The bulls are back... almost. After a horrible performance in 2022, all of the major indexes are up solidly so far this year. The Nasdaq Composite Index is only a little over 1% away from entering a new bull market.
Many investors could be champing at the bit to buy stocks like they're going out of style in anticipation of a sustained upward trend. I seriously doubt that Warren Buffett is one of them. Here's why Buffett could sit on the sidelines in a new bull market.
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Buffett's big concern
Buffett wrote to Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) shareholders in 2022 that his preference is to be 100% invested in equities. At the time, though, Berkshire had $120 billion in short-term U.S. Treasuries and even more in cash.
He seemed almost apologetic for the company's huge cash stockpile. Buffett stated that the reason behind it was his "failure to find entire companies or small portions thereof (that is, marketable stocks) which meet our criteria for long-term holding."
As of its latest financial report, Berkshire's cash, equivalents, and short-term investments totaled $125 billion. Buffett's problem now is the same as it was a year earlier. As his longtime business partner Charlie Munger put it in an interview in late 2022, Berkshire isn't buying many stocks "because there's nothing we can stand buying."
What is Buffett's and Munger's big concern? Valuation. In his 2013 letter to Berkshire shareholders, Buffett explained that they only buy a stock when the price is attractive relative to its future earnings prospects.
All you have to do to understand why Buffett is likely to remain on the sidelines in a new bull market is look at the "Buffett indicator." This metric is the ratio of the total stock market capitalization divided by the gross domestic product (GDP). Buffett stated in 2001 that it was "the best single measure of where valuations stand at any given moment." And at this given moment, the Buffett indicator is well above its historical levels.
Not entirely on the sidelines
Granted, Buffett probably won't stay entirely on the sidelines if and when a new bull market begins. Although there aren't many stocks that he and Munger find enticing, there are a few that I suspect Berkshire will buy.
The obvious candidate is Berkshire Hathaway itself. Buffett and Munger believe in stock buybacks when the price is right. They approved repurchases of Berkshire stock throughout much of last year, including in the first quarter when the share price was higher than it is now.
It also won't be surprising if Berkshire continues to scoop up shares of Occidental Petroleum (OXY -0.09%). Buffett can't seem to get enough of the oil stock. Berkshire secured regulatory approval in 2022 to acquire up to 50% of Occidental. Its stake currently totals 23.5%.
Perhaps Buffett will find a handful of other stocks with attractive valuations to buy. However, it's a pretty good bet that he won't go on a major buying spree anytime soon, aside from Berkshire buybacks and adding to the position in Occidental.
Get in the game?
Many investors who don't have net worths with 12 digits might be more gung-ho to get in the game instead of sitting on the sidelines if a new bull market starts. But should they?
My personal view is that Buffett has the right idea. Even with the major pullback last year, many stocks remain priced at a premium. It's important to consider valuation before buying.
However, retail investors can also check out smaller stocks and some beaten-down tech stocks that Buffett would never have on his radar. Some of these stocks are attractively valued based on their long-term growth prospects, in my opinion.
The best approach is to not succumb to the FOMO (fear of missing out) factor in a new bull market. Follow Buffett's lead by setting the bar high for which stocks you buy, and don't compromise. That's been a winning strategy for the legendary investor for decades -- and it can help you win, too.
