Historical Cycles & Timing 

 

Q. “ What did you learn from 40 to 50 years of investing” 

A.  “In  40  to  50  years  of  investing  there  will  be  4  to  5  booms  and  4  to  5 
busts  and  in  those  busts you have to buy and in those booms or bubbles 
you  have  to  sell.  In  between  those  booms  and  busts  you  can  afford  to 
make  mistakes  but  in  bubbles  if  you  don’t  sell  or  if during busts you don’t 
buy then you will never make serious money” 

  - Warren Buffet 
 

Figure 1: Bank of America Merrill Lynch stock collapses in 2011

In  2011  as  the  European  sovereign  debt  crisis  roiled  the  financial  market 
everybody  thought  that  just  like  Lehman  in  2008,  Bank  of  America  Merrill 
Lynch  would  go  go  kaput  in  2011.  No  investor  wanted  to  touch  Bank  of 
America  Merrill  Lynch  stock  with  a  barge  pole. Shares of Bank of America 
collapsed  almost  to  the  lows  of  2008.  True  to  form  the  investor  of 
Omaha,  Warren  Buffett  used  this  massive  panic  as  an  opportunity  to 
scoop  up  prefered  shares  of  Bank  of  America  Merrill  Lynch  at  an 
extremely attractive valuation level. 

WARREN BUFFETT SAVES BANK OF AMERICA: Oracle of Omaha 

Injects $5 Billion Of Capital Bank Swore It Didn't Need 

Aug. 25, 2011, 9:28 AM

 

For the last several months, as its stock has collapsed, Bank of
America has insisted it had plenty of capital--and thrown rocks at
anyone who suggested the contrary.

Well, it seems those who were worried had a point.

This morning, Bank of America announced that Warren Buffett is

injecting $5 billion into the company in the form of preferred stock.
This apparently much-needed injection has reassured Bank of
America's clobbered shareholders, and the stock is up 25% on the
news.

For the sake of the country (and fellow Bank of America

shareholders), we're glad Bank of America's management finally
acknowledged reality and took steps to deal with it.

Now, of course, Warren Buffett is no fool, so he didn't just go and buy

Bank of America common stock. He bought preferred stock, which
will pay him a nice 6% dividend. By holding preferred stock, he is
also senior to common stock in the capital structure. So if Bank of
America does have to take huge write-offs of inflated asset values in
the future, Buffett and Berkshire won't get hit.
 

For his $5 billion, Buffett is also getting the right to buy a staggering
700 million Bank of America common shares at $7.14 a
share--options that are already in the money. This represents 7%
dilution to Bank of America's common stockholders.

In other words, Buffett is getting a preferred security paying 6% a

year that is protected from dilution from future capital raises AND
an option to buy 7% of the company--all for $5 billion. That's
expensive money. But given that Bank of America waited too long to
raise capital, it's also clearly the best deal they could get.

Measured against Bank of America's massive $2 Trillion balance

sheet, $5 billion is a drop in the bucket. But when Buffett bets on your
company, he's giving you more than money. And hopefully this
injection will restore some confidence in Bank of America's
management and company.

Identifying market extremes 

 
Figure 6: Magazine covers are often great indicators of market extremes 
 

Some of the pointers for identifying market tops are as follows: 

 
1. The news cycle is decidedly euphoric 

 
2. Market  capitalisation  of  hot  sectors  will  blow  out  beyond 
comprehension 

 
3. Both  foreign  &  domestic  investors  will  be  aggressive  buyers  of 
stocks each month 
 

 
4. Bond  issues  to  public  like  tax  free  bonds  will  be  undersubscribed 
while  oversubscription  in  new  offerings  from  equity  or  sector 
mutual funds and IPOs will reach massive proportions 

 
5. The  wisdom  of  new  stock  market  champion  investors  will  be 
regularly covered on financial news channels 

 
On  the  flip  side  the  news  cycle  will  be  downright  depressing  during 
market  bottoms  as  investors  rush  to  pour  their  money  into  bonds  while 
IPOs  of  even  very  high quality companies struggle to get fully subscribed 
even at bargain basement prices. 
 
Figure 7: News articles published at the depths of the midcap correction of 2018