The Barnard Observer
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Home Vault Misc Contact c2003-09 Thomas Barnard
Bouyant Buffett Buys Burlington Northern
Buffett Buys Burlington Northern
It’s a huge purchase. From a look at the map, it looks like Buffett bought the nation’s vascular system east of the Mississippi. It’s bigger than the Louisiana Purchase.
A lot of history here. J.P. Morgan tried to put together only the northern part of the system at the beginning of the last century. James J. Hill had taken the Great Northern from Duluth to Puget Sound by 1893. His bankers were Deutsche Bank and Jacob Schiff at Kuhn, Loeb. J.P. Morgan had handled some bond issues for Northern Pacific.
By 1895 Hill was trying to eliminate competitive threats and suggested to Morgan that they merge them into a single system. Morgan cabled his London associates: "proposed plan in every way desirable all interests." This certainly tracks with his feelings about railroads in general. He had spent most of the latter part of the 1800s dealing with railroad bankruptcies. It seemed whenever two railroads served the same two cities, competition would follow, and one of the railroads would go broke. He became interested in trusts and monopolies as a practical matter. The bankruptcies wore him out.
But such a combination was seen by Morgan's lawyers as restraint of trade, so they agreed privately to "form a permanent alliance defensive, and in case the need offensive" to avoid competition and promote their common interests. Hill and his associates bought 10% of Northern Pacific stock.
Now comes the fun part. On May 4, 1901, Morgan got a cable that a combination of railroad men and bankers had secretly bought up more than half of Northern Pacific. Leading the raiders was E.H. Harriman (the same Harriman who harried Butch Cassidy and the Sundance Kid). Harriman controlled the Union Pacific. Both Hill and Harriman wanted the Chicago, Burlington and Quincy (CB&Q) a substantial line with 7911 miles of track and access to Chicago. Hill with Morgan's help had succeeded in acquiring it for the joint account of the Great Northern and Northern Pacific railroads.
Panic of 1901
Harriman had not quite purchased 50% of the stock of the Northern Pacific, and J.P. Morgan together with Hill started buying shares. Hill put in an order with his banker, Schiff, to get 40,000 more shares, but Schiff did not follow through. By now the stock, which had a range of 45 to 86 in 1900, was up to 149. Short speculators had sold borrowed stock to sell into the rise, sure that such a rise could not continue. But Morgan/Hill were still buying shares in short supply, and the stock on May 9 hit $1,000 per share. This was because the shorts had to buy at ever higher prices to close their short bets. A spectacular rise. Eventually, Morgan and Hill had acquired 420,000 shares or 52.5% of the total.
By May 17th the stock market went into crash mode. When the buying dried up, it first showed up in a gradual decline in Burlington stock. It had been high all morning but suddenly a sharp weakness came about. Prices of stocks such as Harriman's Missouri Pacific, and Union Pacific began to fall. Soon enough the whole market was drowning. Investors that had once held on tightly to their stocks were selling out of pure panic. Others caught on and an overwhelming cry of “Sell! Sell! Sell!” was heard throughout the floor of the New York Stock Exchange.
There was no Federal Reserve back then, responsible parties like J.P. Morgan saved the day. In the end, Burlington Northern not only included the lines fought over above - the Great Northern, Northern Pacific, and Chicago, Burlington and Quincy, but also Santa Fe road, the Frisco line, and the Spokane, Portland & Seattle Railway. It's huge.
So Much for History, What Does This Transaction Mean?
Buffett calls this a bet on America. It is a pretty good piece of forwarding thinking, I think he has identified the way transportation of goods will be going with a higher price of oil. Trucks and train engines both use diesel, but apparently trains use that same fuel 4 times more efficiently. An advantage now, but as fuel costs go up, which they inevitably will, the advantage will become more pronounced.
Okay. But I had suspected for years and years now that the market would fall to single digit PE's and that Buffett would buy an even bigger piece of America. As it is, BNI stock price post Buffett's offer has a PE of 18.44, about double the PE ratio I thought Buffett would be paying for stock. And it feels like a lot for a railroad. I can remember the 1970s when he bought into GEICO for peanuts. Maybe he's lost the ruthless spirit of his youth.
Moreover, according to Robert Shiller's spreadsheet, the S&P's PE is up to 18.91, so he's paying right at the market. It doesn't appear he is bargain hunting at all. I am somewhat mystified by this. As readers will remember, and I will refresh your memory below, PE ratios have dropped to single digits many times in the past 100 years:
When PE's dropped to single digits
1917-25, World War I and on into the twenties (8 years)
1932, the bottom of the Great Depression
1942, U.S. enters World War II
1949, U.S. enters Korean War
1974, the great recession
1977-84, the great inflation (7 years)
So, it has been a solid 25 years since we've had single digit PE's. Yes, we did have a 25 year gap from 1949 to 1974, but this is supposed to be the worst recession since the Great Depression, and we're at a PE of nearly 20? Heck, we're not even in a serious recession as far as stock prices are concerned.
In the Crosscurrents
Well, on the upside, GDP was up 3.5% in the third quarter. How much of this is Cash for Clunkers and the $8,000 incentive credit on new home purchases is not yet clear, but my feeling is that it is quite significant. Auto sales for year-to-date were 8.6 million up to October (versus 11.6 million in 2008), down 25% for the year, but Cash for Clunkers put Ford over the top to make nearly a billion profit. And now the unions don't feel they need to bend so much. One pundit on CNBC said there is $4 trillion on the sidelines versus the $2 trillion he thought would be normal. If investors will they commit these trillions remains to be seen.
Will consumers fire up a great Christmas? With millions on unemployment, I'm thinking Christmas will be nothing special, but GDP may still be positive. The stock market's V-type recovery may run up against an L-type economic recovery.
Forget GDP, think Jobs.
Economists would do well to forget GDP as a gauge of the nation’s health. The only thing that matters is jobs. Jobs are everything - purchasing power, taxes, and the psychological health of the nation. But as of the last reading we lost 263,000 non-farm jobs. We're not even to the point yet where we are not losing jobs.
Yes, I saw that Q3 GDP was up 3.5% like everyone else, but I’m not that enthusiastic. It feels like smoke and mirrors. Earnings are up a bit, productivity is up a bit, but isn't that because businesses have been letting people go? How long lasting will the earnings pop be if revenues don't increase, and it's been pretty spotty.
Investments
I went to check on Value Line to see how far off I was in my own view. Value Line says the estimated median price appreciation potential 3 to 5 years hence is 50%. It was 185% at the March bottom, and it was 35% at the July 2007 high. And they use the language, "We think the stock market is now generously valued and some caution would seem advisable."
And that is pretty much my view. We've had a 50% run-up since the lows of March, the economy is showing some signs of improvement, but it doesn't feel to me sufficient to power-up on its own. Housing still need a boost, and Congress is continuing the credit. There are still all kinds of problems. There's a credit card bubble out there which make leak out into the newspapers one of these days. I think investors should be able to buy stocks they like at better prices when the market finally does a test of the lows. Greed and Fear, Bulls and Bears. Greed has been creeping up over the past six months. Greed and complacency. Investors Intelligence says the bullish investment advisors out-number bearish by 2 to 1. It was roughly the other way around back at the March lows.
As far as growth stocks go, I think it's going to be in biotech, whether or not we get national health. Cell phones are a maturing product, computers are a maturing product line. That doesn't mean that Apple can't produce an interesting iPhone, but probably what we need now is an iCar.
Opinion
If I were Obama, I'd fire up the Mars program. It's a forward-looking, inspiring thing. It would bring on a new product cycle, but the policy makers have not quite figured out just how important new products are in the scheme of things. I think something needs to be done about healthcare, but when Congress included old Medicaid bills in the mis-named Stimulus Bill, weren't they just adding that to the National Debt? And with the baby-boomers about to hit 65 next year, shouldn't he have gotten Medicare on sound financial footing first? I don't think Obama and his team are as clever as they think they are. Here they are just attempting to rescue GM, but didn't GM go down by assuming the burdens of healthcare for its employees? I think the role of government is to set the rules. Get rid of pre-existing conditions, make it so employees cannot just get coverage when they need it, and so on. But leave the administration to the private sector. In the PBS Frontline that I watched, it looked like Germany had it about right. It's in private hands, so the government can't go broke putting old bills on the national debt, no one goes broke from medical bills, and the doctors feel underpaid.
As a writer, I had to watch Bush do his father-son thing for eight years. The son feeling the father failed by not taking over Iraq, thus involving the country in a war that added to the National Debt while at the same time lowering taxes, also increasing the National Debt, a double whammy. Meanwhile, letting the really dangerous parties, El Quaida and the Taliban go on their merry way.
Now I have to watch as Obama does a huge Stimulus Bill, which he is putting on the National Tab, and which as I said above, alarmingly puts old Medicaid bills on the National Debt, and initiates a national health plan, to make good on his father's socialist views. Where is the fiscal responsibility? No wonder some people have turned to gold.
November 5, 2009