Walking on Top of the Flack
Back in WWII, the flack would be so heavy that pilots
thought they might be able to walk on the stuff. So, imagine, if you will, Bugs Bunny, walking
on top of this flack, chomping down on a carrot. He looks down, and says, “Hey, Doc, thanks
for providing this foot path.” Then, of
course, the flacks stops, he looks at the audience, and says, “Uh-oh.”
Think of the flack as all the argument against the bull
market, yet it continues up. There was a
huge rally from 2015 to 2021 as:
1. Interest rates go
to zero.
2. Quantitative
easings
QE1 –
2008
QE2 –
2010
QE3 –
2012
QE4 –
2020
3. The Trump Tax Cuts
– 2017
4. The Federal
Reserve Balance Sheet expanded from $1 trillion to $9 trillion in the years
2008-2022.
So, there has been massive stimulus over the 2008-2021
period, and then when the Covid crisis hit, the Fed increased its balance sheet
from $4 trillion to $9 trillion during 2019 to 2022. Since 2022, the Fed has allowed bonds to
mature, and has done some selling of its huge portfolio, so the balance sheet
has declined from the $9 trillion peak to $7 trillion. Jay Powell seems like a reasonable man in the
job that he is in.
So, one argument for the tremendous rally is stimulus like
the America has never seen. Jeremy
Grantham said this has caused a tremendous asset bubble across all classes. One hopes that there is still something in
the cabinet if we need it. Because the
Japanese dropped interest rates to zero, and there was still no interest in the
market. The Japanese ended up
stimulating the economy through repeated infrastructure works, but their
national debt is even at a higher level compared to GDP than ours in the U.S. Is that a look into our own future?
Warren Buffett and Berkshire – the meaning of the cash
build
Berkshire compares its results against the S&P 500, but
Berkshire is doing something now that the S&P cannot do, and which might
goose its results eventually against the S&P. It is accumulating cash. The S&P 500 is always fully invested. Ideally, Berkshire would invest when there is
a dip in the S&P 500, but that’s not the way Buffett actually thinks, and
if he sees something he likes, he’ll be buying it. He’s explained that in 2008, he’d already
used most of his dry powder. Here are the
significant facts we are faced with:
1. He is selling
Apple at 36x.
2. He is not buying
Berkshire at 12x.
3. He is not
accumulating bitcoin.
4. He is accumulating
cash. Dollars. $325 billion, last reading.
This might be a possible explanation, though I have not
heard an explanation from His Omaha-ness:
Apple is a great brand, which explains the high P/E, maybe he feels it
has gotten ahead of itself. His sales
may not get explained for years. Meanwhile
Berkshire owns insurance companies, a railroad, and other typically low P/E
companies, and he must feel that it is fully priced at this point at 12x of earnings.
The Scope of the Problem
1. Warren Buffett has
examined every company of a certain size within his circle of competence. The S&P is only 500 companies. When he was a kid he read the whole of
Moody’s – twice. Take out the tech
companies, and the drug companies, maybe it’s only 400. But it doesn’t matter really, his memory of
most of these companies goes back decades.
2. Apparently, not
one of those companies is priced within his willingness to buy.
Warren Buffett is a walking encyclopedia of companies. When he fails to find a company to buy, here
is what that means. He followed these
large companies for years and years. For
example, when he bought into GEICO in the mid 1970s he had 25 years of
experience with GEICO because Benjamin Graham was a stockholder and eventually
a director of the company, and he used it as an example when Warren Buffett
studied with Graham at Columbia University in 1950. So, if you add Graham’s 15 or 20 years of
experience with GEICO to Buffett’s, you are talking about 40 years of
experience with the company, when he bought in.
They had had a bit problem with underwriting. They had started writing drivers without the
superior record they formerly insured. When
he bought into GEICO, initially as an investor in the mid 1970s, he brought in
John Byrne from Fireman’s Fund to be the CEO, and cut a reinsurance deal with
State Farm. He knew if he went back to
underwriting superior drivers, results would improve, which would bring
dividends, and Buffett’s specialty is investing those excess profits.
Not outside his CofC, for example, was Burlington
Northern. He likes these kinds of
things. A train of 100 cars has an
advantage over trucking. A truck
requires a power unit for every van of cargo.
A train requires one to four power units depending on the grade it will
be powering up (or down), and that may only require two drivers versus 100
drivers. Further, he can understand that
you can often stack one cargo van on top of another. He understands and likes these kinds of
situations, and he understands the economics.
Apple, under Steve Jobs, inventing new products, especially
the iPhone, was outside Buffett’s circle of competence. But once he saw that it was a brand, and
brand or franchise of exceptional value, he was fine with it. It suited his purposes. Its capitalization was large and he could
invest billions. As he would say,
investors do crazy things when they are enthused about the market, and he
thought that might happen to Apple. He
bought it at a P/E of 10-12, and now the stock selling at 36 times earnings, so
that’s a gain of 2.6x, plus earnings have gone up, so maybe it’s even more of a
gain. And understand, typically huge
companies, GDP companies (companies so large that they reflect the GDP of the
countries they operate in) do not typically trade at very high P/E’s, 10 or so,
because they cannot deliver outsized growth.
All they can do is match GDP, which is typically low growth.
3. So, when we are
saying that Buffett is not finding companies worth buying, he is actually
saying (without saying, another Buffett’s specialties), is that from his
bottom-up approach, that the whole market is very pricey, and he’s looked at
every single company within that S&P universe. He would be at pains to explain that he’s
only talking about companies within his “circle of competence.” This would exclude many biotech, AI, semiconductor
chip companies, which lie outside of that competence.
But to reiterate, I am not privy to his short list to buy, but
apparently, the list is empty, and as he is likely to say, looking at
all these high-priced companies, if a thing looks too good to be true, it
probably is. That was Bernie
Madoff’s point. His investors were
getting a better return than they could ever expect, and they should have asked
how he did it. So, he thought of them as
losers, not victims. Madoff never
invested the money; it was all in a Chase checking account. A true Ponzi scheme. And that may be true of the times we are
living in. If stock prices are too good
to be true…
But what this is saying to the rest of us is: beware.
Be wary. Buffett will be there if
one these companies stumbles and falls, and he thinks he understands the dynamics
of the company, he will either invest, or buy it outright. (Think American Express during the salad oil
crisis, think GEICO). But he may be
there when if there is a large market crack, and stocks fall. So he’s not a timer, he’s an alligator,
waiting for prey to be of a certain size and a certain distance from his chompers. And sometimes he gets opportunities the rest
of us don’t get. Private companies,
where he feels he understands the dynamics, the owners are honest and reliable,
the price not ridiculous, the prospects look good, why he might suddenly buy
something like that. Mars Inc. is a
business he would consider buying if the price were right. Perhaps they would sell to solve for family
inheritance reasons.
3. Buffett has never
been fond of buybacks; nevertheless, he has bought back shares of Berkshire
when the price was right. But now he
even finds shares of Berkshire higher than he is willing to pay. Failing to find any company in the S&P in
his price range, and Berkshire now higher than his price range, the cash
continues to build at a rate that quite astounding. It looks like he will continue selling Apple
into the rally, perhaps only because he thinks he can take that money and find
better bargains.
Buffett is telling us (while only telling us this in his
non-telling way) that this is probably not a wonderful time to invest in
stocks. He will simply accumulate cash
until a good opportunity comes his way.
If a stock market collapse should occur, and he still has the cash, that
will be an accident. He will remind you
that in the last collapse in 2008, that he didn’t have that much dry powder
left.
To sum up. Buffett has looked at most of the S&P 500 on an on-going basis, and the prices are not attractive. He is waiting for better prices, but that might end up being pretty much the same thing as waiting for a market correction, though I take that to be more of a coincidence.
He’s probably the best investor in the world, and if he
cannot find any bargains, all the buying must be being done by lesser lights. When I first started investing in 1975,
picking my stocks from Value Line’s 3-to-5 year list, just about anything I
bought went up. Doubled or tripled. If I had had the right temperament, some of
them would have returned 10 times what I paid for them. On the other hand, it feels that almost
anything I buy now will go down by 40% to 70%.
Too risky for me.
Animal Spirits and a streak of defiance
The main case for a market going to Mt. Fuji highs is that
animal spirits are beyond the beyond.
High spirits, which were magnified by the easy money (ridiculously low
interest rates, QE, more QE) policy of the Fed during the teens started it. But by the time of Covid, even the little guy
was putting his stimulus checks into the market. There was and still exists a streak of “anti-“
in the nation for stocks like Beyond Beef, AMC, Gamestop. A desire to Defy, to disrupt, to unseat the
norm. It is a cultural phenomenon beyond
the scope of this article. This streak seems
to explain the popularity of Trump - to strike out against the swamp, the enemy
within, the deep state. The little guy
investor, who wants to take out the seasoned professional. Certainly, they did for a time, like
Spartacus, make waves. Beyond Beef, AMC,
and Gamestop all went way the hell up. But
Spartacus did not triumph. And while
that particular craziness may have subsided, it turns out that most of those
people have moved on to bitcoin, and the cryptos.
The Case for Bitcoin
Bitcoin represents a couple of things.
1. There is a fixed
amount of the stuff. 21 million
bitcoins.
2. There is a cool
technology behind it called blockchain.
Blockchain is an accounting technology that may turn out be a useful.
3. The chance to
strike out against the establishment, the dollar.
4. Bitcoin goes up as
trading milestones are achieved, such as:
Corporate Treasury Adoption (Dec 2017) by Microstrategy
Chicago Mercantile Exchange launches cryptocurrency contracts
(2017)
Trillion Dollar Milestone (Feb 2021)
National Adoption by El Salvador (Feb 2021)
ETF created by Blackrock (January 2024)
Bitcoin hits 6 figures (Dec 2024)
Traders have a new goal now.
They want the U.S. government to create a “strategic reserve,” such as
it maintains for oil.
And traders are buoyed by another positive non-event event,
Trump likes it. (So, he might create a
strategic reserve). If Trump backs
bitcoin, that may seal unhappy things for his career, and seal disastrous
things for the U.S. The Federal Reserve
is not interested.
But if you look closely at these trading milestones, they
are relatively meaningless, it looks like a house of cards.
Important questions
Will Bitcoin work as a gold replacement?
Bitcoin is somewhat like gold. There is an apparent limit. Bitcoin has a 21 million bitcoin limit. And all the gold in the world is equal to a cube
72 feet in all directions.
In both cases you can mine for more of the stuff. Bitcoin requires massive computing
power. You can do it yourself with an
ASIC, an application specific integrated circuit, a dedicated computer, but the
downside is that the machine won’t be of any use to you if you get tired of mining.
1. What if we have to
choose between gold mining and bitcoin mining?
Gold is usually mined together with copper and other
metals. Copper is king. It is used practically everywhere from
plumbing to circuit boards. So, gold and
copper mining will never be halted. And
for the criminals, one advantage of gold over bitcoin, is that gold can be
melted down, and that can make it hard if not impossible to identify the
source. Bitcoin, on the other hand, is married
to an accounting program which can give you some kind of ownership identification.
2. What if we have
to choose between bitcoin mining and AI training?
Both gold and bitcoin require vast amounts of energy to
mine. At least in the case of gold, you
end up with an actual elemental substance which is a great conductor of
electricity, and has manufacturing, artistic, and is a store of value. With bitcoin you get more bitcoin, which at
the moment, is convertible to actual U.S. cash at a very substantial rate, but
may have no intrinsic value like gold.
If the environmentalists have their way, or if there is a shortage of
energy, it could be that bitcoin mining could be halted temporarily or
permanently. But what if it were a case
of energy going to bitcoin mining versus the very large needs of AI for
training, guess which is going under the bus?
It will be bitcoin mining. AI has
practical uses that bitcoin does not have.
3. Would the
government ever halt bitcoin mining for a moral or legal purpose?
A possible disadvantage of bitcoin, depending on your ethical
core, is that bitcoin came into its own so that people who disabled and
ransomed computers could receive payment over the internet, and get rid of it
before it gets traced. Also, it is used
extensively in money laundering. A lot
of them were Russians. So, that means
that anyone trading bitcoin is helping to make a market for thieves.
With a president with all manner of unseemly behavior, sexual
transgressions, preventing the transfer of power, keeping classified documents,
which the government asked to be returned (but were not), this is not a moment
of high ethical standards. Indeed, it
appears that he doesn’t want anyone in his government who smarter than he is,
and many also have a sexual record, and whose only virtue is loyalty to Trump. We will see how this works out for the
nation.
The Case Against Bitcoin
1. There is a fixed
amount of crypto. So, that governments
could not manipulate the currency. This is
supposed to prevent the degradation of the currency, and maintain its value. But it
would not allow the Federal Reserve to reduce interest rates to zero, and to
buy back mortgage and government bonds, and to stimulate the economy. Its inflexibility could turn out to be its
very downfall. But wait, now stories are
appearing that suggest the total amount of bitcoin may not be inflexible, and
the supply may change. But if it can
change the number of bitcoin, the very point of its existence may be called
into question.
2. Bitcoin is not a
currency. It is not a currency because
it is not used as a currency. It is not
really used to pay debt obligations or to buy goods. So, what is it? It is a store of value, something like gold. Well, it is some kind of futuristic gold,
which uses an accounting program called blockchain, which is seen as a cool
technology. As a store of value, it
holds its value as people bid it up. And
there is another reason why, as of now, it is not likely to be used as
currency, it is extremely volatile.
While this may work when it doubles, it is unacceptable to most
businesses when it drops by, say, 10% in a day.
3. Buffett would ask,
why would I want to own something that does not earn anything when I could buy companies
with earnings? He’s not a particular fan
of gold and silver, either. He and Jamie
Dimon would much rather own a company that is earning profits than to hold a
store of value.
[Sam Bankman-Fried - bankrupt, criminal]
Case in point. Sam
Bankman-Fried, crypto tycoon was at one point a billionaire, in fact, he was up
to $15 billion. Nevertheless, Sam was
convicted of wire fraud, commodities fraud, securities fraud, money laundering,
and campaign finance violations. He
suffered the largest one-day drop in wealth, when he lost 94% of his wealth. Meanwhile, he was doing good by contributing
to politicians. But he is not as clever
about power as Trump. Trump got elected
president, and most of his lawsuits went away.
Maybe he will pardon Bankman-Fried, if someone gives him [Trump] enough crypto.
The concern is that the total of all bitcoin is worth $1.39
trillion, and all of the crypto in the world is worth $3.64 trillion. This is a lot of money, and if there were a
sudden re-appraisal of the value of crypto, that could have real effects –
recession at least. The loss of wealth
would have a sudden negative wealth effect on many people, and they would
adjust their spending down. This would
not be a happy thing for the economy.
Meanwhile, the dollar is a fiat currency, so like bitcoin,
it’s nothing. It is a theoretical
construct, but it requires the confidence of the two parties, the one giving
the currency to pay for something, and the party receiving it. Confidence in the dollar is backed by the USA:
330 million people who use it in the United States, and more
millions throughout the world. I noticed
a long time ago in my trips to Argentina to dance tango and avoid Chicago
weather, real estate is quoted only in USD. At closing, attaches of money are
exchanged. And according to the New York
Times 10% of all paper U.S. currency, about $200 billion, is inside Argentina.
12 knowledgeable people run the Federal Reserve, these are
not all bottom-of-the-barrel second term Trump appointees, these are real
experts. Jay Powell was chosen when
Trump still made some first class appointees in his first term.
15 of the top 20 research universities are situated in the
USA
Silicon Valley is in the USA
1.5 million troops
$55 trillion worth of stocks of the $111 trillion in the
world
Bitcoin is not backed by these kinds of things, so far.
You will know that the speculative crazies are over if
bitcoin collapses. I don’t think bitcoin
is going away, but let’s think about that, CDO’s (Collateralized Debt Obligations) were a
big thing in 2008, but I never hear about them anymore.
The experts on bitcoin:
Warren Buffett and Charlie Munger: Rat poison, rat poison squared.
Jamie Dimon: Pet
rock. Bitcoin does nothing. See here.
Jeremy Grantham:
Bitcoin, crypto lack intrinsic value.
AI and Machine Learning
AI has given us something to think about. AI bounces a problem through its neural
network. The use of weights, changing
weights as solutions work better, makes it look like instant evolution. Used to be that you had to change the DNA,
and see how it played out in the real world.
Or change the hand axe until it fit for a particular problem, cracking
bones for marrow, cracking nuts to get at the meat, and so on. Now you can run it through its paces in
seconds with the use of ultra-fast chips.
So, it can change weights of its answers as it gets better
and better at chess, and it can do in a day what might take human chess players
hundreds of years.
On the other hand, will people actually pay to see recycled
and regurgitated Wikipedia articles? Or
will this just become another overhead expense for the search engines? Apparently, there are some excellent
applications that have already been developed such as for calling up modular
code blocks for software engineers.
Some apparently crazy investing money has gone into AI, but
here earnings have gone up rather remarkably, which supports such investing. Companies such as Google, Microsoft, Apple
and others have powered up their own search engines, but there is a question
about whether these really significant costs can be passed on to the consumer.
Crazy Speculation has moved to bitcoin
The crazy small-guy speculation where Covid stimulus checks
went into AMC and GameStop have now moved on to bitcoin. The Wall Street Journal wrote rather a
disheartening article entitled, “More Men Are Addicted to the ‘Crack Cocaine’
of the Stock Market.” A lot of stock market investors are ending up
in Gambler’s anonymous meetings. With
the Robinhood app on your phone, people find they cannot stop betting. Options trading is hitting new records. This obviously not a market where people feel
they are down in the dumps. It is
probably closer to the top of a market.
The kind of market that Alan Greenspan would call, “irrational
exuberance.” So, keep your head.
Stocks go both Up and Down
Both ways. Since 1975
or so, the market has been a rocket to outer space. People forget that stocks can also go down. This is a whole generation that doesn’t
really believe there can be down periods.
S&P 500 [https://www.macrotrends.net/2324/sp-500-historical-chart-data]
The point of this graph is that it shows that stocks really didn’t do much from its starting point of 1929 thru 1980. That’s 50 years of nothing.
Nikkei [https://en.wikipedia.org/wiki/Nikkei_225]
The point of this graph shows the Japanese market went up
like a rocket from 1970 until 1990. The
Japanese were very full of themselves at that point. Akio Morita of Sony wrote the book The Japan
That Can Say No (to the Americans on trade imbalance). The value of the Emperor’s Palace was worth
all of the real estate in California.
But then the Nikkei went nowhere for 35 years. In fact, it took until 2012 just to hit
bottom. Imagine: for 22 years every time
the market went up for a while it sunk to an even lower low.
The Buffett Indicator [https://www.advisorperspectives.com/dshort/updates/2024/12/05/buffett-valuation-indicator-november-2024]
Buffett is not really a macro guy, but that is by choice. Certainly, he can do macro if he wants. The idea behind the Buffett Indicator is to take all of the stocks in the nation and divide it by the GDP. In the 75 years of this graph, the relation of stock prices to GDP is very nearly as high as it has ever been. Stocks that are high can go higher yet. John Maynard Keynes: "Markets can remain irrational longer than you can remain solvent."
Things which could tend to move the market higher.
Peace could break out in Ukraine. This might make a difference, but it might
not. The market has not been held down
at all by the war in Ukraine.
Peace could break out in Israel. Once again, this may not make a big
difference. It has not held back the
market very much at all.
Continued great AI earnings.
Trump rally.
Things which could move the market lower.
China. China is
opaque, who knows what is going one behind the curtain? Foreign investment, U.S. investment in China
is down significantly. Businessmen want supply
chains less risky than China.
China. The real
estate overbuild is causing lots of problems for banks. Occasionally, one of these problems breaches,
and makes the news. Evergreen. But this stuff is mostly behind the
inscrutable wall of the Chinese dictatorship.
Trump tariffs could backfire. Tariffs did not do well during the 1930s,
making the depression even worse. Ben
Stein apparently ad-libbed a famous tariff bit for Ferris Bueller’s
Day Off. He has updated this bit in
light of the current circumstances. Ben Stein studied
economics at Columbia and Yale. So, even
though he is an actor in the movie, he knows economics.
The Experts
Jeremy Grantham – Staying the course, stocks are high, eventually bubble will pop. Shiller P/E only trades this high 1% of the time. See here.
Warren Buffett – Cash reserves increasing. Selling Apple.
Investment Advice
Avoid crypto. Yes, it
could go very much higher because we are in the midst of the crazies. Addicted gamblers can’t help themselves. Think AI momentum: where the next word is “up”
because the last word was “up.” But it
could be there is no there there.
Buy a small amount of a gold stock like Barrick (GOLD). Inflation has subsided, we will see what happens with the new Congress and government. Certainly, events in California will cause some things to go up. Lumber will certainly go up.
In my fiduciary capacity as a trustee of my father’s estate,
we are 70% cash and 30% in stocks. Apple
and Costco are our big winners. We decided
that stocks were unusually high in 2021-22, and wanted to reduce our
exposure. The stocks we have kept have
done great.
For myself, I am 90% cash.
This is in part an accident on my part.
I received some money from my father, and found no satisfactory home for
it. Something of the Buffett
syndrome. What if Buffett got a sudden
windfall? Where would he put it? Well, he has gotten a windfall in Apple this
year, and what has he done with it? Not
much. Maybe I don’t feel big gains
smart, but not big losses stupid, either.
Published 1/14/2025
