The Market Last Week: The global equity markets had a volatile week, starting on the wrong foot with a shockingly bad 4Q19 GDP report for Japan on Monday morning followed by Apple announcing that it would miss its 2Q guidance later that afternoon. In between the market gyrated, before growing concerns about the band-width of the Coronavirus began to dominate as the week drew to a close. Coronavirus is an issue that will simply not go away, regardless of the mortality rate, because it is extremely disruptive to economic activity wherever it surfaces. Investors seem to be waking up to this. Only the FTSE held its ground last week, with the Japanese and U.S. markets feeling the brunt of growing risk-off sentiment. The week looked like this (second to last column from the right) for the major global equity markets:
In contrast, the Shanghai market was up 4.1% last week, even with China being the epicentre of the Coronavirus. The optimism was based on an aggressive package of economic stimulus measures put in place by the Chinese government to brunt the effect of the virus on the slowing Chinese economy. To be fair, earnings have not been bad in the U.S. during this earnings season, and investors continue to buy dips. Nevertheless, I have a feeling this is going to be somewhat of a pivotable week as we digest the effects of the Coronavirus as it begins to dampen economic activity in countries other than China. (And as I write this, I see that the Italian stock market is opening the morning down 4% on Coronavirus effects on the Italian economy.)
Earnings – Last Week and What’s Ahead: With 437 of the 500 S&P 500 companies now reporting, 64.7% of companies have had positive earnings surprises according to Refinitiv, slightly more than average. The average earnings growth of those companies reporting has been 3.1%, and the forward-looking PE ratio of the S&P 500 is 19.2x, not unreasonable from a valuation perspective. The summary of last week’s earnings and where we stand during this reporting cycle is best summarised by Refinitiv in their report from February 21, found here. Below are a few companies that released earnings last week. The results from banks were not good, with HCBC starting the week with shockingly poor results. Two of the best set of results came from Avis Budget and Domino’s Pizza, and their shares rallied after both reported earnings that exceeded analysts’ expectations and turned in solid revenue growth.
📷 I am going to discuss the Berkshire Hathaway results, which were released on Saturday, in more detail below. Also, as mentioned in the opening section, Apple became one of the first - and certainly not the last - company to guide analysts down on its next quarter’s earnings as the Coronavirus slows the company’s retail sales and affects its iPhone supply chain in China.
This week some of the companies that will be releasing earnings include Home Depot, HP, Shake Shack, Macy’s, Lowe’s, Marriott, Wendy’s Best Buy, Beyond Meat, L-Brands and Toll Brothers.
Warren Buffet’s Letter to Shareholders: If you’ve never read Warren Buffett’s letter to shareholders which begins his annual report, then it is very much worth a read and you can find the 14 page letter here. Berkshire Hathaway released their annual report (beginning with Mr Buffet’s letter) and FY 2019 results on Saturday. Before getting into the letter, I would also urge you - if you are a shareholder - to attend one of the Berkshire Hathaway annual meetings in Omaha that normally occur in early May (this year on May 2). I went to the annual meeting three years ago, and it was an amazing weekend full of activities with the highlight being the nearly all-day shareholder meeting on Saturday. It was truly a “rock concert for investment nerds”.
Let’s get back to the shareholder letter and results. If you recall, BRK adopted new GAPP rules that required the company to mark-to-market their minority investments in companies like Apple, Coca Cola, JP Morgan, American Express and others in 2018, much to the chagrin of Mr Buffet. By having to recognise unrealised gains and losses in minority investments through the income statement in this way, Mr Buffet believe that this introduces tremendous bottom line volatility (which it does), and therefore masks the underlying operating trends of the company. However, Mr Buffet goes out of his way in his opening letter and in the footnotes to the financial statements to provide excellent disclosure and full transparency to shareholders about the company’s different buckets of earnings. The letter contains a good summary of the dividends from (and importantly to Mr. Buffet, the retained earnings of) listed companies in which Berkshire is a minority investor, and the operating earnings of both the company’s insurance and non-insurance companies separately. The letter goes on to discuss some of the key operating businesses of Berkshire Hathaway, specifically P&C insurance and utilities/power. Mr Buffet touches on some topics / issues that are fashionable at the moment, including “green energy” in the form of wind power in the company’s Iowa utility, and issues around corporate governance like board composition and need for a properly staffed Board to more aggressively challenge important corporate decisions. These are all part of nuggets of wisdom in Mr Buffet’s 14 page shareholder letter, and it is worth reading as Mr Buffet is arguably one of the best value investors out there but still has plenty of humility, admitting he and Mr Munger don’t get everything right. Of course, it is momentum strategies that are featuring at the moment, not value strategies, and Berkshire Hathaway shares have recently been underperforming the S&P 500 (11% in 2019 vs S&P 500 (including dividends) of 31.5%). Mr Buffet also touches in his letter on succession, a growing issue for some investors since Charlie Munger is 96 and Mr Buffet is 89. In spite of share underperformance in 2019, the company’s results are solid and, if for no other reason, impressive by their sheer size.
Operating profit (before unrealised mark-to-market income/losses): $24 billion
Net Income: $81.4 bln (including mark-to-market of minority investments in public companies)
Unrealised capital gains on minority investments: $53.7 ban
Cash spent on share repurchases: $5 bln (circa 1% of company’s shares)
Cash / liquid investments available on balance sheet at Y/E: $128 bln
And to close his commentary, perhaps one of the most interesting numbers that Mr Buffet highlights is that Berkshire Hathaway paid $3.4 billion in taxes in 2019, which is 1.5% of all corporate taxes collected by the US government in 2019. I find this amazing. Nevada Caucus / US Politics: Bernie Sanders surged to victory in the Nevada caucus on Saturday, with Biden and Buttigieg finishing second and third. Bloomberg was not on the ballot. Next up is the South Carolina primary on Saturday (29th), followed by the all- important Super Tuesday primaries (including CA and TX) on March 3rd. The momentum seems to be growing for Mr Sanders, but the path forward will be much clearer after Super Tuesday. In the meantime, there is yet another Democratic debate on Tuesday (Feb 25th) in Charleston, S.C. Mr Bloomberg certainly needs to do better in this debate than he did in the last, if he wishes to challenge Mr Sanders, Mr Buttigieg other candidates ahead of him in the polls. Economic date this week: This week in the US we have new and pending home sales data for January, along with inflation data and revisions to 4Q19 GDP (1st estimate was 2.1%, and consensus for revision is 2.1%). The U.K., U.S. and Eurozone all release consumer sentiment data, in addition to other data, during the week, which will be watched carefully by markets.