Money Morning's Three-Minute Review: How Last Week's Events Will Shape This Week's Action

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

Billionaire investing guru Warren Buffett says the ongoing U.S. financial sector meltdown is "poetic justice" for bankers who created the subprime-lending products that have gone sour and failed.

Speaking last week in Toronto, where Buffett had appeared for the Canadian launch of the U.S. corporate-news firm Business Wire, which his company, Berkshire Hathaway Inc. (BRK.A, BRK.B), bought back in 2006, the so-called "Oracle of Omaha" appeared to see substantial irony in the fact that many of the banks that marketed the now-foundering subprime mortgages are now suffering from most of  the fallout.

"It's sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end," Buffett told The Financial Post.

And while Buffett clearly believes financial-service sector players are getting their comeuppance, he appeared to be very worried that consumers and investors might be frozen with fear over the belief the United States is headed into a credit-crunch-fueled economic downturn.

Indeed, Buffett told the newspaper that with the five interest-rate cuts the U.S. Federal Reserve has engineered since August, "low-cost funds are readily available." With that available credit, the U.S. economy should do very well over time.

[For a Money Morning Investment Research Report, "How Buying Like Warren Buffett Can Boost Your Portfolio Profits," please click here. To read the Money Morning Research Note "The One Buffett Book Every Investor Should Read," please click here. Both reports are free of charge].

However, Buffett warned that there is one thing that warrants concern: The health of the U.S. greenback.

According to Buffett, the U.S. dollar is destined to continue its precipitous slide unless the country can slash its massive trade deficit, which the investing guru says is "the biggest factor" behind the greenback's skid against the world's other key currencies.

Buffett has bet against the U.S. dollar in the past. In 2005, Berkshire had made a $21.8 billion bet that the U.S. dollar would fall. Berkshire Hathaway later unwound that successful position as it found other non-U.S. investments to pursue.

During an interview with journalists following the Business Wire press conference, Buffett hinted that the time might be right for dollar-related investments - including a bet on other currencies and against the U.S. dollar - yet again. For instance, even though Buffett said he is "a huge bull on the American economy," he also believes that the Canadian dollar [also known as the "Loonie"] is likely to be worth much more in five to 10 years than it is now. [For the Money Morning Investment Research Report, "Nine Ways to Profit From the Diving Dollar," please click here. This report, too, is free of charge].

Though Buffett's investment style has evolved substantially as his career has advanced [the biography we highlighted earlier does an excellent job chronicling this increasing sophistication in both style and methodology - from the time he was a protégé of the legendary Value Investing Pioneer Benjamin Graham - to the present day], Buffett is still essentially "deep value" investor - albeit one who's able to factor in such intangibles as brand equity, and customer loyalty. He tends to favor companies with relatively simple businesses, very strong management [which he likes to retain, viewing the existing managers as "partners" that are crucial to success], consistent earnings, good returns on equity, and little debt.

Berkshire's amalgamation of widely differing businesses employed about 220,000 people as of the end of last year, and that number is growing as the group continues to expand its portfolio of companies. The units generated a $10.27 billion profit on revenue of $90.2 billion from January to September [Look for two accompanying news "sidebars" - one on recent deals, and the other on key statistics - elsewhere in this story].

Market Matters 

Market/Index

Year Close (2007)

Current Week
(02/08/08)

YTD Change

Dow Jones Industrial

13,264.82

12,182.13

-8.16%

NASDAQ

2,652.28

2,304.85

-13.10%

S&P 500

1,468.36

1,331.29

-9.33%

Russell 2000

766.03

698.93

-8.76%

Fed Funds

4.25%

3.00%

-125 bps

10 yr Treasury (Yield)

4.04%

3.65%

-39 bps

Fret not, equity investors: Some stock market experts are now claiming that all will be well.

Why is that? Well, the markets last week received some excellent news that should serve to ease the concerns of investors across the globe. Let's review:

Did the U.S. Federal Reserve sneak in another interest-rate cut? No.

Has the moribund housing sector suddenly experienced a rubber-band-like rebound? No.

Is that recently approved government economic stimulus package already "bailing" out ailing financial giants? No.

Are retailers praising newfound customer confidence, and projecting record same-store sales to overcome last week's dismal news from industry leader Wal-Mart Stores Inc. (WMT)? Again....and very definitely....no.

Fine, you ask: Just what is this portfolio-saving news that some investors see as a "saving" development?

The excellent news: The New York Giants won the Super Bowl.

Say what?

According to the "highly credible" Super Bowl Predictor (SBP), whenever an original NFL team wins the big game, the market rises over that year [In this case, that original team was the New York Giants, whom my Dad has followed - along with my Pittsburgh Steelers, of course - since the great Y.A. Tittle was tossing touchdowns and winning championships for that New York gridiron squad back in the 1960s. Tittle, incidentally, operates an insurance firm in California's Silicon Valley. Check out his website. According to my Dad, Y.A. hasn't changed a bit since his playing days...]. In fact, the SBP has correctly predicted the direction of the Dow Jones Industrial Average a whopping 80% of the time [in 33 of the previous 41 Super Bowls prior to this one].

Looks like there will be prosperity in our lifetimes, after all - thanks to Eli Manning & Co. [maybe Y.A. did a bit of  "channeling" to help Eli elevate his game to championship levels].

The Super Bowl, of course, is widely watched worldwide, and this year's fourth-quarter thriller was played at a time when U.S. professional sports leagues are pushing hard to build fan bases in overseas markets. It's nice to give our global neighbors a U.S.-related topic to converse about that is not the subprime mortgage crisis, the war in Iraq, or some other topic that portrays the United States in some less-than-stellar light. [For a Money Morning analysis of that global push, please click here. The archived story is free of charge].

In the meantime, in other important related news [albeit of lesser importance than the Super Bowl Predictor...], the U.S. Senate finally put its blessing on the $168 billion Bush Administration economic-stimulus package, which is designed to put cold hard cash in most taxpayers' pockets [a well-timed, bipartisan move in an election year].

In other corporate news, the Microsoft Corp. (MSFT)/Yahoo! Inc. (YHOO) merger moved soap opera continued to unfold, and even rival Google Inc. (GOOG) has weighed in.

But in a story that broke late yesterday (Sunday), Yahoo! is reportedly going to reject Microsoft's $31-a-share, $44.6-billion hostile bid as being too low.

In some other equally dour developments, Wachovia Corp. (WB), American Express Co. (AXP), Capital One Financial Corp. (COF), and Discover Financial Services (DFS) were all victims of rating downgrades stemming from expanding recessionary fears.

On the earnings front, mega-home builders D.R Horton Inc. (DHI) and Toll Brothers Inc. (TOL) reported difficult quarters - without much reason for future optimism.  Networking leader Cisco Systems Inc. (CSCO) posted decent results, but issued a less-than-favorable forecast for the upcoming quarter.

Global telecom firm, Alcatel-Lucent (ALU) reported a quarterly loss and cut its dividend for 2007.  On a brighter note, The Walt Disney Co. (DIS) announced better-than-expected earnings as apparently the economic concerns are not hindering theme park attendance or sales of "High School Musical" DVDs [despite the latest Spears family drama].

Investors withheld judgment on the "time-tested" SBP - for now - and focused instead on the lackluster earnings reports and financial firm downgrades.

Two weeks ago, stocks enjoyed their best showing in four years, so a little profit-taking [actually more than a little] may have been in order.  The equity indexes struggled early and could not muster much rebound momentum. Bonds suffered a mid-week setback as a weak Treasury auction and rumors about a miscalculated economic release [see below] sent treasury prices declining as well.

So the only reason to celebrate these days...The Giants win the pennant!  The Giants win the pennant! (Oops ... wrong sport ... my bad ... I was thinking of the New York Giants and the "Shot Heard Round the World.").

Weekly Economic Calendar

Date

Release

Comments

February 4

Factory Orders (12/07)

Best showing in 5 months

February 5

ISM (Services) Index (01/08)

Surprisingly large drop in services sector activity

February 7

Initial Jobless Claims (02/02/08)

Smaller than expected decline in benefits claims

 

Consumer Credit (12/07)

Slowest rate of borrowing since April 2007

The Week Ahead

 

 

February 13

Retail Sales (01/08)

 

February 14

Initial Jobless Claims (02/09/08)

 

 

Balance of Trade (12/07)

 

February 15

Industrial Production (01/08)

 

Last week, the services sector appeared to join its housing and labor brethren as the latest victim of the economic downturn.  The Institute for Supply Management - Services Index plunged to 44.6 in January [from 54.4 in December], indicating its first monthly contraction since March 2003.  Markets tumbled; nervous consumers freaked [even more]; and analysts scratched their collective heads.  The magnitude of the reduction seemed to be exceptionally substantial for such a short time frame.  Some economists explained that the index has never been a totally reliable predictor of future sector activity.  Others pointed out that the ISM - Manufacturing Index bounced back in January after a "troubling" December report.  As the week progressed, a few rumors even spread that the report was indeed calculated incorrectly, meaning the services sector does not look nearly as dire as some had initially feared.  Only time will tell.

Consumers still appear to be in post-holiday hibernation as the nation's retailers reported some pretty poor January results.  Virtually all sectors experienced disappointing same-store-sales as the International Council of Shopping Centers revealed that the overall numbers were well below forecasts.  Of note, chain stores Limited Brands Inc. (LTD), The Gap Inc. (GPS), and AnnTaylor Stores Corp. (ANN) all posted declines in activity, while discounters Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT) also encountered weaker results.  Even high-end stores like Nordstrom Inc. (JWN) felt the impact of falling consumer confidence.

[Editor's Note: For a related story in this issue by Money Morning Investment Director Keith Fitz-Gerald - who contends that last week's terrible same-store sales report from Wal-Mart is a part of an almost-certain recession warning - please click here.]

While U.S. Federal Reserve Chairman Ben S. Bernanke and friends have been hard at work devising plans to counter the economic downturn, the world's other central banks have not been quite do diligent - perhaps because they are rightly fearful of stoking inflation, something that Bernanke does not seem to fathom. Late last week, the Bank of England agreed to drop its key rate by a quarter point to 5.25%, while the European Central Bank chose to hold its rate steady at 4%.  These moves will make it more difficult for the Fed to continue its easing cycle.

The Warren Buffett File: Statistics of a Stock-Market Master

  • The $213.1 Billion Gorilla: This is the market capitalization of Berkshire Hathaway Inc. (BRK.A, BRK.B), which makes the publicly traded investment vehicle more valuable than Google Inc. (GOOG) [Market Cap: $162 Billion], International Business Machines Corp. (IBM) [Market Cap: $142 Billion], or The Procter & Gamble Co. (PG) [Market Cap: $200.1 Billion]. Berkshire Hathaway is also one of only a handful of companies to hold a AAA-credit rating from Standard & Poor's Inc.
  • The $52 Billion Man: According to Forbes magazine, this is Warren Buffett's net worth - which makes him the world's second-richest man.
  • $37 Billion in Charity: The estimated amount of Warren Buffett's donation after he announced in 2006 that he would give away most of his fortune, the bulk of it to the Bill and Melinda Gates Foundation. The gift doubled the size of the foundation, already the largest of its sort in the world.
  • A "Taxing" $4.4 Billion: Berkshire Hathaway was set to pay this amount in federal income tax on its 2006 earnings - equal to more than half a day's worth of expenditures for the U.S. government.
  • 200 Million Bottles of Coke on the Wall: Actually, the number of Coca-Cola Co. (KO) shares Berkshire Hathaway holds - roughly 8.6% of the beverage company's outstanding stock.
  • A Bargain at $30 Million: If you had invested $10,000 in Berkshire Hathaway back in1965, this is what your stake today would be worth. 
  • 59.3%: Berkshire's biggest annual gain. It occurred in 1976.
  • 42%:  The number of signed policies rose by this amount between 2003 and 2006 at Geico, the Berkshire Hathaway auto insurer. Buffett first invested in Geico in 1951. In 1995, Berkshire made a bid for all the shares of Geico it didn't already own. The next year, Geico became a wholly owned subsidiary of Berkshire. And it still makes great commercials.
  • 10.4% versus 21.4%: The compound annual return based on the book value of one Berkshire Hathaway share - assets minus liabilities, or the ultimate value of a share in liquidation - starting at $19 in 1964, and rising to $70,281 in 2006. That compares with 10.4% for the Standard & Poor's 500 Index, including dividends. 
  • 6.2%: Berkshire Hathaway's biggest annual drop in book value. It occurred during the 2001 market meltdown compared with an 11.9% slide for the S&P 500.
  • 5: The number of cans of Cherry Coke Warren Buffett reportedly drinks each day. Berkshire is Coca-Cola's biggest shareholder.

Sources: Financial Post, Money Morning, Google Finance.

The Moves of a Master: Recent Deals by Warren Buffett's Berkshire Hathaway

  • Set up Berkshire Hathaway Assurance Corp. in December to enter the bond insurance market, since it's currently straining under its connections to sub-prime loans. Bought 3% stake in Swiss Re (OTC: SWCEY), world's largest reinsurer, which had lost a quarter of its value since taking a $900 million write-down in November. Also takes 20% stake in Swiss Re's property/casualty reinsurance business.
  • Spent $4.5 billion for 60% stake in privately held Marmon Holdings Inc., maker of such products as railroad cars, metal fasteners and pipes for plumbing.
  • Spent $4 billion for 80% of ISCAR, an Israel-based cutting-tool business that operates in 61 countries globally.
  • Made major moves on U.S. railroad carriers last year, making first move on Burlington Northern Santa Fe Corp. (BNI) last April. Berkshire bought nearly 40 million shares - or close to 11% - of the railroad. Berkshire also snapped up 10.5 million shares of Union Pacific Corp. (UNP), and 6.4 million shares of Norfolk Southern Corp. (NSC). Berkshire added 3.3 million shares of Burlington at $80 each in August, 6,000 more in September, and 10,200 more in January - which means Buffett now owns more than 18% of the freight specialist.
  • In a highly publicized move in the past few months, Berkshire received a license to start its own bond-insurance company in New York. It also agreed to pay $440 million to buy a reinsurance unit from ING Groep NV (ING), the biggest Dutch financial-services company.
  • In late October, Buffett paid his first visit to South Korea. Berkshire has invested in 20 companies, including a 4% stake in No. 1 Korean steelmaker POSCO Ltd. (PKX).
  • During that same period, reports revealed that Buffett had pared his China investments, believing that market was overvalued.

Sources: Money Morning, Google Finance, The Financial Post.

News and Related Story Links:

  • The Financial Post:
    Wit and Wisdom of Omaha's Sage
  • The Financial Post:
    Buffett Loves That Loonie

About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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