Buffet Exhibits Caution as Markets Embrace Greediness; Would This Wariness Signal a Warning for Investors?
The financial world has seen record-breaking heights this year, fueled by growing expectations surrounding artificial intelligence (AI) and its potential for countless businesses. However, while regular investors are snatching up shares, legendary investor Warren Buffett has remained mostly silent, selling more than buying.
Buffet, famously known as the Oracle of Omaha, has advised investors to be wary when others are overly optimistic, reflecting his conservative investing approach. Loss minimization is his primary goal, and AI might not fall under his area of expertise, which he considers before making investment decisions.
Should investors view Buffet's cautious stance as a warning sign in the current market climate?
Sky-high valuations aren't unusual
In the third quarter, Buffet continued his selling spree, and Berkshire Hathaway's cash reserves reached an astonishing $325 billion, up from $277 billion in the previous quarter. He's been offloading shares of Apple and Bank of America, two major holdings, and hasn't put the money to better use, leading to a substantial increase in the company's cash reserves.
Given the current market's inflated price tags, Buffet's restraint might not be entirely surprising. Investors would be wise to take note of the S&P 500 Shiller price-to-earnings (P/E) ratio. This metric measures inflation-adjusted earnings over a ten-year period. Presently, the ratio is considerably above its average since 2000. Previous instances of such high numbers have often been followed by substantial market drops the following year.
The Shiller P/E ratio was elevated in 2021. In 2022, the S&P 500 dropped by more than 19%. Similarly, the market experienced a significant dot-com crash in the early 2000s due to the tech bubble. Some value-conscious investors may worry about a similar scenario with AI stocks today. A significant percentage are currently trading at eye-popping multiples, such as Palantir Technologies with a staggering earnings multiple greater than 300.
An appealing option for cautious investors
Although the stock market's lofty valuations might be cause for concern, or even a potential crash, simply selling all of your stocks and withdrawing your funds may not be the best strategy. In a market downturn, some stocks will be hit harder than others. Those with more reasonable valuations could survive the storm better than those at exorbitant prices. Timing the market and waiting for the perfect moment to invest can result in missed opportunities.
An alternative approach for investors could be to consider exchange-traded funds (ETFs) focusing on value investments, such as the Vanguard Value Index Fund ETF Shares (VTV). With a minimal expense ratio of 0.04%, the fund mirrors the U.S. Large Cap Value index. The average holding in the ETF has an earnings multiple of just over 20, offering exposure to more reasonably priced stocks than the S&P 500's average multiple of nearly 26.
The top holding in the Vanguard fund is Buffet's own Berkshire Hathaway, representing 3% of the fund's total weight. Besides Buffet's company, investors will gain access to many other blue-chip stocks like UnitedHealth Group and Home Depot through the ETF. Historically, the fund has underperformed the S&P 500, but during a downturn, it could potentially be the smarter choice, considering the current inflated prices of growth stocks.
Prepare for an anticipated correction
While attempting to predict the market is risky, holding onto highly valued stocks could be even riskier because they become susceptible to a sell-off at any given moment.
When stocks are commanding high prices, expectations run high. Any hint of difficulty for the company could cause investors to jump ship. It's not always due to poor earnings reports, as downturns can occur at the slightest indication of trouble in the near future. As such, it's crucial to keep an eye on valuations and possibly allocate funds to cheaper stocks that could be less vulnerable during a downturn yet offer better prospects in the long run.
If you're unsure about which stocks to buy or sell, giving considerations to ETFs focusing on value stocks or similar types of investments could be a prudent choice.
In light of Buffet's selling spree and Berkshire Hathaway's record-breaking cash reserves, some investors might consider his cautious approach a warning sign in the current market climate, given the inflated price tags of many stocks. With the S&P 500 Shiller price-to-earnings ratio considerably above its average, investing in exchange-traded funds (ETFs) focusing on value investments, such as the Vanguard Value Index Fund ETF Shares, could be a wise choice for those looking to mitigate risk in the current market downturn.
