Buffett’s famed annual letter is due to be released this weekend. With that, today we want to talk a bit about his record, his philosophy on markets and successful investing and the high conviction stocks that he has in his $130 billion plus Berkshire Hathaway stock portfolio.
First, only one living investor has a length of track record that can compare to Buffett’s. That’s fellow billionaire Carl Icahn. Icahn actually has a better record than Buffett, and it spans a little longer. But he gets a fraction of the attention of the man they call the Oracle of Omaha.
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The Fed has manufactured a recovery by promoting stability. And they’ve relied on two key asset prices to do it: stocks and housing. Today we want to look at a few charts that show how important the stock and housing market recoveries have been.
While QE and the Fed’s ultra easy policy stance couldn’t directly create demand in a world of deleveraging, it did (and has) indirectly created demand by promoting stability, which restored confidence. Without the confidence that the world will be stable, people don’t spend, borrow, lend or hire, and the economy goes into a deflationary vortex.
But by promising that they stand ready to act against any futures shocks to the economy (and financial markets), investors feel comfortable investing again (stocks go higher). When stocks go higher and the environment proves stable, employers feel more confident to hire. This all fuels demand and recovery. And, of course, the Fed has pinned down mortgage rates at record lows, which promotes a housing recovery, and gives underwater homeowners (at one point, more than a quarter of all homeowners with mortgages) a since that paper losses will at some point be overcome, and that gives them the confidence to spend money again, rather sit on it.
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Along the path of the economic recovery, the Fed (and other key central banks) has been very sensitive to declines in stocks. Why? Because declining stocks has the ability to undo what they’ve done. And if confidence breaks again, it will be far harder to restore it.
The first chart here is the S&P 500. Stocks bottomed in March of 2009, when the Fed announced a $1 trillion QE program.
Source: Billionaire’s Portfolio
Stocks surpassed the pre-crisis highs in 2013 after six years in the hole. But even after the dramatic rise you can see in the chart the damage from the crisis is far from restored. If we applied the long term annual rate of growth of the S&P 500 (8%) to the pre-crisis highs, the S&P 500 should be closer to 3,150 (over 60% higher).
How does housing look? Of course, bursting of the housing bubble was the pin that pricked the global credit bubble. Housing prices in the U.S. have been in recovery mode since 2012. Still, housing has a ways to go. This is a very important component for the Fed, for sustainable recovery.
Source: Billionaire’s Portfolio
Housing prices have bounced more than 30% off of the lows (for 20 major cities in the index) – but remains about 13% off of the pre-crisis highs.
How has the recovery in stocks and housing reflected in the broader economy?
As stocks surpassed pre-crisis highs in 2013, so did U.S. per capita GDP.
Source: Billionaire’s Portfolio
While bloated government debt continues to be a big structural problem for the U.S and the rest of the world, growth goes a long way toward fixing that problem.
And growth, low interest rates, higher stocks and higher housing prices goes a long way toward restoring household net worth. As you can see in the chart below, we have well recovered and surpassed pre-crisis levels in household net worth…
Source: Billionaire’s Portfolio
What is the key long-term driver of economic growth overtime? Credit creation. In the next chart, you can see the sharp recovery in consumer credit since the depths of the economic crisis (in orange). This excludes mortgages. And you can see how closely GDP (economic output) tracks credit growth (the purple line).
Source: Reuters, Forbes Billionaire’s Portfolio
What about deleveraging? It took 10 years to build the global credit bubble that erupted in 2007. Based on historical credit bubbles, it typically takes about as long to de-lever. So 10-years of deleveraging would put us at year 2017. With that, it’s fair to think we could be very near the end of that period, where paying down debt has weighed on economic growth.
You can see in the chart below, the average annual growth rate of consumer credit over the past 55 years is 7.9%. And over the past five years, despite the deleveraging, consumer credit growth has been solid, just under the long term average. And importantly, FICO scores in the U.S. have reached an all-time high.
Source: Billionaire’s Portfolio
With the recent correction in stocks, there has been increased scrutiny on the economy. Some are predicting another recession ahead. Others are waving the red flag anywhere they find soft economic data. Consumption makes up more than 2/3 of the U.S. economy. And you can see from the charts above, the consumer is in a solid position. But stocks and housing remain key drivers of the recovery. The Fed is well aware of that. With that, don’t expect the Fed, in the current economic environment, to do anything to alter the health of the housing and stock markets.
This week, in our BillionairesPortfolio.com, we followed one of the best billion dollar (plus) activist hedge funds into a stock where they own 12.5%, have three board seats, and are in the process of replacing the CEO. These are are three key ingredients in the success of activist campaigns: 1) a big concentrated position (12.5% stake), 2) control (board seats), and 3) change (a new CEO). This activist fund has won on 82% of its campaigns since 2002 and has a price target on this stock that’s more than 150% higher than the current share price. To join us you can subscribe to our Billionaire’s Portfolio (here).
To follow the stock picks of the world’s best billionaire investors, subscribe at Billionaire’s Portfolio.
2/8/16
When housing prices stalled in 2006 and then collapsed over the next three years, the subprime lending schemes quickly became exposed.
Mortgage defaults led to a banking crisis. Due to the highly interconnectedness of banks globally, the problems quickly spread to banks around the world. A banking crisis led to a global credit freeze. When people can’t access credit, that’s when it all hits the fan. Companies can’t meet payroll, don’t have the liquidity to make new orders. Jobs get cut. Companies go bust. Finally, the microscope on overindebtedness of consumers and corporates, turns to countries. Deficits leads to debt. Debt leads to downgrades. Downgrades leads to defaults.
For the most part, defaults were averted because central banks and governments stepped in, in a coordinated way, to backstop failing banks, failing companies and failing countries. From that point, continued central bank stimulus has 1) enabled banks to recapitalize, 2) foiled additional shock events, and 3) restored confidence to employers (to hire), to investors (to invest) and to consumers (to spend again).
To follow the stock picks of the world’s best billionaire investors, subscribe at Forbes Billionaire’s Portfolio.
As we’ve discussed in the past two weeks, persistently low oil prices represent a risk on par with the housing bust. And in recent days we’re seeing the signs of another global financial and economic crisis creeping uncomfortably closer to a “part two.”
As we’ve said, this time would be much worse because governments and central banks have exhausted the resources to bailout failing banks, companies and countries. But central banks, namely the Bank of Japan and/or the European Central Bank do have the opportunity to step-in here, become an outright buyer of commodities (particularly oil), as part of their QE programs, to avert disaster. But time is the oil industries worst enemy and therefore a big threat to the global economy. The longer policymakers drag their feet, the closer we get to the edge of global crisis — a crisis manufactured by OPEC’s price war.
Unfortunately, there are the building signs that the market is beginning to position for the worst outcome…
Key bank stocks in Europe are trading at levels lower than in the depths of both the global financial crisis (2009) and the European sovereign debt crisis (2012).
Source: Reuters, Billionaire’s Portfolio
The credit default swap market for key industries is sending up flares. This is where default insurance can be purchased against a company or country – and the place speculators bet on a company’s demise. Billionaire John Paulson famously made billions betting against the housing market via credit default swaps. Now the fastest deteriorating companies in Europe are banks. And the fastest deteriorating companies in North America are insurance companies (a sector that tends to have investments in high yield debt … in this case, exposure to the high yield debt of the oil and gas industry).
Source: Markit
The early signal for the 2007-2008 financial crisis was the bankruptcy of New Century Financial, the second largest subprime mortgage originator. Just a few months prior the company was valued at around $2 billion.
On an eerily similar note, a news report hit this morning that Chesapeake Energy, the second largest producer of natural gas and the 12th largest producer of oil and natural gas liquids in the U.S., had hired counsel to advise the company on restructuring its debt (i.e. bankruptcy). The company denied that they had any plans to pursue bankruptcy and said they continue to aggressively seek to maximize the value for all shareholders. However, the market is now pricing bankruptcy risk over the next five years at 50% (the CDS market).
Still, while the systemic threat looks similar, the environment is very different than it was in 2008. Central banks are already all-in. On the one hand, that’s a bad thing for the reasons explained above (i.e. limited ammunition). On the other hand, it’s a good thing. We know, and they know, where they stand (all-in and willing to do whatever it takes). With QE well underway in Japan and Europe, they have the tools in place to put a floor under oil prices.
In recent weeks, both the heads of the BOJ and the ECB have said, unprompted, that there is “no limit” to what they can buy as part of their asset purchase program. Let’s hope they find buying up dirt-cheap oil and commodities, to neutralize OPEC, an easier solution than trying to respond to a “part two” of the global financial crisis.
Bryan Rich is a macro hedge fund trader and co-founder of Forbes Billionaire’s Portfolio, a subscription-based service that empowers average investors to invest alongside the world’s best billionaire investors. To follow the stock picks of the world’s best billionaire investors, subscribe at Forbes Billionaire’s Portfolio.
