Berkshire Hathaway is flush with cash! Funds pouring into the leveraged market, is an irrational boom bubble coming?

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Warren Buffett, the stock god, announced last week the stock holdings of his Berkshire Hathaway Inc. with cash reserves reaching a new high. However, with a large influx of funds into the leveraged market recently, will this surge lead to an irrational prosperity in the final stage? What hints does Buffett's cash position give us?

Buffett Indicator is at a historically high level, and the cash position reaches a new high.

Buffett, who is now 94 years old, remains cautious in investing. At Berkshire Hathaway's annual shareholders meeting in May, he expressed his willingness to invest but also emphasized that finding attractive investment opportunities is not easy.

Warren Buffett mentioned in an interview with Forbes in December 2001: the ratio of total market value to GDP can be used to judge whether the overall stock market is too high or too low, so it is widely known as the Buffett indicator. This indicator can measure whether the current financial market reasonably reflects the fundamentals. Buffett's theoretical index indicates that 75% to 90% is a reasonable range, and exceeding 120% indicates an overvalued stock market. According to the chart of Finance M Square, the Buffett indicator has been at a high level for a long time since 2016, and the current value is 205%.

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The cash reserve of Berkshire Hathaway's third quarter reached US$325.2 billion, and for the first time since the second quarter of 2018, the company did not repurchase its own stocks. The cash reserve is almost twice the company's year-end cash balance and the largest cash reserve ever accumulated by Buffett.

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The relationship between Berkshire Hathaway's cash position and the market

According to Bloomberg, over the years, Berkshire Hathaway's cash allocation as a percentage of the company's assets has varied greatly, from 1% in 1994 to nearly 28% today, as well as various situations in between. Records show that as stock valuations rise during prosperous periods, Buffett continues to increase Berkshire's cash allocation—thereby reducing expected returns—and reduces cash when opportunities arise.

For example, during the late 1990s dot-com bubble, as valuations soared, Buffett increased the proportion of cash in his portfolio from 1% four years earlier to 13% in 1998. However, in 1999 (about a year before the bubble burst), he reduced the cash allocation to 3%, probably because he found an attractive target. In hindsight, he might have been better off holding onto that cash for another year when bargains became plentiful, but even the great Buffett couldn't see the turning point. Nevertheless, he did one thing right, which was deploying almost all of Berkshire's cash during the economic downturn.

Then, he shifted again before the outbreak of the financial crisis in 2008. After the market rebounded in 2002, Buffett began to significantly increase his cash allocation, eventually reaching 25% of his assets in 2005. However, the impending crisis led to a big dump in stock prices starting in late 2007, prompting Buffett to use his cash and ultimately reduce the cash-to-assets ratio to 7% in 2010, partially due to his shrewd investment in Goldman Sachs Group Inc.

Bloomberg Opinion columnist Nir Kaissar believes that Warren Buffett is betting on a simple principle: valuation and future returns are inversely proportional. In other words, when assets are expensive, future returns tend to be lower, and vice versa.

The price-to-earnings ratio of the S&P 500 index is approaching historical highs.

The largest fund management companies including BlackRock, Vanguard, Goldman Sachs, and JPMorgan all expect that the future US stock market will be far lower than the historical return rate of 9% per year over the past 150 years.

The current forward price-earnings ratio of the S&P 500 index is 25 times, close to historical highs, while the average price-earnings ratio since 1990 is 18 times.

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Experts calculate that the expected return of the S&P 500 index in the next 10 years is about 4%, which is not much different from the risk-free yield of 4.4% for a three-month Treasury bond. Buffett's increase in cash reserves (mostly short-term Treasury bonds) has strengthened his prudent allocation and is not too surprising.

A large amount of funds pouring into the leveraged market

On the other hand, on the speculative edge of Wall Street, the frenzy of adventure is growing. This week, including MicroStrategy, a self-proclaimed BTC development company, and related high-risk leveraged ETFs, the volume reached 86 billion US dollars, reaching a new historical high. MicroStrategy's stock price rose by 24% in a single week, and a total of 420 million US dollars flowed into two leveraged funds based on the company.

Matt Tuttle, CEO of Tuttle Capital Management, who operates one of the funds, said this week that he has purchased a series of MicroStrategy stocks through leveraged ETFs. His market maker had to buy more stocks to hedge the position. 'Look at all the retail investors buying MicroStrategy options, constantly, constantly, constantly buying, this could get very crazy.'

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Piper Sandler options head Daniel Kirsch said that the daily rebalancing of leveraged ETFs, whether amplifying ETF or single stock returns, may increase the volatility of the underlying assets, especially when daily fluctuations are significant.

Of course, leverage and the widespread fear of missing out among investors may hit longs, just as it recently helped them chase risky assets. Currently, there is no sign that investors are ready to reduce exposure to risky assets.

But will this wave of growth form an irrational boom? What hints does Buffett's cash position give us? It is worth readers to observe and think carefully.

【Disclaimer】There are risks in the market, and investment should be cautious. This article does not constitute investment advice, and users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investing based on this is at your own risk.

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Warren Buffett's company is flush with cash! Funds pour into the leveraged market, is an irrational boom bubble on the horizon? This article was first published in 'encryption city'.