Last week was an important one for the residents of Omaha. For most of the year this mediocre little town in Nebraska is of no interest to the rest of the world, but last week its airport was a hive of activity, its hotels were booked out and you couldn’t get a reservation in any of its uninspiring restaurants for love nor money.
Why? Because Omaha is the home town of Warren Buffett, America’s most famous investor and the world’s second richest man (after Bill Gates), as well as the location of the annual shareholder meeting of his investment vehicle, Berkshire Hathaway.
I usually have little time for the meeting – it’s less a real shareholder meeting and more an irritating love-in between Buffett and his hordes of sycophantic investors – but this year it has served its purpose.
Just as the rest of the investment world appears to be prepared to accept the fact that the US equity market, having lagged for a few years, is back on form (the Dow Jones hit a six-year high last week before falling back on Friday) Buffett’s comments from Omaha should remind us that a new bull market is far from a given.
Warren Buffett: Why he’s not spending his cash in the US
Buffett said he was looking to make acquisitions with Berkshire’s huge $44billion (£23.6billion) cash pile but, tellingly, he was not looking to make them in America.
He has, for example announced a big deal in Israel, purchasing 80% of metal-cutting tools firm Iscar for $2.2billion, and has made it clear he sees little value at home.
I’m with him on this – I can’t see much value there either. Anyone who invests in the US market is taking quite a risk. For starters, while US stocks haven’t risen quite as fast as those in some of the world’s racier markets in the past few years, they are hardly cheap.
The S&P 500 is trading on a price/earnings (p/e) ratio of about 18 times, against a historical average of more like 15 times (the p/e ratio shows share prices relative to company earnings – the higher the ratio, the more expensive shares are).
It is hard to see the ratio coming down much: corporate profits (the earnings part of the equation) have had a fabulous run, but high commodity prices have been eating into margins and hitting consumer confidence. The housing market in the US is also beginning to look shaky, so only a raving optimist could really imagine that trend continuing.
Note that the last lot of employment data showed job growth slowing but wages increasing at 4%, their fastest rate for nine years, a sign workers are starting to react to rising prices with rising pay demands. That’s not good for profits.
Warren Buffett: Rising debts are bad news for the US economy
Those in any doubt that there may be trouble ahead need only turn to another of Buffett’s observations. These days, he told his fans, when he looks through the financial statements of lending companies he finds that the entry for interest accrued but not paid is rising. This, he explained, shows that people are having an increasingly hard time servicing their existing debts, which suggests they aren’t going to be splashing out on too many more SUVs and flat-screen TVs this year. That’s not good for profits either.
Finally the American bulls might look to the past before they dive into the market. The Stock Traders Almanac reminds us that the US market rarely rewards those who invest in the spring: if you had invested $10,000 in the Dow at the end of April 1950, sold at the end of October and repeated this every year you would by now have made absolutely nothing. Had you bought at the end of October and sold at the end of April every year, on the other hand, your pot would now be worth a handsome $534,323.
Stocks also have an odd habit of doing very badly when there’s a new chairman of the Federal Reserve: three of the four new chairmen since 1970 have presided over bear-market lows in their first year of office. Poor Ben Bernanke took over three-and-a-half months ago.
Warren Buffett: the dollar is due to fall
Now it may be that the US market will overcome its many difficulties, ignore valuations, put history behind it, and soar to new highs by the end of the summer, but to me it just doesn’t seem very likely – and even if I thought it was likely I still wouldn’t invest in America.
Why? Because of the currency risk that comes with having a dollar-based investment at the moment. I, like Buffett, have long believed that, thanks to America’s huge current-account deficit, the US currency is due for a nasty fall.
Rising interest rates have rescued it over the past few years as investors, hungry for income, have poured their money into dollars, but they may well not continue to do so now.
Whether last week’s rate rise from the Fed was the last in this cycle or not, the fact that inflation is now pushing up interest rates everywhere means that dollars aren’t the only currency investors can earn a reasonable amount of interest on. As a result market attention has turned back to economic fundamentals, and to the still-rising US trade deficit in particular.
Buffett opened a $21 billion bet against the dollar in 2002. That bet cost him $1 billion last year but this year it rather looks like he’s going to make good money out of it, with the dollar hitting 12-month lows against the euro and pound in the past week. Buying anything in the US now would be to bet against Buffett – and that’s another risk I don’t think I’d want to take.
The good news is that there will come a time when the current problems will make US assets look cheap: as analysts at RH Asset Management point out, back in 1988 when the dollar had fallen nearly 40% in three years, houses in Florida were great value. They may well be again by next spring.
First published in The Sunday Times (14/05/2006)