It is a bit alarming to discover that Warren Buffett has been making the same trades as everyone else.
Buffett built his reputation on the financial equivalent of running into burning buildings. One of the most well-worn items in his aphorism collection: "Be fearful when others are greedy, and greedy when they are fearful."
But according to a regulatory filing last week, big trades by his investment company Berkshire Hathaway in the second quarter included selling off shares in JPMorgan Chase, Wells Fargo, and Goldman Sachs and buying into gold miner Barrick Gold. This looks a lot like being fearful when others are fearful. Banks have lost a third of their value since the pandemic first gripped markets in February. At the same time, the gold price is at an all-time high and Barrick is up almost 30 per cent.
The fall in bank shares and the surge in gold are both closely linked to falling interest rates, and neither has anything particularly good to say about the economy. If you believe growth is set to recover, you think rates will rise, and with them bank margins and profits. Rising rates, meanwhile, are almost always bad for the gold price. Buffett, then, appears to be pessimistic about prospects for recovery (taking some air out of another folksy saying of his: "Never bet against America").
Given he is understood to be the ultimate long-term investor (a third slogan: "Our favourite holding period is forever") it is a little difficult to shrug off these trades as short-term activity. And the numbers involved look big. Berkshire sold nearly US$6 billion ($9.1b) of bank shares and bought more than US$500 million of Barrick Gold.
If Buffett is putting on a tin hat, should we do the same? Before we do, some perspective is in order.
Berkshire Hathaway still has a huge investment in US banks and other financial institutions, worth about US$56b of its total balance sheet of US$788b.
The cornerstone of this portfolio of financials is a US$22b chunk of Bank of America; Berkshire has added another US$2b to it since the close of the second quarter. Given that it is a much larger holding than the JPMorgan stake, it is interesting to consider why Buffett and his team are sticking with it.
While the two banks have significant similarities — similar-sized balance sheets, big retail banking operations, large capital markets operations — BofA has a less risky balance sheet.
This difference manifests itself in several ways. JPMorgan's provisions for bad loans since the Covid-19 crisis began, at nearly US$19b, have been almost twice as high as Bank of America's. This is unlikely to be down to excessive optimism on the part of BofA's risk managers. BofA, as its executives never tire of pointing out, routinely comes out with the lowest loan losses among its peers during the US Federal Reserve's stress tests.
JPMorgan's riskier balance sheet is also reflected in its choice, in recent quarters, to add hundreds of billions in debt securities to its balance sheet while keeping loans more or less flat. Debt securities have a lower risk-weighting than loans under the Federal Reserve's capital regime and JPMorgan is up against its risk limits, unless it wants to cut dividends and retain more equity capital.
Goldman Sachs and Wells Fargo, meanwhile, have risks of their own. Goldman (which Buffett has been selling for a while) is fully exposed to the exuberant capital markets and Wells Fargo is still struggling with the aftermath of its fake accounts scandal of 2016.
So Berkshire's move looks not like an indiscriminate bank sell-off and more like a decision to cut positions in riskier banks while building its biggest, lowest-risk position.
As for Barrick, the investment should not come as a complete shock. Despite Buffett's well-known view that gold produces no wealth, he's always been opportunistic. In 1997, he bought some 111m ounces of silver, writing in that year's letter to shareholders that "inventories have fallen materially, and last summer Charlie [his business partner Charlie Munger] and I concluded that a higher price would be needed to establish equilibrium between supply and demand. Inflation expectations . . . play no part in our calculation of silver's value".
Buffett may have a similar technical thesis about gold but we may never know for sure. He is a man who likes to talk about investment strategy, but usually sticks to generalities.
The larger question about Berkshire is whether Buffett and his lieutenants have a strategy for reversing the company's decade-plus of underperformance.
It has heavy weightings in energy, consumer brands and financials, all areas with longstanding trends working against them. It could once make huge profits as a provider of emergency capital to distressed firms, but that is the Federal Reserve's job now. And the near universal rise in asset prices has made it a struggle to spend its US$147b in cash, which has become a big drag on performance.
If Berkshire is to beat the market again, it will have to make much bigger changes than it did in the second quarter.
Written by: Robert Armstrong
© Financial Times