"Buffett Metric" Does NOT Say It Is Time To Buy $$

So, there is a chart and a story going around regarding Berkshire’s (BRK.A) Warren Buffett that just does not jive to me. Hat Tip to “Davidson” for pointing bringing it to my attention..

First, here is the chart:

Here is the story that follows:

Fortune Magazine) — Is it time to buy U.S. stocks?

According to both this 85-year chart and famed investor Warren Buffett, it just might be. The point of the chart is that there should be a rational relationship between the total market value of U.S. stocks and the output of the U.S. economy – its GNP.

Fortune first ran a version of this chart in late 2001 (see “Warren Buffett on the stock market“). Stocks had by that time retreated sharply from the manic levels of the Internet bubble. But they were still very high, with stock values at 133% of GNP. That level certainly did not suggest to Buffett that it was time to buy stocks.

But he visualized a moment when purchases might make sense, saying, “If the percentage relationship falls to the 70% to 80% area, buying stocks is likely to work very well for you.”

Well, that’s where stocks were in late January, when the ratio was 75%. Nothing about that reversion to sanity surprises Buffett, who told Fortune that the shift in the ratio reminds him of investor Ben Graham’s statement about the stock market: “In the short run it’s a voting machine, but in the long run it’s a weighing machine.”

Not just liking the chart’s message in theory, Buffett also put himself on record in an Oct. 17 New York Times op-ed piece, saying that he was personally buying U.S. stocks after a long period of owning nothing (outside of Berkshire Hathaway (BRKB) stock) but U.S. government bonds.

He said that if prices kept falling, he expected to soon have 100% of his net worth in U.S. equities. Prices did keep falling – the Dow Jones industrials have dropped by about 10% since Oct. 17 – so presumably Buffett kept buying. Alas for all curious investors, he isn’t saying what he bought.

To examine this we need to go back the beginning.

One must remember that in the late 1960 Buffett closed the “Buffett Partnership” because at that time he felt “there were no values” in the general stock market. Yet, according to both the chart above and the story, Buffett would have been buying at this time.

If we fast forward to the mid 1970’s, a time when Buffett said he felt like “a guy in a whorehouse with a suitcase of cash” because stocks we so cheap, we see the above charts value level was actually below 50%. In fact, most of the largest positions in Berkshire’s portfolio, American Express (AXP), Coke (K), Gillette now PG (PG) and The Washington Post (WPO) were accumulted during this time. In fact, Buffett’s buying continued through the 1980’s and until the mid 1990’s when he then found equity values were overpriced, refrained from buying during the tech bubble and was called “out of touch” (he was later proven very right).

Again, looking at the chart we see during that at this time frame the chart values had crept back to the 75% level of the mid 1960’s when Buffett was a seller.

What is inmportant to note and what has been lost in the “Buffett is buying rhetoric” is that Warren’s three largest recent investments, totaling roughly $10 billion, Dow Chemical (DOW), GE (GE) and Goldman Sachs (GS) were NOT stocks purchases, they were preferred investments.

Essentially Buffett is betting their share prices will all rise, in the next 3 to 5 years, when the convertibles convert to common stock. Until then, he has a bond paying 10%. With Treasuries paying essentially nothing, Buffett has found a vehicle that pays 10% to park his cash.

Did Buffett pen the link article above? Yes. To be sure Warren is buying an interest in US companies as witnessed above, just not their common stocks (except Burlington Northern (BNI)).

Buffett’s preferred purchases are not an endorsement of cheap US equities, if anything it says he would rather be a bondholder than an equity one……for now.

Disclosure (“none” means no position):Long Dow, GE, none

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