Berkshire Hathaway (BRK.B), led by the legendary value investor Warren Buffett, will soon release its 13F for the second quarter of 2023, which will reveal the stocks the conglomerate bought and sold in the quarter. However, there are notable indications in Berkshire's quarterly filings this year that Buffett has been scaling back his exposure to U.S. stocks, including his own.
Recently, U.S. stocks have come off their 2023 highs, and the S&P 500 Index ($SPX) has now closed lower for two consecutive weeks, even though the index is still up a healthy 16.6% for the year. Berkshire stock itself is up nearly 16% for 2023, which is roughly in line with the S&P 500. However, in recent years, Berkshire Hathaway shares have routinely lagged the SPX (accounting for dividends), including a 20% underperformance in 2019 – which was Buffett’s sixth-worse underperformance since 1965, when he took control of the company.
Berkshire Hathaway Spent Aggressively on Buybacks in 2020 and 2021
Despite the considerable 2019 underperformance, Berkshire repurchased only about $5 billion worth of its shares that year, and Buffett said in his annual letter that the stock’s valuation was “modestly favorable” at times during the year.
However, over the next two years, Buffett spent generously on share buybacks, and Berkshire repurchased over $50 billion worth of its shares. While his buyback activity dipped in 2022 as the company repurchased about $7.9 billion worth of shares, it was because Buffett aggressively invested cash – including a net buy (difference between total stock bought and sold) of $41 billion in Q1 2022 alone. The heavy investments helped bring down Berkshire’s massive cash pile, which stood at roughly $106 billion by the end of Q1 2022 after surging to almost $150 billion at the end of Q3 2021.
Warren Buffett is Considered Among the Best Allocators of Capital
Until 2018, Berkshire Hathaway had a well-defined share repurchase policy, and Buffett repurchased shares only as long as they traded up to 1.2x the book value. However, that year the company changed its buyback policy – giving discretion to Buffett and his deputy Charlie Munger to repurchase shares.
Buffett is arguably among the best capital allocators of all time, and uses cash to either buy shares of publicly traded companies or acquire companies outright. Over the last couple of years, he has also looked at share buybacks, and defended them in this year's annual letter - even as many have been critical of companies repurchasing shares instead of investing the cash elsewhere.
However, the company’s Q2 earnings, released earlier this month, revealed that not only was the “Oracle of Omaha” a net seller of stocks to the tune of almost $8 billion during the period, but he was also quite frugal with repurchasing Berkshire Hathaway shares, spending only $1.4 billion. As a result, the total cash on Berkshire’s balance sheet swelled to $147.2 billion – the second highest on record.
What is Warren Buffett’s Nightmare?
In an April 2019 interview with the Financial Times, Buffett said that his “nightmare” scenario would be a situation when stocks look expensive and Berkshire Hathaway stock is trading at a fair price.
To be sure, such a scenario would be troubling for any capital allocator – and more so for Buffett, given his value investing credentials. He has in the past preferred to sit out of massive stock market rallies – including famously during the dot-com boom, which we know in hindsight ended up in a bust.
Is Buffett Expecting a Stock Market Crash in 2023?
Berkshire was a net seller of stocks in both the first and second quarters of 2023, and also scaled back its share repurchases in Q2 – which hints that the legendary investor is not too comfortable with valuations of publicly traded companies or his own Berkshire Hathaway stock at current levels.
To be sure, U.S. stock market valuations have indeed run ahead after the historic rally in the first half, when Nasdaq 100 Index ($IUXX) constituents collectively added over $4 trillion to their market caps. The U.S. market cap-to-GDP ratio is around 170%, which is quite overvalued by Buffett’s standards, and the forward 12-month price-to-earnings multiple for the S&P 500 is 19.2x – above the 5-year average of 18.6x and the 10-year average of 17.4x, according to FactSet’s Aug. 4 report.
Furthermore, interest rates - which are a key driver of stock valuations - are currently at the highest level since 2001 after multiple rate hikes by the Federal Open Market Committee. Higher interest rates are almost invariably negative for most stocks, and more so for growth stocks, as these companies have most of their earnings skewed toward the future.
What's Next for U.S. Stocks?
The 2023 stock market rally is built on three main themes. These are:
- U.S. inflation will continue to fall, and the Fed will pause its rate hikes after, at most, one more 25 basis point hike in 2023, followed by lower policy rates in 2024.
- The U.S. economy will dodge a recession and instead head for a “soft landing.”
- The pivot toward artificial intelligence (AI) will help companies increase productivity and earnings in the medium to long term. Notably, most companies will benefit from AI in the longer term, with specialized chip designers like Nvidia (NVDA) among the few exceptional names already benefiting from higher demand and revenues. The market opinion toward AI stocks is quite mixed, though, and both Buffett and Munger are skeptical of the “hype.”
All things considered, I believe that while U.S. stock market valuations are not tempting at current levels, they are not exorbitantly high, either. After the monstrous rally in the first half of 2023, tech stocks seem to be taking a breather, but the probability of a major crash looks low.
On the date of publication, Mohit Oberoi had a position in: BRK.B , NVDA . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
