Warren Buffet’s annual shareholder letter is read by virtually every investment manager. Here are some excerpts:
Of course, the immediate future is uncertain: America has faced the unknown since 1776. It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful).
American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrial Average advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.)
Since the basic game is so favorable…it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it…
The country’s success…boggles the mind. On an inflation-adjusted basis, GDP per capita more than quadrupled between 1941 and 2012. Throughout that period, every tomorrow has been uncertain. America’s destiny, however, has always been clear: ever-increasing abundance.
If you are a CEO who has some large, profitable project you are shelving because of short-term worries, call Berkshire. Let us unburden you.
—Warren E. Buffett, annual letter to shareholders, March 1, 2013
First Quarter 2013 Perspective
Why Warren Buffett is bullish on stocks
As we enter the second quarter of 2013, this article summarizes market developments since the start of the year and shares my thoughts on positioning portfolios for the period ahead. First, a quick recap of the first quarter of 2013.
At the end of March, U.S. stock markets crossed the all-time high reached in October of 2007. This was due to an exceptionally strong performance that started the year following the agreement by U.S. Congress in early January to avoid the “fiscal cliff” that would have required dramatic reductions in spending and risked throwing the U.S. back into recession.
Three things worth noting about first quarter performance:
1. Driven by a strong start in January, global markets were up by almost 9% in the first quarter, led by gains in the United States of over 10%. One word of caution: Last year global markets were up by 12% in the first three months before giving back almost all of those gains in the second quarter, in large measure due to concerns about Europe.
2. On the topic of Europe, in spite of recent headlines regarding the bank crisis in Cyprus and continuing issues in Greece, the European market was up by 7% (in local currency) in the first three months of 2013. While Cyprus and Greece got the headlines, the large bulk of Europe’s economic performance will continue to be driven by the larger countries.
3. Canada continued to underperform the United States and global markets. Since the beginning of 2010, the Canadian market is up by about 15%; in that same time the United States is up by roughly 50%.
Here’s how first quarter performance looked:
|Monthly Returns – Local Currency||Canada||U.S.||Europe||Emerging Markets||World Markets|
Returns to month end, all in local currency, including dividends
Warren Buffett’s view: Stocks still offer value
Warren Buffett is generally considered the greatest investor of all time. From 1966 when he began running Berkshire Hathaway to the end of 2012, the overall U.S. stock market (including dividends) has returned an average of 9.4% annually. That means that $1000 invested in the US market in 1966 was worth just over $74,000 at the end of 2012. During that same time, the book value of Berkshire Hathaway increased by almost 20% per year, twice the U.S. market return. The result: That same $1000 invested in Berkshire Hathaway’s book value would have grown to over $5 million!
This is why Warren Buffett’s views are worth heeding. And that’s also why his annual letter to investors is awaited each year with such anticipation. Three key messages in this year’s letter:
1. Invest in “wonderful” businesses
Buffett is known for saying that he’d rather buy “a wonderful business at a fair price than a fair business at a wonderful price.” He’s written in depth about the competitive “insulation” that makes for a great business. In another well-known phrase, he’s said that he wants to buy businesses “so wonderful that an idiot could run them, because some day an idiot will.”
In this year’s letter, Buffett touched on Berkshire Hathaway’s investment in American Express (of which he owns almost 14%) as well as Coca-Cola, IBM and Wells Fargo, his other three big holdings in which he owns between 6% and 9%. In all four cases, he increased his stake in 2012; he quotes the Mae West line that “too much of a good thing is wonderful.”
2. Look past today’s uncertainty
Buffett addressed the uncertainty that preoccupies many members of the media and which has dampened the willingness of American business to invest. He points out that uncertainty has been a constant in the United States since 1776; the only variable is whether people ignore the uncertainty (which typically happens in boom times) or fixate on it.
Buffett continues to express confidence in the resiliency of American business, just as he did in his famous New York Times article in the fall of 2008 titled “Buy American – I Am” that appeared close to stock market bottoms during the uncertainty in the aftermath of the global financial crisis.
3. Stay in the game
In this year’s letter, Buffett addressed the temptation to, in his words “try to dance in and out (of the stock market) based upon the turn of tarot cards, the prediction of so-called experts or the ebb and flow of business activity.”
He went on to say that since the long-term outcome of investing in stocks is so overwhelmingly favorable “the risks of being out of the game are huge compared to the risks of being in it.”
In an interview that followed the release of his letter, Buffett reiterated his view that given that at some point interest rates will inevitably rise, stocks of quality businesses continue to offer good value relative to bonds, even in the face of the run-up in equity prices since last summer. He also repeated his skepticism about owning bonds saying that today “the dumbest investment is a government bond.”
Click here to read Warren Buffett’s entire letter to investors.
And click here to watch a nine-minute excerpt of the television interview that followed the release of his letter:
What this means for your portfolio
In my newsletter at the end of last year, I outlined some guiding principles in my approach to building client portfolios, three of which I repeat here. I’d be pleased to discuss these guidelines at our next meeting.
1. Adhering to your plan
With low stock valuations and the high risk in longer term bonds, early last year I recommended that clients increase equity allocations and especially global allocations. Given strong stock performance since the mid-point of last year, that has worked out well and I continue to advise that clients hold their maximum equity allocation. But strong performance by equities means that today certain clients are above the top of their equity allocation and below what is needed for fixed income. Where fixed income allocation is below our target, I have been recommending reducing equity weighting to bring portfolios back within their guidelines. This is primarily for clients close to or currently retired and withdrawing income. For anyone 5 or more years from retirement, maintaining a low fixed income and high equity allocation is still recommended. Regardless of what happens to markets in the short term, barring a significant change in your circumstances, you should stick to your longer term investment plan.
2. Diversifying portfolios
When building equity portfolios, I’ve always advocated strong diversification outside Canada. This helped my clients through most of the 1990s, then hurt them in the decade after 2000, then helped them again in the past three years.
Going forward, I have no idea whether the Canadian market will do better or worse than global markets, but I do know that we represent fewer than 5% of investing opportunities around the world. In addition, because of our resource focus Canada’s market will tend to be more volatile over time, than those of the U.S. and yes, even Europe. For those reasons, I continue to recommend geographic diversification of stock portfolios.
3. Focus on dividends and cash flow
The final principle relates to the role of cash flow from investments. Amid the uncertainty surrounding economic growth and equity returns, I continue to place a priority on the cash yield from investments. While the headlines talked about US markets hitting new highs in March, investors who reinvested their dividends saw their account values exceed the 2007 peak significantly earlier.
Dividends on equities in certain global markets continue to make these equities attractive. However, in some traditional high-dividend sectors, such as Canadian Financials, equities that pay steady income are expensive by historical standards and show signs of high being stretched.
Should you have questions about anything in this article or about any other issue, please feel free to give me or one of the members of my team a call and as always, thank you for the opportunity to serve as your financial advisor.