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Berkshire Hathaway
Sitting on Cash Blows

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By mrgroovski3
January 19, 2005

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A lot of smart people think the bear is not over - that we'll see lower lows. There are almost too many people that think this way - it seems it's conventional wisdom nowadays, at least in the material I tend to read. There are plenty of people sitting on piles of cash earning next to nothing, corporations included. Meanwhile, we are significantly off the lows reached in '02. At the same time, by almost any rational measure, stocks are not undervalued. By some measures, some claim, they are as overvalued as they ever have been.

Coming off one of the largest bubbles in history, it's perhaps rational to think (along with many others) that the market will eventually correct below fair value, as it always seems to have done in past bubbles. The cash sits and waits for this buying opportunity for what is sure to come. Meanwhile, the intrinsic value of stocks is likely increasing by maybe 5-10% per year, depending on your opinion of what this long-term rate of growth might be. If you believe that range, then stocks should be nearing a 27%-61% total increase in intrinsic value over what is now nearly 5 years since the bubble burst. If you were sitting on cash well before the peak, your opportunity costs are even greater. Thus is a value investor's dilemma in the new millennium. It's a Catch-22. You can't invest in stocks, you can't find much in the way of alternative investments, and you can't afford to sit on cash unless you know something bad is coming sooner than later.

If you compare the 1929 crash to the current one, lining up an approximate best fit, at this distance in time from the peak, the low experienced in that crash had already come and gone by now. Stocks were, by my understanding, screaming buys (by today's standards) at the low, even in the face of a horrible depression.

The fact that the collapse of stocks in the new millennium did not lead us into depression (yet) like 1929 may be a tribute to all the things we have learned since then, or the so-far, so-good mastery of Alan Greenspan and a tax-cutting Congress/President. Depending on your definition of recession, we never technically even entered one, even though there has been economic malaise for sure. Stock bears certainly like to bash Greenspan, saying his flooding the system with liquidity will lead to one or more of 1) inflation, 2) bankruptcy, 3) more asset bubbles and probably a few I have missed. Maybe the reason stock bears bash Greenspan is that what should have occurred after the bubble broke, hasn't (yet), and there have been no buy points or they have lost their shorts shorting at the low, thinking the big one was yet to unfold.

The rapidly expanding deficit is certainly the new worry. The hangover from this is the new trigger bears point to that sends stocks to their much-anticipated buy points. Foreigners (mainly Japan) may decide they have had enough and quit buying our big, bulging debt in a painful attempt to keep their currencies low and the American consumer buying. So far, they haven't slacked off enough if at all to impact interest rates significantly. Even though Easy Al is now raising rates, having telegraphed the impending interest rate cycle as clearly as possible to the carry trade hedge funds well in advance, more than one stock bear has been spotted scratching their head as the yield curve flattens and long rates refuse to go higher.

Now if foreigners blink first, and stop buying our debt, they can probably kiss their economies goodbye for a few years. Japan has been in malaise for 15 years and counting already. It won't be too many more years until they run into a demographic problem of too many old people that apparently makes ours look like child's play. The trade deficit spigot that is feeding them will slow substantially because rising rates will certainly shut off the home equity ATM cash machine enjoyed by American spendthrifts. The American consumer seems to be loaded up with enough flatscreen TVs, reliable automobiles, cheap Walmart goods and everything else we import from Asia to survive more than a few dark winters with no extra spending cash if they have too. We'll save our money for essentials like food and oil and paying our low fixed rate mortgages (we all have one now, don't we??). We have our gargantuan houses, and we'll hunker down and pay our debts while Japan and China go into a funk because we have no savings left to spend. Europe is not importing a lot of Asian goods because they are in a funk, and Asian consumers aren't yet buying Asian goods in sufficient numbers to make up the slack.

Maybe America will go into a funk, too, if interest rates rise too rapidly. Then, it seems, the whole world will go into a funk. If the dollar drops more, we certainly will be cutting back on our European imports, especially if we don't have the cash. Europe will funk even more than they are now. What their consumers spend may increasingly be spent on American goods. Ditto the funk for Japan, Korea, Taiwan who are all suffering because of China. Maybe China will experience only single-digit growth for a change - or maybe they will crash hard.

Now Easy Al could turn on the liquidity spigot again in an attempt to support the economy and stocks. Stock bears seem to say either it won't work, because he has no room left, or he'll cause stagflation. Recession, or recession with inflation, pick your poison. If Al can't prevent a deep recession, this may lead to the buying opportunity we all salivate for. Then again, with Al's record so far, maybe he can engineer a soft landing, and maybe stock valuations descend but remain high enough to foil value investors once again and recover once liquidity kicks in.

Inflation? What would be the source? If China cools, commodities cool. There are at least a billion new capitalist workers in the system willing to work at very low wages since the abandonment of communism and the onset of globalization by my estimation. Except for a few jobs that can't be outsourced, you can't imagine a way that wage inflation could occur unless protectionism kicks in. By some estimates, all those goods we import from China are marked up in price by a factor of 3 to 4 to value-add marketing and branding and cover stock options of the American companies that sell them. If true, that's a lot of fat to cut that will tend to temper any rise in raw prices of those goods, a Chinese currency revaluation or any number of other cited bogeymen. Is anyone up for ordering their next new car direct from a shiny new Chinese factory over the internet for cents on the dollar, plus shipping and handling?

Oil at $100 a barrel as some doomsters predict? My next car will be E85-ready (ethanol) bi-fuel (ethanol or gasoline) at a minimum, and possibly a hybrid. I could buy such a car today, but there aren't enough choices yet. Soon there will be. There is an ethanol gas station a short jaunt out of my way that was recently selling ethanol at just over the price of gasoline. When I buy this car, I figure I can cut my petroleum-derived gasoline consumption to about 10% of what it once was if I choose. I can make ethanol in my back yard from corn (with a permit) if I so choose. Shell recently announced a way to make ethanol from hay or grass, or maybe both, I don't remember. If I were OPEC, I'd be scared, and I'd certainly would not allow oil to reach anywhere near $100 a barrel.

Easy Al or his replacement may well be free to flood the system with liquidity yet again with no inflation. He just has to watch out for excessive speculation. Derivatives crisis? Maybe he can head that off too with a gush of liquidity. Multiple governments may in fact choose to do so in any such a scenarios. A world awash in too much capital and low inflation may stay that way - for a long, long time. Stocks may not go up much, but they may not go down much either.

Stocks and other investments may stay tantalizingly out of reach of the value investor for long time tracking above their intrinsic value line. At some point, is it possible that the next buy point will be higher than the October '02 low by more than the interest earned on cash? Is it possible that a buy at the '02 low would have actually outperformed cash by that time? Are the days of buying 50-cent dollars over for a while? Surely the history of manias would say no, but history never had Alan Greenspan and the unique circumstances we find ourselves in today.

And so one might wonder, short of some creative investing, what to do with cash....

Comments and sneers welcome.


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