the 1970's. I'm not talking about disco and polyester. Good things happened too, like Led Zeppelin, Baretta and Starsky & Hutch (not to mention the great movies of the 1970's). The headlines didn't bother Buffett at all. In fact, if you had a crystal ball and told him exactly what would happen between 1975 and 1982, he wouldn't have cared. He would have done the exact same thing. Well, OK, maybe he would've acted differently if he was 100% sure you were right. But you get the point.
BRK LTS 1976
The 1976 letter mentions stocks and the big gains and for the first time lists BRK's largest stock holdings in a table (that you see every year these days). Back then, the he listed stocks that had a value of more than $3 million. GEICO convertible preferreds, GEICO common and Washington Post were the largest positions. I'm not going to post the table here (and I don't have an online copy to cut and paste) as it really isn't relevant to this post.
Fortune Article: How Inflation Swindles the Equity Investor (May 1977)
In 1977, Buffett wrote a long article on how inflation is bad for stocks. It's a very good read: see here. And in a box next to the article, it says, "Warren Buffett is in Stocks Anyway".
And why does a man who is gloomy about stocks own so much stocks? "Partly, it's a habit," he admits. "Partly, it's just that stocks mean business, and owning businesses is much more interesting than owning gold or farmland. Besides, stocks are probably still the best of all the poor alternatives in an era of inflation - at least they are if you buy in at appropriate prices."So despite his views on stocks and outlook on inflation, he is still heavily invested in the stock market. No running out of stocks and into "inflation plays". Keep in mind, though, that in order to benefit from his insights into inflation's impact on stock prices, he would have to be correct in his forecast of it. It turns out he was correct in 1977 as inflation did nothing but go up into the early 1980's.
But Buffett's long term performance would have been quite different if he shifted his portfolio around based on what he thought inflation would do. Of course, I can't prove that, but most readers would probably agree with that, and that is one really important point about this article (and Buffett's action).
Remember how many people thought out-of-control inflation would be inevitable due to the Fed's actions during and after the financial crisis. In fact, the same argument has been made after every crisis or crash since at least Black Monday.
So understanding that something would be bad for stocks and then predicting it and acting accordingly are two different things. He understood inflation is bad for stocks but didn't try to dance in and out of the market based on that knowledge.
This is not to say that inflation won't eventually come. I have my doubts, but that's a different issue (I have equal worries about a Japan-style deflation).
BRK LTS 1978
So here is the section from the 1978 letter about insurance investments:
We confess considerable optimism regarding our insurance equity investments. Of course, our enthusiasm for stocks is not unconditional. Under some circumstances, common stock investments by insurers make very little sense. We get excited enough to commit a big percentage of insurance company net worth to equities only when we find (1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively. We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action. For example, in 1971 our total common stock position at Berkshire痴 insurance subsidiaries amounted to only $10.7 million at cost, and $11.7 million at market. There were equities of identifiably excellent companies available - but very few at interesting prices. (An irresistible footnote: in 1971, pension fund managers invested a record 122% of net funds available in equities - at full prices they couldn't buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks.)
The past few years have been a different story for us. At the end of 1975 our insurance subsidiaries held common equities with a market value exactly equal to cost of $39.3 million. At the end of 1978 this position had been increased to equities (including a convertible preferred) with a cost of $129.1 million and a market value of $216.5 million. During the intervening three years we also had realized pre-tax gains from common equities of approximately $24.7 million. Therefore, our overall unrealized and realized pre-tax gains in equities for the three year period came to approximately $112 million. During this same interval the Dow-Jones Industrial Average declined from 852 to 805. It was a marvelous period for the value-oriented equity buyer.So he clearly comes across here as a market timer. BRK had very little in stocks in 1971 but bought more throughout the 1970's. This should not surprise us as Buffett is a bargain hunter and there was a lot of that in the 70's.
But here's a sentence that surprised me (sort of, but not really):
We get excited enough to commit a big percentage of insurance company net worth to equities...He says that they commit a big percentage of net worth to stocks, not float. I always wondered about that. I've made posts in the past that showed that there was usually as much cash and bonds as there was float, so it was obvious that common stock and wholly owned business investments were made from the net worth of the insurance companies, not their float (which would need to be liquid to pay claims).
Anyway, this is good evidence for those who believe that Buffett is in fact a market timer. He obviously did move capital around according to what was the most attractive at the time; he said that high interest rates were attractive in the early 1970's. This is why I wish the reports from back then are available so we can see for ourselves what the allocation between stocks and bonds were, what float and shareholders equity was etc.
But we already knew that he sold out in the late 1960's and bought a lot of stock in the 1970's.
And by the way, this is BRK's large equity holdings in 1978:
Equity holdings of our insurance companies with a market value of over $8 million on December 31, 1978 were as follows: No. of Shares Company Cost Market ---------- ------- ---------- ---------- (000s omitted) 246,450 American Broadcasting Companies, Inc. ... $ 6,082 $ 8,626 1,294,308 Government Employees Insurance Company Common Stock ......................... 4,116 9,060 1,986,953 Government Employees Insurance Company Convertible Preferred ................ 19,417 28,314 592,650 Interpublic Group of Companies, Inc. .... 4,531 19,039 1,066,934 Kaiser Aluminum and Chemical Corporation 18,085 18,671 453,800 Knight-Ridder Newspapers, Inc. .......... 7,534 10,267 953,750 SAFECO Corporation ...................... 23,867 26,467 934,300 The Washington Post Company ............. 10,628 43,445 ---------- ---------- Total ................................... $ 94,260 $163,889 All Other Holdings ...................... 39,506 57,040 ---------- ---------- Total Equities .......................... $133,766 $220,929 ========== ==========
BRK LTS 1979
And he made some comments about bonds in the 1979 letter. After talking about some losses BRK took in the bond portfolio, he says:
We have severe doubts as to whether a very long-term fixed-interest bond, denominated in dollars, remains an appropriate business contract in a world where the value of dollars seems almost certain to shrink by the day. Those dollars, as well as paper creations of other governments, simply may have too many structural weaknesses to appropriately serve as a unit of long term commercial reference. If so, really long bonds may turn out to be obsolete instruments and insurers who have bought those maturities of 2010 or 2020 could have major and continuing problems on their hands. We, likewise, will be unhappy with our fifteen-year bonds and will annually pay a price in terms of earning power that reflects that mistake.
And, of course, there is the possibility that our present analysis is much too negative. The chances for very low rates of inflation are not nil. Inflation is man-made; perhaps it can be man-mastered. The threat which alarms us may also alarm legislators and other powerful groups, prompting some appropriate response.
Furthermore, present interest rates incorporate much higher inflation projections than those of a year or two ago. Such rates may prove adequate or more than adequate to protect bond buyers. We even may miss large profits from a major rebound in bond prices. However, our unwillingness to fix a price now for a pound of See's candy or a yard of Berkshire cloth to be delivered in 2010 or 2020 makes us equally unwilling to buy bonds which set a price on money now for use in those years. Overall, we opt for Polonius (slightly restated): either a short-term borrower nor a long-term lender be.
He later says about BRK' stock holdings:
We continue to feel very good about our insurance equity investments. Over a period of years, we expect to develop very large and growing amounts of underlying earnings power attributable to our fractional ownership of these companies. In most cases, they are splendid businesses, splendidly managed, purchased at highly attractive prices.
Conclusion So Far
OK, so this is getting a little longer than I thought so I will break this up into two periods for BRK: 1965-1980 and then 1980-2013 (if it fits).
So just looking at the period 1965-1980, Buffett does in fact look like a market timer. He bought stocks for BRK from 1965 on and then liquidated all stocks by 1970 year-end and said they "anticipate no further purchases in marketable securities". This was right before the 1972-1974 bear market so the timing looks good. But the stock holdings at BRK in the 1960's was always temporary until the capital was deployed full time, which is what happened in 1970 with the purchase of the bank.
As for insurance investments being invested primarily in bonds, it was the attractive yields offered in the bond market that made it a reasonable decision (plus the float had to be in fixed income investments anyway). We saw in the last letter to his partners that tax-free bond yields offered the same prospective returns as stocks at around this time.
So this is a slightly different decision than moving out of stocks into cash to wait for better prices; Buffett moved investments into something that already offered what he thought was an attractive return. Moving investments to where they offer the best return, to me, is not so much market timing. Moving in and out of cash and waiting for a correction is (or buying puts or other hedging).
This is interesting and relevant given his recent and frequent comment that it is a no-brainer that stocks are better investments than bonds at the moment, and that he would hate to hold cash right now. Of course there is some cash building up at BRK, but that's because they generate so much cash and Buffett wants some buildup to be ready for an elephant.
Also, it's interesting that he said as far back as 1978 that he would put a "big percentage of insurance company net worth to equities when..." As far back as I remember, the impression was that float leverage was utilized in the equity markets to boost book value growth.
And then he writes an essay about how bad inflation is for stocks, and yet he stays fully invested in stocks and doesn't go around looking for investments that will do well in inflationary times.
The late 1970's annual reports spend a lot of time talking about inflation and you can see Buffett struggle with bonds a little bit. His moves in the bond market actually does seem trader-like; trying to avoid what he thinks is inevitable rising interest rates etc. But it is interesting to note that he doesn't do anything with the stock portfolio (except maybe buy more). Many these days would assume that if bonds keep tanking and interest rates keep spiking up, that equity prices too will dive. But since Buffett focuses, not on price, but on the business, he doesn't care about the 'temporary' decline that may come in stock prices from plunging bond prices. So in that sense, he isn't messing around with the equity portfolio.
Anyway, it's been really interesting reading through the first 15 years of BRK's annual reports (focusing mostly on investments).
Some of you (or many!) may think I am forcing the argument a little too much on this issue and trying to fit the facts to my "Buffett is not a market timer" argument. It's true that this period from 1965-1980 isn't the perfect time period to make my point but I think there are clearer examples in the 1980-2013 period that will clarify my point a little bit better than this period.
But either way, I'm not trying to win an argument here or anything like that. I think it's really an interesting thing to think about and I do realize things and learn from reading over old Buffett stuff and thinking about these things.
In any case, you will see at the end why I think all of this stuff is so important.
In a later post, I'll look at the reports from 1980 through 2013 and will also mention the magazine articles he has written about the stock market and what it means in this context.