You may need the cash.
But if the virus returns in the fall, and this winds up like the 1918 flu, there could be $80 billion in losses. There’s even an “extreme” scenario with $140 billion in losses.
Most of Berkshire’s assets are held in insurance companies. Some you know, like GEICO. Most you don’t, like General Re, biBERK Business Insurance, Gateway Underwriters and National Indemnity. The parent company needs to backstop all of them. Warren Buffett’s Berkshire had $137 billion of cash at the end of March.
Warren Buffett Doesn’t See Any Bargains
There’s another reason why Warren Buffett isn’t tossing around cash right now.
The Federal Reserve has pumped so much new money into the economy that there are no bargains. A company that does work, like Apple (NASDAQ:AAPL), sells for nearly 25 times earnings. Even companies that are temporarily out of business, like Carnival (NYSE:CCL), are being snapped up.
The whole idea of value investing, which Buffett has practiced from the start of his career, is that you buy assets below their intrinsic value. With so much free money running around, such assets don’t exist.
The best values this year have been in government bonds. A three-month Treasury had an interest rate of 1.5% at the start of the year. Today it’s 0.1%. An older bond, with a real interest rate, thus has intrinsic value to the holder.
So-called “inflation-protected” securities now carry negative rates. There’s talk of more negative rates coming, government bonds paying less than their face value.
Will Insurance Cover the Coronavirus?
The biggest question in the insurance industry is whether business interruption insurance will cover Covid-19. Exclusions on many insurers’ standard forms don’t mention viruses at all.
Many of these questions will go to court. Some insurers will argue that the virus isn’t “physical damage.” The specific language of an insurance contract, which many business owners don’t clearly understand, will drive a process that has just begun. The legal process will continue long after the virus is gone.
The biggest potential losses in the Willis scenario involve the path the U.S. seems to be on, which it calls “limited success.” This assumes governments lift social distancing rules over economic losses and the virus spreads until controlled by “herd immunity.”
In this case, Willis projects $92 billion of losses in workers’ compensation, $27 billion in losses from economic liability claims, $22.7 billion from event cancellations and losses in other lines.
The Bottom Line
Warren Buffett is in the position J. P. Morgan was over a century ago. He’s the ultimate economic backstop. During the 2008 financial crisis, that meant opportunity. His willingness to backstop banks let the U.S. financial system heal and brought Berkshire Hathaway huge profits.
The current crisis is made for insurance. Berkshire Hathaway companies must shoulder the enormous losses caused by Covid-19. Otherwise the economy can’t recover.
Berkshire Hathaway seems capable of doing that. But that could nearly wipe out earnings in the near term. Some of the smaller companies Berkshire owns may also become victims of the virus.
Berkshire is being very conservative in the current crisis, in the best possible way. That’s good for all businesses. But in the near term it’s bad for Berkshire Hathaway.
Berkshire stock looks cheap now, but as the extent of the damage becomes clear it could fall well below intrinsic value.
Buy it then.
Dana Blankenhorn has been a financial and technology journalist since 1978. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AAPL.