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Weekly Wrap: Why Airlines for Berkshire?

Fri, 18 Nov 2016

Reasonable valuations since Brexit likely prompted Buffett's move to airline shares this quarter. Plus, a home improvement gap and why bond yields are going up.

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Video Transcript

Jeremy Glaser: Berkshire takes to the skies, Home Depot outpaces Lowe's, and the yields keep rising. This time on the Morningstar Weekly Wrap.

Investors are always eager to learn what Warren Buffett's Berkshire Hathaway has been buying and selling. Gregg Warren takes a closer look as to why the firm loaded up on airline shares in the third quarter.

Gregg Warren: Wide-moat rated Berkshire Hathaway's quarterly 13F filing is always of interest to investors, mainly because people are interested in seeing what stocks they may have purchased, what stocks they may have sold. This quarter was no different. A surprise during this quarter was that the company actually bought shares in three different airline stocks: American Airlines, Delta Air Lines, and United Continental. Kind of a strange industry for Berkshire to be moving into--Buffett's been in the past, not heaped too much praise on the industry overall. So it's kind of interesting to see that, but when you look at where the stocks were at the end of June, following the Brexit vote--very, very reasonable valuations. All three stocks are up 25% plus since then. I would be surprised if they stuck in the portfolio very long. These look more like Todd Combs or Ted Weschler kind of positions. The company also did pick up stock, additional shares of Philips 66 during the quarter, raising their stake in that firm. 

The more interesting story overall was what happened with Wells Fargo. Berkshire has been kind of on the sidelines here, their collective holdings in the firm is probably about 10%, or about 9.5% or 9.6% for the corporation overall. But there are other holdings there as well as personal holdings. You know so basically puts Berkshire and Buffett on the sidelines. They need to sort of be quiet, be more of a passive investor when it comes to that. I know they're petitioning to potentially own more of the company, so news on that will follow probably within the next several quarters.

Glaser: Home improvement stores have been riding the wave of an improving housing market, but Jaime Katz sees some separation in the results of the two biggest players, Home Depot and Lowe's.

Jaime Katz: The gap continues to grow for wide-moat home improvement retailers Home Depot and Lowe's, with both companies reporting earnings earlier this week. Home Depot has continued to consistently string together quarters of solid performance, and its third quarter didn't disappoint, with same-store sales growth of 5.5% and earnings growth of 17.5%. Lowe's performance, on the other hand, slid in the opposite direction, and while the company reported positive comp-store sales of 2.7%, it also claimed more than $400 million in noncash charges during the period, with about 40% of the write-downs stemming from initiatives that were undertaken by the company and then eliminated. While the housing market growth still seems to have legs as indicated by both Lowe's and Home Depot commentary, as well as home prices and turnover metrics, we remain concerned that the recent jump in higher mortgage rates ahead could prove a near-term headwind for home improvement retailers. We've already seen mortgage applications decline 9% in the last week as rates have bounced.

Glaser: The equity market was closely eyed in the immediate aftermath of the election, but in many ways the real action has been in the bond market with yields going up across the curve. Sarah Bush explores what is behind the substantial moves.

Sarah Bush: A big part of it seems to be coming from an increase in inflation expectations. That can drive an increase in yields. And if you're thinking about what's driving those inflation expectations, I think the conventional wisdom is that with the new administration talking a lot about a big infrastructure program, especially if that comes with tax cuts, that could really increase fiscal pressures and that could lead to inflation.

A couple of other things we've been hearing about though, too, there's a question about what will restrictions on trade that come about mean for inflation. They can have an inflationary pressure so cheap goods coming into this country, could see a slowdown in those goods and that could make prices rise in the US. But they could also put pressure on global demand which would actually push inflation down--so that's sort of a contradictory pressure there.

Then also if you have restrictions on immigration, that could actually push wage pressures up in the U.S. So it's a number of things going on there.

I think one thing to point out is certainly among managers we've talked to, some think we've started to see this increase in yields as something that's overdone and that the markets are overreacting a little bit, and I think a consistent theme is that there are still a lot of unknowns related to the new administration and what policies they will ultimately take. And that just means volatility potentially in both directions for yields.

Glaser: And in case you missed it, Karen Wallace wrote an article this week with more on how the market's inflation expectations have changed since the election. 

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