Do As Buffett Does

Warren Buffett, the best investor of our lifetime, gave an interview on CNBC this past week. While he may still advocate passive investing for you, his personal choice is anything but. He runs a concentrated investment portfolio with one position, Apple, now over 25% of his investable assets.

Here’s what he shared in his interview:

  1. US economy is humming.
  2. Operating earnings, cash flow and free cash flow are very strong.
  3. Inflationary pressures are intensifying.
  4. Trade issues will be resolved.
  5. Stocks are easily his asset class of choice over bonds and real estate.
  6. He is buying stocks.
  7. He is still having trouble buying whole companies, as the premium to buy is almost prohibitive. This comment is telling as he is really saying that the private value of companies far exceeds their current public values, hence today’s prices are undervalued.
  8. Corporations, such as Apple, are huge buyers of their own stock and would welcome any price weakness to buy more shares at lower prices providing downside support.

Buffett is a true investor with a long-term perspective, but we can assure you that he hates losing money so if he is buying today, that says a lot. He mentioned buying back some Berkshire shares recently, too, under their new company guidelines to shrink the cap as long as it is under the intrinsic value of the shares rather than using stated book. That action is meaningful as Berkshire is essentially a giant holding company owning a cross-section of America ranging from insurance to rails to energy to retailing to housing to chemicals to aerospace components and so on.

So when the Oracle speaks, you better listen. No one has a better read on the economy or a greater sense of value than he. If Buffett sees opportunities in the stock market today, you should too. But always keep reserves and never use leverage to be able to take advantage of dips. Do as Buffett does.

Thank you, Warren, for your common sense and well-thought out view of the investable landscape. We resoundingly agree.

The markets finished the week and month on a high point for the year despite all the noise about trade and troubled areas abroad. If you traded based on all the continuous sound bites, you would have gotten whipsawed! The pundits keep crying wolf although the domestic house keeps hitting on all cylinders. This is not to say that we, as well as Buffett, are not cognizant of all the issues/potential problems and risks facing us. We factor them all in taking a longer term view looking over the valley owning great companies with winning strategies regardless of what may happen. And we outperform all indices, too.

Let’s take a look at what was reported around the globe during the normally slow, summer ending week:

1. The US continues to be the engine of global growth with strong consumer demand along with acceleration in business real and nominal growth, profitability, cash flow; and capital spending. Yes, the US is hitting on all cylinders as we move into the fall. We expect very strong Christmas retail sales.

Inflationary pressures are intensifying as Buffett mentioned, but we expect them to moderate as productivity accelerates offsetting wage increases next year. The all-important core PCE index, excluding food and energy, rose 0.2% in July from June and 2% from a year ago. We have not altered our view of Fed policy expecting a hike in the Federal Funds rate in September and most likely again in December.

We expect second-half real growth around 3% and only slightly less real growth next year. S & P earnings are likely to exceed $162/share in 2018 and $175/share in 2019. We see inflation hanging around 2% excluding any one-time impact from trade tariffs, which we do deem transitory as trade deals are reached.

2. Trade issues remain the number one news story around the world as it impacts everyone in some manner. The US successfully concluded a deal with Mexico but failed to cross the finish line with Canada. Politics rather than economics seems the over riding issue preventing a deal. The simple truth is that Canada needs a deal much more than the US, which plays into Trump’s hand. Exports to the US are three quarters of total exports and nearly one fifth of their total GNP. We wished that Trump took a more conciliatory tone towards our neighbors, as it would only improve the chances of closing a deal.

The US will mostly likely impose tariffs on an additional $200 worth of Chinese goods shortly. China is unable to reciprocate in kind but will most likely use other tactics to show that they are not paper tigers. We still see a chance that negotiators from the Eurozone and Japan will join with us dealing with China on trade, the WTO and protecting IP but only after deals are reached with each one.

We remain optimistic that trade deals will be reached with our allies over the next 6-9 months followed by one with China next year after our elections. As trade deals are reached, we expect acceleration in growth in those regions. Global growth has been stunted by all the trade talks, as businesses need some certainty before moving forward on hiring and spending plans.

3. China’s manufacturing gauge surprisingly picked up slightly in August. We continue to believe that China’s economy will decelerate meaningfully over the next six months despite government actions to stimulate growth by accelerating bank lending reversing earlier policies to strengthen the financial system, cutting taxes and pushing local governments to increase infrastructure spending.

China needs a deal more than us, so don’t believe all the government bravado that the country can sustain its growth despite US trade tariffs. In fact, there is some dissension in the ranks and cracks in President Xi’s stance on China 2025.

By the way, there is a bill in Congress doubling our funding for big infrastructure projects around the world to over $60 billion to counter China’s ambitious One Belt, One Road Initiative. Someone apparently woke up in DC.

4. India, the world’s 6th largest economy, reported a sensational second quarter with real growth over 8 percent. PM Modi has done an outstanding job promoting pro-growth, pro-business policies that are finally showing positive results throughout the economy. Walmart, Amazon and Alibaba’s focus on India is just one indication of the country’s future potential.

5. Eurozone economic activity and inflation weakened in August as anticipated. The ECB has no alternative but to maintain an overly easy monetary policy as growth in consumer demand/employment is not sufficient to offset weakness in exports. The Eurozone no doubt needs a trade deal before growth can re-accelerate. We remain concerned that Germany is moving to increase its dominance over the ECB to the detriment of its southern partners, especially Italy.

Let’s wrap this up.

We agree with Buffett that the US is the place to invest for all the reasons mentioned previously. In fact, our markets are undervalued based on S & P earnings over $167/share over the next twelve months with 10-year treasury bond yields under 2.85%. The truth is that the market multiple should be north of 19 today as financial risk factors are down with bank capital and liquidity ratios at all time highs. The market is selling with a Trump discount due to his unpredictability as he brings uncertainty into the marketplace. While we agree with most of his financial and economic policies, we hate his delivery and bully tactics dealing with our friends and foes alike. But that creates opportunity too for long-term investors like Buffett and us willing to look over the valley and invest for the long term.

Listening to the eulogies Saturday for John McCain only reinforced our belief that both parties need to come together for the common good of the country over party. He was a rebel with a cause that was to make America a better place, a beacon for all. We need many more like him. God bless him.

Paix et Prospérité has not altered its asset mix nor risk controls over the last several months. We remain long stocks, short bonds and have gone to a neutral dollar position as we expect dollar strength to weaken as trade deals get closer a la Mexico and overseas growth reaccelerates later in the year into 2019.

Our portfolios continue to be concentrated in the strongest US financials gaining market share; global capital goods and industrial companies; technology stocks selling at a fair multiple to growth; low cost, market dominant industrial commodity companies generating huge free cash flow; consumer nondurable and healthcare companies with strong unit growth and expanding pipelines; and many special situations where internal change will add to shareholder value. The common thread is great management, great financials and market leading technology selling at a discount to intrinsic value like Berkshire.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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