Warren Buffett, Chairman and CEO of Berkshire Hathaway, speaks during a game of bridge after the annual Berkshire Hathaway shareholders meeting in Omaha, Neb., on May 5, 2019.Nati Harnik/The Associated Press
Whom should you trust about the direction of the U.S. economy – Donald Trump or Warren Buffett?
Mr. Trump, the president-elect, claims his policies will restore an economy “destroyed” by Joe Biden and Kamala Harris. He has promised to accelerate growth with sweeping tax cuts, mass deportations of illegal immigrants and new tariffs.
Mr. Buffett seems unconvinced by the president-elect’s bluster. He has sold massive amounts of stock in recent months and raised his holdings of cash and cash equivalents at his flagship Berkshire Hathaway Inc. BRK-B-N to a record high of US$310-billion at the end of September. The great investor’s rush to cash suggests he isn’t buying into the notion that a brave new world lies ahead.
Investors may want to ponder this. If nothing else, Mr. Buffett’s decision to sell stocks and build a cash mountain suggests you might want to retain at least a bit of skepticism about what lies ahead for the market.
One reason to stay cautious is the fact that U.S. presidents aren’t nearly as important to the economy as many people think. Look at a chart of U.S. economic output this century and the striking thing is how steady the upward progress is no matter who happens to be sitting in the White House.
Gross domestic product typically increases by around 2.5 per cent a year after inflation. Yes, there are crashes – notably the financial crisis of 2008 and the pandemic of 2020 – but for the most part, outside of recessions and the early stages of recoveries, economic growth hums along within a tight band. Looking strictly at the numbers, it is hard to tell when the Obama administration ends and the Trump administration begins.
There are good reasons for this consistency. The biggest determinants of economic growth are population growth, capital investment and technological progress.
Governments have, at best, only limited control over these areas. What control they do have typically tends to take a while to manifest itself. Look back at the past eight decades and you can’t point to any case where a new president has come into power, tinkered with policies and immediately kicked economic growth into a new higher gear.
Mr. Trump is unlikely to set a precedent in this regard. One problem he faces is that – despite his red-hot rhetoric – the U.S. economy is anything but destroyed. It is actually growing at a vigorous 2.7-per-cent-a-year clip with low unemployment of only 4.1 per cent. Even if you take Mr. Trump’s pronouncements as gospel, it is difficult to see how he can suddenly make this happy picture a whole lot better.
So why are many investors excited? Their enthusiasm may reflect Mr. Trump’s eagerness to cut corporate taxes. To be sure, a tax cut would not do that much to spur growth – it would simply add stimulus to an economy that doesn’t need it – but it would boost after-tax corporate profits, which would help support higher stock prices, everything else being equal.
The problem, though, is that everything else might not be equal. Adding unneeded stimulus to an economy already operating near capacity is likely to spur inflation and help keep interest rates and bond yields at elevated levels. That would not be good for stock prices since higher yields would mean that bonds would provide an increasingly attractive alternative to stocks.
Bonds are already tempting. In ordinary times, the earnings yield on stocks – that is, the amount of net income they report for every dollar invested – is often two to four percentage points higher than the yield on a 10-year government bond. Now, though, they are essentially identical: You can earn 4.5 per cent a year on the money you put into a broad index of U.S. stocks or you can earn 4.5 per cent a year by owning a 10-year U.S. Treasury bond.
Since stocks are risky and government bonds aren’t, the obvious choice would seem to be to buy bonds since they are providing similar payoffs with less risk – but that’s not how most investors are playing it. They have bid up U.S. stock prices to breathtaking heights. Look at any valuation metric and U.S. stocks are now around their most expensive levels since the giddy lunacy of the dot-com era in the late 1990s.
Mr. Buffett may simply be reacting to those lofty valuations. He is sidestepping a pricey stock market and buying risk-free Treasury bills when they offer yields equivalent to much riskier stocks.
Should you follow in his footsteps? Maybe so. That doesn’t mean you should suddenly dump all your holdings and huddle in cash – Mr. Buffett continues to own more than US$271-billion in equities – but it does mean you should stay grounded.
Even bulls are now being candid about the risks in the current market. The crew at Capital Economics, for instance, sees the S&P 500 soaring to 7,000 by the end of next year – not because of Mr. Trump’s policies but because of a bubble built on AI hype. However, they then see the bubble bursting and the market crashing, leading to very poor stock-market returns for Mr. Trump’s second term. Play this game at your own risk.