Bank shares that were once Buffett’s favorite are taking the back seat at Berkshire Hathaway

Warren Buffett, Chairman and CEO of Berkshire Hathaway.

David A. Grogan | CNBC

Warren Buffett has begun releasing Berkshire Hathaway’s massive liquidity stock in recent weeks, acquiring an insurance company and billions of dollars worth of shares in energy and computer companies.

But his latest initiatives are more notable for what he has avoided investing in – banks.

For years, major US banks were Warren Buffett’s preferred investment. Like another top industry in Buffett – railways – banks are part of the country’s infrastructure, a nation he is constantly betting on. Banking is a business he understands, after helping save Salomon Brothers in the 1990s and injecting $ 5 billion into Goldman Sachs at the height of the 2008 financial crisis.

In fact, Buffett’s largest holding in three years in a row through 2017 was Wells Fargo. As recently as the end of 2019, Berkshire held large shares in four of the five largest U.S. banks.

But something has changed, and observers say it could have implications for the future of the U.S. economy. Investors and analysts will certainly ask Buffett about his views during the company’s annual shareholders’ meeting on April 30.

(Watch Berkshire Hathaway’s annual shareholder meeting 2022 live on Saturday, April 30 at 9:45 AM ET here:

After Buffett began filling up on bank shares in 2018 by buying into JPMorgan Chase and Goldman as well as Bank of New York Mellon, PNC Financial and US Bancorp, he explained the moves to CNBC’s Becky Quick as a classic value game, one of the hallmarks of his famous investment career.

“These are very good investments at reasonable prices, based on my mindset, and they are cheaper than other companies that are also good business by a certain margin,” he said.

In particular, he was enthusiastic about Jamie Dimon-led JPMorgan and told Quick that he was “stupid” for not buying shares earlier.

‘Poor results’

However, after the onset of the coronavirus pandemic in early 2020, lenders began allocating tens of billions of dollars to an expected deluge of loan defaults. Despite the industry becoming significantly cheaper to own, Buffett turned many of its efforts around, unloading JPMorgan, Goldman and Wells Fargo.

“He sold them at low prices and he missed out on much of the recovery afterwards,” James Shanahan, an Edward Jones analyst covering banks and Berkshire Hathaway, said in an interview. “But there was a lot of uncertainty at the time.”

At last year’s shareholders’ meeting, Buffett explained his thinking: “I generally like banks, I just did not like the share we had compared to the possible risk if we got the bad results that we have not had so far,” Buffett said. . .

Actions by the Federal Reserve to flood the country with money and aid markets averted the worst economic consequences of pandemic-induced shutdowns, and the wave of defaults that industry had anticipated did not materialize.

Now, while the pandemic is finally subsiding in the United States, Buffett has not given the clear signal to the banks. Why?

Main Street over Wall Street

After divesting many of his positions in 2020, he has largely left his bets on the industry untouched, according to an analysis of quarterly applications. By dropping JPMorgan and Goldman, he cut back on his exposure to volatile Wall Street activities, including trading markets and global investment banking.

His remaining financial list – including a massive $ 40 billion-plus position in Bank of America and a much smaller holding in US Bancorp – shows that Buffett wants to focus on basic U.S. retail and commercial banks as a safer place to park his money. The position that Wells Fargo held for years in its portfolio has actually been replaced by Bank of America, its second largest holding overall after Apple.

“What this tells you is that he thinks we need to shut down the hatches because we’re looking at a long cycle of inflation and likely stagnation,” said Phillip Phan, a professor at Johns Hopkins Carey Business School. “Banks are very cyclical, and everything indicates that we are in an environment of high inflation and high interest rates for a while. This typically means that lending activity will be compressed and investment activity will be pressured.”

Despite rising interest rates this year, which typically lift banks because lending margins are improving, equities have been hammered.

JPMorgan shares have fallen 23% in 2022 to reach a 52-week low on Wednesday. Goldman has fallen 18% this year. The concern is that the US economy may stall as the Fed fights inflation with rate hikes, which increase borrowing costs after more than a decade of bottom interest rates.

Waiting for great deals

JPMorgan’s Dimon has sounded the alarm about this risk and surprised analysts this month with a $ 1.5 billion provision in the first quarter for credit losses due to the Ukraine war and the rising odds of a recession.

In other words, it is possible that the “bad results” that Buffett feared in 2020 are still ahead of the industry; they have simply been delayed.

Buffett could wait for even lower rates for banks or a sign that the U.S. will avoid recession to use its significant liquidity reserves. Even after his recent $ 23 billion shopping spree, Berkshire has more than $ 120 billion in cash left.

Another way to see the banks’ diminished role in Buffett’s portfolio is the growing share of technology names led by Apple, thanks to the influence of Berkshire’s relatively new money managers and the urgent need to beat the S&P 500 benchmark, Shanahan said.

“Historically, if you go five or 10 years back, it was always 40% to 50% in financial stocks,” Shanahan said. “The biggest change in the portfolio is that it has become much less concentrated in financial services and much more in technology.”

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