Wedgewood Partners' chief investment officer David Rolfe has a point -- Warren Buffett's Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has mostly underperformed the broad market since the beginning of this bull market back in early 2009. As of the most recent look, the S&P 500 is up 338% from the March 2009 bottom, while Berkshire's shares are only up 328%.
Things are getting worse rather than better, too. The S&P 500 is up more than 19% year to date, while Berkshire's shares have mustered an almost meaningless 2.3%. The fund's Kraft Heinz (NASDAQ:KHC) position has soured, falling nearly 35% since the end of 2018, though the fact that more than half the fund was sidelined as idle cash at the midpoint of the year hasn't helped performance much either.
But for Rolfe to cash out Wedgewood's long-held Berkshire Hathaway position because "Thumb-sucking has not cut the Heinz mustard during the Great Bull Market" looks right past everything Warren Buffett has learned about the stock market during his 78 years as in investor.
And if Buffett isn't budging, we'd all be wise to take note.
Stocks and companies really are oddly expensive
Rolfe isn't apt to be the only frustrated Berkshire shareholder, but he's one of the few to voice his disappointment in Berkshire's lackluster results so publicly. His letter to Wedgewoods' investors (made public just a few days ago to non-Wedgewoods investors as well) explains, "The Great Bull could have been one helluva ... astounding career denouement for Messrs. Buffett and Munger." Wedgewood's chief investment officer further suggests high-payoff picks Mastercard (NYSE:MA) and Visa (NYSE:V) "should have been layups for Buffett."
Fair enough. Although it's easy to pick winners after the fact, Buffett and his proteges arguably did miss out on a couple of opportunities, and Berkshire still arguably underexposed to stock investments at the moment. But Buffett's got his good reasons for mostly remaining on the sidelines during what's been an amazing, albeit erratic, bull market.
Chief among the reasons he was sitting on $122 billion worth of cash as of the end of the second quarter? The now-alarming comparison of the overall market's total capitalization to the nation's GDP. It's a comparison to the economy that can't be gamed by accounting gimmicks or one-time earnings surges.
On average, the nation's total combined market cap is right around the same size as the United States' gross domestic product. In boom times, the cap moving to 120% of the country's total GDP isn't unheard of, or problematic. The size of the stock market swelled to 154% of the U.S. GDP as of 2017 though, thanks to an incredible market rally following Donald Trump's 2016 Presidential election victory that hasn't been fully followed by subsequent corresponding earnings growth. The cap has since been pared back to 142%, according to Advisor Perspectives' Jill Mislinski, but that's still abnormally high.
For perspective, the figure reached 146% in 2000 right before the dot-com bust, and 137% in 2007, right before the subprime mortgage meltdown took hold.
Some might argue the current era of uber-low interest rates justifies higher valuations, and there's some basic truth to that argument. But even adjusting for inflation doesn't quite justify present stock prices. The inflation-adjusted Shiller P/E ratio now stands at 29.5, down a bit from last year's high of 33.1. That's still well above the normal range of between 15 and 20 and closer to readings associated with problems for the market.
It's data like this that lends credence to Buffett's comment from his August letter to shareholders that "the immediate prospects for [buying business to own permanently] are not good: Prices are sky-high for businesses possessing decent long-term prospects."
As for Kraft Heinz, that has admittedly been a misfire. The game's not over yet, though. Next year is expected to mark the beginning of a revenue and earnings recovery. It's still a multiyear project, but given that Buffett's favorite holding period is "forever," Berkshire's got time.
And as for the long-term results that haven't steadily outpaced the overall market's growth, maybe Buffett has lost his touch. Maybe the market doesn't reward what it used to. Or maybe Buffett deserves a break from the assumption that every single growth cycle is perfectly built for his value-oriented, long-term strategy.
Take the hint, for better or worse
Yes, Buffett's willingness to sit on Berkshire's cash hoard is a legitimate concern. Even if it's not an omen of an outright recession, it is a clue that he's waiting for better prices. A mere 10% correction probably wouldn't bring stock valuations back down to more reasonable, palatable levels. It could take a full-blown 20% correction, or a technical bear market, to gain his interest again. Hopefully, such an event wouldn't trigger a true recession, though consumers seem to be oddly sensitive to the market's ebb and flow in the current environment.
Whatever the case, while Berkshire Hathaway's shareholders may be disappointed that Buffett and his team have underperformed of late, what those investors may not be seeing is how well protected they've been -- and still are -- from a market setback that's yet to take shape. That's important too.