Weitz: Raw Material for Correction Has Been There All Along
Fed-induced complacency and inflated asset prices laid the groundwork for this week’s sell-off, says Wally Weitz.
Jeremy Glaser: For Morningstar, I’m Jeremy Glaser. With the volatility in the market over the last few days, we’ve checked in with several fund managers. I spoke to Wally Weitz and he shared with us how he sees the Fed-induced complacency starting to evaporate over the last few days.
Wally, what do you think has been driving this volatility?
Wally Weitz: In the last three or four years we've had – I mean, I'm going to grossly overgeneralize, but my take has been that the firehose of money coming from the Federal Reserve with QE, 1, 2, 3, whatever, has both inflated asset prices, starts with the bond markets but has spread to the stocks and real estate and everything else. So, there is absolute inflation from the extra money, but there has also been – it's brought on sort of a complacency among investors about all the many things out in the world that would otherwise normally scare them. So, all the news we've been seeing this last week or two about China slowing down, they have an overinflated stock market, the emerging markets are feeling fallout from China, there are currency problems, Russia and Korea, all these things have been there. Greece – I haven't heard about Greece in the last couple of days.
All these things have been out there for quite a while; but again to overgeneralize, people have either assumed that it was safe to pay up, pay higher prices because the Fed would keep pumping money in or that even though that was dangerous they would get out at the last minute if everybody is going to try to get out the door.
Glaser: So what has that meant for yout portfolio?
Weitz : Our average portfolio price to values got up in the high 80s and touched 90% the end of last year and then with the market going more or less sideways and the companies continuing to grow the price/value a week or two ago, was more like mid-80s or low-80s and we're feeling a little more comfortable but not excited. And then when we have the market go down, what was it, 6% or 8% in the last few days, the price/value on the portfolios priced this afternoon [Monday, August 24th] at the close ranged from low-70s to mid-70s.
So, our level of interest goes up when the price/value goes down. The raw material to make this correction turn into something bigger has been there all along. We've had dozens of false starts and I don't know whether this will be another false start or whether maybe it will really turn into a 10%, 15%, 20% drop. We're just trying to react to what the market gives us. So, we are nibbling a little bit today [Monday, August 24th] and if the market – if our stocks keep going down then we'll nibble harder and harder and get downright aggressive if price/values get down into 60s again. But they haven't been there since the fall of 2011.
So, anyway, I'd say this--I don't know what normal is anymore because we've had the artificial support of the Fed. But it seems as if business value eventually matters, and business values have been growing and conditions for most of our businesses have been between fair and good, [with] exceptions like energy. But we're not really particularly worried about the world coming unglued, a la '08, '09, I don't think there are serious permanent losses to be had like there were in the mortgage securities. But if people get scared they can create panics and temporary liquidity problems that make prices way overshoot on the downside. So, we're just trying to be sensible in our response but we're not very good at predicting the pattern.
Glaser: Have certain parts of the market been punished more than others? And is that fair? Are you seeing any opportunities opening up?
Weitz: For quite a while it seemed like everything is moving together. It was just monolithic tidal wave of buying. The practices started to diverge some the last few quarters maybe and of course, energy is completely driven by oil and gas prices, and I don't know that we've had a lot of fallout in other industries because of that. People are watching banks to see who has loans to energy companies. But if you just look at asset values of the energy companies that we pay attention to just based on what we are guessing that they would earn over the next 10 years from the oil and gas they have in the ground, we get price/values that look like $0.40 or $0.50, and yet the timing on that is completely uncertain. So, we are not getting very aggressive about those. We have energy positions in our funds that are sort of ranged from 4% or 5% up to maybe 7% or 8% and we've been watching the falling knives and at some point we'll reach out and grab some. But we're not being aggressive about it.
Glaser: Do you think any of these market moves mean the Fed is going to hold off in September and does it really matter when the Fed actually raises short-term rates?
Weitz: Well, I don't think it makes any difference when and what the Fed does with the rates really. I think the volume of money that they've created, the $3 trillion or $4 trillion of cash that they have created by placing new credits in the banks and then taking the cash and buying securities is what I was talking about the Fed action that's been inflating the – both actually inflating the prices and giving people the sort of I think false courage to speculate.
The fact that there is trouble in China and all these other places have impacts in all sorts of different ways, but people have been ignoring that because of all the QE, the drug of QE if you want to call it that. So, I don't think it matters whether they – it seems to me that the central bankers are being way too worried about trying to make sure every corner of the universe avoids any pain. I mean, it's a much more sophisticated version but it's not really so different from China just panicking and going in and buying stocks. It does not seem to me to be the right role. But it doesn't matter whether it's the right role or not, the question is for us as investors to try to sort out what's real and what's not.
So, if we look at a TransDigm or a Berkshire Hathaway or a Discovery Channel or a Liberty Media, or an Aon or any of these businesses, we need to sort out whether something going on in China is really going to affect them or whether just having – if they are inflated by an extra 20% by QE and somebody pulls the plug and the air goes back out, maybe the stock prices go down 20%. I have been writing in my quarterly letters for quite a while now that we really like our companies and their business values are growing but their stock prices have been going up faster than the value and it's just got to reconcile. So, that's not a very – it's hard to make a case that we're going to immediately be up another 10% or 20%, but we don't get to have that happen all the time.
What I just said was sounded sort of – maybe sounded depressing that if things are overpriced then they've got to reconcile. I think that's true. But in the process prices often overshoot on the downside and we are loaded with reserves to take advantage of that. So, this is really – if we do get a good healthy 10%, 15%, 20% correction, I think it will be good for our five-year returns. It just won't be very good for our three-month returns.
Glaser: Wally, thanks for joining me today.
Weitz: Okay. Thank you. You're welcome.
Glaser: For Morningstar, I’m Jeremy Glaser. Thanks for Watching.
Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.