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The Weekend Edition # 32
Turbulent times; Macro: Interest Rates; Earnings: Berkshire Hathaway; Changes to the S&P; Thoughts on Next Week
Welcome to another issue of the Weekend Edition.
Thank you to all who’ve read and subscribed to the newsletter this week!
Here’s what we cover:
Market Recap - Turbulent times
Macro of the Week - Interest Rates
Earnings of Week - Berkshire Hathaway
Around the Markets - Changes to the S&P
The Week Ahead - Economic Calendar & Earnings
Closing Thoughts - Next week
Let’s dive in ⬇️
Market Recap - Feb 22 - Feb 25, 2022
A horrific week for the world, as Russia invaded Ukraine and people continue to suffer. No one wins when there’s a war.
The markets have been extremely volatile as well - the indices gapping down on the news and then recovering on Thursday and Friday. Short interest had peaked and most of the rally seems to be from people covering their shorts.
A look at the sectors for the week:
Commodities have also been soaring with both WTI and Brent crossing $100/bbl this week before heading back down. Soft commodities and precious metals have also had an exceptional week. Gold rode up to c. 1975 and Wheat, Corn both sizable exports from Ukraine, remain elevated as well.
Macro of the Week - Interest Rates
I’ve been reading “The Lords of Easy Money” by Christopher Leonard. The subtitle to the book is “How the Federal Reserve Broke the American Economy”. While we’ve lived through the more recent events described in the book, it’s still a very interesting recollection because it’s written from an inside view of the Fed.
And then I came across this quote in Buffett’s letter yesterday and it all tied into what I’ve also been reading in the book.
The consequences of the Zero-Interest Rate Policy (ZIRP) is not just price inflation but also asset inflation. It stands to reason that when banks are faced with unusually low interest rates, there is overzealous lending in an attempt to “search for yield”. And from that begins a vicious cycle.
At such low rates, people and companies are discouraged from saving, since putting money in a bank would give them a return of next-to-nothing. So the money is “invested” in higher yielding assets - stocks, homes, cars (if available), and whatever, as Buffett describes it.
Banks usually have a set loan-to-value for collateralized lending - say for housing or against farmland. As these asset prices increase, so does the proportion of loans. Until at one point, the prices collapse and borrowers are left with loans that far outstrip the value of their assets.
Companies also find it cheaper to borrow and buy back stock rather than use the money for value creation. This leads to yet higher stock prices but, without the economic activity.
Most importantly, none of this is new ⤵️
Earnings of the Week
The forward 12-month P/E ratio of 18.5 on February 23 was below the five-year average of 18.6. In fact, this marked the first time the forward 12-month P/E ratio was below the five-year average of 18.6 since April 15, 2020 (18.4). - FactSet
The takeaway this week from earnings has been that comps are becoming challenging. Home Depot (HD) reported a top and bottom line beat yet, because they guided lower for the coming quarter, the stock fell more than 9%.
As we near the end of earnings season, I think this is a challenge that we will continue to face into the next season as liquidity conditions tighten and demand reduces. From everything we’ve been seeing over the last two years, the demand for goods has hit record levels, as people stayed home and spent money buying “stuff”. Much of that will begin to taper.
Services, on the hand, may start to pick up with a real re-opening of the economy. Although, Norwegian Cruise Lines (NCLH) missed both top and bottom line estimates, I’m still biased towards the long side on this one.
I haven’t had a chance to look at any of the earnings in detail this week with everything going on in the market. The only thing I read was Warren Buffett’s letter and I’ll be spending the next couple of days going through the annual report. Other than the fact that I’m a big Buffett fan, I think Berkshire Hathaway represents a unique collection of amazing businesses and there’s always so much to learn from their reports.
I leave you with a few quotes from Buffett’s letter on Berkshire’s performance:
Berkshire owns and operates more U.S.-based “infrastructure” assets – classified on our balance sheet as property, plant and equipment – than are owned and operated by any other American corporation… At year end, those domestic infrastructure assets were carried on Berkshire’s balance sheet at $158 billion.
Berkshire pays roughly $9 million daily to the Treasury [in taxes]
Berkshire’s total float has grown from $19 million when we entered the
insurance business to $147 billion.
It’s important to understand that only dividends from Apple are counted in the GAAP earnings Berkshire reports – and last year, Apple paid us $785 million of those. Yet our “share” of Apple’s earnings amounted to a staggering $5.6 billion.
[BNSF] Railroad had record earnings of $6 billion in 2021.
BHE [Energy], our final Giant, earned a record $4 billion in 2021. That’s up more than 30-fold from the $122 million earned in 2000, the year that Berkshire first purchased a BHE stake. Now, Berkshire owns 91.1% of the company.
[Total Equity Investments as of 31 Dec 2021 stood at $350.7B (and had a cost basis of $104.6B).]
Float per share… increased during the past two years by 25% – going from $79,387 per “A” share to $99,497, a meaningful gain that, as noted, owes some thanks to repurchases.
During the past two years, we therefore repurchased 9% of the shares that were outstanding at year end 2019 for a total cost of $51.7 billion. As of February 23, 2022, since year end we repurchased additional shares at a cost of $1.2 billion. Our appetite remains large but will always remain price-dependent.
Around the Markets
Changes to the S&P Indices:
Molina Healthcare to be added to S&P 500; Range Resources to join S&P MidCap 400; Golden Entertainment to join S&P SmallCap 600
Molina Healthcare (MOH) will replace IHS Markit (INFO) in the S&P 500.
S&P SmallCap 600 constituent Range Resources (RRC) will replace Molina Healthcare in the S&P MidCap 400.
Golden Entertainment (GDEN) will replace Range Resources in the S&P SmallCap 600 effective prior to the opening of trading on Wednesday, March 2.
S&P 500 constituent S&P Global (SPGI) is acquiring IHS Markit in a transaction expected to be completed on February 28.
The Week Ahead
TUE, March 01, 2022 - ISM Manufacturing Index + Construction Spending
WED, March 02, 2022 - Beige Book; ADP Employment
THU, March 03, 2022 - ISM Non-manufacturing Index; Factory Orders
FRI, March 04, 2022 - Jobs Friday- Non-Farm Payrolls; Unemployment Data
It’s never dull in the markets. Next week, we’re already in March and with the first Friday of the month comes "jobs data”. We also have the release of the Beige Book next week, signifying we’re two weeks away from the Fed Meeting. This is the last set of jobs data before the meeting and while it's important, it definitely won’t have an impact on the Fed’s decision to raise rates. The Fed has long reached their unemployment goal and the only thing that matters now is inflation.
With the geopolitical situation, the markets will remain turbulent and people will keep taking bets on either side. Fund flow into the Russian Exchange-trade Fund $RSX reached an all time high and 26% of the float is now short, according to Bloomberg. Wheat has been soaring, along with Corn (which is a major export as well), Palladium, Natural Gas, and of course Oil. But, with every headline that comes out the market can change direction so, let’s stay sharp.
Here’s wishing you a good weekend and safe investing.
Ayesha Tariq, CFA
There’s always a story behind the numbers
None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have a long position in $SQ, $BRK-B as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.