Warren Buffett’s $5.4 billion Wall Street warning foreshadows trouble to come

For the better part of six decades, Berkshire Hathaway (BRK.A -0.99%) (BRK.B -1.18%) CEO Warren Buffett was one of the most revered investors on Wall Street. Overseeing a cumulative return of more than 5,650,000% in Berkshire’s ( BRK.A ) Class A shares since becoming CEO has earned Buffett quite the following, as well as the nickname “The Oracle of Omaha.”

Professional and everyday investors frequently look to Berkshire Hathaway’s quarterly Form 13F filing to get a sense of the sectors, industries, trends and stocks Buffett and his top lieutenants, Todd Combs and Ted Weschler, have bought and sold in the last quarter.

But sometimes Berkshire’s quarterly operating results, or its Form 4 filing with the Securities and Exchange Commission, can tell a more thorough story — even if it’s an unpleasant one.

Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.

Warren Buffett has been a net seller of stocks for the past two years

Probably the best thing about Warren Buffett is that he’s usually an open book. Although there were a few occasions when he and his team built up a sizeable position in a stock using confidential treatment — the insurer Chubb is the latest example — Buffett has typically been forthright about his thoughts on the U.S. economy and stock market.

More than once, the Oracle of Omaha has warned investors not to bet against America. While Buffett, Combs, and Weschler are fully aware that recessions are perfectly normal and inevitable, they also realize that boom times and bull markets last substantial more so than recessions and bear markets.

Despite this stance, what Warren Buffett does in the shorter term doesn’t always line up with the long-term ethos that former right-hand man Charlie Munger also instilled at Berkshire Hathaway. Munger died at the age of 99 in late November.

Recently, Buffett has been a somewhat aggressive seller of Bank of America (BAC -2.81%) stock. Between July 17 and August 30, Berkshire’s stake in BofA fell by about 150 million shares, equivalent to about $5.4 billion.

This $5.4 billion selling activity is a pretty clear warning to Wall Street and investors.

For starters, there’s no sector Buffett likes to invest in more than financials, and there’s probably no financial stock he’s favored more over the past seven years than Bank of America. BofA’s interest rate sensitivity, along with CEO Brian Moynihan’s desire to reward his company’s shareholders with a robust capital return program (dividends and share buybacks), made Buffett a happy camper.

That Buffett shed nearly 15 percent of his company’s stake in Bank of America in just over six weeks suggests a clear concern about the U.S. economy and stock market. Like almost all bank stocks, BofA is cyclical.

The other problem is that Berkshire Hathaway is on track for its eighth consecutive quarter of selling more securities than it bought.

Collectively, Warren Buffett oversaw $131.6 billion more in securities sold than purchased between October 1, 2022 and June 30, 2024.

The logical explanation for this is that stocks are historically expensive and Buffett does not want to be part of the “casino”.

Image source: Getty Images.

The stock market is historically expensive

To reiterate, Warren Buffett suggests that investors not bet against America. You will never see Buffett or his team buying put options or shorting stocks.

However, being a long-term optimist and expecting the US economy to grow over time does not mean that the Oracle of Omaha will pay an exorbitant premium for the stock. If a “fair price” cannot be had for great companies, Buffett will sit on his hands as long as necessary until a fair price is reached or simple-day price dislocations occur.

On the basis S&P 500his (^GSPC -1.73%) The Shiller price-earnings ratio (P/E), also known as the cyclically adjusted price-earnings ratio (CAPE ratio), stocks have collectively been more expensive during only two other bull markets in the last 153 years.

S&P 500 Shiller CAPE Ratio data by YCharts.

While the traditional P/E ratio examines a company’s trailing 12-month earnings per share (EPS) relative to its stock price, the S&P 500’s Shiller P/E considers 10 years of inflation-adjusted EPS. The advantage of the latter is that it mitigates the impact of one-off events and shocks, thus providing a more accurate assessment measure.

When tested back to January 1871, the S&P 500 Shiller P/E ranged from a low of 4.78 in December 1920 to a peak of 44.19 during the dot-com boom in December 1999. Since at the closing bell on September 5, the Shiller P/E stood at 35.38, more than double the 153-year average of 17.16.

The bigger concern is what happened in the five previous times the S&P 500 Shiller P/E exceeded 30 throughout history. Although the Shiller P/E is not a timing tool, hindsight shows that the S&P 500 and/or Dow Jones Industrial Average have fallen between 20% and 89% following each previous instance in which stock valuations were extended.

In other words, it’s only a matter of time until the investment euphoria fades and traditional valuation metrics come back into focus. Based on what history tells us, this will happen sooner rather than later.

Buffett’s best buys often come in times of panic

Selling nearly $132 billion more in securities than purchased since early October 2022 boosted Berkshire Hathaway’s cash holdings — which includes cash, cash equivalents and U.S. Treasuries — to an all-time high of 276.9 billion dollars. Chances are good that this hoard of cash will grow even more in the current quarter, given the persistent selloff we’ve seen in Bank of America stock.

While this $5.4 billion warning is a very clear indication from Buffett that economic and/or stock market turbulence is expected, it’s exactly what the Oracle of Omaha is hoping for with such a massive treasure chest at his disposal .

It’s a virtual guarantee that Warren Buffett will continue to buy shares of his favorite stock, Berkshire Hathaway. Over 24 consecutive quarters (that’s six years), he oversaw nearly $78 billion worth of his company’s stock buybacks.

But the bigger story is what price dislocation will attract Buffett next. In the wake of the financial crisis, Buffett invested $5 billion in Bank of America preferred stock. That helped shore up BofA’s balance sheet at a time when banks were Wall Street’s chopped liver. More importantly, it gave Buffett access to warrants that give him the right to buy 700 million BofA shares at $7.14 per share, which he did for Berkshire Hathaway in mid-2017.

Emotional selling periods, while brief, have historically been Warren Buffett’s time to shine. With stocks at one of the most expensive valuations in history, Buffett’s selling activity foreshadows both the danger and the promise of what’s to come.