Stocktake: Buffett’s best days are gone

There's been much chatter lately as to whether Warren Buffett may have lost his touch. Much of the debate centres around Kraft Heinz, with Buffett last week admitting he overpaid for the troubled stock – Kraft shares lost a third of their value last week – after Berkshire Hathaway took a large stake in 2015.

Buffett has made other well-publicised mistakes in recent years. In 2011, he bet big on IBM but it didn't work out, Buffett dumping his remaining shareholding in the fading tech giant last year. His investment in Tesco stock was, he admitted in 2014, a "huge mistake".

Everyone makes mistakes, of course, and Buffett shouldn't be excoriated for occasionally getting things wrong. However, Buffett has been finding it increasingly difficult to beat the markets for some time now. Drew Dickson, founder of London-based Albert Bridge Capital, notes Berkshire's share price has "broadly mimicked the S&P (underperforming a little)" since the end of 2002.

That’s over 16 years ago – long enough to suggest Buffett’s glory days are not coming back.

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Is a trade breakthrough priced into stocks?

It seems every day stocks advance. It’s because of optimism over US-China trade talks. Given the S&P 500 has already gained 11 per cent in 2019 and China’s Shanghai Composite soared 14 per cent in February alone – more than any other major equity index and its widest outperformance relative to global indices in four years – is optimism over trade talks now completely baked into market prices?

If so, stocks might sell off in the event a breakthrough is announced, a classic “buy the rumour, sell the news” reaction. However, a deal is not completely priced in, according to recent analysis from Renaissance Macro Research. It estimates the S&P 500 has gained 107 points this year due to trade positivity but that’s not nearly enough to cover trade-related losses in 2018.

In total, trade woes have sliced some 300 points off the index’s value, it says, suggesting the S&P 500 would be about 11 per cent higher if the issue had not blown up in the first place.

Recent Bank of America analysis echoes this, but some caution is warranted. Renaissance’s figures are based on analysis of market headlines, but headline writers must simplify often unknowable market movements. “Stocks gain on trade hopes” might be the morning headline, only to be replaced by “Stocks slip as trade fears return” in the evening.

For what it’s worth, Stocktake’s best guess is stocks have room to keep rising, but it’s best not to be overly precise – markets are messy and it’s painfully difficult to divine exactly what’s priced in and what’s not.

Stubborn stock markets hold on to gains

Overbought stock markets stubbornly held on to their gains last week, remaining at the upper end of their recent trading range. This “extreme persistence” is now at historic levels, notes Quantifiable Edges blogger Rob Hanna, with the S&P 500 having gone 37 straight trading days since it closed below its short-term 10-day moving average.

That’s freakishly long – there have only been two equivalent runs over the last 46 years, prompting Hanna to caution that stocks are “well overdue a pullback”.

Nevertheless, Stocktake has pointed to several indicators in recent weeks suggesting any weakness will be short lived, and the data continues to indicate as much. The S&P 500 climbed in January and again in February and that’s good, according to LPL Research – during 27 previous instances since 1950, stocks climbed over the remaining 10 months of the year 25 times, averaging gains of 12.1 per cent.

Now, 2019 might well be different to most of those years – stocks may have posted small January-February gains in many previous instances, whereas they have soared 11 per cent in the first two months of this year and the Dow Jones Industrial Average has gained nine weeks in a row. Still, other periods of extreme strength suggest little cause for concern. LPL found 15 previous instances where stocks gained nine weeks in a row; a year later, stocks enjoyed median gains of 18 per cent.

Investors should make room for emerging markets

Emerging markets are cheaper than developed markets but that's not the only reason to add them to your portfolio, according to the new Credit Suisse Global Investment Returns yearbook.

The yearbook, co-authored by market historian and London Business School professor Elroy Dimson, notes the average emerging market (EM) is a volatile beast but this volatility is muted by buying a basket of EM countries. More importantly, EM brings obvious diversification benefits. European and developed market stocks look cheaper than US assets, but the two are highly correlated – when the US falls, the others tend to follow. In contrast, EM are roughly half as correlated with the US as developed markets. If you're concerned your portfolio is too exposed to a pricey US market, then emerging markets appear better diversification candidates than their developed market counterparts.