Warren Buffett is making a big bet on higher interest rates

Warren Buffett's Berkshire Hathaway Inc. sold $1.5 billion of mostly fixed-rate debt to retire floating-rate notes at a time when government bond yields are rising and the U.S. is showing signs of economic improvement.
A unit of Buffett's Omaha, Nebraska-based holding company issued $750 million of 4.25%, 10-year notes yesterday priced to yield 95 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. It also sold $375 million of 3-year, 1.5% notes and the same amount of floating-rate debt yielding 33 basis points more than the 3-month London interbank offered rate, the data show.
"The market scrutinizes Buffett's moves very closely and this would indicate he's thinking interest rates in the longer term may go up," Vijay Chander, Hong Kong-based head of credit strategy at Standard Chartered Plc, said in a phone interview. "That's consistent with our house view that the U.S. economy is improving."
The world's most successful investor locked in interest payments on most of the debt as a report showed U.S. manufacturing expanded in December at the fastest pace in seven months, spurring confidence the world's biggest economy is gaining momentum. Former Federal Reserve Governor Frederic Mishkin said yesterday that while the central bank will complete its $600 billion bond-purchase program, a third round of so- called quantitative easing to spur growth is unlikely.
Treasury Yields
The yield on the benchmark 10-year Treasury note was at 3.35% today after falling to as low as 2.33 in October, according to data compiled by Bloomberg. It will advance to 3.53% by year-end, according to a Bloomberg survey of 66 banks and securities companies, with the most recent forecasts given the heaviest weightings.
Berkshire issued the debt through its Berkshire Hathaway Finance Corp. unit and plans to use the proceeds to repay floating-rate notes maturing this year, it said in a regulatory filing yesterday. It has $1.5 billion due on Jan. 11, Bloomberg data show. Buffett didn't immediately respond to a request for comment e-mailed to his assistant, Carrie Kizer, outside normal business hours in the U.S.
Berkshire guarantees all of Berkshire Hathaway Finance's debt, Moody's Investors Service said in a statement yesterday.
The company, whose holdings range from Burlington Northern Santa Fe Corp. to General Re Corp. and Fruit of the Loom Ltd., last sold public debt in December when it issued $500 million of 2.45%, five-year notes at a spread of 85 basis points, or 0.85 percentage point, according to data compiled by Bloomberg.
Floating Versus Fixed
In the floating-rate portion of the new debt Berkshire is paying 10 basis points less than in its last benchmark sale of similar-tenor securities. The company sold $2 billion of one- year securities, $1.1 billion of two-year notes and $1.2 billion of three-year debt in February, the data show. The 2013 notes, which priced at a spread of 43 basis points more than three- month Libor, traded at 100.55 cents on the dollar yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
When Buffett announced the $26 billion acquisition of Burlington Northern Santa Fe in November 2009, he described the railroad company as an "all-in wager" on the U.S. economy.
"Management believes that the credit crisis has abated and as a result, interest rates for investment grade issuers relative to government obligations have declined," Berkshire Hathaway said Nov. 5 in a filing with the Securities and Exchange Commission.
Stock Rally
Yesterday the Standard & Poor's 500 Index rallied to its highest close since Sept. 3, 2008 after the Institute for Supply Management said its manufacturing index climbed to 57 last month from 56.6 in November. Increased spending by American consumers and business investment is helping drive production gains at factories that make up about 11% of the U.S. economy.
Investors demand 166 basis points of extra yield to hold U.S. corporate debt instead of government securities, according to Bank of America Merrill Lynch's U.S. Corporate Master Index.
Goldman Sachs Group Inc., JPMorgan Chase & Co. and Wells Fargo & Co. managed yesterday's bond sale, Berkshire said in its regulatory filing.
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How to find stocks with a "margin of safety"

From Buy Like Buffett:

Value investors like Benjamin Graham and David Dodd invented the phrase "margin of safety." Those value investing masters classified a stock's margin of safety as the difference between a stock's market price and its true value.
Value investors like Warren Buffett love to buy stocks that are selling at a discount to their true value. This is number nine on our list of the 10 Things To Look For When Buying A Stock.
How do you find a stock's true value?
A stock's true value is based on a number of factors including current earnings, cash flows, earnings potential, P/E ratio, and...
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Warren Buffett is dumping these long-held stocks

From Bloomberg:

Warren Buffett's Berkshire Hathaway Inc. sold stakes in Home Depot Inc. and CarMax Inc. and cut its holding of Nike Inc. as the billionaire replaced a retiring investment manager and built the company's cash holdings.

Buffett's firm lowered its stake in Nike, the world's largest sporting-goods provider, by 52 percent in the third quarter to 3.6 million shares, Omaha, Nebraska-based Berkshire said yesterday in a regulatory filing that listed U.S. equity holdings as of Sept. 30. Berkshire had 2.8 million shares of Home Depot, the largest U.S. home improvement retailer, and 7.7 million shares of auto seller CarMax on June 30.

Buffett has trimmed Berkshire's portfolio since the 2008 financial crisis and instead focused on buying whole companies. The 80-year-old chairman, renowned for multibillion dollar stock bets, is reshuffling his holdings as he welcomes hedge-fund manager Todd Combs, hired by Berkshire in October. Lou Simpson, 73, once identified by Buffett as his emergency stand in, is scheduled to depart at yearend from Berkshire's Geico unit.

"It looks to me like he's selling out of the Lou Simpson holdings," said Gerald Martin, a finance professor at American University's Kogod School of Business in Washington. Buffett may be amassing funds for Combs to invest "or he may have something up his sleeves, a potential acquisition somewhere and he's building the cash for that," Martin said.

Buffett's firm also eliminated stakes in trash hauler Republic Services Inc., NRG Energy Inc., and Iron Mountain Inc., a provider of records management. Berkshire divested or reduced holdings in 12 companies and boosted stakes in San Francisco-based Wells Fargo & Co. and Johnson & Johnson. Berkshire disclosed a new investment in Bank of New York Mellon Corp., the world's largest custody bank.

'Pot Gets Bigger'

Berkshire's equity sales exceeded purchases by about $1.2 billion in the third quarter, according to a Nov. 5 regulatory filing. It was the sixth period out of eight in which the company was a net seller of equity securities. Berkshire held $57.6 billion in stocks on Sept. 30.

"The equity investments have been a great driver of value for the company, but as the pot gets bigger it's harder to put it to work," said Paul Howard, director of research at Solstice Investment Research in Glastonbury, Connecticut. "He'd rather put the money into acquisitions of businesses and make it easier on the new investment managers" by leaving them with a smaller portfolio to oversee, Howard said.

Buffett acquired Burlington Northern Santa Fe in February for $26.5 billion to add a railroad to Berkshire's collection of more than 70 subsidiaries in industries spanning insurance, energy, and ice cream. In the last two years, the firm has cut its stockholding of Moody's Corp. by more than a third and divested a stake in SunTrust Banks Inc.

Procter & Gamble

Berkshire trimmed its stake in Cincinnati-based Procter & Gamble Co., the world's largest consumer-products company, by 1.7 percent to 76.8 million shares in the third quarter. Holdings of Comcast Corp., the largest U.S. cable-television company, dropped about 98 percent. Stephen Burke, a Berkshire director, is chief operating officer at Philadelphia-based Comcast.

Berkshire cut its stakes in Naperville, Illinois-based Nalco Holding Co., the provider of industrial water-treatment services; Ingersoll-Rand Plc, the Swords, Ireland-based maker of air conditioners, and Fiserv Inc., the Brookfield, Wisconsin-based provider of electronic commerce systems and services.

"Investment decisions are made for any number of reasons, not all of which reflect the underlying strengths of a business," Dan O'Neill, spokesman for Iron Mountain, said in an e-mail. "We're not privy to how or why those decisions are made, but our business is strong and performing well."

BNY Mellon

John Demming, a spokesman for Comcast, and Atlanta-based Home Depot's Ron DeFeo declined to comment. Buffett didn't respond to a message left with an assistant. Representatives of Nike and CarMax didn't immediately respond to messages.

Buffett's firm had 1.99 million shares of BNY Mellon at the end of the third quarter. The stake in Wells Fargo rose to 336.4 million shares from 320.1 million at the end of June. Berkshire has increased its Wells Fargo stake in four quarters since the beginning of 2009 as reductions in short-term interest rates and financial industry rescue programs helped revive banks' profits. BNY Mellon advanced 37 cents to $28.10 in late trading yesterday.

"That is very much a vote of confidence not only in Wells Fargo, but in the commercial banks and the banking sector," said David Kass, a professor at the University of Maryland's Robert H. Smith School of Business. "Warren Buffett is perhaps more confident now in the economic outlook that our recovery, however slow, will continue."

Johnson & Johnson

Buffett, who also is chief executive officer, has said Berkshire will divide his roles as head of investments and operations among more than one successor. Combs, who has specialized in financial-services investments, may initially manage $2 billion to $3 billion, Fortune magazine reported.

Berkshire increased its stake by 3.2 percent in New Brunswick, New Jersey-based Johnson & Johnson, the world's largest maker of health-care products, according to the filing. The stake was 42.6 million shares as of Sept. 30.

Buffett has said he built his equity portfolio by buying and holding stocks of companies that he believes have durable competitive advantages. Berkshire is the top shareholder in Coca-Cola Co., the world's largest soft-drink maker, and American Express Co., the biggest credit-card issuer by purchases.

Berkshire increased its stake in Munich Re, the world's biggest reinsurer, to more than 10 percent in October. Buffett's firm disclosed a three percent stake in the German company in January. Yesterday's filing by Berkshire includes only U.S. holdings. Equity investments abroad are reported to local regulators.

To contact the reporter on this story: Andrew Frye in New York at afrye@bloomberg.net; Natalie Doss in New York at ndoss@bloomberg.net.

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net.

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