Thank You, Warren

Market participants got a huge boost of confidence after Warren Buffett revealed on Friday that he bought a ton of equities in the first quarter, including an additional 75 million shares of Apple Computer. Berkshire Hathaway now owns over 230 million shares of Apple worth more than $43.0 billion dollars representing nearly 25% of Berkshire’s total investment portfolio, excluding over $100 billion in cash and equivalents. Warren and his team are the antithesis of passive management, which he advocates. As we have written many times “Do as Warren does, not as he says.”

Warren is the ultimate investor. He supported his view at Saturday’s annual meeting by revealing that a $10,000 investment in the market 70 years ago would be worth over $50 million today. Not so for bonds or hard assets like gold. He espouses the virtues of compounding returns by owning great companies with superior management for long periods of time. Buffett would rather invest free cash generation in businesses, as it is tax efficient rather than paying dividends, which are taxed twice. He would buy his own stock only at a substantial discount to book value, which is understated, too.

Buffett likes to buy consumer (“brand obsession’) or unique franchises, as we all know, like Coca Cola and Burlington Northern. He has explained his rationale for owning Apple many times in the past but we found these additional purchases particularly opportunistic, as analysts/portfolio managers were concerned about slowing hardware sales combined with Apple’s huge presence in China both putting pressure on the stock. The bottom line is that Buffett realizes that there may be bumps in the road but he invests for the long term. He doesn’t let the “noise of the day” influence his long-term investment decisions. After all, Apple has a unique franchise, has superior management, is immensely profitable with tremendous free cash flow that can/will be used to enhance shareholder value and sells at a discount to the market.

As Buffett is widely considered the best investor of our time, his actions gave everyone reason to pause and re-evaluate their current view which has been bearish. While we do not consider ourselves direct disciples of Buffett, who we have worked with over the years, we invest using many of the same criteria. Investing with great management is our first decision followed by an analysis of the company’s competitive advantage, which sets it apart from the pack. We then project longer-term volume trends, operating margins, earnings and cash flow potential. If the company’s stock is selling at a sufficient discount to our ultimate valuation assumption discounting cash flow, we buy and hold it until fully valued.

Paix et Prospérité continues to outperform all indices sticking to our disciplines much like Buffett. We view market corrections as opportunities to add to our core positions as long as we have not altered our overall investment view. We continue to view the market as undervalued today with S & P earnings reaching $155 in 2018 with 10-year treasury yields rising to 3.25% by year-end. We see further growth in 2019 too. But not all stocks will participate. Herein lies our strength.

Buffett remains forever optimistic in the future of America. By the way, Berkshire’s first quarter operating earnings grew 49% to $5.3 billion. His operating companies are a true cross section of America and give him unusual insight as to what is happening economically in America. He believes that the corporate tax cut will lead to acceleration in the domestic economy and a boost in capital spending especially in the production side of our economy. Charlie Munger added that it was about time that steel tariffs were instituted, complimenting Trump. That was a surprise!

Warren Buffett and Charlie Munger serve as role models. No one has their long-term record of success spanning now over 50 years outperforming the market creating a huge holding company, Berkshire Hathaway, worth nearly $500 billion today. They review all the facts, reflect on mindset shifts; do the first hand independent research and invest accordingly. Sounds familiar!

Two other notable events last week were the Fed meeting and the unemployment report. The Fed remained on hold as expected and introduced a word, “symmetric”, when discussing their 2% inflation objective. It is clear that the Fed is willing to let the economy run hot permitting inflation to breach 2% remaining one step behind pushing rates higher. Our yield curve is not steeper as foreigners are aggressively buying our bonds, as rates overseas remain ridiculously low as both the BOJ and ECB maintain their excessive ease policies.

The unemployment report could not have been better with the unemployment rate falling to 3.9% as there was a 164,000 gain (previous 2 months revised up 30,000) in employment; the labor participation rate fell to 62.8%; and hourly wage gains were up only 2.6% year over year while hours worked remaining constant. Factory employment rose a surprisingly strong 24,000 jobs in the month supporting our focus on the production side of our economy over consumption. It really was a goldilocks report!

First-quarter earnings reports keep rolling in above expectations. Managements are optimistic that better days are ahead as their order books are increasing and price realizations are improving for those with pricing power. We would not want to be selling a product that Amazon sells for obvious reasons. Most corporations are using the tax break to increase wages, increase capital spending, building new more efficient capacity and on technology.

We continue to expect economic activity to accelerate in the US as we move through the year. Second-quarter real GNP will likely exceed 3%. Growth in the Eurozone has slowed slightly due in good part to the strength of the Euro. Remember that exports are a larger percentage of European GNP than here. Inflationary pressures remain subdued, so it is clear that the ECB will maintain its overly accommodative policy well into 2019 until inflation challenges 2%. Japan, China, India and the Emerging Countries are all doing quite well economically. The bottom line is that we see no reason to alter our 3.9% growth forecast for 2018.

On the other hand, Trump’s focus on open, fair and reciprocal trade agreements that also protect our IP remains the number one concern of the markets and us too. The US ran a $566 billion trade deficit in 2017 which reduced GNP by nearly 1.5%. Negotiations are ongoing with our major trading partners but change takes times so do expect a fast resolution anytime soon. We do expect the US to begin instituting some trade tariffs on some European and Chinese imports by month’s end, which will be followed by retaliatory tariffs against us. Both sides must show that they mean business for negotiations to get serious, so that it can conclude with a fair deal for all sides. We do expect a new NAFTA deal soon which is very important. The bottom line is that we do expect trade skirmishes but not an all out trade war. Clearly Buffett factored all of this in his decision to add to his Apple holdings. He looks out across the valley and invests accordingly. Interestingly Forbes wrote an article about me titled “Looking Beyond the Valley.”

Trump continues to move forward on his pro-growth, pro-business agenda with America First. Tax reform, regulatory relief and his trade agenda make the US the destination spot for both domestic and foreign companies to build plants to supply our needs. It does not hurt that America is nearly energy sufficient too. We continue to believe that we are at the beginning of a multi year surge in capital spending in America, which is one of our key investable themes. Industrial and capital goods companies are all reporting meaningful increases in orders and backlogs. And they have pricing power to improve margins. We continue to see a shift in the composition of our GNP away from a reliance on consumption to production.

In addition, we continue to emphasize the banks who will benefit from loan growth and a steepening yield curve; technology at a fair price to growth; industrial commodities including domestic aluminum and steel for obvious reasons and special situations like DWDP and FMC where internal changes will lead to higher valuations down the road.

The bottom line is to stay the course; think like Buffett and invest for the long term.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

 

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