Buffett and Munger Are Licking Their Chops

The financial markets have been under immense pressure ever since Trump announced that he would be raising tariffs to 25% on the initial $250 billion of Chinese exports to the U.S. on May 10th while also threatening to impose 25% tariffs on the remaining $300 billion of Chinese exports by the end of June unless substantive movement was made in trade negotiations. His administration then threw down the gauntlet by blacklisting Huawei from dealing with our technology companies threatening China 2025. Trump went all in.

The simple truth is that no one knows what the eventual outcome will be to the trade conflict so traders run for cover as the pundits/experts remind us all throughout the day how bad things could get: The sky is falling! As you would guess, cash levels have gone through the roof; investor sentiment has plummeted and even investors are frozen despite historically cheap valuations. Markets hate uncertainty! Bearishness is everywhere which is consistent with market bottoms, not tops. Our market remains undervalued… we see no recession, we see a friendly Fed and we buy great companies with rising earnings, cash flow/ free cash flow with above market dividend yields (far above 10-year treasury yields) and large share repurchase programs.

We think Buffett and Munger must be licking their chops right about now as the earnings yield on stocks as an asset class has further widened its gap to bond yields.

We also know that one tweet could turn things around. So, what to do? While we spent a lot of time over the last few weeks putting the trade war in perspective as exports from China are a tiny sliver of our economy and theirs too, we recognize that it is newsy to embellish the worst-case scenarios which we deem unlikely. We are bombarded all day about the downside risks of the trade war without discussing any of the long-term positives. Do you think that Buffett and Munger listen to CNBC?

We are most concerned about the near-term uncertainties/disruptions all of this creates for consumers and businesses around the world. Clearly companies will accelerate shifting their supply chains and may already have begun buying as much as possible ahead of the June 30th possible cutoff points. And consumers, seeing the possibility of higher tariffs filtering through to higher consumer prices later in the year may buy early altering their historic patterns. It could be a great fall but miserable Christmas for retailers.

The hike to 25% tariffs is a one-off event. It won’t happen again next week or next year. In the meantime, prices hiked for higher tariffs will come down over time as supply chains are shifted out of China and demand will recover quickly. In the end, higher tariffs may be deflationary and stimulate growth. How ironic! An investor, like a company, must take a long-term view making only some small changes along the way to preserve/redirect capital to benefit overall performance. It’s hard playing the long ball sometimes, but we can assure you that Buffett/Munger know that compounding returns over time is the key to success. They measure their success over decades, not years nor months nor days. And they have done pretty well.

The greatest opportunities come at times like this. Are you an investor or a trader?  We can only imagine that Buffett and Munger are looking at the chance to finally commit billions buying stocks and hopefully companies at bargain prices as others panic out of fear. Both of them love to buy as stocks are falling. Is Apple a better buy at $178 or $210? Munger has probably added to his Chinese holdings big time too which have been hit fallen more than stocks here. They truly look longer term over the valley when everyone is looking in the abyss. They look at the long-term potential for each investment and compare it to its current cost/intrinsic long-term value to come to an estimate of future returns. We try to do that, but we don’t have the Buffett/Munger advantage of having the float of a huge insurance company balance sheet to invest. So, we raised a lot of cash and shifted the composition of our portfolios weeks ago taking some risk off to be in position to take advantage as others panic.

Our one disagreement with Buffett/Munger and the Fed is that we feel that low inflation is NOT transitory therefore the stock market multiple today is way too low. That’s a biggie!

One side note about the recent decline of the markets: while the averages may not have declined much from their recent highs, take a look under the hood and you will find devastation in many sectors of the market, especially if there is any Chinese exposure like semis. As we mentioned weeks ago when we took cash to over 17% of our assets by first selling anything with Chinese exposure and then reducing sectors that were dependent on an acceleration in global growth which we had thought would take place with a trade deal. Yes, we shifted our view!  We added defensive stocks with stable growth/high dividend yields, technology and some additional special situations all with great managements, winning strategies, huge free cash flow, and not penalized much, if at all, by higher Chinese tariffs.

Let’s take a quick look at some of the data points reported last week which for the most part came out on the weaker than expected side:

1.) We were most disappointed with the Fed notes which came out last week. The Fed is one step behind on both the prospects for the U.S. economy and inflation. The Fed is standing pat expecting the economy to do fine and inflation to pick up. Wrong on both counts especially if trade tariffs are increased on all Chinese exports. Low inflation is NOT transitory. We continue to believe that the December Fed rate hike was NOT justified and needs to be reversed. The Fed failed to acknowledge in their notes the impact of our rates on the dollar which continues to soar as the yield differential widens with rates abroad. The U.S. economy needs lower short rates and a weaker dollar. We expect the Fed to lower rates BEFORE the fall.

It was reported last week that U.S. manufacturing survey slumped to a 9-year low in May. In addition, the services index fell to a 39-month low. Both numbers remained over 50 indicating growth continues albeit slowly. New orders for manufactured durable goods fell 1.1% in April after rising 1.7% in March, shipments fell 1.6% after a 0.5% March decrease and unfilled orders declined 0.1% after rising 0.1% the month before. Finally, new home sales declined in April although up nearly 7% from a year ago.

While we have lowered our second-quarter GNP to 1.5%, consumer spending is likely to have accelerated to 2.5% gain from the first quarter. We cannot see the economy really accelerating much beyond 2.25% in the second half of the year led by the consumer without a resolution on trade. We still believe that 2020 will be a better year as Trump pulls out all stops to win the election…. that may include several trade deals. You can bet on it!

2.) The big news out of Europe was the resignation of Theresa May as Prime Minister of Britain after continuing to fail backing for the Brexit divorce agreement. If a hard Brexit occurs, it is not good for anyone. We continue to have a bleak outlook for all of the Eurozone without major financial, fiscal and regulatory reforms. What more can the ECB do at this time? Nada!

Economic activity continues to weaken in the Eurozone and growth is likely to be less than 0.3% in the second quarter and less in subsequent quarters. European stocks are statistically cheap for a reason.

3.) Japan’s economy is not much better than Europe’s. Manufacturing activity fell back into contraction in May as exports fell at the fastest pace in four months. We do not believe that Prime Minister Abe will move forward on raising the sale tax in October although he says that he will. Japan’s economy, as is others, are tied to the success of trade talks with the U.S. and China. We would avoid investing here until we know more on trade.

4.) The re-election of Prime Minister Modi and his government was a real bright spot last week. We continue to favor investing in India as we have all year.

A successful investor, like Buffett and Munger, take the long view investing in great companies when others panic not discriminating amongst investments. Management is the key. Why not listen to both the Home Depot and Lowe’s quarterly conference calls and discern for yourself which one you would want to own longer term? A hint…we own HD! Also listen to Target and Kohl’s quarterly conference calls. Another hint…. we have owned TGT!

We do NOT buy the market. We buy stocks in companies that can excel in any environment. When these stocks go down caught in trading programs, it is an opportunity to add to them at better prices. Buffett/Munger do and say the same thing every time. Maintaining excess liquidity, staying disciplined and being patient are necessities during stressful times like this.

Buffett/Munger are licking their chops as stock prices are falling into their buy zones.

We need to be thankful/remember those who sacrificed their lives for our way of life.

We have added to our defensive stocks that would not be hurt from higher Chinese tariffs…mainly health care and consumer related. We have also added to domestic sectors that benefit from lower interest costs… mostly housing related. And we have added to technology companies that drive security and productivity returns far above the buyer’s cost of capital. While we have reduced our financials somewhat due to Fed’s stubborn stance, we like the sector very much as it is significantly undervalued relative to intrinsic value. And we keep adding to and finding new special situations which are individually unique and have nothing to do with the economy. We have reduced holdings in areas hurt by higher tariffs and lower global growth. Cash is up! We own no bonds and are flat the dollar which will remain strong until the Fed cuts rates.

Remember to review all the facts; pause, reflect and consider mindset shifts; look always at your asset mix with risk controls; do independent research… and

Invest Accordingly!

Bill Ehrman

Paix et Prospérité LLC



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