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Warren Buffett's Silent Warning: 147 Billion Reasons Investors Should Tread Cautiously

Motley Fool - Fri Sep 22, 4:06AM CDT

Since becoming CEO of Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B) in 1965, Warren Buffett has put on an absolute moneymaking clinic for Wall Street and everyday investors. As of the closing bell on Sept. 15, 2023, he'd led his company's Class A shares to an aggregate gain of better than 4,500,000% over 58 years, or nearly 20% on an annualized basis.

While riding the Oracle of Omaha's coattails has made investors a lot of money, what's invaluable about Warren Buffett is his willingness to share his investing philosophy. Investors can sift through decades of annual shareholder letters and countless hours of annual shareholder meeting discussions where Buffett has openly shared his thoughts on the stocks, America, and the U.S. economy.

Though Buffett is often very direct with his investment thoughts, such as when he described his top holding Apple as "a better business than any we own" during Berkshire Hathaway's 2023 annual shareholder meeting, some of his other meaningful actions can be quite subtle.

Warren Buffett at Berkshire Hathaway's annual shareholder meeting.

Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.

The Oracle of Omaha offers investors more than 147 billion reasons to be cautious

On multiple occasions as Berkshire CEO, Warren Buffett has preached an investment philosophy of never betting against America. He strongly believes that America's economy will steadily grow over long periods, and that high-quality businesses stand to benefit from this economic expansion. This buy-and-hold ethos is why brand-name companies like American Express and Coca-Colahave been fixtures in Berkshire Hathaway's portfolio for the past 30 and 35 years, respectively.

But investors will sometimes find that what Warren Buffett preaches over the long run, and what he does over shorter periods, may not always align.

For example, the Oracle of Omaha and his investment team have been net-sellers of equities since the beginning of October 2022. Over the past three quarters, Berkshire Hathaway has sold a net of:

That's $33.03 billion of aggregate net-equity security sales over the past nine months. What's noteworthy about this selling activity is that it's coming with Wall Street's three major stock indexes still well below their record-closing highs, which were set between November 2021 and January 2022.

However, this isn't the biggest eye-opener for investors. Berkshire Hathaway's growing cash position is of far greater interest.

Whereas a hearty cash position would normally be viewed favorably by investors, the eyebrows start going up when famed investor Warren Buffett becomes gun-shy about putting his company's capital to work. As of June 30, Berkshire's cash balance reached $147.4 billion. This somewhat steadily growing treasure chest provides a subtle yet clear indication to Wall Street and everyday investors that Buffett isn't seeing much in the way of value in the stock market right now -- and that's a potential reason for investors to tread cautiously.

Stocks aren't cheap, and that could be a problem

Keep in mind that when I say "tread cautiously," I don't mean pool your cash under the mattress and hide under a proverbial rock for the next couple of quarters. Even though Warren Buffett and his team have been net-sellers of stocks for the past nine months, they've continued to add to select existing holdings and/or take positions in new businesses. They're simply being more mindful of where they're putting their company's cash to work.

The fact is that Buffett and his investing lieutenants, Todd Combs and Ted Weschler, have every reason to be more careful with Berkshire's cash given that stocks aren't cheap.

The valuation metric that's of particular concern is the Shiller price-to-earnings (P/E) ratio for the benchmark S&P 500(SNPINDEX: ^GSPC). The Shiller P/E ratio is also commonly known as the cyclically adjusted price-to-earnings ratio, or CAPE ratio.

While a traditional P/E ratio divides a company's share price (or an index's value) into its trailing-12-month earnings per share, the Shiller P/E is based on average inflation-adjusted earnings from the previous 10 years. Focusing on a full decade's worth of inflation-adjusted earnings softens the impact of wild one-year swings in corporate earnings.

S&P 500 Shiller CAPE Ratio Chart

S&P 500 Shiller CAPE Ratio data by YCharts.

As of Sept. 15, the S&P 500's Shiller P/E closed at 30.59. For context, that's 79% above the Shiller P/E's historic average of 17.05, when back-tested all the way to 1870. But this variance from the mean isn't the biggest concern.

Over a 153-year period, there have only been six instances where the S&P 500 Shiller P/E has surpassed 30 during a bull market or meaningful bounce from a previous bear market. In the previous five instances, the S&P 500 and Dow Jones Industrial Average went on to lose between 20% and 89% of their value. We're currently witnessing the sixth such instance of the Shiller P/E parking itself above 30 since 1870.

If there's one thing the S&P 500 Shiller P/E can't do, it's time market downturns. When valuations become extended, they can stay that way for weeks, months, or even multiple years. However, an S&P 500 Shiller P/E ratio above 30 does suggest that a significant downturn of at least 20% is coming at some point in the future.

While Buffett and his team may not be using this exact tool to weigh stock valuations, Berkshire Hathaway's growing cash pile is a clear indicator that deals are few and far between at the moment on Wall Street.

A businessperson holding a stopwatch behind nine steadily growing stacks of gold coins.

Image source: Getty Images.

Patience has been a virtue for Warren Buffett and his investors

Given the Oracle of Omaha's phenomenal track record, some investors are bound to be disappointed by Berkshire's growing cash balance. Buffett opting to generate 5% annually from short-term Treasury bills is a far cry from the home-run, long-term investment gains investors are used to seeing.

At the same time, I'd encourage investors not to mistake Buffett's investment complacency as a sign of weakness or defeat. He's navigated his way through dozens of periods of uncertainty on Wall Street and, as noted, his track record speaks for itself. Being patient and relying on a simple numbers game has been a strategy that's paid off handsomely for Berkshire Hathaway and the company's long-term shareholders.

This "simple numbers game" refers back to Buffett's main thesis of not betting against America. Even though the stock market won't always offer amazing deals, the U.S. economy tends to grow steadily over time. This means corporate earnings are also moving higher over the long run -- and corporate earnings growth is what ultimately justifies higher equity valuations.

Though Warren Buffett, like the rest of us, will never be able to accurately forecast when stock market downturns will occur, he does know that bull markets handily outlast bear markets. Based on research from wealth management company Bespoke Investment Group, the average bull market for the S&P 500 (1,011 calendar days) since September 1929 has lasted approximately 3.5 times longer than the average S&P 500 bear market (286 calendar days).

Rather than trying to time when these normal and inevitable downturns will occur, Buffett has piled into and acquired predominantly cyclical businesses. These are companies that will ebb and flow in lockstep with the U.S. economy. While Berkshire Hathaway may take its lumps during periods of uncertainty, these choppy waters are always short-lived.

If history proves accurate once more and the stock market turns lower, Buffett and his team will have plenty of cash to deploy. If not, Berkshire's existing holding in cyclical businesses will thrive. It's a win-win scenario for Buffett and his long-term investors.

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American Express is an advertising partner of The Ascent, a Motley Fool company. Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway. The Motley Fool recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.

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