Active Stocks
Thu Mar 28 2024 15:19:25
  1. Tata Steel share price
  2. 155.75 1.90%
  1. ICICI Bank share price
  2. 1,091.10 0.65%
  1. HDFC Bank share price
  2. 1,446.15 0.38%
  1. ITC share price
  2. 429.05 0.25%
  1. Power Grid Corporation Of India share price
  2. 275.85 1.77%
Business News/ Opinion / Opinion: Warren Buffett needs new reason to be bullish on stocks
BackBack

Opinion: Warren Buffett needs new reason to be bullish on stocks

The Oracle of Omaha may have a harder time than usual justifying his rosy crystal ball

A shareholder holds a drink posing with a cartoon Warren Buffett at the opening cocktail party for the Berkshire Hathaway annual meeting in Omaha, Nebraska on Friday. Photo: ReutersPremium
A shareholder holds a drink posing with a cartoon Warren Buffett at the opening cocktail party for the Berkshire Hathaway annual meeting in Omaha, Nebraska on Friday. Photo: Reuters

Warren Buffett’s Berkshire Hathaway Inc. will be holding its annual meeting this weekend. That means Omaha, where Buffett’s investment vehicle and insurance firm is based, will be flooded with investors who hang on every word of the world’s most famous stock picker.

If asked, Buffett is likley to say, as he almost always does, that stocks will continue to go up. Buffett is perennially positive, which is understandable. As the world’s third-richest person, things have tended to work out for him. But Buffett has typically tried to back up his bullishness. If pressed this year, however, the Oracle of Omaha may have a harder time than usual justifying his rosy crystal ball.

Buffett has typically hung his stock market bullishness, or, in a few rare instances, bearishness, on the ratio that compares the total value of all publicly traded companies with gross domestic product. When the market cap of US stocks collectively equal about 80% of GDP, as it did in early 2009, Buffett has said it is time to buy. When the value grows to 130% of GDP, as it did in late 2007, it is time to sell. The problem now is that the measure crossed 130% in early 2017 (it also reached that threshold in late 2015, before stocks dropped), and the stock market has continued to rise. It is now close to 150%, even with the market’s recent wobbles.

So Buffett should be saying sell, right? Maybe not. There is reason to believe the gauge is not that useful anymore, or at least out of whack. The measure is essentially a giant price-to-sales ratio for the entire market. And companies with higher profit margins tend to have higher price-to-sales ratios. In general, though, corporate profit margins have tended to be higher than average over the past few years. And there is reason to believe, especially now that U.S. tax rates have been cut, that they will stay that way. That might mean Buffett’s favorite stock market gauge should be higher than normal, though how much higher is difficult to say. Not to mention that the largest US companies derive more and more of their sales and growth overseas, so comparing US stock market values with the domestic economy might be less relevant.

Lately, Buffett’s case for the stock market has rested on low interest rates. Yes, stocks look expensive, but they can stay elevated as long as interest rates stay low. This year, though, interest rates have risen, and as a result the valuation of stocks, as measured by price-to-earnings ratios, has dropped. Earnings, on the other hand, have risen. The combination means that stocks are basically flat for the year. Nonetheless, investors have seen for the first time the flip side of Buffett’s low-interest-rates-equal-higher-stocks paradigm. Many think interest rates will continue to rise, though yields seem to have levelled out in the past few weeks.

This could be why Buffett, despite not backing off his bullishness, has tended to bring up the market less and less. In 2012, Buffett dedicated three pages of his annual letter to why he thought investors should buy stocks. This year’s letter contained a warning on volatility and a chart of how much Berkshire’s stock has dropped in the market’s worst periods. Not that Buffett predicted a drop. He was just saying. It appeared as if his enthusiasm was wearing off. If Buffett’s going to continue to tell investors to be bullish, he’s going to need a new reason. Bloomberg View

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 05 May 2018, 11:30 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App