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The Calculus of Value

https://www.oaktreecapital.com/insights/memo/the-c...

What’s the bottom line of the calculus? Fundamentals appear to me to be less good overall than they were seven months ago, but at the same time, asset prices are high relative to earnings, higher than they were at the end of 2024, and at high valuations relative to history. Most bull markets are built through the addition of a “constellation of positives” on top of a well-functioning economy. Today I see elements that include the following:

the positive psychology and “wealth effect” resulting from recent gains in markets, high-end real estate, and crypto,

the belief that, for most investors, there really is no alternative to the U.S. markets, and

the excitement surrounding today’s new, new thing: AI.

These are the kinds of things that have the ability to fire investor imaginations and contribute to bull markets, and they certainly seem to be doing so now.

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The existence of overvaluation can never be proved, and there’s no reason to think the conditions discussed above imply there’ll be a correction anytime soon. But, taken together, they tell me the stock market has moved from “elevated” to “worrisome.”

Snip:

"But not all assets have earning power (as I define it), and thus not all have calculable investment value. I describe earning power as the money you can make by owning and operating an asset – that is, I omit from “earnings” the possible gains from simply holding an asset and ultimately selling it. A diamond ring, painting, or classic car doesn’t produce earnings for its owner (short of renting it out or charging people to look at it). For this reason, its economic potential comes exclusively from the possibility of selling it at a profit. And the person who buys it is likely to be doing so in the hope of selling it to someone else at a still-higher price . . . despite the fact that it won’t produce earnings in the interim. I think of assets that don’t produce operating cash flow or have the potential to do so in the future as not having earning power, and that makes them impossible to value objectively, analytically, or intrinsically (see my 2010 memo about gold, All That Glitters)."


A warning about all things "Crypto"?

I like his INVESTCON levels:

...I think of progressively applying the following Investment Readiness Conditions, or INVESTCONs, in the face of above average market valuations and optimistic investor behavior:

6. Stop buying
5. Reduce aggressive holdings and increase defensive holdings
4. Sell off the remaining aggressive holdings
3. Trim defensive holdings as well
2. Eliminate all holdings
1. Go short

In my view, it’s essentially impossible to reasonably reach the degree of certainty needed to implement INVESTCON 3, 2, or 1. Because “overvaluation” is never synonymous with “sure to go down soon,” it’s rarely wise to go to those extremes. I know I never have. But I have no problem thinking it’s time for INVESTCON 5. And if you lighten up on things that appear historically expensive and switch into things that appear safer, there may be relatively little to lose from the market continuing to grind higher for a while . . . or anyway not enough to lose sleep over.

Yes, I've been at INVESTCON 5 for a while, it's about as far as I can go.

THE question...is Berkshire an aggressive holding?

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Berkshire Hathaway FAQ

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