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Buffett has one big investing lesson in this year’s annual letter

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Warren Buffett believes investors should avoid using borrowed money to outperform.

The Oracle of Omaha explained the perils of using debt and leverage in his 2017 annual letter to Berkshire Hathaway shareholders released on Saturday.

“Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long-term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips,” he wrote.

The investor shared the data which revealed Berkshire Hathaway’s stock declined by a range of 37 percent to 59 percent multiple times over the last five decades.

“This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period,” he wrote. “Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

Buffett predicted the company’s stock will fall again by similar large declines in the next 53 years.

“No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow,” he wrote. “When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt.”

The investor shared an excerpt from British Nobel laureate Rudyard Kipling’s 1895 poem “If—” to illuminate the investing lesson:

“If you can keep your head when all about you are losing theirs . . .
If you can wait and not be tired by waiting . . .
If you can think – and not make thoughts your aim . . .
If you can trust yourself when all men doubt you…
Yours is the Earth and everything that’s in it.”

Buffett blasted the belief that bonds were a lower risk investment over the long-term. He recommended investors stay in equities due to negative impact from inflation on the purchasing power of fixed income holdings.

“I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier – far riskier – than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates,” he wrote. “It is a terrible mistake for investors with long-term horizons – among them, pension funds, college endowments and savings-minded individuals – to measure their investment ‘risk’ by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”

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Xi’s speech shows how Biden faces a very different China

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Parts of the market are in bubble but pose low risk to the S&P 500: Goldman

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People walk by the New York Stock Exchange (NYSE) in lower Manhattan on October 02, 2020 in New York City.

Spencer Platt | Getty Images

Parts of the market are in bubbles, but they are unlikely to take the overall market down with them when they pop, according to Goldman Sachs.

The Wall Street firm said exuberance around special purpose acquisition companies, as well as around investor interest in companies with negative earnings are cause for concern. It added that these speculative areas don’t pose a risk to the S&P 500.

“Pockets of the market have recently demonstrated investor behavior consistent with bubble-like sentiment,” Goldman chief U.S. equity strategist David Kostin told clients. “But these excesses present low systemic risk to the broader market given their modest share of market cap.”

Fifty-six SPAC initial public offerings have already been completed in 2021, raising $16 billion, Goldman notes. It said this adds to the 229 U.S. SPACs that raised $76 billion in 2020, which was dubbed the “year of the SPAC.”

“Low interest rates, the flexible structure, and the two-year window to find a target before returning capital suggest the popularity of SPACs will continue in the near term,” Kostin said. “Importantly, we see little risk to public equity markets should investor enthusiasm for SPACs subside.”

It’s been a mania in SPACs as businesses shy away from the traditional initial public offering market, roiled by the coronavirus pandemic and wild volatility. A SPAC is a blank-check company formed to raise funds to finance a merger or acquisition within a certain time frame. The target firm will be taken public through the acquisition. 

Shades of 2000

There is also bubble-like behavior in stocks with negative earnings with sharp recent outperformance, Goldman said. In the last 12 month, stocks with negative earnings have outpaced the average stock by 40%, a 97th percentile ranking. Goldman also said the trading volumes of these negative earnings stocks are at a historic extreme.

“These firms account for 16% of equity trading volumes, exceeding the 15% share in 2000. Although this surge appears unsustainable, it also appears to pose little risk to the broad market because these companies account for just 5% of total market cap,” said Kostin.

But Kostin sees reasons to not worry about the overall market. He is among the bigger bulls on Wall Street, predicting an 11% rally in the S&P 500 to 4,300 by year-end.

Equity valuations are extremely elevated on an absolute basis, he said, but added that taking into account the low interest rate environment, the S&P 500 trades below its average historical valuation. Investors see low interest rates as a type of valuation cushion.

Even economist Robert Shiller, creator of the cyclically adjusted price-to-earnings ratio or CAPE index, pointed out that the index shows that equity valuations are “not as absurd as some people think,” provided interest rates remain relatively low, Goldman’s note said.

Plus, the current market lacks the extreme investor leverage that is common in stock bubbles, Goldman said. Thanks to unprecedented fiscal stimulus, consumers are cash rich, with U.S. household disposable income growing strongly in 2020. These excess savings pushed the debt service ratio to its lowest in 40 years, making the strong equity inflows funded by cash rather than leverage.

Beware these companies

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Tencent shares fall over 5% after closing in on $1 trillion valuation

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WeChat mascots are displayed inside Tencent office at TIT Creativity Industry Zone in Guangzhou, China, May 9, 2017.

Bobby Yip | Reuters

GUANGZHOU, China — Tencent shares dropped more than 5% on Tuesday — one day after a huge rally pushed its valuation to nearly $1 trillion for the first time.

The Chinese internet giant saw its shares hit as high as 767.5 Hong Kong dollars on Monday, rallying 11% at one point. That pushed the company’s market capitalization to 7.35 trillion Hong Kong dollars ($949 billion) on Monday.

Monday’s rally appeared to be propelled by bullish calls by two investment banks. In a research note, Citi raised its target price to 876 Hong Kong dollars from 734 Hong Kong dollars, a 14% rise from Monday’s close.

UBS also upped its price target on Tencent from 700 Hong Kong dollars to 830 Hong Kong dollars — that’s a more than 8% rise from Monday’s close.

But investors took profit on Tuesday, driving Tencent shares lower by around 5.48% to 724.50 Hong Kong dollars at 2.45 p.m. local time. The stock was down over 6% earlier in the day but pared some losses.

Investors are waiting for Tencent’s 2020 results for the fourth quarter and full year, which will be released in March.

Analysts are expecting revenue to come in at 131.83 billion yuan (about $20.36 billion) for the December quarter, a 24.6% year-on-year rise, according to Refinitiv estimates. Net income is expected to grow nearly 29% to 32.85 billion yuan.

Tencent is known for its huge gaming business which analysts expect to have performed well in the fourth quarter. Revenue from smartphone games in particular are expected to grow 46% year-on-year to 38 billion yuan, helped by new title releases, according to a recent note from Jefferies.

Other analysts have also backed that up.

“We expect solid results in upcoming 4Q20, with strength in the game business overall,” Macquarie analyst Han Joon Kim said in a note published Jan. 19.

But Tencent has also been growing other areas of its business including advertising, cloud computing and financial technology via its WeChat Pay mobile payment system.

WeChat, in particular, has been a focus of investors.

Last week, Tencent announced that transactions on its WeChat Mini Programs rose more than 100% in 2020 from 800 billion yuan in 2019. The company did not reveal the 2020 figure. But it highlights the way that Tencent is trying to monetize and increase the stickiness of its messaging app WeChat, which is used by over a billion people.

Mini Programs are apps people can use within WeChat without having to leave the messaging app. They have been a key part of the growth of WeChat.

Though the monetization efforts of WeChat are still in the early stages, analysts see this as a long-term effort.

“We continue to find stronger emphasis on improving accessibility and functionality than monetization. We think lack of monetization of mini programs in 2021 is fine, as there is limited expectation of such embedded in earnings expectation anyways,” Macquarie’s Kim said.

“Rather, Tencent’s growing influence in on-line commerce activity will strengthen the stock’s long-term narrative and support its valuation multiple.”

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