Why Warren Buffett Is Cautious | The Acquirer's Multiple®

During his recent interview with Tobias, John Huber, Managing Partner at Saber Capital Management discussed why Warren Buffett is being so cautious right now. Here’s an excerpt from the interview:

Tobias Carlisle:
Can I talk to you about a few of the positions that you’ve written about publicly? So Markel and Berkshire.

John Huber:
Sure.

Tobias Carlisle:
I think that both got unusually cheap recently, and that the businesses are, as you say, maybe a little bit more tied to the fortunes of the economy than other businesses, but still both exceptional balance sheets run by exceptional managers with an eye to the very long-term. Markel of course is an 11, $12 billion company, Berkshire is a $440 billion company. So Markel, and run by a 58 year old rather than a 90 year old. So a much longer runway. But just talk through those positions and where you see them now.

John Huber:
Yeah, they’re both really great companies. I don’t happen to own either of them right now. Berkshire appears to me to be cheaper than I think it’s ever been since 2009. What’s interesting is, and this is something I, as I watched the meeting at the CenturyLink, which was just sort of an odd experience, I don’t know if you watched Buffett’s annual meeting, but he’s in the CenturyLink with like five people and the place is just totally empty. So very conducive to social distancing in that particular venue. But it was very odd that he… So he said a couple of things.

John Huber:
One is he, obviously, the takeaway was he seems quite bearish on the stock market and the economy.

Tobias Carlisle:
I’ve never seen him like that before. He’s always, to me, extremely optimistic.

John Huber:
He has been optimistic, I would say for the last probably, I don’t know, 15 years. He was very optimistic during the last crisis. One of the things he said, he had never bet against America theme, which I think is absolutely right. In fact, I was reading this book by Alan Greenspan, just this, or I’m reading it currently, and this sounded like something Buffett would cite the statistic, but you know, in 1776, I think there were three or 4 million people here in the US and the output of per capita per head of that group of people was about $4 a day in 2020 dollars. So in current dollars our GDP per capita essentially was around $4 a day. And now we have 330 million people and the output is around $130 a day or something in that ballpark.

John Huber:
So we’ve seen, what is that? A 32-fold increase in real GDP per capita. It just shows you the power of the productivity or just shows you the productivity gains that we’ve achieved and the standard of living increases that we’ve had in this country over a relatively, in the scope of history, a relatively brief period of time.

John Huber:
So I think Buffett’s right, never bet against America, the tailwind is too great. But, yeah, he definitely seems cautious, to say the least. But I was thinking about it. He has been bearish in the past. He was bearish in 1999, he gave a famous talk in Sun Valley and was essentially booed off the stage when he gave that talk.

Tobias Carlisle:
Is that true?

John Huber:
I don’t think literally, but people were… In Snowball, the book by Alice Schroeder, she opens the book I think or very early in the book has a section where a lot of the technology guys were there and they were kind of whispering under their breath as Buffett was warning about the lofty heights of the stock market at that time. So I think he predicted that stocks would return like 4% a year over the next decade and that actually proved to be optimistic.

John Huber:
People thought it was dire and they thought it was way too pessimistic. If you look at public opinion polls in 1999, people were expecting 13% returns, 15% returns, over the next decade like they just saw in the previous decade. And when Buffett said 4%, it was just away out of consensus view. And again, that decade turned out to be even worse than that prediction.

John Huber:
So I think he was bearish in ’99 and I think he was bearish in the mid 80s during the merger boom. So in Lowenstein’s book, there’s a spot, which is the first bio which was written in the mid 90s, there’s a few chapters that talk about the merger boom and stock prices started getting out of control because at that time companies were trading. So coming out of the bear market in the early 80s, companies were trading well below replacement value and we had significant inflation. And so, real assets were appreciating in nominal terms.

John Huber:
And you had Volcker, the Fed chairman, sort of famously broke the back of inflation and then you had interest rates coming down and it led to cheaper money. And there were a number of factors that kind of led to this merger bonanza and inflated stock prices to a level where I think Buffett just became uncomfortable.

John Huber:
So he didn’t make, if you go back and look at his annual letters from the mid 80s, I don’t think he bought a single stock between 1984 and 1987. And so, there was like a two or three year, maybe it was two year period, 85, 87, that he didn’t do much of anything.

Tobias Carlisle:
And he wound up his fund too, I guess in, that was ’69, right? The fund. So he must have been quite bearish then too.

John Huber:
Yeah, I think he was bearish in the late 60s and he was bearish in the mid 80s. In fact, he actually sold stocks in a pension fund. And again, this is in the Lowenstein book which is kind of remarkable. But he actually sold stocks prior to the crash. I don’t think he sold a lot of, he didn’t sell his positions, his core positions or anything, but he sold some smaller positions that were sort of in some of the pension funds that Berkshire’s insurance subsidiaries managed prior to the crash. Because I think he was worried about the level of the markets. But of course then he was buying hand over fist after the crash of ’87.

John Huber:
And then I think, that was really the point where he became more of the buy and hold forever. So he bought Coca-Cola I think in ’87 or ’88. And that was really the first… Washington Post, he’s never sold, but there have been some others, but really that was the beginning of what I would call the current Warren Buffett mantra, which is sort of buy these stocks and hold them forever. And of course, that doesn’t hold true for every position because he still sells things, so when he makes a mistake. That’s one of the best. The most underrated aspects of Buffett I think is his ability to change his mind when he’s wrong. And he evidenced that with the airline sales-

Tobias Carlisle:
IBM.

John Huber:
Oh, yeah. Yeah. IBM, Tesco, the grocery store in the UK, which is a relatively smaller position. He sold those. So he does sell things I think when he realizes he made a mistake. But, yeah, he seems bearish.

John Huber:
But, yeah, I guess back to Berkshire itself as a stock, one of the things that was interesting about the meeting is he stopped buying back shares in March, which was really surprising because he has always said that he’s always sort of benchmark intrinsic value somewhat to book. So he’s always sort of tethered his estimate of intrinsic value to book value in some way. And he’s adjusted that slightly over the years as book value [crosstalk 00:52:30]-

Tobias Carlisle:
It’s gone up. It’s gone up. And then more recently, the last pronouncement was basically, “We’re going to ignore book value, we’re going to make it our own assessment of that.” Which to me said it’s going to be even higher than 1.3 times book or whatever it had been in the past.

John Huber:
Right. And that makes sense because the railroad that he bought in 2009 for 26 billion is probably worth a 100 billion today, but the assets are still held on the books at the price that he paid in 2009. So it certainly makes intuitive sense that book value has become less tied to intrinsic value. But what’s I guess unique about this particular time is he was buying shares in January and February at 1.3 times book and then he stopped buying at a level that got as low as I think 1.15 or so, by my estimates. And it’s hard to know exactly what it was, but just sort of adjusting for the markdown in his $250 billion stock portfolio. And you can kind of get a rough estimate of what the price to book ratio was in March at the bottom of the market.

John Huber:
And so, my conclusion on that whole thing is I think Berkshire is extremely cheap, but I think Buffett is cautious because I think he doesn’t want to see the boat that he spent 50 years building, start to develop holes when he’s 90 years old. He’s said many times in the past, he’s talked about all sorts of different debacles like the LTCM debacle in the late 90s was a famous example of sort of greed gone haywire or greed on steroids or something, where so much leverage was used by extremely smart people to produce more money that they didn’t need.

John Huber:
He’s got this quote that basically says, “Once you’re already rich, you don’t need to get rich again, basically.” And so, I think the issue with Berkshire right now is he could, and this is just my complete speculation. I don’t know that this is the case, but I think he could be looking at the environment and seeing potential for a significant litigation in business interruption, insurance, potentially workers’ compensation, which Berkshire’s a big underwriter of.

John Huber:
And I think there have been some court, in fact, there was one court case in France last week where Axa is going to have to… Basically the French court ruled that they’re going to have to reimburse certain restaurants for two months of revenue. And so, I think if you start to violate contract law and even if it’s clear that these contracts do not… A pandemic is a…

Tobias Carlisle:
It’s carved out.

John Huber:
It is carved out. If you’re just going to start to override that, then who knows? How do you handicap that? Who knows what the losses could be? I mean, it could be a hundred billion. And I think Buffett has said before that Berkshire is fit to withstand a $250 billion hurricane season or even more and which would be multiples of the worst hurricane. I forget what the damage Katrina caused, but it would be multiples of that. And Berkshire wouldn’t even see any hit to its capital. So it’s an extreme fortress and I don’t think there’s any doubt it’s still is an extreme fortress. But I think when you have the uncertainty of the pandemic possible litigation, it’s hard to know what the claims will end up being when the dust settles from this.

John Huber:
And he said at the meeting, the other thing he kind of said, it didn’t get a lot of publicity, but I think he tipped his hand a bit when he said, “There’s no law that says a major storm can’t come during a pandemic.” So if you have a Katrina this summer and you combine it with all of the possible claims from the pandemic, it could be sort of a once in a 500 year flood. And I think he just wants to be prepared for that.

John Huber:
And I think he probably views that as a tail risk that’s probably got one or two or 3% or even lower odds. But he said before that, he doesn’t want to take even a 1% chance of something bad happening. So I think that’s more likely the reason why he wasn’t more aggressive in buying stocks, but that’s just my [crosstalk 00:57:19]-

Tobias Carlisle:
As opposed to him thinking that there might be another leg down or there might be another opportunity. You think it’s more of the risks that he’s seeing now?

John Huber:
Yeah, I really don’t think he’s timing the market. I could be wrong on that. The other school of thought is he’s close to Bill Gates. And I’ve been following Bill Gates, the blog that he writes has been very interesting in learning about the epidemiology of this virus. But I don’t think, I mean, it’s possible he’s looking at it and saying, “There could be another leg down,” but when you have 137 billion in cash, for him not to use 10% of that to buy stocks, is quite surprising.

John Huber:
It would be abnormal for him not to be buying when the S&P is down 35%, and you could be buying stocks that you liked [crosstalk 00:58:18]-

Tobias Carlisle:
You can buy your own stock.

John Huber:
Buy your own stock. If you liked your stock at 210, why aren’t you buying it at 160? The idea that the intrinsic value… He said, somebody asked him that and his answer was, “The price to intrinsic value hasn’t changed.”

Tobias Carlisle:
I found that a little confusing when he said that, honestly. I wasn’t sure whether he was referring to 210 or closer to the bottom. Yeah, sorry. Yeah.

John Huber:
Yeah. Well, that confused me as well because the price to book, it’s harder to reconcile that. Because the price to book was lower in March than it was when he was buying shares in January. So it tells you that either his view of the intrinsic value of the business itself has gone down. And that certainly could be the case. The pandemic was a game changer. And so, maybe the railroad is worth less, maybe the utilities are worth less, although that’s hard to imagine because the utility is more of a recurring cashflow business. And the intrinsic value of any asset doesn’t change all that much by what happens this year, it changes a lot by what happens over the next five to 10 years.

John Huber:
But a downturn in earnings, a cyclical downturn in earnings doesn’t change the values by all that much, yet stock prices were down 35% on average and up to 50%. So it’s hard to reconcile that. The only explanation is, he believed that book value was overstated or intrinsic value had gone down.

Tobias Carlisle:
The explanation that I like the most is that, if you have a range of outcomes and you have some valuation that’s based on a range of outcomes, if you introduce a new outcome or you put some more weight on the lower end of that spectrum, that will naturally pull down your intrinsic value estimate. And that seems to be the way that Buffett thinks. He doesn’t want any possibility of the thought, having too much weight in the lower end of that spectrum with outcomes manifesting. So he’s always trying to avoid the worst possible outcome rather than trying to capture the best possible outcome.

John Huber:
Yeah, I think that’s it. And that’s sort of what we were talking about with the pandemic risk is when you introduce that new risk, however, remote that risk is, it’s going to have some element of lowering your intrinsic value. And so, if there’s a risk of a hundred billion dollar industry wide claim, then you have to account for that.

John Huber:
And really, I don’t think he’s doing anything fancy in terms of trying to get too precise with this. I think he’s just saying, “Hey, there’ll be more times to buy stocks. I want to make sure that the painting that I’ve spent my entire life painting or putting together, doesn’t start to develop cracks.” So I think he’s just more thinking about the downside.

John Huber:
And then the other side of it is private business fallout hasn’t occurred yet. So in terms of private deals, he just hasn’t had enough opportunities. He sort of lamented the fact that the Fed came in… He didn’t lament the fact-

Tobias Carlisle:
He was front-run a little bit by the Fed, where previously they’ve performed that role for bigger businesses.

John Huber:
Yeah, exactly. He has sort of played the role of J. P. Morgan, the man. J. P. Morgan famously bailed out the financial system in 1907 and Buffett sort of did that in 2008, not exactly, but he was able to provide capital. Whereas it took the Fed six months or so, in 2008, to really enter the picture.

John Huber:
They did some minor things in the fall of ’08, well, they did some major things in the fall of ’08. But compared to what they did this time, it’s pretty remarkable what they’ve done. So I was just looking at the Fed’s balance sheet just last week and they put $3 trillion into the financial markets in six weeks. It has absolutely been unprecedented despite the overuse of that term. In the last couple of months, it really has been remarkable what they’ve done.

John Huber:
So, yeah, I think Buffett he’s always lamented private equity as a competitor and now he’s got the Fed, so it’s a tough game for him. But Berkshire itself as a stock, we’ve been chatting about the company, but the stock itself does look cheap. I think the reality for Berkshire is it exists on the far left side of that barbell that I described earlier, and I think there are better ideas out there than Berkshire Hathaway is a stock investment, but it’s a great company and it’s…

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