Is Warren Buffett’s Berkshire Hathaway (BRKB) souring on the stock market? That’s the takeaway that a number of bearish analysts attached to Berkshire’s latest portfolio rebalancing decisions.
The multinational conglomerate completely closed out two of its S&P ETF holdings, including the SPDR S&P 500 ETF (SPY) and the Vanguard S&P 500 ETF (VOO). It should be noted that Buffett has previously called low-cost S&P 500 ETFs “the best investment most people can make.”
Berkshire also completely divested its stake in Ulta Beauty (ULTA) and trimmed its stakes in Bank of America (BAC), Citigroup (C) and Capital One Financial (COF).
In terms of Berkshire’s decision to exit the market-tracking S&P funds, it must also be noted that those holdings represented less than 1% of the firm’s total portfolio. Therefore, it can’t necessarily be assumed that Buffet has turned bearish on the broad market outlook.
And while it does perhaps warrant a certain measure of caution when selecting individual stocks for your portfolio, there’s a reason why you shouldn’t allow Buffett’s latest move to cause you any undue alarm.
Undoubtedly one reason why investors (and possibly the Oracle of Omaha himself) are feeling increasingly nervous about the broad financial outlook is because the latest earnings season has seen its fair share of high-profile stocks tanking on missed estimates, prompting worries that rising costs are undermining profit margins. That said, the number of earnings beats has evened things out and prevented the sellers from gaining an undue advantage. The end result has been a mostly sideways trend in the major averages.
Indeed, for the last couple of months the Dow, the S&P 500 and the Nasdaq Composite have been range-bound, making no meaningful gains since December. There have certainly been areas of relative strength—most conspicuously in the financial sector stocks—but several key industries (notably the semiconductors) have exemplified the trendless environment by merely marking time over the last several weeks.
But in spite of a lack of discernible trend, market liquidity has been ample enough to prevent a major sell-off and has largely kept the bears at bay so far this year. Arguably the best major index for determining just how much liquidity is available for equities in the aggregate is the Russell 2000 small-cap index.
Why the Russell 2000? In the words of veteran market technician, Sherman McClellan (inventor of the famous timing indicator known as the McClellan Oscillator), small caps are important because…
“…the small cap stocks are more sensitive to interruptions in the flow of liquidity (money availability). They are like the canaries that coal miners once employed for warning of deadly methane gas pockets; small cap stocks are much more likely to suffer if liquidity begins to dry up. When liquidity is strong, it is easier for the entire market to go up, since there is plenty of money to go around. But when liquidity gets tighter, only the strongest can survive as investors abandon their more marginal stocks in favor of the more liquid ones.”
The above statement is the best explanation I can offer as to why big-cap and mega-cap stocks are commanding most of the investing spotlight right now, while smaller-cap names are increasingly struggling in the shadows. On that score, here’s what the small-cap tracking ETF, the iShares Russell 2000 ETF (IWM), looks like as of mid-February.
Unlike most major large-cap indexes, which are currently right at or just under their yearly highs, the average small-cap stock is conspicuously below its late-November high. In fact, the IWM is 7% under its nearest peak, showing that underperformance in the small caps has been more pronounced than in mid-caps and large caps.
This isn’t a bearish argument, for even the lagging small caps are still technically in an intermediate-term rising trend and are within easy reaching distance of their all-time highs. What the lagging performance of the Russell 2000 tells us is that while overall liquidity isn’t so profuse that it’s creating an “all boats are rising” market environment, it is still fairly abundant.
And while this suggests that a certain measure of circumspection is in order when it comes to initiating new long positions, it also tells us that the growing fear that a bear lurks just around the corner isn’t a particularly strong case right now.
