Warren Buffett warns of ‘bleak future’ for debt investors

Warren Buffett has warned that debt investors face a “dark future” days after a sell off hit government bonds and spill over into global equity markets.

The 90-year-old CEO of Berkshire Hathaway told shareholders in his closely watched annual letter that it was best to avoid the fixed income market, in which the company itself is a big player.

“Fixed income investors around the world – whether they are pension funds, insurance companies or retirees – face a bleak future,” he wrote. “Competitors, for both regulatory and rating reasons, need to focus on bonds. And bonds aren’t the place to be these days.

Treasury prices fell dramatically last week, driven by shifts in investors who are seeing faster economic growth take hold. Optimism around a global expansion has also rekindled concerns about spike in inflation, even nascent, and the prospect that central banks may need to adjust their stimulus policies.

Many investors had decided to adjust their portfolios ahead of the T-bill liquidation this week, buying lower-quality debt securities offering higher yields. Buffett warned on Saturday that the decision of insurers and bond buyers to “juice the pathetic yields now available by shifting their purchases to bonds guaranteed by weak borrowers” was a concern.

“However, subprime loans are not the answer to inadequate interest rates,” he said. “Three decades ago, the once powerful savings and credit industry was destroyed, in part by ignoring this maxim.”

Berkshire reduced its holdings of corporate debt slightly in the quarter, and the vast majority of its cash – around $ 113 billion – was held in short-term Treasuries by year-end. The company holds $ 3.4 billion in long-term US government debt.

The negative assessment of the sovereign debt market accompanied Berkshire’s fourth quarter results, which showed the company’s net profit rose nearly 23% year-over-year to $ 35.8 billion. dollars, or $ 23,015 per Class A share.

The rise was propelled by gains on investments and derivative bets, as the US stock market as a whole advanced in the last three months of 2020. Accounting rules require Berkshire to report changes in the value of its investments in shares in companies such as Apple, Coca-Cola. and Verizon as part of its quarterly earnings, which results in large fluctuations depending on the direction of the market.

Berkshire’s underlying business showed some resilience towards the end of last year, with operating profit up just under 14%. For the full year, which included the fallout from the coronavirus crisis, operating profit fell 9% from the previous year to $ 21.9 billion.

Buffett devoted much of the company’s firepower in the fourth quarter to buying back Berkshire shares, spending $ 8.8 billion on his own shares. For the entire year, it bought back $ 24.7 billion worth of its shares. Share buybacks helped shrink Berkshire’s gigantic cash flow, reducing it from $ 145.7 billion at the end of September to $ 138.3 billion at the end of the year.

Buffett justified the purchases in his letter, saying he and Berkshire Vice President Charlie Munger “made these purchases because we thought they would both increase intrinsic value. . . and would leave Berkshire with more than enough funds for any opportunities or problems it might encounter.

Investors pushed Buffett for years as he struggled to find a significant acquisition target to expand his empire, letting his cash flow grow. The company’s stock price has lagged the S&P 500 benchmark for two consecutive years.

“The buyouts stole the show and were very strong,” said Jim Shanahan, analyst at Edward Jones. Shanahan estimated that Berkshire had already spent an additional $ 4.5 billion on share buybacks in 2021, continuing the pace set last year.

Line graph of performance (%) showing that Berkshire shares have been lagging the market for the past 2 years

Buffett admitted he did not fulfill his negotiating mandate and also admitted that the $ 36.8 billion purchase price he reached in 2016 for Precision Castparts, the largest takeover ever accepted by Berkshire, was “a mistake I made”. The company took a $ 9.8 billion depreciation on the division in the second quarter.

The unit, which makes aircraft parts for companies such as Boeing and Airbus, laid off more than 13,000 people last year, accounting for 43% of the staff cuts Berkshire made last year.

Precision Castparts “is far from my first mistake of this kind. But it’s a big problem, ”added Buffett.

Berkshire, which has utilities across the country, has decided to devote part of its war chest to renewable energy projects and is working on a multibillion dollar project to upgrade power lines .

“Our nation’s electric utilities need a massive makeover, the ultimate costs of which will be staggering,” he wrote. “The effort will absorb all of Berkshire Hathaway Energy’s revenue for decades to come. We welcome the challenge and believe that the additional investment will be appropriately rewarded. “

Mr Buffett said he was looking for projects of a similar scale.

Cash and cash equivalents column chart (in billions of dollars) showing Berkshire cash slips as Buffett redeems shares

Rising stock markets will likely limit the prospects for acquiring Berkshire in the immediate future. Instead, Buffett and Munger focused much of their attention on the company’s growing stock portfolio, which reached $ 281 billion in 2020.

“Most big companies had no interest in someone taking them over,” he said. The company took stakes in Verizon and Chevron last year and slightly scaled back its biggest stake: Apple.

“He was stubborn about pricing and really stuck to his evaluation discipline,” Shanahan said. “As a result, he missed opportunities.”

The dean of the investment world also used his annual letter to reaffirm his faith in the US economy, telling shareholders that the country had “moved forward” and that they should “never bet against America.”

“In its brief 232 years of existence, however, there has been no incubator to unleash human potential like America,” he wrote. “Despite serious disruptions, our country’s economic progress has been breathtaking. “

Carol M. Barragan

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