Warren Buffett Really Rained on the Parade

This piece originally appeared on Money & Markets.

A lot of value investors came out of the woodwork to buy the dip in March and April following the coronavirus rout.

One was conspicuously absent from the party: Berkshire Hathaway’s Warren Buffett.

Buffett is a hero to generations of value investors. In fact, he’s one of my heroes.

One glance at his returns will show you why. From 1964 to 2019, Mr. Buffett grew Berkshire Hathaway’s by an almost absurd 2,744,062%. Over the same period, the S&P 500 returned 19,784%.

In past crashes, Buffett has always swooped in and bought the dip. He certainly did in the last crisis when he bailed out Bank of America, Goldman Sachs and General Electric, making himself billions in the process. The is the man whose self-described secret is being “greedy when others are fearful and fearful when others are greedy.”

But this time around, Buffett chose to sit on his hands. His cash hoard actually grew to $137 billion at the end of the first quarter from $128 billion at year end. At today’s prices, about 30% of Berkshire Hathaway’s market value is just the cash in the bank.

But not only is Buffett not buying. He’s actually selling. The Oracle of Omaha dumped $6.1 billion in stock in April, including his positions in American Airlines, Delta, United Airlines and Southwest Airlines.

This should be sobering to anyone with money in the market.

You can take comfort being in the market when Mr. Buffett is buying. Buffett isn’t always right, and like a lot of value investors he’s often early to the party. But buying by Buffett is that ultimate seal of approval… and that reassuring pat on the shoulders that says it will be all be ok.

In His Own Words

As always, Buffett was eminently quotable at the Berkshire Hathaway annual meeting this past weekend. But one quote really stood out. On why he hadn’t put his cash to work, Buffett said:

“We haven’t done anything because we don’t see anything that attractive to do.”


“This is a very good time to borrow money, which means it may not be such a great time to lend money.”

There are several takeaways here.

The first is a point that I made last month: Even after the March tumble, stocks aren’t cheap. In fact, they’re still priced a lot more like a market top than a market bottom.

The second takeaway is that bonds aren’t exactly a screaming buy either. As Buffett put it, this isn’t such a great time to lend money.

In a normal, functioning market, interest rates reflect risk. You get rewarded with a higher interest rate for accepting greater credit risk and a longer time to maturity. But in its attempt to save the system from collapse, the Fed has massively distorted the bond market. Interest rates no longer reflect the risk being taken but rather the price at which the Fed is willing to buy.

Now, make no mistake. This isn’t a Fed-bashing hit piece. I understand why the Fed opened the floodgates the way they did, and I don’t think they had much of a choice if we are to be honest. Had the Fed not backstopped everything, we likely would have seen the financial system fail.

But that doesn’t mean we get a free lunch here. We will pay for the Fed’s move with lower bond returns, lower long-term growth and possibly with nasty inflation a few years down the line.

So, What Should You Do?

So, stocks and bonds are both expensive. Fantastic. What are we supposed to do?

I have one recommendation out of Buffett’s playbook. Most of us don’t have $137 billion laying around, but keeping a little more cash than usually on hand would seem like a good idea.

It also makes sense to prune your portfolio a little. Buffett dumped his airlines because he doesn’t have a good read on when their situation improves.

But at the same time, you don’t have to sell everything. Buffett still has a portfolio full of blue chips like Apple (AAPL), Coca-Cola (KO) and American Express (AXP).

I’d also add one final recommendation that the Oracle might disagree with. I think it makes sense to own a little gold. You don’t have to get carried away, but putting something like 5% of your net worth into precious metals gives you a degree of protection from currency instability should the Fed’s bailout efforts take a wrong turn.

The 60/40 Portfolio is Dead

The following first appeared on Money & Markets.

Responding to rumors that he had taken ill and died while on a speaking tour in Europe, Mark Twain told The New York Times: “The reports of my death are greatly exaggerated.”

Well, I don’t want to “greatly exaggerate,” but I think it’s fair to say that the 60/40 portfolio is dead. Or at the very least, it’s going to be on life support for a while.

It had a good run.

According to Vanguard, a portfolio invested 60% in stocks and 40% in bonds generated a compound annual return of 8.6% going back to 1926. That’s a stretch that includes the Great Depression, World War II, the stagflation of 1970s, the tech bubble and bust, and the 2008 meltdown.

It’s a portfolio that has clearly survived the test of time. And it’s easy to assume that it will continue to post numbers like these indefinitely.

Unfortunately, that doesn’t seem likely.

I’m no permabear and this isn’t an anti-buy-and-hold hit piece. I’m generally the optimistic sort, and when I err it’s usually on the side of being too aggressively invested, rather than too conservatively. But the numbers here are pretty straightforward. And they don’t look great.

Breaking Apart the 60/40 portfolio

We’ll start with the 60% invested in stocks, using the S&P 500 as a proxy.

As I wrote last month, the S&P 500 never got truly cheap during the coronavirus bear market. Yes, the market dropped 35% in record time, which brought it down to something closer to “fair value.” But at no point did it ever approach anything close to the valuation lows seen in previous bear markets.

Furthermore, those lows were short-lived. The market ripped higher in April, and today the S&P 500 is essentially at breakeven for the past 12 months.

The S&P 500 is trading at a cyclically adjusted price-to-earnings ratio (“CAPE”) of 26.5 today. If history were any guide, that would suggest annualized returns over the next decade to be close to zero.

Now, I’m the first to admit that historical comparisons should be taken with a grain of salt. Interest rates are lower today, which means that, all else equal, stock prices should be higher. The S&P 500 is also dominated by capital-light tech companies that should, all else equal, trade at higher valuations than clunky industrial firms.

I get all of that, which is why I think the S&P 500 will generate halfway decent returns over the next decade. But I still expect those returns to be lower than the historical average.

All About Bonds

But let’s say I’m wrong. Let’s say that it really is different this time and for reasons I can’t currently imagine, we really are in a period of permanently higher stock prices.

I actually don’t consider that idea to be crazy. Stranger things have happened.

But even if stock prices continue to push ever higher, there’s a big, gaping black hole where bond returns used to be.

The 10-year Treasury today yields 0.63%. A more diversified basket of bonds, such as the iShares Core U.S. Aggregate Bond ETF (NYSE: AGG) yields a little better at 2.6%. We’ll be generous and use that as our return assumption.

If we invest 40% of the portfolio in bonds, yielding 2.6%, and stocks generate 10% — which is generous given today’s valuations — that gets us a portfolio average of 7%.

That’s not all that bad. But again, it also assumes the market continues to perform in line with past returns, which is a stretch.

Let’s say instead that the stock market returns 5% per year going forward, rather than 10%. That knocks the returns of a 60/40 portfolio down to just 4% per year.

And let’s say the value investors are right and that stocks are priced to deliver essentially zero returns over the next decade. That knocks the return of a 60/40 portfolio down to just 1% per year.

This is why I really believe the 60/40 portfolio is dead, or at least dead for the next decade.

Again, this isn’t a bear hit piece. I’m not forecasting the stock market goes to zero or even that we retest the March lows. Maybe we do, maybe we don’t. Who knows.

Regardless, this should be a wake-up call. If your retirement planning “needs” an 8% return to be viable, you might need to consider working longer or cutting back some expenses.

You may also want to be a little more creative in your allocation. You can leave a good chunk of your investments in a 60/40 portfolio but also carve out some space for active strategies or for alternative investments, including gold or other precious metals.

But the worst thing you can do is carry on as if nothing has changed. Whether or not the 60/40 portfolio is dead, it’s certainly not priced to deliver the sorts of returns we’ve all become accustomed to.

The Best Chinese Stocks to Buy and Hold

The following is an excerpt from The 10 Best Chinese Stocks You Can Buy.

This a precarious time to be investing in China. But many Chinese stocks, particularly in the technology and service sectors, look attractive if you’re willing to deal with some volatility.

Even before the coronavirus outbreak, which originated in Wuhan province, relations between China and the West were strained. The U.S. and China have been engaged in a tit-for-tat trade war for most of the Trump presidency, and there is widespread fear in Western capitals that 5G telecom equipment manufactured by Huawei is capable of state espionage.

Trade tensions alone were reason enough to make many investors wary of Chinese stocks. Then the COVID-19 pandemic happened, exposing the risks of a globalized supply chain.

Consider Apple (AAPL). The world’s leading consumer electronics maker has been reporting supply disruptions since February stemming from Chinese factory closures, and JPMorgan recently estimated that the launch of the new iPhone, which usually comes out in September or October, might be delayed by a few months.

Going forward, a lot of companies might be reconsidering the merits of cheap Chinese manufacturing and opt to stay closer to home. But the truth is that China has long evolved past the smokestack stage of development. The country is a major technology and digital entertainment hub, even if the vast majority of its products and services are destined for domestic use.

You have to be careful when investing in Chinese stocks, as shareholder protections aren’t quite up to Western standards. Already this year, major accounting scandals have upended iQIYI (IQ) and Luckin Coffee (LK). But that’s a risk you take when you invest in emerging markets, and that’s why it’s important to diversify and avoid heavy concentration in any single stock.

Here are 10 of the best Chinese stocks on the market right now. Each is poised to do well no matter what happens next in the coronavirus and trade war sagas.

ZTO Express

If you like the idea of owning China’s Amazon, it only makes sense that you would also like the country’s version of United Parcel Service (UPS). Greater demand for e-commerce means greater demand for shipping and delivery services. It really is that simple.

This brings us to ZTO Express (ZTO), the largest player in Chinese express parcel delivery with a market share of 19.1% as of last year. The company has a fleet of more than 7,350 line-haul vehicles serving approximately 30,000 pick-up and delivery centers throughout China.

Like many Chinese stocks over the past few years, ZTO’s growth rates boggle the mind. Parcel volume jumped by 42% last year after jumping by 37% and 38% in 2018 and 2017, respectively. First-quarter 2020 volume figures aren’t available yet, but it’s likely that widespread lockdowns only made ZTO’s services all the more essential. Just understand ZTO might see activity similar to UPS in which a shift in consumer and product mix hamper profits in the short term.

China probably will record its first true recession in decades this year, but you’d never know it by looking at ZTO’s stock price. The shares have continued to push higher all year and are currently at all-time highs.

We don’t know a lot about what comes next in the post-coronavirus world. But it’s safe to assume that in any reality, ZTO and its peers deliver more parcels.

To read the rest of the article, see The 10 Best Chinese Stocks You Can Buy.

Why Dividend Growth Matters More than Raw Yield

A high dividend yield is nice.

A high dividend growth rate is ultimately better.

When Ray Dalio speaks, people tend to listen. Dalio is the billionaire founder of Bridgewater Associates, the largest hedge fund management company in the world. And it seems Mr. Dalio has a lot to say these days.

Back in January, Dalio said that “cash is trash” in a CNBC interview, and he repeated that sentiment earlier this month, saying that COVID-19 stimulus measures would eventually ignite inflation and that cash would “not be the safest asset to hold.”

I’d agree and would add that bonds — which pay a fixed coupon rate — aren’t much better.

This reminds me of one of my favorite income metrics: yield on cost.

How Yield on Cost Works

The yield on cost is the current annual dividend or interest income divided by your original purchase price. This isn’t going to be a meaningful metric for a short-term trader, but it’s something every long-term income investor will immediately understand and appreciate.

It’s best explained by example. Let’s compare the yield on cost between a hypothetical 30-year junk bond yielding 5.5% trading at par and Realty Income (O), one of my very favorite income stocks. Realty Income also happens to yield 5.5% at current prices.

We’ll start with the bond: $10,000 invested in the bond will produce exactly $550 per year in income in Year 1. But by year 30, it’s still producing exactly $550 per year. Your yield on cost is no different than your current yield. (We’ll also just ignore the likelihood that a company issuing a junk bond goes bankrupt long before we hit the 30-year market. Work with me here!)

Now, let’s compare that to Realty Income. Since going public in 1994, Realty Income has raised its dividend at a 4.5% compound annual rate. Just for grins, we’ll assume that dividend growth is a little slower over the next 30 years and compounds at just 4%.

In Year 1, a $10,000 investment in Realty Income also pays $550. But after 10 years of compounding at 4.5%, that annual payout jumps to $854.13 per year. After 20 years, it grows to $1,326.44. And after 30 years, it grows to $2,059.92.

$854.13 represents a yield on cost of 8.5%.

$1,326.44 represents a yield on cost of 13.3%

And $2,059.92 represents a gargantuan yield on cost of 20.6%.

Now, there are a couple things to keep in mind here. Yield on cost compares the current payout to the original purchase price. It takes no account of the current stock price, which also would presumably rise over time. Compare that to a bond again. The best you can ever hope to get from a bond at maturity is its original par value.

Also, 30 years is a long time to own a stock and might not be realistic for all investors. I’ve personally owned Realty Income for over 10 years and would like to own it for another 20 years. But I also bought the shares when I was a spry 32 years old.  Had I bought the shares having already reached retirement age, the 30-year yield on cost would be a little ridiculous.

And finally, it’s important to remember that dividends can cut just as easily as they can be raised. We’re getting a stark reminder of that this year due to the COVID-19 business disruptions. Goldman Sachs estimated last month that S&P 500 dividends would drop by 25% this year.

So, you’ll still want some cash and bonds in your portfolio, particularly if you’re in or near retirement. But if Dalio is right, and cash really is destined to become trash, you’ll want to own assets that throw off income streams that keep pace with inflation.

Should I Open a Roth IRA Right Now?

If your income is temporarily depressed due to COVID-19 disruptions, this might be a good time to open a Roth IRA or do a Roth conversion.

The following article first appeared on Money & Markets.

William Roth, the late U.S. senator from Delaware, should have his face on Mt. Rushmore.

OK, that might be a bit of an exaggeration. He probably doesn’t belong in the American pantheon with the likes of Washington and Lincoln. But as the sponsor and namesake of the bill that created the Roth IRA, Roth certainly has a special place in U.S. history for American retirement savers.

The Roth IRA — its cousin being the Roth 401(k) — can be thought of as the mirror image of the traditional IRA or 401(k) plan.

Traditional retirement plans give you a tax break in the year you make the contribution and allow for tax-free compounding of all capital gains, dividends and interest. You pay taxes as ordinary income when you eventually take the funds out in retirement, and you’re generally required to start taking distributions after the age of 70 ½.

In Roth accounts, you get no current-year tax break. But all investment gains likewise get to compound tax free. All distributions after age 59 ½ are tax free, and – importantly – there are no required minimum distributions, or RMDs. You can let the account grow tax free until you croak, if that suits you, and let your heirs spend it.

So should you open a Roth IRA right now?

That depends.

Most financial planners naturally gravitate toward the Roth accounts, but I take a more nuanced view. Depending on your income level, your other assets, and your retirement planning, a traditional IRA or 401(k) might be a far better option.

Let’s say you’re in the prime of your career and you find yourself in a high tax bracket. Furthermore, you know that once you stop working, your income will drop significantly and you’ll be in a lower bracket. And in any event, you’re going to need these retirement funds to fund your living expenses when the day comes.

Well, if that’s you, you want the tax break today. You should go with a traditional 401(k) or IRA.

Now, let’s say you’re young and you’re in a low tax bracket. Or let’s say that, for some reason, you find yourself in a lower tax bracket than usual. Perhaps your spouse is out of work or you had business setbacks that have temporarily depressed your income. Or, let’s say you already have a nice nest egg set aside to fund your retirement and you’re looking more to leave a tax-advantaged gift to your children or grandchildren.

In any of these cases, the Roth IRA right now or 401(k) is the way to go.

Converting to a Roth IRA

2020 is a strange year, to say the least. With the Covid-19 lockdowns disrupting business, many people are writing it off as a lost year altogether.

But crisis years like this give us the opportunity to make the proverbial lemonade out of lemons. If you are truly in dire financial straits, you shouldn’t be putting money into a retirement account at all. You should be staying liquid in cold, hard cash.

But let’s say your income has taken a hit but that you also have sufficient savings to get through this without distress. In that case, you have options. You can make Roth contributions to your 401(k) or IRA this year and go back to making traditional contributions once your income rebounds and you find yourself in a higher bracket again.

Or, if you want to make a major planning move, you can convert your existing traditional IRA or 401(k) to a Roth IRA right now. Depending on the size of your account, this could land you with a massive tax bill. So you’ll really want to do the math to figure out of this makes sense for you. But if your income is in the toilet this year due to virus disruptions, it very well could make sense.

Also, note that not all company 401(k) plans allow for a Roth conversion. This is something you’ll need to discuss with your plan sponsor.