Investing legend Warren Buffett and his conglomerate, Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B), have not given investors many reasons to buy into the strength of this market. Recently, Berkshire has largely been a net seller of stocks, and has refrained from buying individual stocks or even repurchasing its own shares. Additionally, it has been building a hoard of cash and short-term Treasury bills that now exceeds $320 billion.
One might have speculated that the holding company was stockpiling cash in preparation for something big. But after its additional large sales of Apple(NASDAQ: AAPL) and Bank of America(NYSE: BAC) stock in the third quarter, one logical conclusion is that Buffett expects a market correction. That's not exactly the type of news that investors might have hoped for, but it comes with a silver lining.
Buffett is good at timing the market
By definition, a market correction is when a major broad index such as the S&P 500 pulls back by 10% to 20% from its recent high. Most corrections are eventually followed by recoveries that send those indexes back to new market highs, but for investors, such significant drops in their portfolios can be stressful.
Billionaire investor David Einhorn, who runs the hedge fund Greenlight Capital, has pointed out that while Buffett prides himself on being a long-term investor, he has also historically been good at timing market corrections.
- Buffett closed his first fund -- the Buffett Partnership -- in 1969 after growing concerned about accounting malfeasance at a growing number of companies in the market.
- Buffett then bought stocks after the market bottomed in the early 1970s following an oil crisis in 1973-1974. In 1974, Buffett purchased 11% of outstanding shares in the Washington Post.
- In 1986, Buffett refrained from the "euphoria" on Wall Street and fled into bonds right before a broad market decline and 1987's Black Monday.
- Buffett and Berkshire didn't get into trouble during the Great Recession. Instead, they took advantage and injected billions of dollars of capital into Bank of America and Goldman Sachs in deals that eventually generated phenomenal returns.
Part of Buffett's success has been his ability to avoid being over-exposed during stock market downturns. Now, Buffett and Berkshire Hathaway again seem to be signaling that the market is overheated. This doesn't mean the market will collapse tomorrow, but Buffett likely believes a shift in sentiment is upon us.
The silver lining: American Express
Perhaps the silver lining in all of this is that Berkshire Hathaway maintained its large stake in payments and credit card giant American Express(NYSE: AXP), making no material sales in the third quarter based on fair value disclosures in the company's recent earnings report. American Express earlier this year leapfrogged Bank of America as the conglomerate's second-largest equity holding and now makes up 14.5% of Berkshire's roughly $284 billion stock portfolio.
What's interesting about American Express is that its business is heavily dependent on consumer health, which makes it a cyclical stock. Cyclical stocks don't usually perform well during recessions.
Berkshire Hathaway has been buying and selling shares of American Express for decades, but it hasn't meaningfully sold shares since 2012. Although American Express generally caters to higher-income individuals who tend to be better positioned to weather a recession, Buffett might have considered trimming that stock position if he foresaw a big economic downturn on the horizon.
While he still could sell some American Express stock, the fact that he hasn't yet could suggest that Buffett is less worried about the U.S. economy and more concerned about the U.S. stock market. After all, most data right now suggests that the market is overvalued, but that the overall economy is on solid footing. A strong economy could deter the Federal Reserve from lowering benchmark interest rates as much as investors expect it to. That, in turn, could lead to a market decline as investors adjust their expectations to a world where interest rates remain higher for longer.
Don't get me wrong: Buffett's sales of Apple and Bank of America stock are concerning, and could suggest that he sees a market correction on the horizon. But market corrections can be healthy when the market gets too frothy, and a correction that takes place against the backdrop of a solid economy may not last for long. Long-term investors normally can ride out market corrections as long as they can avoid panicking. And corrections often present buying opportunities for those who are looking ahead to the recoveries that have historically followed them.
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Bank of America is an advertising partner of Motley Fool Money. American Express is an advertising partner of Motley Fool Money. Bram Berkowitz has positions in Bank of America. The Motley Fool has positions in and recommends Apple, Bank of America, and Berkshire Hathaway. The Motley Fool has a disclosure policy.
