From 2000-2003, Buffett invested in bonds more than any other security. In 1999-2000 the S&P soared to historical highs as the dot-com bubble reached its peak. From 1999-2000, the U.S. Federal Reserve raised 10-year Treasury bond rates six times in an effort to slow the economy.
“If government interest rates, now at a level of about 6%, were to fall to 3%, that factor alone would come close to doubling the value of common stocks.” Buffett wrote in a Fortune piece in 1999. “Incidentally, if you think interest rates are going to do that--or fall to the 1% that Japan has experienced--you should head for where you can really make a bundle: bond options,” From 2000-2002, the 10-year Treasury yield rates hovered around the 4%-6.5% range.
Berkshire Hathaway (BRK.A)(BRK.B) prefers to invest in equities or buy entire businesses with excellent economics, capable management and at sensible prices. When unable to do so, and when the bond rate is high, they consider bonds instead. Though Buffett has had some degree of activity in “junk” bonds throughout his career, he bought more than usual in 2001. Most notably, he began purchasing obligations of FINOVA Group in 2001, a distressed finance company, eventually accumulating 13% of its $11 billion of debt. In his 2001 investment letter, Buffett noted that “fat returns are nowhere to be found (at least we can’t find them).”
Buffett was also beginning to favor stocks again in 2001. That year, in his second piece for Fortune as the market was plunging from the dot-com bubble, he wrote that, “Today stock market ‘hamburgers,’ so to speak, are cheaper. The country's economy has grown and stocks are lower, which means that investors are getting more for their money. I would expect now to see long-term returns run somewhat higher, in the neighborhood of 7% after costs,” he said.
By the time the stock market was picking up in 2003, Buffett said that the market for bonds no longer looked good, but that he would load up on the securities if they became attractive again. “Yesterday’s weeds are today being priced as flowers,” he said.
Buffett began selling out of bonds at the beginning of 2003, when interest rates began falling closer to 3%-4%.
By 2004, Buffett was moving away from bonds and the stock market, even though the S&P had fallen significantly, keeping most of his funds in cash. The problem was that Buffett continued to find no attractive securities or businesses to buy. As a result, he had $43 billion in cash and cash equivalents in 2004.
“My hope was to make several multi-billion dollar acquisitions that would add new and significant streams of earnings to the many we already have. But I struck out,” he said. Berkshire’s per-share book value that year gained only 10.5%, falling short of the S&P’s 10.9%.
His career-high cash holdings peaked by the middle of 2005, approaching $50 billion or 30.4% of his portfolio, and his stock holdings had shrunk to 29.0% from 51.2%. His bond holdings had dwindled to 16.0% from 33.3% in 2000. Part of his decreasing equity percentage had to do with the sell of several large stakes in companies such as Walt Disney (DIS), Freddie Mac (FRE) and Travelers.
Additionally, at the time Berkshire had grown so large that stock investments comprised a far smaller percentage of Berkshire’s net worth – from 114% in the 1980s to less than 50% in the early 2000s. Berkshire made several acquisitions from 2000 to 2003, including food distributer McLane and manufactured housing maker Clayton Homes.
During this time, the value of his stock holdings increased in step with the S&P’s trek upward until its crash in 2008.
Buffett’s cash and bond holdings inverted at the outset of the market crash in 2008 – he went back to bonds and held more of them than cash.
The value of his stocks declined sharply as he made several major missteps, in addition to the general free-fall of the market in 2008. He bought large amounts of ConocoPhillips stocks at the peak of oil and gas prices, just before energy prices plunged. He also suffered an 89% loss on shares of two Irish banks affected by the crash.
As far as bonds and cash, he began moving away from them in 2008, saying that, “Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.”
The credit crisis afforded Buffett the opportunity to make investments he had been looking for over the last several years. The terms of the deals were better than any that could be expected during favorable stock market conditions. In the mid-2008, Berkshire began owning positions in non-traded securities of Dow Chemical (DOW), General Electric (GE), Goldman Sachs (GS), Swiss Re and Wrigley with a carrying value of $26.0 billion. The five positions returned the company dividends and interest of $2.1 billion annually.
“Our ability to come up with cash when the rest of the world was petrified for some reason has allowed some deals to get done,” Buffett said at the 2011 Berkshire shareholder meeting in a comical understatement.
Buffett invested $5 billion in preferred shares of Goldman Sachs, which paid a 10% dividend, at the height of the credit crisis. He also purchased warrants allowing him to buy an additional 5 billion shares of common stock at $115 a share. The investment paid off in the second quarter of 2011, when Goldman redeemed the shares and paid Berkshire a $1.6 billion profit.
He managed another profitable deal with General Electric Co. when it was in dire need of capital just a week after the Goldman investment. Buffett bought $3 billion of preferred GE stock with a 10% dividend and the option to purchase $3 billion more common shares at a strike price of $22.25 over the next five years. Several months after his investment, GE slid to $7 per share and now trades at $18.78, having not yet met Buffett’s strike price.
Buffett then bought a 3% stake in Swiss Re, the largest reinsurance company in the world, under the conditions that he get a fifth of all premiums from the company’s property and casualty insurance over the next five years. When Swiss Re offered to pay back the loan in Nov. 2010, before the deadline, he made a $1 billion profit.
Berkshire’s allocations in stocks dipped slightly in the first quarter of 2010 due to the completion of its purchase of Burlington Northern Santa Fe, of which it had been acquiring shares since 2006. The acquisition also accounts for the correlating dip in cash – the transaction amounted to $22 billion.
Berkshire recovered the cash quickly, and at yearend held $38 billion of cash equivalents. Buffett anticipated that the cash would remain where it was, waiting for better rates to return, unless an opportunity with decent returns came along. “Our elephant gun has been reloaded, and my trigger finger is itchy,” he said in his 2010 shareholder letter. In March of 2011, he found his target and acquired fuel additives maker Lubrizol (LZ) for $9 billion.
Of the near future of the current swelling market, Buffett gave the sage advice, “No matter how serene today may be, tomorrow is always uncertain…Don’t let that reality spook you.”