The Days Ahead: Job numbers.
One-Minute Summary: Most of the economic data was weak. That includes the ISM Manufacturing, pending and existing home sales and personal income. But these were all very much expected. The Fed’s move back in January (“we’re patient”) looks exactly right. It's not often that expectations and results are so finely tuned. But this time we knew the tax cuts would run out of steam and uncertainty around China, Europe, trade and government shutdowns would lead to lower numbers. Jerome Powell repeated them all in his talks with Congress last week.
Two points. First, slowing, not a recession. A recession is not two quarters of declining GDP. It’s a far more complicated run of data that includes GDP, employment, claims, hours worked and trade sales (full list here). And those are not flashing red. Second, this should keep rates low for a while. The 10-Year Treasury is at 2.75%, only 20bps higher than two years ago.
It’s been a stunning start to the year. In the first two months, the S&P 500 is up 11.5%, small and mid caps up 15%, China up 27% and Europe up 11%. We'd like to see a pause but would remind ourselves that markets do not correct by going sideways. So having some protection in place seems fine.
As 2009 begins to run off the 10-year returns , we’d like to celebrate that the 10-year compound rate of return in stocks is now 16.75% (see below).
That’s a remarkable number that only comes along every couple of decades (h/t Dan Wiener). So, yay. But a year ago, the same number was 9.8%. The big improvement is because the horrendous 2008 year falls off. The lesson? Stay invested, ride through painful downturns and don't trade the headlines.
1. What did Warren Buffet just do?
Change the bar for measuring Berkshire Hathaway. New accounting rules forced his hand.
There are two ways to think of buying Berkshire. One, a portfolio of companies selected by a legendary stock picker. Two, a group of businesses assembled by a legendary manager. For many, it’s the first. So, when you buy Berkshire you get a bunch of great performing stocks. They're here on page 12. It's like the world’s best-known mutual fund. The biggest holding is Apple but the most famous is Coca-Cola where Warren Buffet has made a 19x return. They amount to $170bn of a $497bn company.
The other $327bn is $127bn of cash and $200bn of operating companies managed out of Omaha. Companies like Geico, BNSF (the U.S.’ third largest railroad), Precision Castparts, an aviation parts manufacturer, reinsurance, energy and other. The “other” includes companies in distribution, mobile homes and retailing (see page A-1). Together they make around $24bn, although this popped to $45bn in 2017 due to tax cuts.
One accounting rule change later and losses on the stock portfolio run through the income statement. In 2018, stocks went up, down and up, and Kraft Heinz had a bad year. Berkshire reported a loss of $1.1bn in the first quarter, then a $12bn profit, another $18bn profit, and a $25bn loss in the fourth quarter. Add those together and the company reported $4bn for the year compared to an average of $26bn for the prior five years. Buffet used to tout book value as the way to measure Berkshire. That was fine if you didn't have to account for swings in the portfolio companies. You got a nice steady increase in book value and could ignore market values. Now you can't because they hurt/flatter the income account every quarter.
So what’s the new measure? Share price. Seems simple enough and on that measure Berkshire does just fine. The rolling five-year returns (below) aren't what they were but they still comfortably beat the S&P 500.
We like Berkshire simply because it has solid growth and well managed, conservatively financed businesses that are worth more than their carried cost. Its value is $495bn with cash and stocks. Take those away and it’s earning some $24bn on a market value of $196bn or a PE of around 8. That looks compelling.
2. How’s U.S. growth doing?
Slowing. It's no surprise the U.S. economy eased in late 2018. For the entire time after the 2009 crash, the norm was 2% growth. Yes, there were flurries of higher and lower growth and there were brief times in 2011 and 2014 when the economy contracted. The tax cuts were exciting but merely brought forward purchases. It wasn't until later in the year that people figured out the cuts were mostly for companies and high-end income earners.
So, Q2 growth was 4.2%, slowed to 3.4% and 2.6% for the final quarter. For calendar 2018, the economy grew 2.9%, so above prior years but not by much and, dare we say, not as much as the tax cutters promised. Here’s the chart, with the slowdown in the bubble on the right.
What were the drivers? On the plus side, defense spending and investment in intellectual property (which is basically capex for tech companies) were very strong and inventories rose. But on the downside, consumer spending grew less (and savings went up), net exports worsened and Federal and state and local government expenses slowed...a lot.
Going into Q1 2019, there are a number of headwinds including a sharp drop off in capital goods, gas prices no longer falling, government employees who almost certainly cut back spending and some seasonal problems which have made the Q1 GDP numbers a problem for the last decade.
So, there’s the slowdown. We knew it was coming. The start to the year is even slower….the Atlanta GDPNow folk have us at 0.3% for Q1. There’s no evidence that the tax cuts have done anything to raise the capacity of the U.S. economy. We're back to the 2% world. That should keep rates low for a while and the Fed on hold…which is good for Treasuries.
Bottom Line: The market feels overbought. Just as the downturn in late 2018 was overdone so too this rebound all feels headline driven. The macro news is moving markets. We'd rather see bullish comments from companies but they’re not in that sort of mood right now.
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--Christian Thwaites, Brouwer & Janachowski, LLC
Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice. We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security. The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended. Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data. Past performance is no indication of future results.
All charts from Factset unless otherwise noted.