Warren Buffet is Warning You… (Most Won’t Listen)

Warren Buffett is leaving Berkshire Hathaway with its largest cash of pile ever, $347 billion worth of cash. To put that in perspective, it's roughly equal to the entire GDP of Colombia, and it's enough to hand out $1,300 to all 260 million adults that live in the United States today. Buffett is stepping down as the CEO of Berkshire Hathaway, but his actions leading up to that moment have been some of the most unusual of his entire career. There's only a few moments over the course of his lifetime where Buffett chose to hoard this much cash. Today, his cash pile makes up a staggering 30% of Berkshire Hathaway's total assets. This is the single highest level on record. The only other time it reached similar levels was in 2006, right before the global financial crisis. Other notable spikes occurred at the end of 2021, right before the bear market of 2022, and in 2000, right before the dot-com bubble burst. This is precisely why Buffett has been called by many the Oracle of Omaha, because it seems like he's been able to successfully anticipate and sidestep some of the most turbulent and painful periods in recent financial history. You see that quite clearly by looking at this chart that shows how well Berkshire Hathaway's stock performs against the S&P 500 over time. Add in the recession bars of the dot-com bubble and the 2008 financial crisis, and you can see that Berkshire Hathaway's performance during these periods of economic turmoil was exceptional. A lot of this strong performance during these periods can simply be explained by the fact that he had a larger than usual allocation to cash. So is history repeating today? Is Buffett's record cash accumulation today hinting at another major crisis ahead that's going to make his bet pay off and lead to another significant outperformance of Berkshire relative to the S&P 500? Now, although all of this makes it look like Buffett knows something about the future of the economy, he has said many times that this is not how he operates. In fact, he's gone as far as saying that being an economist is overall a useless profession, at least when it comes to generating returns in the marketplace. Instead, his strategy is not one of predicting, but rather one of investing in great businesses at a reasonable price. And the truth is, if he can't find attractive businesses at a reasonable price, then he prefers to allocate more to cash. There's a lot of this happening today. The overall stock market is very expensive by nearly every historical measure. In fact, one of Buffett's favorite stock market valuation indicators, called the Buffett indicator, is showing the stock market is at one of the most expensive levels in history. This is a metric that compares the total market capitalization of U.S. stocks relative to U.S. GDP, effectively measuring how over or undervalued the stock market is relative to the size of the real economy. And right now that number stands at 200%, meaning the stock market is worth twice the entire U.S. economy. This is the highest level on record. This chart shows us how far the Buffett indicator is deviating from its historical trend at any given point, and it's currently sitting roughly two standard deviations above its historical trend today. The last time we saw a deviation of the Buffett indicator to this extreme was during the peak of the dot-com bubble in 2000 and just before the 1970 recession. For the last few years, the stock market has remained at very expensive levels, explaining why Buffett has not been finding attractive areas to invest his cash into. Now, to be clear, these valuations are not a timing tool. Theoretically, valuations can stay high for extended periods of time or stay low for extended periods of time. But usually over a long enough time horizon, you'll see that valuations eventually revert to the mean. And if you use them like Buffett does, that will mean that you're investing in stocks right at the moment where businesses are at attractive prices and have plenty of runway to appreciate in value, and you're hoarding cash at the right moments when businesses are not attractive and have lots of potential downside. For example, investing in stocks in the early 1980s or the bottom of the financial crisis in 2009, when they were historically cheap, provided some of the best returns to investors on a 10-year horizon as valuations appreciated significantly. On the flip side, if you were hoarding cash when valuations were high, like in the late 1960s or in 1999, you avoided some painful drawdowns. This is why Berkshire Hathaway has been able to generate a 1,400% return over the last 25 years, roughly a 15% compounded return per year. This is almost five times greater than the S&P 500 over the same time period that has just returned 300%. A $100 investment into Berkshire Hathaway back then would now be worth $15,600, and we happen to think that Berkshire Hathaway is still a great long-term investment opportunity today. From a valuation perspective, the stock is currently trading at just 12.8 times its earnings. This is less than half of the valuation of the S&P 500 index, which currently sits at a P-E ratio of 28.6. This is a historically wide gap. Over the past 15 years, Berkshire Hathaway's average price-to-earnings ratio has hovered around 17, while the S&P 500 has averaged at about a P-E ratio of 22. That's a typical spread of just five points. Today, the spread is over 15 points. So there is a valuation disconnect between Berkshire Hathaway and the S&P 500 that is quite spectacular today. We think that Berkshire Hathaway is a great alternative to traditional value ETFs. These typical value ETFs simply track a basket of cheap stocks. Berkshire Hathaway, on the other hand, combines active capital allocation with a portfolio of high-quality, wide-moat businesses in line with Warren Buffett's philosophy. This is what the returns of some of the mainstream value ETFs look like going back to 2006. They generated between a 200% and 400% return. And this is Berkshire Hathaway's return. It generated over a 700% return over the same time period. The holding company significantly outperformed the typical value strategies while maintaining comparable levels of volatility and risk, along with exposure to value stocks. So in conclusion, Warren Buffett's huge cash allocation might look like it's predicting an economic crisis to some investors, but it's really just a Over the long run, this strategy is eventually going to pay off. But as mentioned earlier, valuations are not a timing tool, and his cash allocation is not telling us he's predicting an economic crisis. I recently launched a new product called the Trading Mentorship, where I'm taking private clients step-by-step to work individually on their trading and investment strategies. The idea behind this membership is to provide a much more personalized approach where I can actually keep track of your progress, understand where you need help, and how we can get you to reach your goals, whether that's on the investing or the trading front. We're accepting new clients little by little. We currently have a waiting list for the membership, but if you're interested in applying to the mentorship, make sure to click the link down below for more information. Thank you for watching.