I spent part of last week thinking about “the great ones” who have made their mark in sports and investing. One of these was Wayne Gretzky, considered by many to be the greatest hockey player ever. So while the young and exciting Edmonton Oilers came up short in their playoff run against the Anaheim Ducks last week, it was great to see Gretzky in the box cheering on his old team. Reportedly, Gretzky is often in the locker room with the Oilers, sharing his wisdom and experience with the younger players. Gretzky was the heart of one of the greatest hockey dynasties of all time, the Oilers of the 1980s, winning the Stanley Cup five times. His most famous quote is pertinent to investing: “I skate to where the puck is going to be, not where it has been.”
The job of investors goes far beyond trying to understand why things are the way they are today. They need to try and understand where they will be tomorrow and the next day, and the day after that. As another great one, Bob Dylan, once said: “You don’t need a weatherman to know which way the wind blows.” Most popular financial reporting and research does a great job of explaining why things are the way they are today, but too often they provide little insight into where things will go in the future.
In recent years, one place many investors have turned for insights and wisdom is the highly anticipated Berkshire Hathaway annual report and shareholder meeting, dubbed “the Woodstock of Capitalism.” Thirty years ago, these meetings were relatively small, modest affairs, but today they’re attended by thousands of investors and are accompanied by extensive reporting and live media coverage. Last week, Warren Buffett was in his usual sparkling form, dispensing pithy insights and observations and generating loads of commentary and analysis in the process.
I was a devotee of “Buffett-ology” long before it became fashionable. In 1983, I was a young bond salesman at Salomon Brothers. One day the head of the equity desk, John Freund (another great one), asked me if I’d like to help him with one of his important clients. I said yes, although I wasn’t particularly well qualified at the time and I suspect I was asked simply because I was the only bond salesman that hung out at the equity desk at the end of the trading day. The client’s name was Warren Buffett, and I had the privilege of working with him on fixed income business for the next seven years. It proved to be an education.
When Buffett was asked last week how he would like to be remembered, he replied that it was not necessarily as a great investor, but rather as a great teacher. Many have already concluded that he is a great teacher and that’s why his written words and interviews receive so much attention. Last week, the statement that generated the most interest was his strong endorsement of stocks over bonds. “It absolutely baffles me who buys a 30-year bond,” he said. In a world of low yields, I can understand why Warren Buffett asked the question and I’ll do my best to provide an answer.
One of Buffett’s other fascinating insights last week was his observation that some of the largest companies in the U.S. no longer require any capital to run them. Of course, people have been talking about capital-light companies for some time, but these companies have now come to dominate business in recent years, and when Warren Buffett talks about it, people sit up and take notice. By way of example, he mentioned Alphabet, Apple, Facebook, Amazon and Microsoft, all of which have larger market caps than Berkshire Hathaway and are far less capital intensive. From his perspective, said Buffett, they’re ideal businesses because they require little or no capital to run them. But what he didn’t talk about was the impact that these large, rapidly growing companies are having on capital markets in general.
Follow the Money
One of the implications is that these fantastic wealth creation machines generate earnings and income without having to plow back significant money into their businesses. But ultimately the money has to go somewhere. Apple, for example, is sitting on a cash hoard of over U.S. $250 billion. It invests a good part of that in fixed income. Microsoft is now a substantial dividend payer and a stalwart of many equity income portfolios and, of course, these dividends require reinvestment.
Now juxtapose this emerging phenomenon with a consistent challenge for capital markets over the last 20 years, which is that the world’s fastest-growing economies have been throwing off substantial earnings and income that are beyond the ability of their own capital markets to absorb. That’s the reason why there has been a consistent flow of capital from China, Brazil and India into developed markets. Since the financial crisis, 80% of the world’s growth has come from the developing world. Indeed, a large part of the demand that’s driven global rates to low levels and credit spreads to fairly tight levels stems from this flow of capital from the developing economies to the large, liquid and more evolved economies of the developed world. Couple this with Buffett’s comments about U.S. companies that generate substantial earnings without the need to reinvest and one begins to see why low yields, tight credit spreads and high market multiples may persist for some time yet.
To finish, the answer to Warren Buffett’s question about why people invest in 30-year bonds yielding 3% is, in our view, pretty simple. The world is full of investors that can’t bear the short- to medium-term volatility of a portfolio containing nothing but businesses and equities. The fact is that a 30-year U.S. Treasury bond may not be a great investment on its own. But it can be a powerful diversifier in a portfolio that contains a substantial proportion of risky assets. In the low inflation world we’ve lived in for the last 20 years, long Treasuries have consistently been negatively correlated to risky assets when measured over a medium-term horizon. While I understand why Warren Buffett and others may have doubts about the 30-year bond, I believe long-term high quality bonds remain a valuable diversifier from risk assets.
In Case You Missed It
- U.S. Producer Price Index: +0.5% in April month-over-month and +2.5% year-over-year
- U.S. Retail Sales: +0.4% in April
- U.S. Consumer Price Index: +0.2% in April month-over-month and +2.2% year-over-year (core CPI increased 0.1% month-over-month and 1.9% year-over-year)
What to Watch For
- Monday, 5/15:
- NAHB Housing Market Index
- Tuesday, 5/16:
- U.S. Housing Starts & Building Permits
Statistics on the Current State of the Market – as of May 12, 2017
|S&P 500 Index||-0.3%||0.4%||7.6%|
|Russell 1000 Index||-0.3%||0.3%||7.4%|
|Russell 1000 Growth Index||0.0%||0.9%||12.4%|
|Russell 1000 Value Index||-0.7%||-0.4%||2.7%|
|Russell 2000 Index||-1.0%||-1.2%||2.3%|
|MSCI World Index||-0.1%||1.0%||9.2%|
|MSCI EAFE Index||0.4%||2.2%||12.6%|
|MSCI Emerging Markets Index||2.5%||2.6%||16.9%|
|STOXX Europe 600||-0.1%||2.9%||15.0%|
|FTSE 100 Index||2.1%||3.4%||5.8%|
|CSI 300 Index||0.2%||-1.4%||2.5%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.1%||0.0%||0.3%|
|Citigroup 10-Year Treasury Index||0.1%||-0.4%||1.5%|
|Bloomberg Barclays Municipal Bond Index||0.3%||0.4%||2.7%|
|Bloomberg Barclays US Aggregate Bond Index||0.2%||0.0%||1.6%|
|Bloomberg Barclays Global Aggregate Index||-0.2%||-0.3%||2.6%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.1%||0.2%||1.4%|
|BofA Merrill Lynch U.S. High Yield Index||0.4%||0.2%||4.1%|
|BofA Merrill Lynch Global High Yield Index||0.2%||0.3%||5.0%|
|JP Morgan EMBI Global Diversified Index||0.4%||0.2%||5.7%|
|JP Morgan GBI-EM Global Diversified Index||0.6%||0.7%||8.5%|
|U.S. Dollar per British Pounds||-0.5%||-0.4%||4.3%|
|U.S. Dollar per Euro||-0.6%||0.3%||3.6%|
|U.S. Dollar per Japanese Yen||-0.5%||-1.6%||3.0%|
|Real & Alternative Assets|
|Alerian MLP Index||0.6%||-1.5%||1.0%|
|FTSE EPRA/NAREIT North America Index||-1.3%||-1.9%||-1.7%|
|FTSE EPRA/NAREIT Global Index||-0.3%||-0.5%||4.2%|
|Bloomberg Commodity Index||1.0%||-0.6%||-4.4%|
|Gold (NYM $/ozt) Continuous Future||0.1%||-3.2%||6.6%|
|Crude Oil (NYM $/bbl) Continuous Future||3.5%||-3.0%||-10.9%|
Source: FactSet, Neuberger Berman.