Warren Buffett buys companies with solid business models that are not fully appreciated. In other words, companies that appear cheap.
Japan’s five major trading houses — Mitsubishi Corp, Mitsui & Co, Sumitomo, Itochu and Marubeni — fit the bill in terms of being cheaply valued, having been hit hard by the global pandemic and collapse in commodity prices earlier this year. The Sage of Omaha has disclosed a $6.3bn investment in the quintet, and signalled he will upsize it.
In the context of Berkshire’s $150bn pile of cash and an overall equity portfolio north of $200bn, led by a chunky stake in Apple, the foray into Japan is not going to move the needle, but it does send an interesting message.
At a time when US technology company valuations are skyrocketing and their stocks can suddenly surge on next to no news, and banks — another Buffett favourite — are held back by rising loan losses and rock bottom interest rates, investors face a more volatile, dislocated and inflationary future.
About a fifth of the Japanese trading houses’ profits are gleaned from cyclical commodities and resource-related operations. In recent years they have shifted towards private equity and venture capital, so they may also provide Berkshire with plenty of upside from future deals and investments, accelerated by the corporate consequences of the pandemic.
Commodity prices, led by metals such as copper and gold, have rebounded sharply in recent months, as have bond market expectations of long-term inflation. An index of industrial metals has rallied by a third from its March nadir and sits at its best level in 16 months.
Playing a key role here has been a retreating US dollar — back at levels from May 2018 relative to its peers in the G10 countries — while so-called commodity currencies and shares in global industrial companies have bounced handily. Early days, but a reflationary trade is brewing.
That is no small measure thanks to the efforts of the Federal Reserve. Last week the US central bank affirmed that it will tolerate a higher rate of inflation over the coming years, a policy choice with capacity for supporting commodity prices a lot further. Having been trapped within a long downward trend over the past decade, a broad basket of commodity prices is showing signs of breaking out.
Against this backdrop, owning commodity trading houses with a global footprint merits appeal — as might owning a slice of the one of the world’s largest gold miners, Barrick Gold, which also appeared in the Berkshire portfolio recently, at the same time as Mr Buffett cut back his stakes in several large US banks.
True, banks can benefit from higher market volatility, but trading houses look the better bet since they can benefit from a combination of low borrowing costs and rising commodity prices.
Much rests on whether inflation really is coming, and it is very much an open question among economists and investors. But the combination of easy money and rising government spending soaked up by central banks is showing signs of resonating across financial markets. And for all the dazzling growth allure of large tech, Apple and its peers look very expensive after stocks have run well ahead of earnings expectations.
The contrarian approach is one of building stakes in companies and sectors that are cheaply valued and with scope to benefit from a world of higher inflation and central bank control of interest rates.
Detractors highlight Mr Buffett’s mixed record of recent years, but a hallmark of successful long-term investing is recognising a shift in the narrative and buying well ahead of the herd.