Tue, Mar 1, 2016|Justin Brill

The Last Two Times This Happened, Stocks Fell off a Cliff

Has Warren Buffett lost his mind?... More trouble for the U.S. economy... The last two times this happened, stocks fell off a cliff...

Following the release of his annual shareholder letter last weekend, billionaire investor Warren Buffett appeared on financial-news network CNBC yesterday morning.

Buffett mostly repeated the ideas discussed in the letter, but he also said something that left us scratching our heads...

One of the hosts asked Buffett if he thought buying software giant IBM (IBM) was a mistake. IBM is one of only two losing stock positions his company holds today – the other is farm-equipment maker John Deere (DE) – and Berkshire is currently showing a loss of nearly $3 billion on its $13.8 billion investment.

At first, his answer to this question was "classic" Buffett...

He repeated his well-known stance that he's happy to see great stocks fall, so that he can buy more. He pointed to several times over his career when his investments initially declined in value before rebounding. And he said he expects IBM will do the same, and said he has "never sold a share."

But he also hedged these ideas in a way he has rarely done...

He repeated "I could be wrong" several times, even noting, "If I'm wrong, you know, we'll sell 'em and take a big loss." He admitted that his partner – Berkshire Hathaway Vice Chairman Charlie Munger – didn't agree with his bullish stance. And most "un-Buffett" of all, he said something that likely shocked his legions of value-investing fans...

What you pay for a stock, it doesn't mean anything. What means something is where the company's going to be in five or 10 years... And I think that IBM will be worth more money.

To be fair, Buffett's approach to investing has changed a great deal from his early days. He's no longer a strict value investor like his mentor, Benjamin Graham.

But as our colleague Dan Ferris – editor of Extreme Value – pointed out in a private e-mail, this is the same man who is famous for saying things like [emphasis added]...

We don't sit around and talk about the future of industries. We have no reports or staff. We just review what comes in and look for companies with a durable competitive advantage at an attractive price...

And...

The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.

In fact, Buffett even contradicted himself in this year's annual letter, where he wrote, "Of course, a business with terrific economics can be a bad investment if it is bought at too high a price."

Buffett's returns have suffered in recent years, particularly since the early 2000s.

Longtime Digest readers know Porter believes it's because Buffett has strayed from the strategies that made him the wealthiest man on the planet... buying great "capital-efficient" businesses at fair prices. As he explained last year in the March 6 Digest...

There can be no doubt that the Buffett of the last 15 years isn't doing nearly as good a job as he once did. He has had dozens (or even hundreds) of opportunities to buy incredibly high-quality businesses at dirt-cheap prices over the last 15 years. My newsletters have recommended plenty of them: Tiffany, Starbucks, Hershey, Harley-Davidson, eBay, Disney, and McDonald's, to name just a few.

But Buffett didn't buy any of these great businesses. Instead, he spent $44 billion on a railroad. That's 44 times more capital than he invested in Coca-Cola. He also invested $15 billion in IBM, which he specified by name in his 1996 letter as one he would never buy. Few investors realize how critical these decisions will become over time.

Based on Buffett's latest comments, it sounds like his problems are likely to continue.

What do you think? Has Warren lost it?

We see more new data suggesting trouble in the U.S. economy...

In addition to the early signs of a slowdown in manufacturing and services we've been following, a new report this morning showed U.S. small-business activity could be slowing, too...

The Thomson Reuters/PayNet Small Business Lending Index plunged 13% in January to its lowest level since November 2014. The index measures how much money small businesses are borrowing. According to Bill Phelan, president of loan-information firm PayNet, this level of borrowing isn't even enough to replace old equipment, let alone buy more. "This is a dramatic form, an extreme form of hunkering down," he said.

Thomson Reuters notes the index is a strong leading indicator for U.S. economic growth one or two quarters down the road. This makes sense, since small businesses account for a huge portion of U.S. economic activity. If they're struggling, the broad economy is likely to follow.

Regular readers know we don't base investment (as opposed to trading) decisions on technical analysis or "chart reading."

But charts can be useful for assessing the "big picture" in stocks. This is especially true when other evidence suggests a trend change from bull market to bear market is possible, like it is today.

We've already discussed how our colleague Jeff Clark's favorite long-term indicator has already flipped to official bear market territory. Today we note another long-term indicator has turned down as well...

In a note Sunday, Jonathan Krinsky – chief market technician at research firm MKM Partners – warned that the benchmark S&P 500 Index was on the verge of a long-term "bearish crossover." Specifically, Krinsky said one long-term moving average (the 10-month moving average) was about to cross below another (the 20-month moving average).

If you're not familiar with these terms, don't worry. All you really need to know is this bearish crossover is a sign that the market's long-term uptrend has stalled... and it's rare to see.

Krinsky says there have only been two confirmed signals in the last 22 years. Those occurred in March 2001 and May 2008, just before the worst parts of the last two bear markets began. Notably, the big decline in the summer of 2011 – which fooled many into believing a bear market had begun – did not trigger the signal.

As of yesterday's close, there is now a third confirmed signal. As always, we'd never put too much weight on any indicator... but it is one more warning sign in a growing list of concerns. And if history is any indication, the downtrend in stocks could soon resume.

We apologize for repeating ourselves... but if we can help even one more subscriber avoid losing his hard-earned savings, it's worth the effort.

If you still haven't prepared for a bear market in stocks, you must act now. Click here to sign up for our Bear Market Survival Program.

You'll get instant access to the first six modules, covering everything you need to know about raising cash, holding gold, shorting stocks, and buying distressed assets.

You'll also be the first to receive the seventh and final module when it's published this Friday, in which Porter and his team will put all these lessons together and help you build a "bulletproof" bear market portfolio of your own. Get all the details right here.

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New 52-week highs (as of 2/29/16): Kaminak Gold (KAM.V), NovaGold Resources (NG), and Sturm, Ruger (RGR).

In the mailbag, one subscriber says his bear market strategy is working... and another skeptical reader comments on Porter's OneBlade razor. Send your questions and comments to feedback@stansberryresearch.com.

"Porter, et. al. It's working. Today, my account showed a very gratifying gain of 3.8% overall, on a day when the S&P Index was down by 0.8%. Here's how it breaks down:

2 – long bonds = +$156 from Credit Opportunities newsletter

6 – short options = +$231 selling puts

5 – long options = +$208 buying calls

Note – This is the Alpha strategy, applied mostly to gold stocks and also CMG, another of your recommendations

6 – short stocks = +$504 Mostly recommended bank stocks.

4 – long stocks = +$389 Insurance and a few other recommendations

Total for the day: +$1,492

"Thanks for the education." – Paid-up subscriber Stephen K.

"Hey Porter, I didn't really believe you when you wrote about OneBlade many times; but I decided to take you up on the latest offer figuring, hey, I'd only be out $99 bucks instead of $300. I received my OneBlade this past Friday, and I was impressed with how it looked and the quality of everything in the package. I knew though, that looks can be deceiving so was still skeptical. I'd already shaved that day so I would have to wait till the morning to give it a try.

"I was tentative at first, afraid that I would cut myself. As I gained confidence, I FELT the difference between the OneBlade shave and my old system. I was blown away with the results. But I had one last test: I had not told my wife I was making the purchase, fearful she would not approve. When I was done, I asked her to feel my face. The look on her face was priceless! She exclaimed, 'Wow, what did you do? It feels like you've had a shave at an old time barbershop with a straight razor!'

"I told her what I'd done and she couldn't have been happier for me (and her). She and I both love the results. Thank-you for a great product that has exceeded my expectations!" – Paid-up subscriber Rick T.

Regards,

Justin Brill
Baltimore, Maryland
March 1, 2016

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