WWBD?
The stock market appears at a cross-roads. On one hand, many believe that we are about to stick the soft landing, in which case, late cycle stocks, energy, materials, health care, and consumer staples, should be bought because these sectors have historically done well in the late cycle. On the other hand, others worry that that the long and variable lags of the past rate increases are beginning to appear. We should get the first rate cut in roughly one month, but past rate increases will continue to work and will continue to slow the economy, threatening a hard landing. In which case, selling the first rate cut seems appropriate, as the Bank of America strategist suggests. Who’s right? Who knows. We all have our opinions at PWM, but there is certainly no consensus.
What Would Buffett Do?
Warren Buffett likely is not very concerned about a hard or soft landing. We can only speculate on that point, but what we can tell you what he has done lately and it’s not like anything else he has done in the recent past. He is selling a lot of stock. The chart below shows Berkshire Hathaway’s net purchases and sales of securities by quarter since 2017. The second quarter of 2024 is clearly an outlier. Compared to the last 7 years, Buffett has been a very sizable seller in 2024. Is Warren trying to tell us something?
Kenny Rogers famously sang: “You’ve got to know when to hold ‘em, know when to fold ‘em. Know when to walk away, know when to run.” In the second quarter, Mr. ‘Buy and Hold’ Buffett appears to have had a serious change of heart.
As the market swooned recently, there was plenty of speculation that Buffett had ‘called the top’ and was sending the rest of us a message. When stocks quickly recovered, that talk quickly subsided. So maybe there is no message. Nonetheless, we suggest there is still a lesson to be learned.
Buffett’s selling has been all about Apple (AAPL) and Berkshire has sold about half of its Apple stake through the first half of the year, with most of the sales in the second quarter. Apple is a terrific company, so what’s the problem? We suspect that Berkshire just can’t live with such a large position in Apple (almost half the portfolio at the start of 2024) when growth has slowed and the valuation has risen substantially. A value investor normally isn’t going to sell a winner just because it’s expensive. It has to coincide with some fundamental change. Back in 2016, when Berkshire was building its position in Apple, the P/E ratio was around 10, and the free cash flow yield was around 11%. Today Apple’s P/E is above 30 and the free cash flow yield is closer to 5%. (Free Cash Flow Yield is calculated like a dividend yield, but using free cash flow instead of the dividend.) It goes without saying that is a substantial shift from cheap to expensive which has occurred while growth has been slowing. That is not an attractive combination.
Another likely factor in the decision to sell is that Apple had become such a large holding in the portfolio. Buffett has never been afraid of concentrated positions, but a very expensive, concentrated position is another thing altogether. While many on Wall Street believe that adding AI to iPhones is going to spark a new surge in iPhone sales, apparently Buffett disagrees and voted with his feet. It is/was simply time to walk away. For Berkshire, assuming Apple was half of the portfolio, if Apple were to experience a correction (-20%), it would push the entire Bershire portfolio down 10%, other things being equal.
This is an important lesson for those with concentrated positions in their portfolios. Many have had fairly small positions in NVIDIA (NVDA) become very large positions in the AI frenzy. When that happens, there is always the concern of selling too soon, of creating a tax bill and therefore a tendency to hold on too long. That doesn’t mean you have to sell it all, but you shouldn’t be afraid to take some profits when the valuation of concentrated stock positions get expensive. Even the great ones do that. They try to be opportunistic, but they do not fret about taxes or trying to catch the top. Paying capital gains taxes on a big gain is far better than having no gain at all.
This Weeks’ Data
Initial Jobless Claims: 233K, less than last weeks’ 249K and less than expected.
Continuing Jobless claims: 1.875 million, a slight up tick from last week and as expected.
Advance Retail Sales (July): +1.0% MoM vs. 0.3% expected, June revised to -0.2%; Ex-autos, +0.4% vs. 0.1% expected.
Housing Starts and Permits: Starts -6.8% MoM vs. -1.5% expected; New Permits -4.0% MoM vs. -2.0% expected
Quick conclusion: It’s a draw. The economy is not rolling over and the labor market is still holding up, but the important housing sector is getting weaker.
Have a great week!
What We’re Reading
How to deal with election anxiety
Harris’ plan to fight price gouging: what is the legal framework?
Bye, Google: These 3 AI search engines help you find stuff faster
China port explosion snarls trans-Pacific container trade
Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Apple Corp, Hard Landing, Recession, Soft Landing, Stock Market, Warren BuffettBy: Adam
