When Warren Buffett explained his logic for dumping airline stocks, he was blunt.
“It turns out I was wrong,” Buffett said via teleconference at the Berkshire Hathaway annual meeting.
“The airline business — and I may be wrong and I hope I’m wrong — I think it has changed in a very major way,” he added.
For an investor whose favorite holding period is “forever,” the exit was a big pivot.
In 2019, Berkshire Hathaway was one of the biggest airline investors around, with stakes of 9 to 11% each in the “big four” airline operators — American, Delta, Southwest, and United.
If shareholders could get Buffett on a new conference call today, they might ask about Goldman Sachs.
Every quarter, large investors are required to file a disclosure form with the Securities and Exchange Commission (SEC) known as a “13F.” This form provides information on the purchase and sales of large stock holdings.
You can use 13F data to track what the world’s biggest investors are doing, and TradeSmith applies algorithms to this data for our “Billionaire’s Club” portfolios.
Berkshire Hathaway’s latest 13F filing revealed some notable sales. The most eyebrow-raising portfolio change was an 84% reduction in Goldman Sachs, from 12 million shares in the prior quarter to fewer than 2 million by the end of March.
It’s easy to see why Buffett soured on airlines. The airline business is likely to have significantly lower travel volume moving forward, coupled with lower revenue per flight (no more customers packed in like cattle) and persistently higher costs. Those factors will make it hard to turn a decent profit.
But what about investment banks? Why might Buffett see Goldman as a dud, too?
Part of it relates to the yield curve, which has become a lot flatter in recent years. The flatter the yield curve, the harder it is for banks to make money.
In simple terms, the yield curve is the long-term interest rate minus the short-term interest rate. For example, the difference between the U.S. Treasury ten-year yield and two-year yield is currently 49 basis points, or a little less than half a percent.
The steeper the yield curve, the more profit banks can make, because banks prefer to borrow short-term and lend out long-term. When a bank borrows funds at the short end of the curve, and then issues loans and mortgages based on the long end of the curve, it captures the difference and turns it into profits.
This is why commercial bankers once joked about the “3-6-3” lifestyle — borrow at 3%, lend at 6%, and show up on the golf course by 3 o’clock in the afternoon.
A yield curve that is flat — or even “inverts” and goes below zero, as happened briefly in 2019 — is bad news for banks and other financial institutions. With a flat yield curve, there is less profit to be had in borrowing short and lending long. Sometimes there is no profit at all.
Historically, the yield curve has been much steeper than it is today, meaning the spread was much wider.
In 2009, the ten-year-versus-two-year spread climbed above 280 basis points, or 2.8%. At various points in the years that followed, it rose as high as 400 basis points, or 4%.
The current spread, at less than 50 basis points, is a more than 87% reduction from peak levels. That means a drastic reduction in net interest margin (NIM), a key form of income for banks.
The other problem that banks face — and which Buffett likely sees clearly — is a deterioration in borrower quality and reduced opportunity in the investment banking business in general. For the investment banks, it’s going to be a lean couple of years at least.
A flatter yield curve will reduce trading desk profits along with lending profits. A coming wave of defaults and bankruptcies will disrupt balance sheets. If the U.S. debt market prices in negative interest rates, that will be another big headache to deal with. And a persistent wave of deflation (with pockets of isolated inflation here and there) might be the biggest challenge of all.
Then, too, Goldman Sachs is only a shadow of what it once was.
Fifteen years ago, Goldman was the most powerful investment bank in the world. The power and reach of the Goldman trading desk, along with deep advantages in areas Goldman literally invented — like institutional block trading and risk arbitrage — made the firm a colossus.
But now, Goldman’s trading operations have been greatly diminished in size and emphasis, and Goldman has pivoted to acting more like a retail or commercial bank. In these areas Goldman is a small fish in a big pond, and other banks (like JPMorgan) are better positioned.
As we have said before, we don’t think Buffett is being defeatist. Instead he is being realistic. We’ll be watching the Berkshire Hathaway 13F filing with an extra close eye in upcoming quarters, to keep tabs on what else he is selling.