Buffett prepared for inflation with cash position of 32.5% of liquid portfolio!

[LearningMachine]

At the May 1, 2021 meeting, Buffett acknowledged "very substantial inflation" using the clearest language he has ever used on inflation:

Quote

 

We're seeing very substantial inflation. It's very interesting. I mean we're raising prices. People are raising prices to us, and it's being accepted. I mean it's not -- if we get...

Well, take homebuilding. I mean the cost of -- we've got 9 homebuilders in addition to our manufactured housing and operation, which is the largest in the country. So we really do a lot of housing. The costs are just up, up, up. Steel costs, just every day they're going up.

And there hasn't yet been -- because the wage stuff follows. I mean if the UAW writes a 3-year contract, we got a 3-year contract. But if you're buying steel at General Motors or some place, you're paying more every day.

So it's an economy really. It's red hot, I mean. And we weren't expecting it.

 

 

At the same time, BRK March 31, 2021 Balance Sheet shows

• Total Cash: $145.439 Billion
• Investment in Equity Securities: $282.097 Billion
• Liquid Portfolio (Cash + Equity Securities + Fixed Income Securities): $447.563 Billion
• Cash as percent of Liquid Portfolio: 32.5%

 

I understand Cash position is only 16% as a percentage of total assets, including hard assets.   I also understand he has said he also needs some cash for any circumstances that might be faced by BRK.  I also understand Buffett has been preparing for inflation all his life by being in the right businesses with pricing power. 

 

That said, even with all the early data on the onslaught of immediate inflation that he is getting, he is choosing to have almost a third of his liquid portfolio in cash, not in gold, not much in oil, but in cash!

 

Based on his experience in 1970s that he has recalled so many times, he is probably one of the most prepared individuals for inflation!  

 

I wonder if he is hoping for another 1974-style opportunity, and the best way he could think about preparing for that was to be in cash!

 

What do folks think about Buffett's strategy? 

Edited June 15, 2021 by LearningMachine

[wachtwoord]

Why would you hold cash if you are expecting high inflation? Sounds like a larger hurdle to argue for holding cash as you'll need to overcome the loss of purchasing power implied by the higher inflation too.

[Xerxes]

I got no clue of any particular strategy, but as it happens to be, his portfolio has plenty of hard assets that will retain value. I know BRK has been borrowing by issuing long-dated bonds so that is good.

 

It is the lack of having cash and lots of liability that will retain your wealth in a bad inflationary environment and not an abundance of cash. I guess the surplus cash for BRK would be to take advantage of a collapsing equity markets as a consequence of anything (including inflation), but it is not a preparation for inflation, in of itself.

 

I would also distinguish between good inflation and bad inflation. The former (inflation with growth) is what you want and hope for and the latter (inflation with no growth) is what you don't want. If i am not mistaken the last time we had bad inflation in the 1970s, gold went up through a multi-fold monster bull market. That is the type of environment were gold does really well (when real wealth is being eroded).

 

In fact Tobias C., recently on one of his podcast, made the point that the yellow metal that Buffett doesn't care about matched his own returns in the 1970s.

 

Edited June 15, 2021 by Xerxes

[SharperDingaan]

Very smart thing to do .....

 

A number of companies will be desperate for re-financing, should market interest rates turn up quickly, &/or in a material way. Last time around, even the great GS had to come knocking on BRKs door - offering a very attractive convertible. Electic cars, and US energy infrastructure very much in need of a serious upgrade - where do you think people are hoping that the incremental equity, supporting the incremental debt, is going to come from 

 

SD

 

[wachtwoord]

I wasn't asking about the many great assets that BRK surely has that will retain long term value.

 

I'm asking (in isolation) why holding an asset rapidly losing purchasing power (his speculation) and increasing in supply has a positive expected return. Your argument is that there will be a large demand. My follow-up question is then: why will 3rd parties have a large demand for an asset rapidly losing purchasing power in the future?

 

Are you (and Buffet) preparing for another liquidity crisis, dispite the inflation?

[wescobrk]

I think the cash is for two reasons: 1) lack of finding something cheap with S&P trading in the 20's on a multiple and 2) he is going to err more on the side of leaving a ton of ammo for Todd and Ted as he knows (sadly) his mortality is almost up (of course I'm rooting for him to live another decade.

He was actually selling Apple during the lows of Covid last year shows how timid he is now towards marketable securities.

[Xerxes]

 

4 minutes ago, wachtwoord said:

I wasn't asking about the many great assets that BRK surely has that will retain long term value.

 

I'm asking (in isolation) why holding an asset rapidly losing purchasing power (his speculation) and increasing in supply has a positive expected return. Your argument is that there will be a large demand. My follow-up question is then: why will 3rd parties have a large demand for an asset rapidly losing purchasing power in the future?

 

Are you (and Buffet) preparing for another liquidity crisis, dispite the inflation?

 

My comment was just a general comment on the first post and not related to anything you had mentioned. 

 

Unrelated but related = > 

Jamie Dimon: JPMorgan is hoarding cash because 'very good chance' inflation here to stay (cnbc.com)  

 

[thepupil]

I pulled Berkshire's annual for year ended 1998, when 10 yr treasuries yielded 6% and were very much positive / real. Berkshire was running very low duration back then too. Buffett has always had the 70's seared in his mind and seems to have been on the wrong side of the long duration trade for decades. I am not saying he is wrong. I think the cash / very ST FI makes sense in the context of the rest of his portfolio. But I don't think Berkshire is positioned any differently today than 5,10,20+ years ago. 

 

So I think his strategy is consistent. Run an overcapitalized insurance company. Don't take (much, if any) duration/credit risk. Own equities. I don't think it has to do with the current inflationary trends of 2021. 

 

Edited June 15, 2021 by thepupil

[DooDiligence]

I'm betting that WEB role plays a lot of different scenarios & I'm confident in his intuitive competence & luck.

 

Admittedly, it's fun to spitball what's going on in his mind.

[Xerxes]

Perhaps I ought to post this in the book section. I bought this last year based on a suggestion on podcast. It goes over the 1970s but primarily looks at the Great Bull Market of 1982-1999 and the subsequent bust. It is really entertaining, looks at inflation, the 'sadistic' bear of the 1970s that keep despairing the investors, and has lots of good gems in it. Berkshire is there as well (how could it not be).

 

I have not finish it yet, but it is going fast. 

 

Bull!: A History of the Boom and Bust, 1982-2004 eBook: Mahar, Maggie: Amazon.ca: Kindle Store 

[wachtwoord]

2 hours ago, Xerxes said:

 

 

My comment was just a general comment on the first post and not related to anything you had mentioned. 

 

Unrelated but related = > 

Jamie Dimon: JPMorgan is hoarding cash because 'very good chance' inflation here to stay (cnbc.com)  

 

Sorry I misunderstood.

 

I saw the JPM news before the BRK. Dismissed JPM but saw the BRK and wondered what was going on.

 

@thepupil

So indeed despite and not because of. 

Edited June 15, 2021 by wachtwoord

[LearningMachine]

11 hours ago, wachtwoord said:

Why would you hold cash if you are expecting high inflation? Sounds like a larger hurdle to argue for holding cash as you'll need to overcome the loss of purchasing power implied by the higher inflation too.

 

Because 10% inflation in prices will take more than 7 years for prices to double.  However, 10% inflation/interest rate will have an immediate impact on discount rate and also an immediate impact on cost-of-capital for some.  

 

When inflation was running red hot in 1970s, if you had invested in S&P 500 in Dec 1972, you'd have lost 46% of your investment as of Sep 1974. 

However, if you had prepared in advance and stayed in cash until Sep 1974, and had invested at that time, you'd have done ok.  

 

This was a time when P/Es were not high to begin with, and interest rates were not that low to begin with.  This time, it will be devastating if inflation/interest rates shot up that high by any chance.

 

That said, it is possible that Mr. Market might be irrational and not look at that impact on discount rate for some amazing companies, and not give us an opportunity like 1974.  So, we have to be prepared both ways.  However, I think it is likely that it will give us an opportunity for at least not-so-amazing companies.

 

The video at https://www.youtube.com/watch?v=AcQ0UlSzohA does a better job of explaining how market's discount rate is impacted by higher inflation and higher interest rate, e.g. risk premium goes up and risk-free rate goes up.  On top of that, margins go down for companies without a lot of pricing power. Also, as Buffett explained in his infamous inflation article, asset-heavy companies have to replace the assets at high-inflation cost, not leaving much for shareholders. 

 

Edited June 15, 2021 by LearningMachine

[rkbabang]

My guess is that he thinks having that dry powder readily available is worth the inflation risk, knowing that if the right opportunity arises he can put that to work and make many many times what he lost due to inflation while waiting.

[JRM]

It's basically a barbell approach.  70% equity and 30% cash.  Will probably be fine.

[wachtwoord]

14 hours ago, LearningMachine said:

 

Because 10% inflation in prices will take more than 7 years for prices to double.  However, 10% inflation/interest rate will have an immediate impact on discount rate and also an immediate impact on cost-of-capital for some.  

 

When inflation was running red hot in 1970s, if you had invested in S&P 500 in Dec 1972, you'd have lost 46% of your investment as of Sep 1974. 

However, if you had prepared in advance and stayed in cash until Sep 1974, and had invested at that time, you'd have done ok.  

 

This was a time when P/Es were not high to begin with, and interest rates were not that low to begin with.  This time, it will be devastating if inflation/interest rates shot up that high by any chance.

 

That said, it is possible that Mr. Market might be irrational and not look at that impact on discount rate for some amazing companies, and not give us an opportunity like 1974.  So, we have to be prepared both ways.  However, I think it is likely that it will give us an opportunity for at least not-so-amazing companies.

 

The video at https://www.youtube.com/watch?v=AcQ0UlSzohA does a better job of explaining how market's discount rate is impacted by higher inflation and higher interest rate, e.g. risk premium goes up and risk-free rate goes up.  On top of that, margins go down for companies without a lot of pricing power. Also, as Buffett explained in his infamous inflation article, asset-heavy companies have to replace the assets at high-inflation cost, not leaving much for shareholders. 

 

 

Thanks for the information and the lecture video. Much appreciated!

[woodstove]

Very interesting discussion.  That Damodaran talk was excellent.  What came through as desirable was repricing power re keep up with inflation.  I think Berkshire positioning is fine. 

[scorpioncapital]

¨This was a time when P/Es were not high to begin with, and interest rates were not that low to begin with.  This time, it will be devastating if inflation/interest rates shot up that high by any chance¨

 

I think profits would be much higher, even if companies could not keep up with pricing power if inflation was unexpectedly 10%. Therefore even if pe now is say 30x, if profits double will be 15x. The stocks may still go down to say 10x pe but it is not more devastating than in the 1970s. 

 

Also it is not clear that stock market crashes are only influenced by inflation. inflation can be high or low when stock markets crash. Inflation does tend to produce sideways markets (and there is a good book called the little book of sideways markets that is worth reading I feel for the period ahead). These are markets that may not go down or up too much for many years. In this scenario, i feel you want income, you can do arbitrage, you can accumulate great companies on dips, but you should not expect 10 baggers except perhaps in some venture capital fields. Even there, there will be more headwinds than has been so far.

[John Hjorth]

On 6/15/2021 at 4:04 PM, thepupil said:

I pulled Berkshire's annual for year ended 1998, when 10 yr treasuries yielded 6% and were very much positive / real. Berkshire was running very low duration back then too. Buffett has always had the 70's seared in his mind and seems to have been on the wrong side of the long duration trade for decades. I am not saying he is wrong. I think the cash / very ST FI makes sense in the context of the rest of his portfolio. But I don't think Berkshire is positioned any differently today than 5,10,20+ years ago. 

 

So I think his strategy is consistent. Run an overcapitalized insurance company. Don't take (much, if any) duration/credit risk. Own equities. I don't think it has to do with the current inflationary trends of 2021. 

 

thepupil,

 

Great post! - & thank you for sharing your thoughts.

[John Hjorth]

On 6/15/2021 at 4:10 PM, DooDiligence said:

I'm betting that WEB role plays a lot of different scenarios & I'm confident in his intuitive competence & luck.

 

Admittedly, it's fun to spitball what's going on in his mind.

 

Jeff,

 

Ha! - Exactly this! [One will never know in advance - Just get used to it!]

[Cigarbutt]

^Slightly different opinion on the position of the portfolio now versus 5, 10 or 20 years ago and the inflation question.

First, Mr. Buffett has maintained (whatever the explanation or cause) a more or less 100% coverage of cash and fixed income over float with slightly lower float coverage with cash and fixed income when there were not as many reasons to hate cash.

Even if the float portfolio was always protected against inflation and the potential effect on fixed income instruments, there has been a radical change in the relative size of the fixed income portfolio and in its composition and one may suggest that it is extra-protected at this point. Comparing with other insurers makes this almost six-sigma difference now even more apparent. A nice feature of the present "position" is that the incredibly-low duration cash and fixed income portfolio could reveal its optionality value in pretty much any circumstance or environment, if that's considered something of value, at a minimum to help with deep sleep.

During 1998 and 1999, BRK was digesting GenRe and numbers moved around a bit but the integration did not really change the conclusion here as a similar "pattern" in asset allocation was reported in the following years (1999 to 2002).

 

In 1998, float was 22.8B, fixed income was 21.2B and cash+CE was 13.6B.  Fixed income over float was 0.93  In 1998, the cash/FI over float was unusually high and cash went down by 9.8B in 1999.

Of the FI 21.2B, 30% was 5-10 years, 30% was more than 10 years and 6% were MBS. Also, 12.2B were US gov.-related and 4.6 were corporates.

 

In Q1 2021, float was about 140B, fixed income was at 20.0B and cash+CE was around 145B. Fixed income over float was 0.14. Cash/FI over float is again relatively high (similar to 1997-9 and 2004-6 and that's all i'm goin' to say about that). 

Of the FI 20.0B, 9.8B was less than 1 year, 8.8B was between 1 and 5 years. End of 2020 numbers reported about interest rate risk reveal immaterial changes and extremely low duration. Also, 3.2B were US gov.-related, 12.1 were highly graded foreign gov.-related and 4.2 were corporates.

 

While float has been multiplied by more than 6x, exposure to longer term debt has remained essentially the same (in absolute numbers) and duration is down, significantly, even if relatively low to start with. Corporate debt exposure is also down (absolutely and relatively++).

 

The following graph borrowed from a Seeking Alpha article sort of says something similar with the distance between the cash line and the float line being the fixed income exposure. It seems that cash levels, for the first time in history, has taken over the float line but that's another story.

[redskin]

On 6/15/2021 at 9:04 AM, thepupil said:

I pulled Berkshire's annual for year ended 1998, when 10 yr treasuries yielded 6% and were very much positive / real. Berkshire was running very low duration back then too. Buffett has always had the 70's seared in his mind and seems to have been on the wrong side of the long duration trade for decades. I am not saying he is wrong. I think the cash / very ST FI makes sense in the context of the rest of his portfolio. But I don't think Berkshire is positioned any differently today than 5,10,20+ years ago. 

 

So I think his strategy is consistent. Run an overcapitalized insurance company. Don't take (much, if any) duration/credit risk. Own equities. I don't think it has to do with the current inflationary trends of 2021. 

 

https://www.wsj.com/articles/SB890230215616525000

[LearningMachine]

On 6/19/2021 at 4:40 AM, scorpioncapital said:

¨This was a time when P/Es were not high to begin with, and interest rates were not that low to begin with.  This time, it will be devastating if inflation/interest rates shot up that high by any chance¨

 

I think profits would be much higher, even if companies could not keep up with pricing power if inflation was unexpectedly 10%. Therefore even if pe now is say 30x, if profits double will be 15x. The stocks may still go down to say 10x pe but it is not more devastating than in the 1970s. 

 

Also it is not clear that stock market crashes are only influenced by inflation. inflation can be high or low when stock markets crash. Inflation does tend to produce sideways markets (and there is a good book called the little book of sideways markets that is worth reading I feel for the period ahead). These are markets that may not go down or up too much for many years. In this scenario, i feel you want income, you can do arbitrage, you can accumulate great companies on dips, but you should not expect 10 baggers except perhaps in some venture capital fields. Even there, there will be more headwinds than has been so far.

 

How long do you think it would take for profits to double?  If 10% inflation and subsequently 10% risk-free rates really happen, discount rate will have to be more than 10%, i.e. P/E could go below 10 like it did in 1974.  So, I should really be asking how long do you think it would take for profits to triple or quadruple given today's Shiller P/E is 37.47 and S&P 500 P/E is 44.88 at https://www.multpl.com/s-p-500-pe-ratio.  

 

Any chance we might get opportunities in the years it takes for profits to double, triple or quadruple to get to appropriate P/E for the new inflation rate/interest rate/discount rate? 

Edited June 22, 2021 by LearningMachine