Warren Buffett: 'It is a different climate than it was six months ago' ⚠️
Plus a charted review of the macro crosscurrents 🔀
OMAHA, Neb. — After a volatile week, stocks closed lower with the S&P 500 shedding 0.8%. The index is now up 7.7% year to date, up 15.6% from its October 12 closing low of 3,577.03, and down 13.8% from its January 3, 2022 record closing high of 4,796.56.
As we’ve been discussing on TKer, one of the biggest concerns in the stock market has been the expectation by many that earnings growth could go negative in 2023.
On this near-term matter, Berkshire Hathaway CEO Warren Buffett doesn’t have good news for you.
"In the general economy, the feedback we get is that perhaps the majority of our businesses will actually report lower earnings this year than last year," Buffett said at Berkshire’s annual shareholders meeting on Saturday.
He reflected on the widespread supply chain disruptions everyone has faced since the onset of the coronavirus pandemic.
“It was an extraordinary period,” he said. “And that period has ended.“
For more on how supply chains have normalized, read: We can stop calling it a supply chain crisis ⛓
During that period, however, many companies, including those under Berkshire’s umbrella, over-ordered and now sit on excess inventory that will have to be cleared out at unattractive prices.
“It is a different climate than it was six months ago, and a number of our managers were surprised,” Buffett added. “Some of them had too much inventory on order, and all of a sudden it got delivered, and people weren’t in the same frame of mind as earlier.”
While the prospect for lower prices might be welcome news for customers struggling with inflation, it’s bad news for corporate profitability.
“We'll start having sales at places where we didn't need to have sales before,“ he said.
For more on this, read: What Fed Chair Powell said about the relationship between profit margins and inflation 💸
With a market value of $719 billion, Berkshire is one of the largest companies in the world. The diversified conglomerate’s massive portfolio of companies includes dozens of businesses across almost every imaginable industry, employing over 382,000 as of the end of 2022. Its well-known brands include GEICO, BNSF Railway, Fruit of the Loom, Precision Castparts, Benjamin Moore, Duracell, and Dairy Queen.
As such, Berkshire is considered a bellwether of the economy. So it’s worth heeding Buffett’s warning when thinking about the near-term outlook for the business environment.
‘Nothing is ever sure’ ⚠️
That said, don’t mistake Buffett’s warning on earnings as a sign to sell. In fact, Buffett would be the first person to advise against trading on short-term expectations
“Nothing’s sure tomorrow,” he said. “Nothing’s sure next year. Nothing is ever sure in markets or in business forecasts or anything else.”
In response to a question about opportunities in value investing, Buffett criticized those chasing short-term gains.
“The world is overwhelmingly short-term focused,” he said. “If you go to an investor relations call, they're all trying to figure out how to fill out a sheet to show the earnings for the year.”
Obviously, Buffett and his colleagues do buy stocks with the expectation that prices will go up. However, if you ask him about time frames, he’ll tell you its in the order of 20 years.
For more on Buffett’s thoughts on short-term earnings, read: Warren Buffett blasts ‘one of the shames of capitalism’ 🤬
What investors should make of all this 🤔
Not that anyone should pay attention to quarterly tweaks in Berkshire Hathaway’s portfolio, but as of the end of Q1 the company held $328 billion in stocks, up from $309 billion three months earlier. So Buffett isn’t exactly dumping stocks.
Even assuming the S&P 500 were to report negative earnings growth in 2023, history says this does not guarantee prices will fall for the year. Quite the opposite: stock prices usually rise in years when earnings fall. (Also, worries about weak earnings growth is an old story and has arguably already been priced into the market.)
Investing isn’t about only looking at the positives while ignoring the negatives. It’s about thinking holistically and making informed decisions while balancing the good with the bad.
This is why Buffett’s frank language about the short-term challenges his businesses face is refreshing amid his ongoing long-term optimism with regards to stocks and the U.S. economy.
For more investor wisdom:
Warren Buffett reminds us how picking winning stocks is extraordinarily hard 🤓
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🛑 Fed signals the end of rate hikes. On Wednesday, the Federal Reserve tightened monetary policy further by announcing a 25-basis-point rate hike, bringing the central bank’s target range for its policy rate to 5.0% to 5.25%. This was the 10th straight rate hike announcement, and it brought the range to its highest level since September 2007.
With the announcement, the Fed changed the language of its monetary policy statement in a way that suggested this could be the last rate hike for now.
Specifically, it dropped this phrase from its prior statement (emphasis added):
“The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.”
And replaced it with (emphasis added):
“In determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.“
But make no mistake: This is not the beginning of easy monetary policy. From Fed Chair Jerome Powell’s press conference on Wednesday:
“Inflation has moderated somewhat since the middle of last year. Nonetheless, inflation pressures continue to run high. And the process of getting inflation back down to 2%, has a long way to go.”
So, inflation has eased in a way that the Fed seems comfortable not having to tighten monetary policy further, but inflation remains high enough that monetary policy will remain tight for at least a little while.
For more on the Fed’s announcement, read: The end of rate hikes wouldn't be the end of tight monetary policy 🦅
👍 The labor market is hot. According to the Bureau of Labor Statistics, U.S. employers added an impressive 253,000 jobs in April. While the prior two months figures were revised down by 149,000 jobs, they remained positive.
Employers have added 1.14 million jobs since the beginning of the year. Total payroll employment is at a record 155.67 million jobs.
During the period, the unemployment rate fell to 3.4%, the lowest level since 1969.
Average hourly earnings rose by 0.5% month-over-month in April, up from 0.3% in March. This metric is up 4.4% from a year ago, up slightly from the 4.3% rate in the prior month.
📈 Job switchers get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in April for people who changed jobs was up 13.2% from a year ago. For those who stayed at their job, pay growth was 6.7%.
For more on why the Fed is concerned about high wage growth, read: The complicated mess of the markets and economy, explained 🧩
💼 Jobs openings cool, layoffs pick up. The March Job Openings & Labor Turnover Survey confirmed that the labor market, while still hot, continues to cool. Job openings declined to 9.59 million in March, down from 9.97 million in February. This represented the lowest level of job openings since April 2021.
During the period, there were 5.84 million unemployed people — meaning there were 1.64 job openings per unemployed person. This continues to be one of the most obvious signs of excess demand for labor.
For more on job openings, read: Were there really twice as many job openings as unemployed people? 🤨
Employers laid off 1.8 million people in March. While challenging for all those affected, this figure represents just 1.2% of total employment. While this latter metric has ticked up in recent months, it’s mostly just normalizing back to pre-pandemic levels.
Hiring activity continues to be much higher than layoff activity. During the month, employers hired 6.15 million people.
For more on why this metric matters, read: Watch hiring activity 👀
Here’s JPMorgan on the JOLTS data: “The job openings and quits rates remain historically high, and the layoff rate remains historically low, but all three are moving in the direction of a cooler labor market.“
For more on the labor market, read: The labor market is simultaneously hot 🔥, cooling 🧊, and kinda problematic 😵💫
🚗 Car sales jump. Via Renaissance Macro economist Neil Dutta: “In April, total light vehicle retail sales advanced to 16.15 million units SAAR, according to Autodata, the highest since the early stages of the pandemic. As supply chains improve, more vehicles show up on dealer lots, we see some incentive activity return and unsurprisingly, sales respond. Of course, buyers right now have been waiting for months; they are motivated despite tough financing conditions.“
For more on consumer strength, read: Consumer finances are in remarkably good shape 💰
👍 Manufacturing surveys improve. From S&P Global’s April U.S. Manufacturing PMI (via Notes): “US manufacturing output has regained some encouraging momentum at the start of the second quarter, having stabilised in March after four months of decline. While the upturn is in part linked to greatly improved supply chains, helping reduce backlogs of orders, April also saw a welcome upturn in new order inflows for the first time since last September.“
While the ISM’s April Manufacturing PMI (via Notes) signaled contraction for the sixth consecutive month, the headline index ticked up month-over-month with improvements in key categories including new orders, production, and employment.
For more on broad measures of the U.S. economy, read: Still waiting for that recession people have been worried about 🕰️
👍 Outlook for business investment is bullish. From BofA: “We are bullish on capex, particularly in the old economy capex after 10+ years of underinvestment. Re-shoring is also big secular tailwind - mentions of re-shoring +128% YoY. But it might not be just the old economy capex. The emerging AI cycle suggests potentially an everything capex cycle — AI mentions +85% YoY. Tech capex accelerated to +39% YoY so far vs. +3% in 4Q, led by Microsoft. Overall, 1Q23 capex is tracking +9% YoY so far (down from +18% YoY in 4Q), but excluding GOOGL (-36% YoY in 1Q, but guided to flat YoY capex for the full-year 2023), capex is +13%.“
For more on what’s looking up in the economy, read: 9 reasons for optimism 💪
👍 Services surveys improve. From S&P Global’s April U.S. Services PMI: “April saw an encouraging acceleration of service sector growth which, combined with indications of a renewed upturn in manufacturing, suggests the economy has regained some momentum at the start of the second quarter. Companies have reported an improvement in confidence compared to the gloomier picture seen late last year, with service sector companies also benefiting from a post-pandemic tailwind of spending shifting from goods to services, notably among consumers.“
The ISM’s April Services PMI signaled acceleration in activity driven by improvements in new orders. Employment cooled but continued to signal growth.
For more on the outlook for the economy, read: The glass-half-full view of what could be the next recession 🥃
⛓️ Supply chain pressures ease. The New York Fed’s Global Supply Chain Pressure Index— a composite of various supply chain indicators — fell in April and is hovering at levels seen before the pandemic. It's way down from its December 2021 supply chain crisis high. From the NY Fed: “Global supply chain pressures decreased again in April, falling to 1.32 standard deviations below the index’s historical average. The March value was revised downward from 1.06 to 1.15 standard deviations below the index’s historical average. There were significant downward contributions from Euro Area delivery times, Euro Area stocks of purchases, and Korean delivery times. While the overall index declined, there was a notable upward contribution from Taiwan stocks of purchases.”
For more on why normalized supply chains haven’t resulted in cooler inflation, read: What Fed Chair Powell said about the relationship between profit margins and inflation 💸
🚨 Debt ceiling warning. Treasury Secretary Janet Yellen (via Notes) warned the U.S. could default on its debts “by early June, and potentially as early as June 1, if Congress does not raise or suspend the debt limit before that time.”
For my thoughts on the debt ceiling, read: A brief note about the debt ceiling...
Putting it all together 🤔
Despite recent banking tumult, we continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ And on May 3, the Fed signaled that the end of interest rate hikes may be here.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations).
All of this means the market beatings may continue for the time being, and the risk the economy sinks into a recession will be relatively elevated.
At the same time, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
For more on why this is an unusually unfavorable environment for the stock market, read: The market beatings will continue until inflation improves 🥊 »
For a closer look at where we are and how we got here, read: The complicated mess of the markets and economy, explained 🧩 »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
When the Fed-sponsored market beatings could end 📈
At some point in the future, we’ll learn a new bull market in stocks has begun. Before we can get there, the Federal Reserve will likely have to take its foot off the neck of financial markets. If history is a guide, then the market should bottom weeks or months before we get that signal from the Fed.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
'Past performance is no guarantee of future results,' charted 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. According to their research, 29% of 791 large-cap equity funds that beat the S&P 500 in 2019. Of those funds, 75% beat the benchmark again in 2020. But only 9.1%, or 21 funds, were able to extend that outperformance streak into 2021.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
Here’s some info on how the index is constructed, according to the NY Fed: “We use the following subcomponents of the country-specific manufacturing PMIs: ‘delivery time,’ which captures the extent to which supply chain delays in the economy impact producers—a variable that may be viewed as identifying a purely supply-side constraint; ‘backlogs,’ which quantifies the volume of orders that firms have received but have yet to either start working on or complete; and, finally, ‘purchased stocks,’ which measures the extent of inventory accumulation by firms in the economy. Note that in case of the U.S., the PMI data start only in 2007, so for the U.S. we combine the PMI data with those from the manufacturing survey of the Institute for Supply Management (ISM).“
Great update thanks