The big question on the mind of just about every investor right now is whether the U.S. economy will tip into a recession, and if it does, how severe will that recession be? Naturally, the market is curious about what legendary investor Warren Buffett thinks given that the 92-year-old is one of the most successful investors ever. Plus, he has quite a lot of experience with recessions.
While Buffett has not outright stated there will be a recession, he did say at Berkshire Hathaway's (BRK.A 1.18%) (BRK.B 1.30%) annual meeting earlier this month that he expects to see earnings decline in most of Berkshire's businesses as the economy slows.
Still, it's quite possible that Buffett is not that worried about a recession. Here's why.
Image source: The Motley Fool.
Buffett is betting on the consumer
Interestingly, since the start of the pandemic, Buffett has trimmed a lot of his more traditional bank holdings, and that theme continued this year after Berkshire eliminated its longtime positions in US Bancorp and Bank of New York Mellon in the first quarter.
However, Berkshire, the company Buffett has run since 1965, made sizable bets on Ally Financial (ALLY 0.88%) and more recently Capital One (COF 0.90%), both of which specialize in consumer lending. It would seem an odd time to invest in companies that depend on the health of the consumer on the eve of a big recession because consumer loan losses can spike higher than many other loan categories in a downturn.
Ally has an $86.3 billion retail auto loan book and does a lot of lending in the prime and near-prime space. While many of these are strong borrowers, especially in prime, they are certainly susceptible to elevated loan losses during a recession.
Capital One is even more interesting. Around 30% or more of the company's credit card borrowers have FICO scores below 660. These borrowers are even more vulnerable during a recession and most banks have already seen cracks in the credit quality of this customer segment.
While I think Buffett likes both of these management teams and believes Ally and Capital One are reserving for future loan losses prudently, he must feel somewhat confident in the U.S. consumer to make such investments amid so much economic uncertainty.
It's also possible that Buffett believes the U.S. consumer is heading into the storm from a position of strength. Unemployment is still at historic lows, and while the personal savings rate has dropped, consumers as of January were still sitting on $1.4 trillion of excess savings, according to the research firm CFRA (which pulled data from the U.S. Bureau of Economic Analysis).
Never bet against America
Buffett has often said that he would never bet against America, so as a long-term investor, the Oracle of Omaha likely believes that while Ally and Capital One may face some near-term pressure, they will be good stocks in five years or a decade from now.
Both Ally and Capital One also trade below their tangible book value, which indicates that some of the pressure they are expected to face in a recession has likely been somewhat priced in.
While Berkshire is not necessarily betting the farm on Capital One or Ally, they are certainly not Berkshire's smallest positions, either. Ultimately, I think these investments show that Buffett and Berkshire have confidence that the economy can successfully navigate whatever might be headed its way.
