As the stock market continues to make new record highs, value investors start to find fewer bargains and worry about the overvaluation of the market. We have had a lot of discussions about this. In principle, you can always find bargains in any market, but if as whole the stock market is overvalued, you might just be finding stocks that are relatively undervalued instead of truly valued.
GuruFocus hosts two overall market valuation pages. One is based on the ratio of total market cap over GDP. The other is based on Shiller P/E. The valuation indicator used by Warren Buffett is the percentage of total market cap (TMC) over the U.S. GNP. Since the actual difference between GNP and GDP is minimal, our stock market valuation based on the total market cap over GDP is a very good indicator. When the ratio is below 50%, the market is significantly undervalued. When the ratio is between 50% and 75%, the market is modestly undervalued. When the ratio is among 75% to 90%, the market is fairly valued. When the ratio is between 90% and 115%, the market is modestly overvalued. Otherwise, the market is significantly overvalued. As of today, the ratio indicates that the market is modestly overvalued and the expected future return is around 3% a year.
One question we were asked by users is whether we can use Gurus’ asset allocations as an indicator for the bullishness or bearishness of the Gurus. That is a good question. The first Guru we want to check is, of course, Warren Buffett.
We will use the asset allocations of Berkshire Hathaway (BRK.A)(BRK.B) as the indicator. We want to see whether Berkshire Hathaway’s asset allocations can reflect Warren Buffett’s thoughts about the market valuations. Is he bullish or bearish on the stock market? Are bonds a better investment to him? The data we have comes from annual and interim reports of Berkshire Hathaway. It is the quarterly data that ends on 3/31, 6/30, 9/30 and 12/31 each year. Our research is developed into four parts.
1. Percentage of Cash, Bonds and Stocks
Can we use the percentages of stocks, bonds and cash as an indication on the preferences of Warren Buffett’s asset allocations?
The above chart 1 shows the percentage of cash and cash equivalents, fixed maturity securities and equity securities in Berkshire Hathaway’s assets since 12/31/1995.
We point out that the relative percentages can be significantly affected by the prices of stocks and bonds. For instance, in the market crash of 2008, Berkshire’s stock holdings were down about 50%, which dramatically reduced the percentages of stocks. But in general, we can still see the preference of Warren Buffett at different periods.
Berkshire had the highest level of stocks in 1995, which was more than 80% of all. It stayed that way until 1998, when Buffett was worried about the overvaluation of the market and significantly increased Berkshire’s holdings in bonds (Fixed Maturity Securities). We all know that starting in the year 2000, bonds have delivered much better returns than stocks.
The percentage of equity securities declined significantly because of the financial crisis since 2007. His cash position went up greatly since 2000 and went down since 2005. From 3/31/2010 to 6/30/2011, his cash and cash equivalents’ position increased slightly.
Currently Berkshire has about 50% of its liquid asset in stocks. Cash and others are about 35%, and bonds are 17% — the lowest level since 1995.
Clearly Buffett is bearish on bonds. Is he bullish on stocks? Probably yes.
2. Cash and Cash Equivalents (Cash) to Total Shareholders’ Equity
We want to see if there is a clear pattern that Warren Buffett increased his cash and cash equivalents position during the financial crisis so as to minimize the potential dramatic loss resulting from equity securities. Here I use cash and cash equivalents divided by total shareholders’ equity.
From above chart 2, we can see that Warren Buffett reduced Berkshire’s cash positions dramatically in 2001 to 2002, when the tech bubble burst and he was finding bargains. He then steadily increased cash positions starting in 2003. In 2005 through 2006 he was saying that he had an elephant gun, but couldn’t find an elephant. The highest figure is 50.96% at the end of the first quarter of 2005. After that, Berkshire’s cash level declined and he invested in Bank of America and Goldman Sachs in the financial crisis, and bought Burlington Northern and Lubrizol afterwards. Most recently he deployed $12 billion in Heinz. Berkshire’s cash relative to equity is about 20% of the equity.
3. Fixed Maturity Securities (Bonds) to Total Shareholders’ Equity
From above chart 1 and chart 3, we can see during 3/31/1999 to 12/31/2002, Warren Buffett was very bullish on bonds as bonds were at 60% of Berkshire’s total equity. His bonds position started to decline from more than 40% of his assets allocation to around 20% as he bought more stocks. Starting 3/31/2007, Warren Buffett only slightly added more positions in bonds. Yet we can tell from his fixed maturity securities, as demonstrated on the above charts, it is likely that he is bearish on bonds now.
4. Equity Securities (Stocks) to Shareholders’ Equity
From above chart 1 and chart 4, we can see that Warren Buffett reduced Berkshire’s stock positions dramatically in 1998, indicating he was very bearish on stocks. He then steadily decreased cash positions and bought more stocks until 2003. After that, Berkshire’s stocks level went up a little bit to 56.95% at the end of the third quarter of 2008. There was another dramatic decline of stocks position from 9/30/2008 to 3/31/2009, probably because the stocks’ value shrunk during financial crisis. As of Dec. 31, 2012, Berkshire’s stocks relative to equity is about 45.13% of the equity, which is low relative to most of the time since 1995, but much higher than bonds and cash. It is likely that Warren Buffett is relatively bullish on stocks.
Conclusion: Warren Buffett is known for not caring what others do in the stock market. But from his asset allocations we can get some idea on where he is finding value among stocks, bonds and cash. Apparently he is bearish with bonds as the percentage of bonds is at the lowest level. As for stocks, he is relative bullish. Stocks are now his largest position relative to bonds and cash. And Berkshire has been buying more Wells Fargo, Davita, etc. For the details of what Warren Buffett is buying, go to Warren Buffett’s stock picks.