Volatility Gets Crushed While Berkshire Rides the Recovery

Despite this morning's weak July report, U.S. stocks climbed higher today, with the S&P 500 (SNPINDEX: ^GSPC  ) , and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) both adding 0.2% by the end of the session, establishing new (nominal) record highs in the process. This looks like a manifestation of the Fed-engineered "liquidity rally."

Here's another one: the CBOE Volatility Index (VIX) (VOLATILITYINDICES: ^VIX  ) , Wall Street's "fear index," which, after closing below 13 yesterday, closed below 12 this afternoon. (The VIX is calculated from S&P 500 option prices, and reflects investor expectations for stock market volatility over the coming 30 days.) That's the VIX's lowest closing value since March 15, and it falls well within the bottom 10% of the entire series going back to the inception of the index in Jan. 1990.

Perhaps you're thinking that the current low value simply reflects the fact that the next 30 days mainly overlap with August -- traditionally, the doldrums month in the stock market calendar. That simply isn't the case; I ran the numbers, and it turns out that, when one looks only at the data for the months of August, the current VIX value ranks even lower within that set than it does within the full series (fifth percentile vs eighth percentile). Volatility looks mispriced, and the Fed is the main suspect.

Follow-up: Facebook breaks even
This afternoon, Facebook's (NASDAQ: FB  ) stock closed above its IPO offering price for the first time since the day the company went public in May 2012. With the shares now at "break even," you may want to review this article from yesterday in which I ask whether it is a buy today.

Berkshire beats
Berkshire Hathaway
(NYSE: BRK-B  ) earned $2,763 per share in the second quarter, a 47% year-on-year increase. However, the latest earnings included $622 million in net gains from the firm's substantial derivatives positions, which can be highly volatile quarter to quarter, or even year to year. Strictly on the basis of operating profits, Berkshire managed to book earnings of $2,384 per share, for a 5% year-on-year increase. Nevertheless, that was enough to beat Wall Street's expectations of $2,170 per share.

Berkshire's results suggest that the company is benefiting nicely from even the modest rate of economic recovery in the U.S., in particular, with regard to energy or energy-related activities. Profits in the energy and utilities businesses, as well as those of Burlington Northern Santa Fe, which has substantial exposure to the coal industry, were up 10%.

Trading at 1.44 times their book value, Berkshire shares don't look overpriced yet, despite having gained nearly 40% over the past 12 months, beating the S&P 500 by 12 percentage points in the process. On an earnings multiple basis, they look more expensive, at 19.8 times estimated earnings per share for the next 12 months, but that doesn't account for the $35.7 billion in cash -- 12% of the company's market value -- sitting on Berkshire's balance sheet.

Speaking of which, that cash figure is down from the previous quarter's $49.1 billion, mainly reflecting the $12.3 billion allocated to the acquisition of H.J. Heinz. That's one elephant Warren Buffett managed to bag, but he'd be delighted to bag another -- great businesses are a better repository of shareholder wealth than cash.

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