A few months ago, we pointed out that Warren Buffett, the so-called "Oracle of Omaha" said during the 100-year anniversary celebration of Forbes magazine that the "Dow will be over a million" over the next 100 years and "that is not a ridiculous forecast".
Of course, the second part of that statement was promptly ignored by the financial media, which churned out "shock and awe" headlines like "Warren Buffett Says The Dow Is Going Over One Million."
Without context, this might appear to be an incredibly bullish call. But Dow one million 100 years from now would actually represent a deceleration in the Dow's CAGR to 3.9% pre-tax, or closer to just 3% post-tax returns per year (assuming tax rates don't trend toward 100% during the intervening period). A more optimistic prediction (at least based on past performance) would be for the Dow to hit 140,000,000 in 100 years.
Well, we received another update on Buffett's long-term thinking on Friday when the Wall Street Journal reported that Berkshire Hathaway is holding more than $100 billion in cash or cash-equivalents - i.e. Treasury bills - on its balance sheet.
The company is doing this at great expense to shareholders (referring to the opportunity cost that comes with avoiding higher-yielding assets) and Buffett - who is expected to release his widely read annual shareholder letter this weekend - has vowed to find a better place to park this cash. Because of this conservatism, Berkshire is now one of the largest holders of Treasury debt.
However, Buffett has been promising to find a home for the cash for a few years now - which makes one wonder whether this is part of a deliberate strategy...
Berkshire has used its mounting cash pile to become one of the world’s largest owners of U.S. Treasury bills after struggling to find big companies to buy in recent years.
It held $109 billion in cash as of Sept. 30, up from $86 billion at the end of 2016 and more than double what it had at the end of 2006. Nearly all of that was invested in short-term bills, according to Mr. Buffett.
Berkshire has an outsize presence in the $2 trillion market for Treasury bills, a type of government debt that matures in a year or less. It held more bills around the end of the third quarter than large countries such as China and the U.K. It also had more at that time than the $13.5 billion held collectively by a group of 23 primary bond dealers that are obligated to underwrite U.S. government debt sales.
Berkshire’s holdings are big enough that when bond dealers need bills for a specific date, they will come to Berkshire and arrange a trade, Mr. Buffett said.
"We’re the ones they call. We’ve got the best inventory," Mr. Buffett said in a 2017 interview with The Wall Street Journal. "That’s a new sideline for us here."
"There’s no way I can come back here three years from now and tell you that we hold $150 billion or so in cash or more, and we think we’re doing something brilliant by doing it," he said at Berkshire’s annual meeting last May. "I would say that history is on our side, but it would be more fun if the phone would ring."
Berkshire's cash holdings swelled by $3.3 billion last week when Phillips 66 bought back 35 million shares.
This massive inventory of T-Bills, which is a sizable portion of all outstanding short-dated debt, may be causing some of the recently noted distortions in the bond market, where short-term funding costs have risen rapidly in the form of the Libor-OIS spread, which has jumped to the highest level in over a year.
Buffett has famously resisted handing out dividends to investors - but has said Berkshire would begin buying back stock if shares ever fall below 120% of book value. Both classes of Berkshire stock were trading at 165% on Thursday.
"He’s aware that [Berkshire’s cash] is not earning a high rate of return for shareholders," said David Kass, a professor at the University of Maryland’s Robert H. Smith School of Business and a Berkshire shareholder. "Paying out a special cash dividend, a one-time dividend at the discretion of management, makes some sense."
Berkshire earns revenue from holding and trading its Treasury bills, but the profit is minimal relative to its overall business operations. Berkshire’s head trader, Mark Millard, opted not to speak with WSJ.
WSJ also pointed out that other corporations with large cash piles prefer to hold higher-yielding assets like corporate bonds. But Buffett prefers to hold Treasury bills because they offer more liquidity during a downturn. Berkshire typically buys about $4 billion in Treasury bills every Monday at government auctions, or less than 4% of what the Treasury is selling, Mr. Buffett said on CNBC in January. He joked: “We’re very careful about how many we bid for.”
Buffett's probity famously allowed Berkshire to throw a life line (and secure desperation deals that proved to be extremely lucrative over the following years) to Bank of America, Goldman Sachs and General Electric.
But with so much cash on hand, Buffett would have wide latitude to take advantage of the next downturn, potentially positioning Berkshire - which hasn't bought a company since 2015 when it closed on Precision Castparts, its largest deal ever - to buy whatever's on its wish list at a substantial discount.
Could this really be Buffett hinting that, though he feels compelled to maintain his optimistic rhetoric in public, he's in reality bracing for the next crash?