Buffett screams sell! Not so fast.
“Buffett screams sell!” “Buffett sounds alarm!” They were the headlines that greeted me recently, about Oracle of Omaha, when I opened my news app to read up on what others thought about the rally in markets since 2022 – a rally that anyone following would know we frequently and repeatedly explained would transpire, and a rally that has accelerated following the election of Donald Trump as the next U.S. President.
In the attention-seeking world of financial news, few names carry as much weight as Warren Buffett. Known as the “Oracle of Omaha,” his investment moves are scrutinized for signals about the market’s future. Recently, speculation has arisen that Buffett is anticipating a significant market downturn. But is this conclusion justified? Let’s delve into the evidence to explore why jumping to such a conclusion might be premature.
Aside from the fact the recent speculation about Berkshire’s portfolio changes inadvertently turns a long-term investment strategy that buys businesses with high rates of return on equity driven by sustainable competitive advantages into a short-term trading signal, the articles in question possibly misread the accumulation of cash in Berkshire Hathaway and the cessation, last quarter, of Berkshire’s share buybacks.
I wrote about some of the issues with that conclusion here and recorded a podcast with Nabtrade here.
Understandably, both actions could be construed as signalling the market is expensive, so to address that question, it would be worth looking at current prices and comparing them to earnings and history. Hopefully, the data reveals something worth considering before selling up prematurely and running for the hills – which no long-term investor should do, pretty much ever.
As you read, remember that today’s investors are more reactive than ever, with technology and online trading enabling real-time pricing-in of future expectations. This hyper-reactivity, however, means markets swing as much on speculation as on fundamentals. In the long term, however, fundamentals always win out.
The first observation is that the stock market has experienced significant gains since the bear market of 2022. But as I have remarked innumerably before, a bull market always follows a bear market, and 2022 witnessed a very bearish market. And don’t forget, higher market valuations in such a context are not necessarily harbingers of an impending crash but often reflect a market rebounding in anticipation of corporate earnings improving.
Recently, U.S. advisory firm Ritholtz looked at the forward price-to-earnings (P/E) ratios on the date of the past six presidential elections, revealing current valuations are not unprecedented.
On past election days – like 2004, 2008, and 2012 – stocks were cheaper due to recovery phases. However, comparing the P/E ratios from 2020 and 2024 shows that despite a nearly 90 per cent increase in the S&P 500 since November 2020, valuations have remained relatively stable. This stability suggests that stock prices have risen in tandem with earnings growth, maintaining previous P/E levels.
Earnings growth: the fundamental driver
Meanwhile, recent data indicates that corporate earnings have kept pace with rising stock prices, and projections suggest continued growth. While analyst forecasts are not infallible, they provide a reasoned basis for optimism. The alignment of earnings and stock prices implies that the market is not inflating without substance (P/E ratios aren’t expanding amid hubris) but is grounded in improving corporate performance.
Further, as we’ve noted previously, much of the elevated valuation in the S&P 500 stems from a handful of mega-cap stocks that now dominate the index by weight. These companies, including Nvidia (NASDAQ:NVDA), Microsoft (NSADAQ:MSFT), Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), and Meta (NASDAQ:META), command higher valuations because they have consistently delivered growth and improved profitability. In fact, they have become more profitable as they have grown. In contrast to what we are taught at finance school about large businesses attracting competition with returns on equity subsequently mean-reverting, these businesses have grown their return on equity (ROE) as their equity has increased. They have become exponentially more valuable as they have grown.
Investors expressing concern over high valuations might what to consider these leading mega-cap tech companies are priced higher for valid reasons, reflecting their dominant market positions and future dominance, at least while Trump is at the helm.
For those of you still wary of lofty mega-cap valuations, the market offers alternatives. Small and mid-cap stocks currently present more attractive valuations compared to their larger counterparts and are cheaper now – on a P/E basis – than before the pandemic. While lower valuations can indicate higher risk or market skepticism, they also represent potential opportunities for discerning investors seeking value outside the crowded space of large-cap equities.
And remember, since 1970, the combination of disinflation and positive economic growth, has been positive for innovative companies with pricing power – of which there is a surfeit in the small cap space.
Ultimately, the speculation about Buffett anticipating a crash overlooks the nuances of his investment philosophy, which emphasises long-term value and growth. Market timing is notoriously tricky, even for seasoned investors. Instead of fixating on the possibility of a crash, investors will benefit from sticking with the approach we have long advocated – quality and growth.
It’s natural to seek insights, if not guidance, from those who have amassed epochal fortunes from investing like Warren Buffett. But concluding that he expects a market crash may have more to do with clicks than investment returns. The evidence suggests that the market’s current level is underpinned by solid earnings growth and that valuations, while higher in some sectors, are justified by the performance of leading companies.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Wes Horn
:
Hello Roger
Do you think there may be signs of some speculative excess in markets generally though, which isn’t a good sign, i.e. a correction may not be too far away? Some Australian shares are rising vertically on momentum, driving them to what appears to be excessive valuations. Bitcoin is booming. Markets are at or near all-time highs. It is pretty much fact that shares with high valuations come down the most in a correction. It doesn’t mean they’re necessarily bad. In fact, it could be that buying opportunity we wait for with shares on our watchlists. It seems with a lot of positive talk, caution may be warranted instead of going all in at this time. As a long-term investor it can be difficult playing the waiting game to invest more at a better time.
Rgds, Wes.
Roger Montgomery
:
Hey Wes, speculative excess is a sign of a bubble forming but it does not ‘cause’ corrections. Markets are vulnerable to corrections when speculative excess is present but generally (not always) there’s a concern on the horizon that investors worry will cause a change of sentiment. I think we haven’t really seen the levels of speculative frenzy that we should be worried about…YET!