Warren Buffett spent $7 billion to $8 billion on positions in Delta Air Lines, United Airlines, American Airlines, and Southwest Airlines. In 2021, as the scale of the Coronavirus-induced lockdown became apparent, the Oracle of Omaha, Warren Buffet sold all his airline stocks. This was no casual decision, Buffet has said that his favorite holding period is “forever” and his strategy is to buy companies, milk them of cash, pay no dividends, and compounds his returns by holding.
Why did Warren sell? Well, you don’t have to be an investing genius to see any virus that stops global commerce will affect business travel and thus reduce revenues flowing to airlines, thus airlines stock prices were going to fall. Buffet got out to avoid a diminution in the value of his position.
At the 2021 Berkshire Hathaway Annual Shareholders meeting Buffet said he diverted so the airlines would find it easier to get the CARES Act government funding, ok but the story is not about Buffet but about what happened when he sold.
Usually, Buffet buying a stock is a stamp of approval on that stock, ditto when he sells. When Buffet sold in May 2020, the shares of the US-based airlines tumbled with American Airlines falling 7.7%. After Buffet sold, stock of the airlines rose in April as retail investors bet against the judgment of Buffet.
Was Warren Buffet wrong?
Let us take a look at another example. Hertz filed for bankruptcy in May 2020, meaning that its stocks became worthless, its shares kept falling to as low of $0.40, yet its stock appreciated in price to a high of $6.00 as retail investors (again), many of them on Robinhood, pumped up purchases on this stock because it was rising in price, in essence creating a self-fulfilling buying hurricane and pumping up a stock worth zero. The higher prices were trailed by even higher demand.
Were the retail investors naïve? No, they understood the risk when Hertz tried to take advantage of the demand by selling new shares with this clear warning: “we expect that common stockholders would not receive a recovery through any plan unless the holders of more senior claims and interests, such as secured and unsecured indebtedness are paid in full.”
So what’s going on? Is investing dead? We can argue that retail investors bought into Airlines because they were aware the US government would rescue the airlines with a package worth billions. They also anticipated that the stock price having fallen so low represents a discount to the existing price. They were buying low to eventually sell higher.
Why would retail investors buy a bankrupt company? It appears the rules of investing have evolved from buy low to sell high, to buy high to sell higher.
The price of any stock used to be the discounted present value of all future earnings, thus if I say the price of Zenith Bank today is N20, I am stating that if I take all earning of Zenith Bank from the future and discount them back to today using an agreed discount rate, I will arrive at N20. The P.E. relates the price of the stock to the earning and is often looked at as a measure of how expensive the stock or market is when compared to earnings. The PE of the US markets as measured by the Schillers CAPE valuation is at 36.6. this represents the second-highest level, since 1890. CAPE looks at the last 10 years of earnings adjusted for inflation.
Investing was a “simple” exercise in seeking to determine the intrinsic value of a stock, using fundaments such as market share and earning and then buying if intrinsic value is less than the market price and vice versa. Not anymore!
This goes far beyond traditional assets, there is an uptick in selling prices of alternative assets such as NFT and cryptocurrencies, with cryptocurrencies like Dogecoin up 675% in 3months.
So is investing dead? Not yet. The issue is liquidity, excess liquidity in the US. The average retail investor has seen two stimulus cheques from the US governments and interest rates at record lows. This means the average US investor has an incentive to take on more risk to earn above safe fixed income yield. Another driver is the record appreciation in home prices, especially in the suburbs. Many American homeowners can take “equity” (difference between home value and mortgage, if any) from their homes at record low rates and invest. This excessive liquidity is looking for where to “park” and is showing up on heightened valuations aka “bubbles.”
In Finance, there is a theory called the Greater Fool theory, where prices can keep rising as long as the current holder of any asset can sell that position to another investor at higher prices. The new holder then sells to a new investor at a higher price and so on. We are watching that right now.
In the long run, the market will correct, and valuations will again reflect earnings, the trigger will be the decoupling of the US Federal Reserve from bond-buying and the rise in yield which signals inflation. My advice to any investor is to ensure that when the market corrects, you are vested in quality assets.