Is Warren Buffett Inspiring a Rail Bubble?

NEW YORK (TheStreet) -- The Warren Buffett bubble in railroads has burst twice already; is it going to be punctured again before year-end?

That is the question being posed by UBS Investment Research, and which led to a downgrade on Union Pacific ( UNP), judged by UBS the most expensive stock in the rail sector.

The rail industry has outperformed the S&P 500 by 10% since Berkshire Hathaway ( BRK.A) announced its acquisition of Burlington Northern ( BNI) on Nov. 3.

The two previous Buffet investments triggered a spike in rail shares , which in turn was shortly thereafter followed by the rail sector giving back half of those gains.

Let's take a look at the movement of the major North American railroad stocks versus the S&P in the weeks following the two previous big Berkshire Hathaway ( BRKA) sector plays.

The first bubble began in April 2007, after Berkshire Hathaway revealed that it had amassed an initial 10.9% interest in Burlington. Burlington stock jumped 6.5%, and the rail sector went up 4% the day after the announcement. The rails proceeded to outperform the S&P 500 by 9.2% over the next 9 trading days.

However, on the subsequent eight trading days, the rail group underperformed the market by 4.2%.

What UBS analysts have dubbed the Buffet-inspired premium was in evidence again in October 2007.

Berkshire Hathaway filings showed that Buffet had taken his stake in Burlington above 15%. Again, Burlington shares rose 6% on the news, leading a same-day rail group rally of more than 5%, versus an S&P daily performance of 4.2%.

In an even more dramatic waning of euphoria, however, the rail group's outperformance last only one day, and the sector gave back 2.4% of those gains over the next week and a half.

The October 2007 bubble was smaller than original because the market had already digested Buffet's focus on the rail industry, and was skeptical about the potential for a full blown acquisition.smaller than the spike after Buffett's initial 10.9% investment in Burlington of April 2007."

Which brings us back to the original, provocative questioned posed by UBS: is the current Buffet-inspired bubble about to pop?

After Berkshire announced its intention to acquire 100% of Burlington on Nov. 3, the rail group (ex-BNI) same-day rally of 6% was just a warm-up for a two week rise of 16% and outperformance through Nov. 23 of close to 10%.

With Warren Buffet as stationmaster, is a rail disaster ahead, or is this all just a bunch of noise and it is full speed ahead for the sector?

Before answering this question, it might be a good idea to consider some of the reaction to the UBS analysis from institutional investors.

-- Reported by Eric Rosenbaum in New York.

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