Warren Buffett's Silent Warning: 128 Billion Reasons to Expect Stocks to Head Lower

For nearly 60 years, Berkshire Hathaway (BRK.A 1.39%) (BRK.B 1.53%) CEO Warren Buffett has been putting on a clinic for Wall Street. Since taking over the lead role for Berkshire Hathaway in 1965, he’s led his company’s Class A shares (BRK.A) to an annualized return of 19.8%, which doubles up the 9.9% total return, including dividends paid, of the benchmark S&P 500 (^GSPC 1.62%) over the same stretch.

Given this penchant for outperformance, it’s no surprise that new and tenured investors alike wait with anticipation for Warren Buffett’s annual letter to shareholders, as well as Berkshire Hathaway’s quarterly/annual filings and 13Fs. Pretty much anything that would give investors a clue as to what Warren Buffett is thinking and how he views Wall Street is something of interest to the investing community.

Warren Buffett at Berkshire Hathaway's annual shareholder meeting.

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

Warren Buffett’s silent warning to investors

A little over a week ago, Berkshire Hathaway released its fourth-quarter and full-year operating results, along with Buffett’s annual letter to shareholders. While the Oracle of Omaha’s annual letter was filled with the typical level of directness and wisdom we’ve come to expect over many decades, it was Berkshire Hathaway’s annual report that, arguably, stole the show.

For many decades, Warren Buffett has preached an unwavering message to not bet against America. He’s an investor who believes that great businesses will continue to grow in value over the long run, and that positioning Berkshire Hathaway’s investment portfolio to take advantage of the natural expansion of the U.S. economy will make him and his shareholders richer. Based on the 3,787,464% aggregate gain in Berkshire Hathaway’s Class A shares (as of Dec. 31, 2022) since he took over, it’s hard to argue against this assessment.

But what Buffett preaches over the long term doesn’t always align with his short-term actions. The biggest telltale can be seen in Berkshire Hathaway’s cash position. Between June 30, 2022 and Dec. 31, 2022, Berkshire Hathaway’s cash, cash equivalents, and Treasury securities grew from $105.4 billion to $128.7 billion. 

On one hand, Buffett and his investing team have made clear that they want to ensure Berkshire Hathaway is never strapped for cash. Having a healthy safety net of capital is important to the Oracle of Omaha and his investing lieutenants, Todd Combs and Ted Weschler.

On the other hand, Warren Buffett just gave investors more than 128 billion reasons to expect the stock market to head lower. Buffett and his lieutenants buy stakes in great businesses when they’re perceived to be at or below a fair valuation. With Berkshire Hathaway’s cash position growing more than $23 billion in six months, and the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite still well below their record highs, it’s a pretty clear indication that Buffett, Combs, and Weschler see minimal value in today’s stock market.

A twenty-dollar bill paper airplane that's crashed and crumpled into the business section of a newspaper.

Image source: Getty Images.

Time to pencil in a recession?

One of the clearest reasons stocks could give up their early-year gains is because a trio of recession-probability indicators are screaming that trouble lies ahead.

The first, the Federal Reserve Bank of New York’s recession-probability indicator, examines the difference in yield between the three-month and 10-year Treasury bonds. When the yield curve inverts — i.e., short-term bonds have higher yields than longer-dated bonds — bad things tend to happen. As of January 2023, the probability of a U.S. recession per the NY Fed stood at 57.13%.  Since 1966, anytime this probability has surpassed 40%, the U.S. had entered a recession within 12 months.

US ISM Manufacturing New Orders Index Chart

US ISM Manufacturing New Orders Index data by YCharts. Gray zones denote recessions.

There’s also the ISM Manufacturing New Orders Index, which is a subindex of the more popular U.S. ISM Manufacturing Index (also known as the “Purchasing Managers Index”). The ISM Manufacturing New Orders Index measures new industrial order activity. Readings are based on a scale of 0 to 100, with 50 representing a line-in-the-sand baseline. Any figure above 50 represents expansion in industrial orders, while a number below 50 implies contraction. Since the early 1950s, a figure below 43.5 has been a telltale warning that a recession is imminent. The January 2023 reading was 42.5. 

The Conference Board Leading Economic Index (LEI) concurs with the other two recession-probability tools that trouble is on the horizon. The LEI is composed of 10 economic inputs and reported as a six-month annualized growth rate. Though a slightly negative LEI can sometimes be nothing more than a benign warning, a decline of 4% or more has been a surefire tell of an impending recession since 1959. The December 2022 LEI came in at -4.2%. 

While the stock market has an extensive history of being forward-looking and bottoming out before the end of a recession is declared, the major indexes haven’t reached their nadir prior to a recession being declared since before World War II. In other words, if a recession is, indeed, imminent for the U.S. economy, history would suggest the current bear market isn’t over and hasn’t reached its bottom.

Thinking long-term has made Buffett (and his investors) a fortune

In recent years, Warren Buffett building up Berkshire Hathaway’s war chest and not deploying his company’s capital into new investments has been a precursor of rough times for Wall Street. But there’s a pretty sizable difference between guessing what happens over the next 12 to 24 months and having a rock-solid view of what the next 20 years might look like.

Even if the Oracle of Omaha and his investing lieutenants are a bit more reserved at the moment with Berkshire Hathaway’s capital, they’re very clearly optimistic about the future. Let’s not forget that Buffett’s company owns around five dozen (mostly cyclical) businesses, as well as oversees a nearly $328 billion investment portfolio, which is composed of dozens of cyclical stocks. In no way has Buffett thrown in the towel — even if the company’s rising cash balance suggests there aren’t many intriguing values at the moment.

Likewise, history is very much on the side of patient investors. According to data updated annually by market research firm Crestmont Research, patience has always paid off if you trust in the S&P 500. Crestmont’s analysis shows that if you, hypothetically, purchased an S&P 500 tracking index at any point since the beginning of 1900 and held on to that position for 20 years, you always made a positive total return, including dividends paid.

Best of all, most long-term investors made a substantial amount of money. You can count on one hand how many of the 104 ending years Crestmont examined (1919-2022) that resulted in an annualized total return of 5% or less. By comparison, more than 40 ending years produced an annualized total return over 20 years of at least 10.8%! 

While Warren Buffett’s silent warning to investors could lead to some amazing deals in the months and quarters to come, this long-term data should give investors the confidence to continue putting their money to work in the stock market.