Warren Buffett (Trades, Portfolio), chairman and CEO of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and one of the most famous value investors of all time, is perhaps best known for his success in the stock market.
However, the Oracle of Omaha also has plenty of valuable advice in regards to other types of investments and economic policy in general. Due to his focus on “what is important and what is knowable,” he has been able to remain well prepared to take advantage of opportunities where they arise by never betting on things that cannot be known in advance.
For example, when Residential Capital filed for bankruptcy in 2012, Berkshire owned $900 million of the company’s debt. The conglomerate then entered the auction for the company’s assets; if Berkshire won the auction, it would be getting a good deal on the assets, and if it lost, the winner would purchase the debt for a higher price. Buffett ensured that no matter the outcome of the situation, his company would benefit.
In March, the U.S. Federal Reserve cut the target interest rate to zero to combat the economic fallout from coronavirus-related shutdowns. With no further ammo in its weapon of choice for propping up the economy, investors can’t help but wonder if negative interest rates are just around the corner. This seemingly counterintuitive quantitative easing measure was already implemented in Japan and some European countries a few years after the 2008 financial crisis, providing a precedent.
With the cards showing that interest rates will stay at zero or even dip into the negatives in the years to come, we can look to Buffett to see how the guru is preparing for the future rate environment – regardless of whether it goes negative or stays at or above zero.
Buffett’s views on negative interest rates
“It’s a crazy subject, it really is crazy… I’ve never tried to predict interest rates,” Buffett said in a March 2020 interview with Yahoo Finance. When asked how low he thought interest rates are going to go, he replied:
“I would say that’s the most important question in the world, and I don’t know the answer. If we knew the answer, it wouldn’t be the most important question."
In the interview, Buffett said there is no point trying to gamble on where interest rates will go next. Instead, investors should only rely on the things that they can know.
That is part of what makes diversification so important. If interest rates go higher, some companies will benefit, while others will be hurt. On the other hand, negative interest rates would be beneficial for some companies and detrimental for others. There’s also debt to consider; while positive interest rates benefit companies with low debt, negative interest rates reward companies with high debt and punish those holding money in savings.
“It does have the effect of making all assets more valuable,” Buffett said of negative interest rates in a CNBC interview in 2016, after Japan lowered its rates into the negatives as its economy struggled to grow nearly a decade after the financial crisis. The value of assets tends to adjust naturally with the economy and inflation. Given this, paying interest acts like gravity against most companies, while negative rates encourage them to borrow more and expand in order to collect the interest payments made to them by the issuers of the debt.
The reverse implication, of course, is that negative interest rates make cash less valuable. Any individual or business holding money in the bank is effectively paying other individuals and businesses to borrow their money. Thus, companies that need to maintain more cash than debt would be put in an awkward position. “Berkshire Hathaway is sitting with billions of dollars (of euros) in an insurance company that we have in Europe, and they will bear a negative rate. I mean, we would be better off if we had a big mattress in Europe that we could stick all this stuff in,” Buffett said, explaining how negative rates would act as a headwind to the insurance industry. “Why would you want to collect your receivables? It goes into a negative… you know, it distorts everything.”
Joining the debt splurge
One way to ensure ample liquidity in uncertain market conditions is to shore up on cheap debt by tapping into the markets of countries that already have negative interest rates. With a $128 billion cash pile at the end of 2019, Berkshire is not likely to be strapped for funds, but if the conglomerate is issuing debt, it most likely has a reason for doing so. In the yield-starved lands of negative interest rates, it is easier to find buyers for the bonds than it is in the U.S., where companies with investment-grade debt issued $117 billion in bonds during the first week of April alone, setting a new record.
After “a big one-two punch” from Covid-19 and the oil price war in March, Berkshire issued a 195.5 billion yen ($1.8 billion) debt offering, the biggest yen-denominated bond offering from a foreign company since September 2019, when Berkshire issued a 430 billion yen offering, the biggest yen-denominated issue ever by a foreign multinational business. The new 10-year notes were priced at 105 basis points, doubling the 50 basis points of the larger yen-denominated debt issuance from half a year ago.
Japan isn’t the only country with negative interest rates. In March, Berkshire issued a billion euros ($1.09 billion) worth of senior notes at an interest rate of zero percent, aiming to raise funds by offering some of the most “attractive” rates in the eurozone. The actual yield for the bonds comes out at 0.205% from issuance to the date of maturity in 2025. This may not look attractive in and of itself, but it is certainly better than paying for the privilege of owning debt that isn’t even guaranteed to be repaid.
One may claim that if negative interest rates are a possibility, it would make more sense for financially stable companies wo wait and see if this comes to pass before issuing debt. However, there are two main problems with doing this. For one, it makes the most sense to take on debt when you need the money for something. As Buffett said, focus only on what is knowable. The second problem is that there is a different set of complications that comes with an environment where you pay to lend money and get paid to borrow it, not the least of which is lack of supply. Just like companies with low credit ratings must pay higher interest on their bonds, not everyone would have access to the (likely limited) supply of negative interest debt issuance opportunities.
Takeaway
In the end, it is impossible to predict the future. As Buffett says, trying to profit off those predictions is a waste of time. Instead, investors should focus on “what is knowable and important.”
We know that some countries do have negative interest rates, an opportunity that Buffett identified and is using to take on cheap debt for Berkshire. We know that some companies would be helped and some would be hurt by negative rates, and vice versa. We know certain things about the companies that fall within our circle of competence, and we know the investment theses that we have developed. As for the rest, Buffett asks himself:
“Can I function without knowing that? Same way as predicting what business is going to do, or what the stock market is going to do, I can’t do any of those things. But that doesn’t mean I can’t do well investing over time."
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research or consult registered investment advisors before taking action in the stock market.
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