With deflation today's bigger threat, has Warren Buffett finally lost the plot?
Just as the spectre of deflation is gaining ground, Warren Buffett is taking the contrarian view and positioning Berkshire Hathaway's bond portfolio for higher inflation. Has he lost the plot?
In the second quarter, Buffett continued to rebalance Berkshire's $34.5 billion fixed-income portfolio toward shorter maturity bonds, which bonds are less sensitive to increasing interest rates. When interest rates go up, which, barring a Japanese "lost decade" scenario, will eventually happen, bond values go down -- but the shorter maturity bonds go down less.
Buffett's inflation warning
Back in August 2009, Buffett wrote an opinion piece in the New York Times warning investors that lawmakers will be tempted to simply let the Federal Reserve print away the exploding US national debt instead of making hard choices, i.e. some combination of raising taxes and reducing government spending.
In this context, Buffett's actions make perfect sense for two reasons:
- Sure, the immediate risk the US is facing is deflation, but the longer-term risk is, without a doubt, inflation. In that regard, Buffett isn't so much taking a contrarian view as he is taking the long-term view, which is exactly the perspective he has always adopted in his business and his investment decision-making.
- Within a system as complex as a national economy, Buffett knows that inflation doesn't pop up on appointment; the timing is completely unpredictable, and it could happen faster than the market currently anticipates.
An effective inflation hedge
While high inflation is bad for bonds, eating away at the purchasing power of the fixed income stream they represent, equities are an effective hedge against rising prices. That is particularly true of the shares of businesses with a well-protected franchise and pricing power.
Franchise businesses for the win
Happily for Buffett, these are exactly the type of shares he favours, and Berkshire's portfolio is chock-full of them. Among the best known are Coca-Cola, American Express, and Procter & Gamble -- all three of which represent core positions that go back several decades.
His UK holdings, companies like Tesco (LSE: TSCO) and Diageo (LSE: DGE), follow a similar theme.
To top it all off, high-quality shares such as these are suitable investments whether the environment is deflationary or inflationary. Even if you don't agree with Buffett on the economic outlook, it's tough to argue with his investing approach.
More on the economy and the markets:
> For two weeks in September we will be opening the doors of our Champion Shares PRO newsletter service. In order to keep our exclusivity, only a select number of our readership will be able to join us. This is your chance to guarantee your place! Click here to join the priority waiting list.
> A version of this article, written by Alex Dumortier, was originally published on Fool.com. Bruce Jackson, who has an interest in Berkshire Hathaway, has updated it.
