Warren Buffett, the CEO of Berkshire Hathaway, made a surprising move that caught the attention of Wall Street. For the first time in 30 years, Buffett has held his highest level of cash, about $325 billion. This makes up roughly 30% of Berkshire Hathaway’s total assets.
Buffett’s company has had an impressive track record. Its stock price has climbed at a 19.8% compound annual rate between 1965 and 2023. This has substantially outpaced the broader market.
However, in the first three quarters of 2024, Berkshire sold $133 billion worth of shares in other companies. This is significantly higher than the $6 billion of stock it purchased. Buffett cited the possibility of a higher capital gains tax rate as a key reason for taking profits off the table.
But there may be more to the story. Selling a large chunk of stock and watching the cash pile up to a massive level could signal that Buffett is seriously concerned about the stock market’s current valuation. The Cyclically Adjusted Price-to-Earnings (CAPE) ratio is a widely followed valuation tool.
Buffett’s cautious cash accumulation
This metric adjusts the traditional price-to-earnings ratio by accounting for inflation and using the average of the previous 10 years’ earnings. Its goal is to smooth out bottom-line fluctuations.
Currently, the CAPE ratio is 37.9, significantly above its long-term average of 17.2. This suggests a 120% premium to that level. Historically, the CAPE ratio has shown a high inverse correlation with forward returns. Buffett and Berkshire Hathaway might indicate that adopting a more cautious approach is wise.
There is a possibility of disappointing stock market performance in the future. However, there is no strict rule that the CAPE ratio can’t continue to rise or that its elevated status always leads to poor returns. This becomes clearer considering the M2 money supply among the four major global economies (U.S., Europe, China, and Japan), which has doubled over the past 14 years.
Increased money in the financial system can support higher asset prices. Moreover, the popularity of passive investing means investors continue to buy stocks regardless of valuation. While taking cues from Warren Buffett is crucial, making accurate predictions is challenging, especially when market and economic dynamics are in flux.
A prudent approach remains to invest early and often with a long-term mindset.
