“If we continue with these interest rates, stocks will look very cheap”
Berkshire Hathaway AGM 2015 – Pender’s Key Take Away Thoughts (Part 4)
We attended the Berkshire Hathaway 2015 Annual Meeting in Omaha. We like to hear first hand from two of our value investing icons. We took away four key thoughts. This is the fourth.
“If we continue with these interest rates, stocks will look very cheap” – Warren Buffett
At the Berkshire Hathaway AGM, a question was asked about the general valuation levels of the stock market and whether it was overvalued. Specifically, Buffett was asked about his two historical favourite indicators of market valuation which are Market Cap-to-GDP and Corporate profits-to-GDP. Both measures suggest that US stock markets are overvalued. Buffett opined that today’s high valuations are due to the ultra-low interest rate environment which they thought would be almost impossible just a few years ago. At the end of the day, all investment opportunities must be weighed by opportunity costs.
If the main alternative to ownership of stocks are bonds with record low yields, then stocks will look relatively attractive. With respect to predicting tomorrow’s general stock price movements and interest rates, Charlie Munger countered “Since we failed to predict what is happening now, why would anyone ask about our opinion about the future?” Berkshire’s management team does not think about macro factors when making individual investment decisions. Munger said “We are swimming all the time and let the tide take us.” In other words, they keep looking for attractive investments irrespective of the macro environment. Berkshire bought its railroad BNSF in the midst of the financial crisis and it has been a terrific investment.
The S&P500’s valuation on metrics like the P/E ratio is not cheap by historic standards, but on the other hand, we are also living in a highly unusual period of incredibly low interest rates. P/E ratios are often evaluated on a static basic, but should be adjusted when there are meaningful changes in interest rates because of the opportunity costs involved. If interest rates go up a lot, today’s valuations will look dear. If they stay low, they will look cheap. We have nothing to add to Munger’s prediction comments. Nevertheless, whether the general market is cheap or not, at Pender we believe there will always individual opportunities within the market that are attractively priced because they are either ignored, misunderstood, or become cheap in periods of panic selling. The overall market was not cheap in 1999 either, but it was a two-tiered market of very expensive stocks (large blue chip stocks and technology/telecom-related) and attractively priced stocks (small cap and less glamorous businesses). Overall, attractively priced stocks did well despite the tough markets over the next decade. The market’s best opportunity set may change over time, but the interest rate environment will continue to have a heavy influence on all asset classes.
Felix Narhi, 5 May 2015
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