Warren Buffett versus similarly leveraged S&P 500

From an email discussion group of hedge fund/bond fund managers….

I get the Financial Analyst’s Journal as part of my CFA registration. The attached article [“Demystifying Buffett’s Investment Success”] investigates the extent to which Berkshire Hathaway “beat the market”. It has significantly outperformed the S&P 500, especially before about 2000. Warren is called the “Oracle of Omaha”. This author finds that the return has been higher on his ownership of public companies (where he owns a stock we all could buy) than on the private companies. He concludes that this raises doubt that he has a superior management style and incentives. I am not sure I agree with that conclusion. He also said that BRK has debt, so you need to compare his return with a stock portfolio that is 170 percent of its equity, through leverage. That and a couple other factors pretty much explain his success. I guess that is good news, because it should be possible to keep it up when Warren eventually steps down.

In other words, the correct benchmark for Berkshire Hathaway is not the S&P 500, but rather a leveraged S&P 500 (since the trend for this index has been up, especially following the election of King Donald, the leveraged index outperforms the basic index).

Separately, is now a good time to buy Berkshire Hathaway? We’ve had some great years for the stock market so it seems as though the good times are due to end. Berkshire Hathaway was able to scoop up some great deals during the last panic (2008-2009).

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Time to buy foreign stocks and emerging markets in particular?

End-of-year portfolio rebalancing time.

What about this being the year of buying foreign stocks, especially emerging markets?

From a banker friend:

Since coming out of 2008/2009 the place to be has been US stocks, and more specifically US Large Cap growth stocks. On a relative basis US has outperformed International for something like 8 out of the last nine years. Last year, International and Emerging markets shined. That being said, if you look back to the period between around 1999 through 2007 International was the spot to be.

“Emerging Markets to US valuation ratio falls to its lowest since 2008” (October 2018; Economic Times (India)) suggests that emerging markets are a relative bargain. Bloomberg, July 2018:

Profits in developing countries rival those in the U.S. The EM index’s operating margin was 14.2 percent in the second quarter, compared with 13.8 percent for the S&P 500. Profit margins were also similar — 9.9 percent for the EM index compared with 9.5 percent for the S&P 500.

Yes, U.S. companies are generating a higher return on investment than those in emerging markets, but that’s only because U.S. firms are more levered. The EM index’s debt-to-equity ratio was 99 percent in the second quarter, compared with 113 percent for the S&P 500. After adjusting for leverage, the two indexes’ return on assets, return on equity and return on capital are all comparable.

The difference, however, is that emerging-market companies are far cheaper. The EM index’s price-to-earnings ratio is 13.3 based on 12-month trailing earnings per share, compared with 21.1 for the S&P 500. That difference is even more stark when looking beyond one year. The EM index’s P/E ratio is 14.7 based on 10-year trailing average EPS, compared with 29.5 for the S&P 500.

Is it reasonable to say that most of the good stuff that could happen to U.S. publicly-traded companies has already happened? They’ve had their tax rate cut from 40 percent (varies a bit by state) to around 25 percent. They’ve had interest rates set near zero for a decade. What else good can happen that isn’t already priced into current sky-high S&P 500 valuations?

(A lot of “U.S.” companies, of course, get the majority of their growth from foreign markets and some get the majority of their revenue from non-U.S. markets (see Apple, for example). So even if the U.S. stagnates (due to migrant caravans being stalled at the border?), some of these companies can still grow at the rate of world economic growth.)

A lot of bad stuff could yet happen to American companies. The festival of deficit spending could end and taxes raised so that we’re actually paying for all of the stuff that we demand from our Great Father in Washington. Regulations that favor trade unions could be imposed. Costs of defending employment lawsuits, including regarding #MeToo accusations, could increase.

So with limited upside and plenty of downside risk, why not sell U.S. stocks and buy foreign?

If buying foreign, why not go with the investments that have been out of favor, i.e., emerging markets? The Vanguard FTSE Emerging Markets ETF (VWO) tracks the “FTSE Emerging Markets All Cap China A Inclusion Index.” More than half of this index is China, Taiwan, and India. If you like to “buy on bad news,” you’ll be cheered to see 10 percent Brazil and South Africa in the index as well! (I’m hugely negative on South Africa’s economy; a growing population and fixed natural resources do not add up to a bright future as far as I can tell.)

Europe seems to be messed up, but maybe it would make sense to buy German and English stocks right now? The scary news about Brexit should already be priced into English currency and share prices. The news about Germany having been turned into a migrant camp should also already be priced in (and maybe it is bad news for Germans, who will be poorer per capita and suffer from more crowding and traffic jams, but is it bad for a Germany company?). I would be happy to buy Estonian securities. I have full confidence in that economy! (see https://philip.greenspun.com/blog/2016/08/01/estonia-tough-campaign-stop-for-bernie-sanders/) What is there to buy, though? The whole country has half the population of metropolitan Boston.

Readers: What do you think? Sell some U.S. stuff as soon as there is euphoria from the Federal government being restored to full operation and buy emerging? The professionals seem to recommend roughly 45 percent non-U.S. holdings for long-term investors.

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Why the stock market keeps going up

Americans are out of work.  Factory orders are sluggish.  The economic news is grim yet the U.S. stock market keeps going up.  Can this be consistent?  Sure!  It is possible to believe simultaneously that the American people are getting poorer and that the largest American corporations are going to get ever richer.  How could this happen?  Group A and Group B can get richer if they work together to grow the pie.  Alternatively, Group B can get richer by transferring wealth from Group A.


We’ve discussed this already in this blog in the context of airline CEOs who managed to take $billions in taxpayer money and transfer quite a bit of it into their personal checking accounts as salaries, bonuses, guaranteed pensions, etc.  But there are more subtle ways in which corporations can acquire property formerly held by the public.


For example, movie studios (notably Disney) and other corporate copyright holders recently purchased a federal law that extended copyright out to 100 years (the Founders had it at 14; it was 75 years until recently).  There was no way for them to argue that this law would provide an incentive to authors because it applied to works that were created in the 1920s, i.e., whose authors had been dead for half a century or more.  The effect of this law was to transfer public average-Joe property (public-domain works) into the hands of large corporations, i.e., the companies whose shares are going up.


Disney figures in another corporate property transfer.  Ever since the dawn of aviation it has been held that airspace belongs to the public and is to be regulated for the benefit of all by the FAA.  This is what, for example, prevents the owner of a farm in Missouri from demanding that Delta Airlines pay him a tax every time they fly over his farm.  In May of this year that changed for the first time.  Disney essentially now owns the airspace over Disneyworld and Disneyland and they can exclude anyone from overflying.  They’d been trying for years to exclude planes towing advertising banners but Sept. 11th gave them a security rationale (though neither the TSA or the FAA felt there was a security risk or wanted to transfer the airspace into private hands).  Background story: http://www.aero-news.net/news/sport.cfm?ContentBlockID=9601


Let’s hope the comments section will fill up with other examples of this trend.  But the bottom line is that the time seems ripe to invest in the S&P 500.  Look around you at stuff that you believe to be public property.  Very likely it will soon be given away to America’s largest corporations and consequently their stock will go up even if they don’t innovate.

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Dumping money blindly into index funds?

If you put money blinding into stock index funds, you’re helping managers steal from America’s public corporations, according to a special issue of Fortune magazine (start here and then click on the other articles under “special package”).  Could it be that the great investing lesson we learned from the last few decades, i.e., that index funds outperform managed mutual funds, will turn out to be inapplicable to the changed environment of the 21st century?

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Wall Street gets fined

The Wall Street firms will pay $1.4 billion for their sins of the 1990s, under a settlement reached yesterday.  It seems that they instructed their analysts to recommend buying the stocks that their investment bankers were taking public (for a fixed 7 percent share of the proceeds that seems to have been as unaffected by competition as the 6 percent collected by realtors).  This happy marriage resulted in an explosion of profits for Wall Street throughout the 1990s.


How discouraged from defrauding investors are they going to be in the future?  According to the New York Times, Citigroup paid $400 million or 0.2 percent of their organization’s value (about $200 billion according to finance.yahoo.com).  Merrill Lynch paid $100 million or about 0.25 percent of its market capitalization.


Let’s figure out what this would be like for the average American family, whose median wealth was $63,000 in 2001 (before the economy collapsed).  0.2 percent of $63,000 would correspond to one of the family members being fined $126, less than one-third the cost of the average speeding ticket (including insurance hikes) in the U.S.

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