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Buffett’s Calling a Recession — and He’s Probably Right

The insurance and investment segments are in great shape, but the operating businesses are where Buffett expects things to slow.
Buffett letter 2023

I always look forward to the first Saturday in May…

And not just because of the Kentucky Derby — it’s also when Warren Buffett hosts the Berkshire Hathaway annual shareholders meeting.

I first made the trek to Omaha in 2014 to attend the meeting. If you’re a shareholder and haven’t been, I highly recommend it, especially since Buffett is turning 93 this year and his partner Charlie Munger is turning 99 next year. Sadly, time is ticking if you want to see the duo in action.

As always, this year’s meeting was full of great information. Yes, Berkshire is a huge insurance company with a massive investment portfolio. But inside Berkshire, there are huge operating businesses, and the performance of those businesses provides a great overview of how the U.S. economy is performing.

In short, if the economy is doing well, Berkshire is likely doing well.

While the insurance and investment segments are in great shape, the operating businesses are where Buffett expects things to slow.

This all translates to Buffett saying we’re in (or are soon to be in) a recession.

All About Inventory

According to Buffett, the U.S. economy just went through the “most extraordinary economic period since World War II.”

That’s a heck of a statement.

But it makes sense: The government flooded the system with stimulus money. The Fed added fuel to the fire with 0% interest rates. Everyone who owned a home refinanced their mortgage, dropping their mortgage payment substantially. That was stimulative. And, of course, the government handed out a ton of cash to individuals and businesses.

With all the extra cash, consumers bought “stuff.” Lots and lots of stuff, which depleted the inventory on hand at many retailers. In response, retailers bought as much inventory as they could get their hands on.

By the time a lot of that inventory arrived, consumers began to slow their purchases. The stimulus wore off, and unfortunately, retailers were stuck with all this inventory.

That’s where we are today.

According to Buffett, he expects earnings out of the operating businesses at Berkshire to be lower than before. A broad-based decline in earnings is one sign of a recession.

Is it time to sell stocks based on this? Of course not. We’re likely in a recession now. But it doesn’t appear to be a big one.

It will take time for businesses sitting on inventory to clear what they have — be it through sales, markdowns, or write-offs. That’s painful, but it also isn’t catastrophic. The stronger players, like all of Berkshire’s operating businesses, should survive.

One Berkshire Segment That’s Growing

As I mentioned, Berkshire isn’t just a bunch of operating businesses. It also has a massive investment portfolio.

This isn’t all just common stocks such as Apple AAPL , Chevron CVX and Occidental Petroleum OXY . It’s also a massive pile of cash.

Buffett remarked that this pile of cash — $120 billion or so — earned the company a whopping 0.04% in prior years. That pencils out to $50 million.

This year, with higher rates on short-term government bonds, that cash pile should see interest income grow 10,000%. That means Berkshire’s cash pile should generate $5 billion in interest income.

From $50 million to $5 billion… and all of it essentially risk-free.

Shareholders and the media bashed Berkshire for holding so much low-earning cash in years prior. Many were calling for the company to pay a dividend. (It didn’t.)

But now, it’s printing money… and in a low-risk way.

Despite declining earnings in its operating businesses, interest income will likely more than offset the decline. It’s truly a remarkable situation.

Commercial Real Estate

Another topic that stood out to me at the meeting was commercial real estate.

Munger’s point: “The country will get through it all right, but it’ll, as they say, involve a different set of owners.”

What he’s saying is that the existing owners will lose their property, likely handing it over to the banks.

I agree with his take. I wrote about beaten-down office stocks last month, which you can read here. Many of these properties, at current interest rates, are worth far less than the debt they carry.

And just like in the 2008 financial crisis, owners will decide to stop paying their mortgages and hand the keys back to lenders.

All this to say, Berkshire is a pretty safe investment here. The stock trades for around 1.4X book value per share. It has been an active repurchaser of its stock around (or slightly below) this valuation.

I own the stock and will continue to own it for the long term.

From an investment perspective, the idea of a recession is a lagging indicator. A recession is called by the National Bureau of Economic Research, typically many months after it’s occurred.

And markets recognize this.                                                                        

We’re probably in a recession. My response: So what?