What Buffett said at Berkshire

A version of this post first appeared on TKer.co

OMAHA, Neb. — Warren Buffett, CEO of Berkshire Hathaway, has mixed feelings about artificial intelligence (AI).

“It has enormous potential for good and enormous potential for harm,” Buffett said at Berkshire’s annual shareholders meeting on Saturday.

He shared a personal experience with AI that had him shook.

“Fairly recently, I saw an image in front of my screen,” he said. “It was me, and it was my voice and wearing the kind of clothes I wear. My wife or my daughter wouldn’t have been able to detect any difference. And it was delivering a message that in no way it came from me.”

He explained: “When you think about the potential for scamming people… Scamming has always been part of the American scene. If I was interested in investing in scamming— it’s gonna be the growth industry of all time.”

Buffett drew comparisons to the emergence of nuclear weapons.

“We let the genie out of the bottle when we developed nuclear weapons, and that genie has been doing some terrible things,” he said. “The power of that genie scares the hell out of me. And I don’t know of any way to get the genie back in the bottle. And AI is somewhat similar. It’s part of the way out of the bottle.”

In the context of investing, analysts have mostly spoken bullishly about AI thanks to the potential for improving productivity across many sectors. TKer has written about this narrative here, here, and here.

Asked later about how Berkshire’s own businesses could be disrupted by AI, Buffett noted the technology would affect “anything that’s labor sensitive” and that for workers it could “create an enormous amount of leisure time.”

Greg Abel, vice chairman of Berkshire’s non-insurance businesses, added that “we’re in the early innings” of understanding the impact.

Buffett has taken this tone before

Buffett, arguably the most successful stock market investor in history, is well-known for his persistent bullish long-term view of the U.S. economy and stock market.

“I understand the United States’ rules, weaknesses, strengths,” Buffett said on Saturday. “I don’t have the same feeling generally around the world. And the lucky thing is that I don’t have to.”

But he’s no stranger to expressing caution on matters with significant downside risks — especially in regards to technology.

For example, Buffett has been vocal about his concerns about cyber attacks. Here’s some language I shared in the March 5, 2023 issue of TKer:

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As you can see, this dire tone from Buffett is not new.

What’s important is that it has never stopped him from being bullish on stocks for the long run.

Zooming out

Emerging technologies like AI come with risk, as they have the potential to scale up bad behavior in the same ways they’ll scale up good behavior.

Broadly speaking, you can never be certain about how risky anything is. And even worse, there are limits to how much you can hedge a risk before you eliminate the potential for a reasonable return.

Unfortunately, this is just the nature of investing in stocks. And it speaks to why returns in the stock market are relatively high — investors demand a high premium for the uncertainty tied to taking on the risk.

“Nothing’s sure tomorrow,” Buffett said at last year’s meeting. “Nothing’s sure next year. Nothing is ever sure in markets or in business forecasts or anything else.”

We can only hope that history repeats, and the good outcomes far outweigh the bad outcomes — as they always have.

Reviewing the macro crosscurrents

There were a few notable data points and macroeconomic developments from last week to consider:

Stocks climbed last week with the S&P 500 rising 0.5% to close at 5,127.79. The index is now up 7.5% year to date and up 43.4% from its October 12, 2022 closing low of 3,577.03. 

The labor market continues to add jobs. According to the BLS’s Employment Situation report released Friday, U.S. employers added 175,000 jobs in April. It was the 40th straight month of gains, reaffirming an economy with robust demand for labor.

Total payroll employment is at a record 158.29 million jobs, up 5.98 million from the prepandemic high.

The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — rose to 3.9% during the month. It was the 27th consecutive month below 4%. While it’s above its cycle low of 3.4%, it continues to hover near 50-year lows.

Wage growth cools. Average hourly earnings rose by 0.2% month-over-month in April, down from the 0.3% pace in March. On a year-over-year basis, this metric is up 3.9%, the lowest rate since June 2021.

Job openings fall. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 8.49 million job openings in March, down from 8.81 million in February. While this remains elevated above prepandemic levels, it’s down from the March 2022 high of 12.18 million.

During the period, there were 6.43 million unemployed people — meaning there were 1.32 job openings per unemployed person. This continues to be one of the most obvious signs of excess demand for labor.

Layoffs remain depressed, hiring remains firm. Employers laid off 1.53 million people in March. While challenging for all those affected, this figure represents just 1.0% of total employment. This metric continues to trend below pre-pandemic levels.

Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.5 million people.

People are quitting less. In March, 3.33 million workers quit their jobs. This represents 2.1% of the workforce, which is the lowest level since August 2020 and below the prepandemic trend.

A low quits rate could mean a number of things: more people are satisfied with their job; workers have fewer outside job opportunities; cooling wage growth; productivity will improve as fewer people are entering new unfamiliar roles.

Labor productivity inches up. From the BLS: “Nonfarm business sector labor productivity increased 0.3% in the first quarter of 2024 … as output increased 1.3 percent and hours worked increased 1.0%. … From the same quarter a year ago, nonfarm business sector labor productivity increased 2.9%.”

From JPMorgan: “Labor productivity had been running at a particularly strong pace for much of last year … and some reversion lower was likely, but we suspect the underlying trend for productivity growth remains stronger than today’s preliminary quarterly growth suggests.”

Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in April for people who changed jobs was up 9.3% from a year ago. For those who stayed at their job, pay growth was 5%.

Key labor costs metric heat up. The employment cost index in the Q1 2024 was up 1.2% from the prior quarter, up from the 0.9% rate in Q4. This was the hottest print since Q3 2022. On a year-over-year basis, it was up 4.2% in Q1, unchanged from the Q4 level.

From Renaissance Macro: “Plenty of indicators out there that show cooling labor costs. Unfortunately, the best one, the Employment Cost Index, is not one of them.”

Unemployment claims tick lower. Initial claims for unemployment benefits stood at 207,000 during the week ending April 27, unchanged from the week prior. While this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.

Consumer vibes recovery stalls. The Conference Board’s Consumer Confidence Index fell in April. From the firm’s Dana Peterson: “Confidence retreated further in April, reaching its lowest level since July 2022 as consumers became less positive about the current labor market situation, and more concerned about future business conditions, job availability, and income. … In the month, confidence declined among consumers of all age groups and almost all income groups except for the $25,000 to $49,999 bracket. Nonetheless, consumers under 35 continued to express greater confidence than those over 35. In April, households with incomes below $25,000 and those with incomes above $75,000 reported the largest deteriorations in confidence. However, over a six-month basis, confidence for consumers earning less than $50,000 has been stable, but confidence among consumers earning more has weakened.”

Consumers feel less great about the labor market. From The Conference Board’s April Consumer Confidence survey: “Consumers’ appraisal of the labor market deteriorated in April. 40.2% of consumers said jobs were ‘plentiful,’ down from 41.7% in March. 14.9% of consumers said jobs were ‘hard to get,’ up from 12.2%.”

Many economists monitor the spread between these two percentages (a.k.a., the labor market differential), and it’s been reflecting a cooling labor market.

Gas prices tick up. From AAA: “The national average for a gallon of gas waffled up and down over the past week before settling higher by two cents at $3.67. The slight increase in pump prices happened despite a lull in domestic gasoline demand and falling oil prices. … According to new data from the Energy Information Administration (EIA), gas demand rose slightly from 8.42 million b/d to 8.62 last week. Meanwhile, total domestic gasoline stocks increased by .4 million bbl to 227.1 million bbl. Tepid demand, increasing supply, and falling oil prices could lower pump prices.”

Card data mixed on April spending. From JPMorgan: “As of 23 Apr 2024, our Chase Consumer Card spending data (unadjusted) was 2.6% below the same day last year. Based on the Chase Consumer Card data through 23 Apr 2024, our estimate of the U.S. Census April control measure of retail sales m/m is 0.28%.”

From Bank of America: “Total card spending per HH was up 0.5% y/y in the week ending Apr 27, according to BAC aggregated credit & debit card data. This was a bounce back from last week’s -0.5% y/y total card spending growth rate. Retail ex auto spending per HH came in at -0.2% y/y in the week ending Apr 27.”

Home prices rise. According to the S&P CoreLogic Case-Shiller index, home prices rose 0.6% month-over-month in February. From S&P Dow Jones Indices’ Brian Luke: “Since the previous peak in prices in 2022, this marks the second time home prices have pushed higher in the face of economic uncertainty. The first decline followed the start of the Federal Reserve’s hiking cycle. The second decline followed the peak in average mortgage rates last October. Enthusiasm for potential Fed cuts and lower mortgage rates appears to have supported buyer behavior, driving the 10- and 20- City Composites to new highs.”

Mortgage rates rise. According to Freddie Mac, the average 30-year fixed-rate mortgage rose to 7.22% from 7.17% the week prior. From Freddie Mac: “The 30-year fixed-rate mortgage increased for the fifth consecutive week as we enter the heart of Spring Homebuying Season. On average, more than one-third of home sales for the entire year occur between March and June. With two months left of this historically busy period, potential homebuyers will likely not see relief from rising rates anytime soon. However, many seem to have acclimated to these higher rates, as demonstrated by the recently released pending home sales data coming in at the highest level in a year.”

There are 146 million housing units in the U.S., of which 86 million are owner-occupied. 39% are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.

Services surveys signal growth is cooling. From S&P Global’s April U.S. Services PMI: “Demand has weakened, as signaled by the first fall in new orders for goods and services for six months, in part a reflection of both businesses and households adjusting to higher costs and the prospect of higher for longer interest rates. Business optimism has likewise cooled, dropping to the lowest since November, and companies are taking a more cautious approach to staffing levels.”

The ISM’s April Manufacturing PMI signaled contraction in the industry.

Manufacturing surveys deteriorate. From S&P Global’s April U.S. Manufacturing PMI: “Business conditions stagnated in April, failing to improve for the first time in four months and pointing to a weak start to the second quarter for manufacturers. Order inflows into factories fell for the first time since December, meaning producers had to rely on orders placed in prior months to keep busy. However, there are some encouraging signs. The drop in orders appears to have been largely driven by reduced demand for semi-manufactured goods – inputs produced for other firms – as factories adjust their inventories of inputs. In contrast, consumer goods producers reported a further strengthening of demand, hinting that the broader consumer-driven economic upturn remains intact.”

It’s worth remembering that soft data like the PMI surveys don’t necessarily reflect what’s actually going on in the economy.

Construction spending ticks lower. Construction spending declined 0.2% to an annual rate of $2.1 trillion in March.

Business investment activity is up. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — grew 0.1% to $73.76 billion in March.

Core capex orders are a leading indicator, meaning they foretell economic activity down the road. While the growth rate has leveled off a bit, they continue to signal economic strength in the months to come.

Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.3% rate in Q2.

The Fed holds steady. The Federal Reserve announced it would keep its benchmark interest rate target high at a range of 5.25% to 5.5% as inflation data remain hotter than desired.

From the Fed’s statement (emphasis added): “Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been a lack of further progress toward the Committee’s 2% inflation objective.”

The bottom line: The Fed will keep monetary policy tight until inflation rates cool further. That means the odds of a rate cut in the near term will remain low.

Putting it all together

We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.

This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.

So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.

At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.

Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.

Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.

At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.

And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.

A version of this post first appeared on TKer.co