This blog post originally appeared on RealMoney Silver on March. 2 at 8:25 a.m. EST.
From the hallowed halls in Omaha to the masters of the hedge fund universe in New York City, Mr. Market is humbling the greatest investors in history.
Many asset management franchises and investment managers with outstanding long-term track records are currently on their knees and cornered into risk-averse mode for fear of further investment losses or investor redemptions.
There are numerous reasons attached to the drubbing, including but not restricted to the major issues below:
- Economy -- a spiraling downturn in the world economy;
- Credit -- a still weak and clogged transmission of credit;
- Populism and political change -- an anti-capital President Obama;
- Structural -- ultra bear ETFs and momentum-based quant funds; and
- Structural (part deux) -- hedge and mutual fund redemptions.
In turn, the net worth of households, endowments, pension plans and other institutions have been caught by the dramatic descent in world share prices, contributing to the negative feedback loop for the economy.
"A lot of people were buying these stocks all the way down. Their models couldn't pick up what was garbage, so they couldn't adjust quickly enough." -- Bill King, Market Strategist, M. Ramsey King Securities
Almost no asset class in the equity universe has been spared in a synchronized downturn that has hit nearly every strategy,
Over the weekend, the single most successful investor over the past five decades, value investor Warren Buffett, issued his
shareholders, but what has transpired since year-end is even more interesting than what was contained in his annual missive.
But first, let me regress.
"John Maynard Keynes essentially said, Don't try and figure out what the market is doing. Figure out a business you understand, and concentrate." -- Warren Buffett
For nearly a year, I have
issues that I have had with the Buffett way. Many of
have been realized and have, arguably, contributed importantly to the recent drop in Berkshire Hathaway's book value and the halving of the company's share price since early 2008.
If current trends continue over the balance of the year, 2009 will mark the third annual drop in book value at Berkshire Hathaway since 2001.
"I used to be Snow White, but I drifted." -- Mae West
It has never been my intention to overly dramatize Warren Buffett's investment miscues nor was it my intention to understate his remarkable long-term investment achievements. Rather, it
my intention to underscore that his massive move in shorting the market (through a put derivative position on the world's major indices) represented a
As suggested in the analysis that follows, I estimate that Berkshire Hathaway has lost approximately $15 billion, before counting back the premium of $4.9 billion, on the sale of puts on the major indices.
"Not everything that can be counted counts, and not everything that counts can be counted." -- Albert Einstein
It was also my intention to question Buffett's analysis of the value of the assets that comprised the asset side of many of his investments in the financial sector and question, in turn, the foundation to his value investing style that seemed to rely so importantly on his perception of a discrepancy between inherent value and real book value relative to market value.
From my perch, the
(so dear to Buffett) perceived to have been protecting the businesses of some of his largest investments (especially of a financial sector kind) were, at the very least, threatened and, worst-case scenario, those moats have been flooded.
Stated simply, Buffett's investment strategy over multiple decades could either:
- have been abandoned by the Oracle of Omaha, owing to his reluctance to alter/sell off his strategic and principal holdings and maintain a tax-efficient portfolio approach; or
- have been influenced by his mistaken analysis of the changing competitive landscape facing some of his portfolio companies (in other words, the moat has been flooded!).
Now back to the present.
"The first rule of investing is don't lose money; the second rule is don't forget rule No. 1." -- Warren Buffett
According to Berkshire Hathaway's fourth-quarter release, book value dropped by $11.5 billion, or 9.6%, in 2008. According to my pal, Ram Partners' Jeff Matthews, this was the largest annual drop in book since Buffett began investing other people's money in 1956 and only the second year in which Berkshire Hathaway experienced a decline in book value.
What is surprising, though, is that through only the first two months of 2009, Berkshire Hathaway has already suffered its second worst drop in book value in history ($9 billion-plus!).
"Price is what you pay; value is what you get." -- Benjamin Graham
At year-end 2008, Berkshire's investment portfolio had an unrealized gain of about $12 billion, with a market value of $49 billion compared to a cost basis of $37 billion. As recently as year-end 2007, Berkshire Hathaway had an unrealized gain of $35 billion in its investment portfolio.
Stated simply, the potholes that began to appear in Buffett's investment portfolio in September 2008 have worsened during the first two months of 2009. Indeed, by my calculation, the market value of Berkshire's investment portfolio -- excluding recent preferred investments in
and so forth -- is down by almost 25%, or by an additional $12 billion, this year. So, despite decades of investing, the market value of Berkshire's investment portfolio has astonishingly returned to Buffett's cost basis of approximately $37 billion.
Below are my 2009 year-to-date estimates of the decline in value of some of Berkshire's largest individual equity holdings since the end of 2008:
- Wells Fargo (WFC) - Get Report -- $5 billion loss;
- American Express (AXP) - Get Report -- approximately $1 billion loss;
- ConocoPhillips (COP) - Get Report -- approximately $1 billion loss;
- Procter & Gamble (PG) - Get Report -- approximately $1 billion loss;
- U.S. Bancorp (USB) - Get Report -- approximately $1 billion loss;
- Coca-Cola (KO) - Get Report -- approximately $1 billion loss; and
- Kraft (KFT) -- approximately $1 billion loss.
In addition to the losses in Berkshire's investment portfolio, I calculate that the unrealized loss from the liabilities associated with the company's equity index put options ($35 billion notional),
if the put options expired on Friday
, would have produced an additional decline (and non-cash charge) of over $5.5 billion this year. This places the aggregate losses associated with Berkshire's foray into equity index put options at approximately $15 billion (before the $4.9 billion premium received).
In summary, that's a total theoretical pretax loss of about $17.5 billion on Berkshire's investment and derivative losses in only two months of 2009 vs. a consolidated shareholders' equity of $109.2 billion as of Dec. 31, 2008, down from $120.7 billion at year-end 2007. It should be noted, however, that the estimated $17.5 billion loss must be adjusted for taxes in order to develop a projected GAAP loss to Berkshire's book value. Using a 45% effective tax rate produces a $9.6 billion book loss for the first two months in 2009, not materially less than the full-year $11.5 billion hit to book value experienced by Berkshire for all of 2008.
On page 77 of his 2008 annual letter, Buffett estimates that consolidated shareholders' equity has taken an additional $8 billion after-tax loss since the end of 2008. I suspect that the $1.6 billion difference (from my $9.6 billion estimate and Buffett's $8 billion estimate) reflects the difference in the timing of Berkshire's calculation last week as its portfolio losses Thursday and Friday were sizeable.
This all speaks to my conclusion last year that Buffett's strategy miscues and style drift would, in the fullness of time, result in investors assigning a less-than-premium valuation to the investment component of Berkshire Hathaway, making the stock's valuation move closer toward most closed-end equity funds, which trade at a discount.
This already seems to be occurring as the $9 billion-plus reduction in book value year-to-date (excluding gains from operating businesses) compares to a $28 billion reduction in the market capitalization of Berkshire Hathaway.
"The rumors of my death have been greatly exaggerated." -- Mark Twain
Away from the dual impact of investment and derivative losses, it should only be fair to mention that Berkshire's operating results featured record fourth-quarter 2008 insurance and investment income. As well, 2008's non-insurance income was the best yearly toll ever; it represented one of the best relative years of performance in Berkshire Hathaway's operating divisions.
Today's low prices, painful though they may be, are the market's own shovel-ready stimulus. Before you know it, the stock market, and the residential real estate market, too, will be on their way back up again -- just don't ask when.-- Jim Grant, Grant's Interest Rate Observer
Bear markets end when
Despite the market carnage in general and at Berkshire Hathaway in particular, I am
over the past two weeks as:
elements of my checklist are starting to show more positive signs; and
market sentiment and, arguably, valuation are at negative extremes.
Two years ago, few saw the cracking foundation of credit, of the economy and our stock markets.
Here's the hard truth: Nobody knows when this recession will end. Economic forecasting is a dark art, and predicting when recessions begin and end is its weakest link. That said, my best guess is that growth will return in the fourth quarter of this year.-- Alan S. Blinder, Professor, Princeton University
Even fewer will see the seeds of recovery and anticipate a resumption of growth.
Similar to everyone else, I am terrified by the spiraling down in stock prices, but I have to make a judgment as to what degree of economic activity and what level of corporate profits the markets are now discounting.
My conclusion is that there are developing investment bargains, or, to borrow a phrase contained in Buffett's letter on Saturday, I am beginning to "feel like a mosquito in a nudist colony."
Nevertheless, regardless of my view, in an environment where the big boys are being annihilated and almost every investment strategy is being questioned, redefined and readjusted, we remain in a setting where most should err on the conservative side by keeping investment and trading positions at well-below-average sizes and maintaining that precious commodity called cash.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds were long General Electric, Wells Fargo and American Express, and short Kraft, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Long/Short LP.