Markets & Stocks
Is Buffett buying?
Rumors abounded Tuesday that the Oracle of Omaha was getting out of bonds, and getting into stocks.
October 15, 2002: 4:11 PM EDT
By Justin Lahart, CNN/Money Staff Writer

NEW YORK (CNN/Money) - Does Warren Buffett think the worst is over?

According to several sources, rumors abounded Tuesday that Buffett's Berkshire Hathaway was unloading a big position in zero-coupon Treasurys and shifting into securities tied to the stock market.

"I'm hearing this from enough areas that I'm giving credence to it," said D.A. Davidson bond trader Mary Ann Hurley of the rumor. "Buffett is definitely a person who likes to play the odds, and in this case the bet seems reasonable -- he's playing the thought that interest rates aren't going to go much lower from a 40-year low."

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Berkshire Hathaway didn't return calls for comment.

Any Treasury buyer hopes that interest rates will head lower, but zero-coupons are the highest-stakes bet you can make. With zero-coupon bonds, also called STRIPS, there are no interest payouts: You buy the bond at a discount and receive face value when it matures. That feature makes zeros react much more strongly to interest rate movements.

In selling zeros -- that is, betting against rates falling further -- Buffett would signal a reluctance to believe that the economy is on its way to a double-dip recession.

One of the chief worries among investors is that a double dip would foster deflation, which could drive yields on the benchmark 10-year Treasury well below the current 4 percent or so. If, on the other hand, evidence emerges that the recovery is on firm footing, the 10-year yield could head north of 5 percent very quickly. Holding onto zeros would be extremely painful if that happened.

Zero tolerance

Buffett is known for being active in the zero-coupon market. In his 1997 annual letter to shareholders, he disclosed that Berkshire had made a $600 million paper gain on an investment in zero-coupon bonds. Berkshire's present position in zeros is unknown, but according to its latest annual report it held $8.8 billion in Treasury and agency debt at the end of 2001, up from $3.7 billion at the end of 2000.

"Buffett has made timely purchases of STRIPS in the past, so people pay attention" noted Miller Tabak bond strategist Tony Crescenzi.

The chatter was that Buffett was using the cash he raised in his bond sales to buy equity-linked securities, like convertibles bonds -- corporate bonds that convert into stock at maturation. That would be in keeping Buffett's investing style, thinks Mizuho futures strategist Phil Ruffat, since convertibles typically offer investors regular payouts on their way to maturation.

"He would be receiving a stream of income and at the same time getting gains off any price appreciation," said Ruffat.

Because of those payouts, putting money into convertibles wouldn't be as risky as putting them into equities directly. Earlier this year Buffett made investments in two beleaguered firms, Williams and Level 3 Communications, through convertible bonds. Both deals were structured in a way that limited the potential downside to Berkshire.

Miller Tabak's Crescenzi cautioned against putting full faith in the rumors just yet, saying that if Buffett really has been making these moves, we'll likely hear about it in the days to come. As much as they can, the traders involved in the sale would try to keep mum about it until it was finished.

"If it really is going on now, we'll hear more, rather than less, about it later," said Crescenzi.  Top of page

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