More Cash than Ideas – A Change in the Outlook!

More Cash than Ideas – A Change in the Outlook!

Two weeks ago I appeared on ABC The Business with Ticky Fullerton as I do each Tuesday fortnight. The video footage follows below and you will notice that I mention that we could only find four companies in the top 100 that were trading at any discount to intrinsic value.

What has changed in the last fortnight? Well, firstly, one of the four stocks has taken off. Orica announced a surprisingly strong result and its shares surged.

So now, as the following chart from Skaffold shows, there are only three stocks in the top 100 that are cheap. As I mentioned on TV with Ticky, this is not something to be celebrating. With only three companies in the top 100 trading below intrinsic value, there must be 97 that are above. That means there are 97 that are expensive. In other words the market is probably expensive.

And then, when looking at the ASX 200 compared to that index’s intrinsic value, we discover that it too seems to be expensive.

A big driver of the strength in the index has been the banks’ share prices. But now the CBA is trading at one of the biggest four premiums to intrinsic value it has recorded in the last ten years. And after each of the previous three occasions, the share price fell by more than 15%.

Finally, it appears Warren Buffett is raising cash levels again.

Before you jump to any imminent conclusions, the last time Buffett built cash, it occurred over two or three years before the GFC hit. The point is a building of cash isn’t an imminent sign of a correction, merely a sign that, like us, he cannot find many things to buy.

Here’s What Buffett’s track record looks like:

1956:
Aged 25 started Buffett Partnership Ltd. Turned $10,000 in 13 years through the 1960’s go-go years to $300,000 in 1969.

1969:
Buffett liquidated the partnerships, returning capital to investors and inviting them to either follow him at Berkshire Hathaway or investing with other managers he recommended.

From his May 29, 1969, partnership letter:

1. Opportunities for investment that are open to the analyst who stresses quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years

2. Our $100 million of assets further eliminates a large portion of this seemingly barren investment world, since commitments of less than about $3 million cannot have a real impact on our overall performance, and this virtually rules out companies with less than about $100 million of common stock at market value

3. A swelling interest in investment performance has created an increasingly short-term oriented and (in my opinion) more speculative market

The Dow lost 35% between 1969 and 1970.

Between 1973 the Dow fell 16.6% and in 1974 the market fell 27.5% during the height of the inflationary crisis that crippled the US economy in the early ‘70s.

1974:
Buffett returns with a featured interview on 1 November 1974 in Forbes Magazine in which the following exchange was transcribed:

“How do you contemplate the current stock market, we asked Warren Buffett, the sage of Omaha, Neb.”

“Like an oversexed guy in a whorehouse,” he shot back. “This is the time to start investing.” [Forbes substituted ‘whorehouse’ with ‘harem’ when they printed the story — a sign of the times.]

It was also the interview that produced the famous “Swing you Bum” quote that described investor’s penchant for shouting advice to their fund managers to buy something, anything.

Forbes ended the 1974 interview with the following concluding remark from Buffett; “Now is the time to invest and get rich.”

You can download the full interview here.

In 1975 the Dow rose 38.32%, 17.9% in 1976, it fell 17% in 1977 and 3% in 1978 but it rose 4% in 1979, 15% in 1980, fell slightly in 1981, rose 15% in 1982, 20% in 1983, fell 4% in 1984, rose 28% in 1985, 23% in 1986.

And then there was the bull market of the late 1990s.

1999:
During the heady internet boom when the NASDAQ’s average listing premium for new floats was 90%, Buffet raised Berkshire’s cash pile to $48 billion.

In September, 1999, he was again quoted in Fortune magazine, “What I am about to say – assuming it’s correct – will have implications for the long-term results to be realized by American stock-holders. . . . . Over the next 17 years, equities will not perform anything like – anything like – they have performed over the past 17 years. . . If I had to pick a probable annual return it would be 4% after inflation, and if 4% is wrong, I believe the percentage is as likely to be less as more.”

In April 2000 the internet bubble burst and the so-called ‘Lost Decade’ began.

2008:
Amid the collapse of Lehman Brothers and towards the depths of the global financial crisis, Buffett demonstrated the benefits of being greedy when others are fearful. He tossed lifelines to a handful of large blue-chip companies and five years later the income return alone is approaching 40% after Mars recently bought back $4.4 billion in bonds issued to Berkshire.

He was quoted in October this year in The Wall Street Journal saying: “In terms of simple profitability, an average investor could have done just as well investing in the stock market if they bought during the panic period…You make your best buys when people are overwhelmingly fearful.”

2013:
On the 19th of September this year however, on CNBC Buffet was quoted as saying stocks have “moved a long way” in the past five years, going from “ridiculously cheap” to “more or less fairly priced now.”

“We don’t find bargains around but we don’t think things are way overvalued either. We’re having a hard time finding things to buy.”

It’s that last quote that’s interesting.

In October however he also noted that it would be better to be in good equities than in cash. This is a statement about absolute returns. Good quality shares will produce a better long term return that cash (not necessarily every week, every month or every quarter of course). He has also made the observation that the US economy (based on what his companies are experiencing – Berkshire owns the second largest real estate agency in the US and one of the largest, if not the largest, home building companies – is plodding along steadily. It’s neither racing ahead nor is it slipping into a double dip recession) and while such conditions exist one should not expect an imminent correction.

Perhaps income hunger yield chasers in the banks and the like might be able to take some comfort. The cash haul however at Berkshire is now $49 billion. It’s up from $47 billion at the start of the year and up from $42 billion at September 30, 2013.

I wouldn’t make as much of the cash balance as many others are, however the comments on CNBC are worthy of taking notice of.

MORE BY RogerINVEST WITH MONTGOMERY

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.