🎙️ Bare Shelves

Happy Monday! Let’s kick off the week with some stats that highlight the growing wealth of American households.

Imagine this: Nearly one in three Americans now holds a stock portfolio valued at over half a million dollars. That's right – 30% of the population has equity investments worth more than $500,000. And 37% of Americans own homes valued above the same threshold.

The upshot? A big tailwind for consumer spending. Homeowners and equity investors are enjoying their new levels of wealth as air travel and restaurant spending hit record highs this summer.

— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• Where are all the good stocks?

• Buffett trims Bank of America stock

This, and more, in just 5 minutes to read.

Chart(s) of the Day

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In The News

🤔 Where Are All of The Good Stocks?

Low interest rates have traditionally been widely viewed as beneficial for stocks — just ask small-cap fund managers lately.

But their impact on the stock market is more complex. And this is worth paying closer attention to as the number of publicly traded companies has decreased drastically. 

Zoom out: We all know the current market is dominated by a handful of large tech companies like Nvidia, Microsoft, and Apple, which have driven much of the recent gains. The top-heavy market structure is reminiscent of the 1994-99 tech boom, when the S&P 500 outperformed small-cap indices by a mile. 

• Historically, investors seeking diversification during such periods have turned to small-cap stocks. But the latest bull market has made this strategy less effective. The number of stocks in broad market indices has declined dramatically. For example, the FT Wilshire 5000 Index now contains only 3,381 stocks, far fewer than its name suggests.
  

• Consider that there are roughly three times more stock funds than listed American companies to invest in. Although 70% of the world’s stock market value is American—including all 10 of the most valuable firms—under 10% of listed worldwide companies are American, less than half the proportion of the 1990s tech boom.

Cheap debt, baby: This shrinking pool of public companies is partly because of prolonged low interest rates and the rise of index funds, which have made smaller U.S. companies attractive acquisition targets.

• As a result, many profitable small companies have been bought out by larger corporations or private equity firms using cheap debt. If rates were a bit higher, they’d be much harder to do so.
  

• And, because the remaining small-cap stocks often have lower profit margins than historical norms, they’re less attractive investments. Traditional valuation metrics can be misleading, as many small-cap companies are unprofitable and thus excluded from certain calculations.

Explained: Low interest rates make it easier and less expensive for larger companies or private equity firms to borrow money to fund acquisitions, which allows them to pursue more deals and potentially pay higher premiums for smaller companies.

• And, with low yields on bonds and other fixed-income investments, acquirers look to small-cap stocks to generate higher returns. Smaller companies can have more growth potential, making them appealing targets.
  

• So, because of prolonged periods of low rates, many small-caps firms have been acquired, reducing the overall pool of available investment options. Meanwhile, low rates fueled private equity activity, with firms using cheap debt to finance leveraged buyouts of promising small-cap companies.

Why it matters:

Many big tech companies are at or around all-time highs, the market is generally viewed as fairly expensive right now, and a lot of investors are asking the same question: Are there any bargains available right now in public markets?

A look ahead: Stock investors will likely continue facing challenges because of the long period of low interest rates. Until the U.S. market sees an influx of new, high-quality small companies or existing ones become more attractively priced, investors should temper their expectations for returns similar to past small-cap rallies. 

Bottom line: There are fewer public stocks than there used to be. And of the available stocks, it’s arguably more difficult than ever to find profitable, undervalued companies. 

Read more

More Headlines

🇺🇸 Biden drops out of presidential race, endorses Harris

✈️ Travel season: This tourism tsunami shows no signs of slowing down

💰 Costs from the global outage could top $1 billion

✍️ Howard Marks memo: The folly of certainty

🤔 What Trump-Vance could mean for Wall Street

🎸 Bruce Springsteen is officially a billionaire

☕ Activist Elliott reportedly has a significant stake in Starbucks

🏦 Berkshire Hathaway Trims Bank of America Stock

Warren Buffett cut his firm’s largest position, Apple, by about 13% early this year. Now, the Oracle of Omaha is trimming his second-biggest position: Bank of America.

What to know: Buffett’s Berkshire Hathaway sold about 34 million shares of the bank, roughly $1.48 billion, according to a public filing last week. 

• Berkshire still retains over 998 million shares, valued at over $42 billion, positioning it as the bank's largest shareholder.
  

• Bank of America shares are up 25% this year, though they had a brutal 2023. They have risen 37% over the past few years, compared to the S&P 500’s 84% gain. 

Context: In 2011, Buffett invested $5 billion in Bank of America, acquiring preferred stock and the option to purchase common shares, signaling his confidence in the bank after the financial crisis. His capital injection alleviated concerns about the bank's capital adequacy, leading to a nice rise in its stock value and, thus substantial returns for Berkshire.

Over time, Buffett exercised these rights and made additional share purchases, building a significant stake that became one of Berkshire's primary equity holdings. As of this spring, Bank of America was Berkshire’s second-largest stock position at about 10% of the portfolio, trailing only Apple (roughly 40%).

Why it matters:

At the company's annual meeting in May, Buffett suggested that tax considerations might have influenced the decision to sell Apple shares.

David Kass, a professor at the University of Maryland's business school who closely follows Buffett's investment moves, proposed that similar tax considerations could have played a role in the Bank of America sales. He speculated that Buffett might also be concerned about high valuations in the market, particularly in the banking sector.

Of note: Berkshire has reduced or eliminated stakes in several banks in recent years, including Wells Fargo, JPMorgan Chase, and Goldman Sachs. About 1% of Berkshire’s portfolio is in Citigroup. Last year, he bought a small position in Capital One for about 0.5% of the portfolio. 

Cash is king: Buffett is sitting on a record cash pile of roughly $200 billion. Analysts believe this signals that Buffett might believe the market is overheated or that there just isn’t a wonderful investment opportunity out there. 

• The question remains whether Buffett’s Bank of America sale is just a trim or the start of more selling for Berkshire. Same goes with Apple, though Buffett has heaped praise on both companies over the years, stating they are “wonderful” businesses. His ideal holding period is “forever.”

Berkshire shines bright: Berkshire Hathaway shares rose to a record last week, up about 20% this year and 108% over the past five years, well ahead of the S&P 500.

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Quick Poll

On Friday, we asked: Do you believe the Treasury market can continue to absorb large debt issuances without significant disruptions?

— More than half of respondents say the Treasury market won’t always be able to absorb large debt issuances without major disruptions. “You cannot sustain this amount of debt and continue to drive blindly towards the cliff ”

“The U.S. may have the world’s reserve currency and the strongest economy in history, but even the US can't spend and borrow without limits. Debt will catch up to all of us/US eventually.”

“No free lunch, the consequences of debt eventually catch up with those who accrue it. The only way to avoid the pains of paying off debt is to be disciplined with the budget and ruthlessly eliminate debt as an option. ”

— Others said, “When national debt increases faster than our economy is growing, it will inevitably become unsustainable.”

See you next time!

That's it for today on We Study Markets!

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