DID YOU KNOW
Warren Buffett is heavily in CASH
In our Do or Did You Know? blogs we provide readers with useful information that generally is not realized by inexperienced investors. In Chapter 1 of our publication, When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), we introduce investing styles, including the Contrarian and Value approach.
Renown value investor Warren Buffett, from whom many strategies have been imitated by professionals and newbies alike, and his firm Berkshire-Hathaway, quietly started reducing holdings and building cash reserves, to prepare for lower price opportunities years ago!
One of his famous quotes is mentioned in our publication, which states that one should “Be Fearful when others are Greedy, and Greedy when others are Fearful.” This basic premise refers to buying equities at a discount/extreme lows, and selling them when they become expensive/overbought. As the markets are known to often sell off at cycle highs (when buying volume dissipates after sharp increases) and become attractive at cycle lows (when selling volume slows and stops after massive drops), these pivot points become high probability profit opportunities.
For longer term investors, this is known as “value” investing, a strategy used to purchase fundamentally sound companies when they are trading at a temporary “discount,” and/or for buying leading stocks after larger market downturns, as they tend to recover first.
Recently, Mr. Buffett has added to his cash reserves (now around 40% of the portfolio), and has been a “net seller” for 2-3 years (11-12 quarters), indicating an expectation of a market downturn. Mr. Buffett is a legendary investor with his methods, but also tends to not be trader, and is often early on his calls. Concerns in current market conditions include, inflation, high market valuations (22x earnings), increasing retail traders creating a “gambling” mentality, and over-exuberance.
As a matter of fact, this investor is so famous that he has his own economic metric called the “Buffett Indicator.” This simple ratio is calculated by dividing the total current Market Capitalization by the Gross Domestic Product, and broadly measures long-term valuation in the markets.
Buffett Indicator
According to Mr. Buffett, the higher the TMC exceeds the GDP, the more over-bought and vulnerable the market becomes, while the opposite is true for the reverse direction. The gauge is measured by 100% (or 1.0 ratio), meaning the higher above that mark, the more likely the market is set for a pullback, or correction, while the further beneath 100% suggests good value and buying opportunities.
There are also tiers to this gauge that should be noted, as history shows very high readings preceding major downturns. The 2007 Financial Crisis saw the gauge exceed 1505, the Dot-Com bubble in the 1990’s peaked at 160-170%, and it surged to 200% during the Pandemic in 2020. The following is a basic guide to stock conditions at varying levels…
Below 89% (0.89) = Highly Undervalued
89% (0.89) to 115% (1.15) = Moderately Undervalued
115% (1.15) to 140% (1.40) = Fair Value
140% (1.40) to 165 % (1.65) = Moderately Overvalued
Above 165% (1.65) = Highly Overvalued
Currently, as we create this blog, the indicator reads 217 (2.17), well above the extreme high-risk level, which explains why the cash position is so high. Should the gauge continue to rise, it would not be surprising if the cash position increases.
Some variables related to the gauge include the effect of interest rate levels, and high-growth stocks, which can skew the GDP (generally calculated over a 1-year period). However, the long-term theme of this indicator and its history of accuracy, garners enough attention to keep it in mind, especially if it continues to rise. Though there’s no specific time frame for a crash/correction, history says to heed the warning. Critics might point out that significant gains have been lost over the past couple of years employing this method, which is true for shorter-term traders. However, for long-termers, the paper gains realized will amount to nothing should a major drawdown wipe out those gains.
Though the S&P 500 and Nasdaq have powered higher, led by technology and the MAG7 (Amazon, Microsoft, Apple, Alphabet (Google), Nvidia, Tesla, and Meta), the widespread gains have declined over several quarters, creating a divergence and narrower market conditions. Keep in mind that CASH is an actual position, though it erodes with rising inflation, and can be put to use in less risky short-term treasuries (which Mr. Buffett does) while waiting for more favorable investment opportunities.
Those opportunities may be on the horizon, as the seasonally strong period ends in a few weeks, and the months of February and March are generally more volatile. His approach is also to be patient, which is never a bad thing. Utilizing the Fear & Greed Index, which we highlight in our weekly updates, is another source for timing entries in a shorter time frame. As always, perform your “due diligence” and follow your plan, whether you follow Mr. Buffett’s approach or not.
*** As always, this information is not intended to be financial advice, and should not be considered as any specific buy or sell recommendation, but rather a guide to assist the reader in some further understanding of the financial markets.
