Berkshire Hathaway is flush with cash, and a large amount of funds are pouring into the leveraged market. Is the arrival of irrational prosperity and the bubble?

Warren Buffett, the stock god, announced last week the stock holding situation of Berkshire Hathaway Inc., with cash reserves reaching a new high. However, a large amount of funds has recently flooded into the leveraged market. Will this upward trend form an irrational prosperity at the end? What clues does Buffett's cash level give us?

Buffett indicator is currently at a historically high level, cash level hits a new high again.

At the age of 94, Buffett remains cautious about investing money. At the Berkshire Hathaway annual shareholders' meeting in May, he expressed his willingness to invest, but also emphasized that finding attractive investment opportunities is not easy.

Warren Buffett mentioned in an interview with Forbes in December 2001 that the ratio of total market capitalization to GDP can be used to judge whether the overall stock market is too high or too low, and is therefore called the Buffett indicator. This indicator can measure whether the current financial market reasonably reflects the fundamentals. Buffett's theoretical range is 75% to 90%, and a value exceeding 120% indicates an overvalued stock market. According to the chart from Finance M Square, the Buffett indicator has been at a high level since 2016, with the current value at 205%.

Berkshire's cash reserve for the third quarter reached $32.52 billion, and for the first time since the second quarter of 2018, no stock buybacks were made. The cash reserve is almost twice the company's year-end cash balance and is also the largest cash reserve ever accumulated by Buffett.

The relationship between Berkshire's cash position and the market

According to Bloomberg, the proportion of Berkshire Hathaway's cash allocation to the company's assets has varied greatly over the years, from 1% in 1994 to nearly 28% today, as well as various situations in between. Records show that as stock valuations rise during prosperous periods, Buffett has continuously increased Berkshire's cash allocation - resulting in a decrease in expected returns - and reduced cash when opportunities arise.

For example, during the dot-com bubble in the late 1990s, as valuations soared, Buffett increased his cash allocation from 1% four years earlier to 13% in 1998. However, in 1999 (about a year before the bubble burst), he reduced his cash allocation to 3%, probably because he found an attractive target. In retrospect, he might have been better off holding onto that cash for another year when bargains became plentiful, but even the great Buffett couldn't see the turning point. Nevertheless, he did one thing right, which was deploying almost all of Berkshire's cash during the economic downturn.

Then, he shifted gears again before the 2008 financial crisis. After the market rebounded in 2002, Buffett began significantly increasing his cash allocation, eventually reaching 25% of his assets in 2005. However, the looming crisis caused stock prices to undergo a big dump starting from the end of 2007. Buffett utilized his cash and ultimately reduced the cash-to-assets ratio to 7% in 2010, partly due to his astute investment in Goldman Sachs Group Inc.

Bloomberg View columnist Nir Kaissar believes that Buffett is betting on a simple principle, that is, the valuation is inversely proportional to the future return. That is, when assets are expensive, the future rate of return is often lower, and vice versa.

The P/E ratio of the S&P 500 index is close to a historical high.

The largest fund management companies including BlackRock, Vanguard, Goldman Sachs, and JPMorgan all expect the future US stock market to be far below the historical return rate of 9% per year over the past 150 years.

The current forward price-earning ratio of the S&P 500 index is 25 times, close to historical highs, while the average price-earning ratio since 1990 is 18 times.

Experts estimate that the expected return rate of the Standard & Poor's 500 index over the next 10 years is about 4%, which is not far off from the yield of risk-free three-month Treasury bills at 4.4%. Berkshire's increase in cash reserves (mostly in short-term Treasury bills) has strengthened its prudent allocation, which is not too surprising.

A large amount of funds poured into the leveraged market

On the other hand, on the speculative edge of Wall Street, the frenzy of adventure is increasing day by day. Including MicroStrategy, a self-proclaimed BTC development company, and related high-risk leveraged ETFs, the volume reached $86 billion this week, reaching a historical high. MicroStrategy's stock price rose by 24% in a single week, with a total inflow of $420 million into two leveraged funds based on the company.

(MicroStrategy's BTC premium of up to 256% plummeted by 16% under Citron's short-selling)

Matt Tuttle, CEO of Tuttle Capital Management, which operates one of the funds, said that this week he bought a series of MicroStrategy stocks through leveraged ETFs. His market maker had to buy more stocks to hedge the position. 'Look at all the retail investors buying MicroStrategy options constantly, constantly, constantly. This could get really crazy.'

Piper Sandler's options manager, Daniel Kirsch, said that the daily rebalancing of leveraged ETFs may amplify the volatility of the underlying assets, whether it is the return of the ETF or a single stock, especially when there is significant daily volatility.

Of course, leverage and the general fear of missing out among investors may hit longs, just as it recently helped them chase risky assets. Currently, there are no signs that investors are ready to reduce exposure to risky assets.

But will this wave of rise form an irrational prosperity? What hint does Buffett's cash position give us? It is worth the readers' careful observation and thinking.

Is this article about Berkshire Hathaway's hands full of cash and a large influx of funds into the leveraged market, signaling the arrival of an irrational boom? It first appeared on Chain News ABMedia.