Warren Buffett’s annual letter to shareholders will hit in a few days.
“The Letter” gets released every year on the last Saturday before March.
Today, I’d like to prepare you for what’s coming.
For the first time ever, Buffett will address the performance of Precision Castparts Corp. (PCC)
This is a really big deal.
Berkshire Hathaway acquired PCC for a whopping $32 billion in cash.
Prior to the PCC purchase, Buffett referred to his core business as the “Powerhouse Five,” which is comprised of…
- BNSF, a railroad
- Berkshire Hathaway Energy
- Marmon, an industrial and heavy machinery company
- Lubrizol, a specialty chemicals company
- IMC, a metalworking giant.
Together, the “Powerhouse Five” represent Berkshire Hathaway’s five most profitable noninsurance businesses, earning $13.1 billion last year.
But next Saturday when Buffett’s letter hits, PCC will officially make it the “Powerhouse Six.”
Put simply, PCC is Buffett’s strategic investment into the aerospace industry.
PCC makes structural investment castings, forged components and airfoil castings for aircraft engines and industrial gas turbines.
Its customers include blue chips like Airbus and Boeing. The company’s website claims that “with few exceptions, every aircraft in the sky flies with parts made by PCC.”
If Buffett reports bullish news on PCC, expect all stocks in the aerospace industry to get a boost.
However, there is reason for concern here.
In inflationary environments, capital-intensive companies, like Buffett’s “Powerhouse Six,” will not perform well.
Click below for the details.
Ahead of the tape,
Investment Director, Wall Street Daily
Question: Martin, the consumer price index numbers just hit and I thought it would be prudent to understand exactly what the latest data are trying to tell us. Get us up to speed on what’s happening.
Martin Hutchinson: Yes, absolutely. The consumer price index came in pretty strong. It was up 0.6% in January, and the core consumer price index, excluding food and energy, was up 0.3%. If you look at the 12-month figure, January on January last year, the CPI is up 2.5%. And the core is up 2.3%, and those were above the 2% Fed target.
Question: What about Janet Yellen, Martin, and her promise of higher interest rates. How does that factor in?
Martin Hutchinson: I don’t think she’s gotten there yet. We’ve had easy money for a decade. For example, the M2 money supply was up 6.6% in the year to Jan. 30. Basically, money supply is real growth plus inflation, so if you subtract the fourth-quarter GDP, which is up 1.9% from the previous year, from that 6.6% you’d expect 4.7% inflation, and we haven’t got that. But that suggests that there is some inflation hiding there in the weeds waiting to bite us. Yellen has said she wants higher interest rates, but she said that last year too. She said she was going to raise them four times. And in fact, she only raised them once, in December. Even now she wants three rate rises this year, but from her testimony before Congress this week, she seems to be thinking of the first not till June, which is pretty back-loaded.
If you look at the Taylor rule, which was invented by economist John Taylor, who was at the Fed in the 1990s — that’s a sort of middle-of-the-road rule for looking at where the federal funds rate should be. And under that, the federal funds rate with unemployment relatively low at 4.8% should be at 3% or 4% today, not at a 0.5–0.75%. And that’s because the economy is close to capacity, and under a normal system interest rates should be much higher than they are.
Question: Hutchinson, please help me understand the spread between where the Taylor rule suggests where the fed funds rate should be and where it actually is.
Martin Hutchinson: Basically, if the federal funds rate is well below the Taylor rule rate, that suggests that the interest rates are well below their natural level, and so you’d expect higher inflation. Now we’ve had eight years of very suppressed growth, partly because of heavy regulation, but President Trump’s come in saying he’s going to rev up the economy. He’s going to deregulate, and he’s going to do a burst of infrastructure spending. He’s essentially taking off brakes that have been there for eight years. Unless interest rates go up pretty quickly, I think we can get inflation at the 4% or 5% level pretty quickly, by the end of the year perhaps, and it could go much higher. Because Janet Yellen will find it tough to raise interest rates because of all the quantitative-easing money on bank balance sheets. There’s $2 trillion of excess reserves that are all sitting there waiting to be lent and spark higher inflation.
Question: Bottom-line it for me, Hutch. Inflation needs to be something our readers account for in their portfolios, right? And if so, how do they do it?
Martin Hutchinson: I think the best broad way to fight inflation is through a gold miners ETF — the VanEck Vectors Gold Miners ETF. This is only halfway between its annual low and its annual high, so it’s pretty conservatively priced. It’s an $11.2 billion fund with only a 0.52 expense ratio, so it’s a good deal. And the reason you buy the gold miners is that they’re better leverage than holding gold directly, because their mining costs are only about $300 below the gold price all in, about $800 or $900, compared with the gold price of $1,200. So if gold rises 20%, to $1,500, then mining profits will double and you’ll expect miners share prices, GDX, to double as well. And that’s an exciting way of getting something back from all the ravages of inflation.
Question: Thanks for your time today, Martin.
Martin Hutchinson: Great to be with you.
Question: This is Wall Street Daily signing off.
Senior Analyst, Wall Street Daily