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Retail earnings and GDP — What you need to know for the week ahead

Myles Udland
Markets Reporter

After a bit of a see-saw week, stocks finished in the green to cap a second week of gains.

And in the week ahead, a full economic schedule and a rush of retail earnings should give investors plenty to key off.

On the economic data side, month-end reports on manufacturing data, consumer confidence, and auto sales are expected, while the second estimate of fourth quarter GDP will also be released on Wednesday. Economists expect the annualized pace of growth in the final three months of 2017 will be downgraded slightly, to 2.5% from 2.6%. According to the Atlanta Fed’s latest GDPNow tracker, the U.S. economy is on track to grow at an annualized rate of 3.2% to start 2018.

And while Friday does mark the first Friday of the month, we will not get the February jobs report until the following Friday, news that will come just a few days ahead of the next monetary policy announcement from the Federal Reserve.

On the earnings side, notable earnings expected out this week should include Lowe’s (LOW), Mylan (MYL), (CRM), Square (SQ), as well as a flood of retail and apparel names, notably TJ Maxx parent company TJX (TJX), L Brands (LB), Best Buy (BBY), Kohl’s (KSS), Nordstrom (JWN), Gap (GPS), J.C. Penney (JCP), Foot Locker (FL), and Macy’s (M).

Macy’s earnings will be a highlight in the week ahead as fourth quarter results from the retail sector are a focus for investors. (Stuart Ramson/AP Images for Macy’s)

On Monday, the latest letter to Berkshire Hathaway (BRK-A, BRK-B) shareholders from Warren Buffett will likely be a big topic of market discussion, with Buffett revealing that the Trump tax cuts led to a $29 billion gain for Berkshire in 2017.

Investors will also continue to keep an eye on Walmart (WMT) and Amazon (AMZN) shares, which last week diverged notably as Walmart fell 11% after disappointing earnings on Tuesday and Amazon shares closed at a new all-time high on Friday of $1,500 on the nose.

Another story surely to make headlines in the week ahead is the increasing number of major companies distancing themselves from previous relationships with the NRA in the wake of this month’s mass shooting at a high school in Parkland, Florida that killed 17. On Saturday, both Delta (DAL) and United Air Lines (UAL) would no longer offer discounts to NRA members.

Economic calendar

  • Monday: New home sales, January (+3.6% expected; -9.3% previously); Dallas Fed manufacturing index, February (30 expected; 33.4 previously)
  • Tuesday: Durable goods orders, January (-2.5% expected; +2.8% previously); FHFA home price index, December (+0.4% expected; +0.4% previously); S&P Case-Shiller home price index, December (+0.6% expected; +0.75% previously); Richmond Fed manufacturing index, February (15 expected; 14 previously); The Conference Board consumer confidence, February (126 expected; 125.4 previously)
  • Wednesday: Fourth quarter GDP, second estimate (+2.5% expected; +2.6% previously); Chicago PMI, February (65 expected; 65.7 previously); Pending home sales, January (+0.5% expected; +0.5% previously)
  • Thursday: Personal income, January (+0.3% expected; +0.4% previously); Personal spending, January (+0.2% expected; +0.4% previously); “Core” PCE, year-on-year, January (+1.5% expected; +1.5% previously); Initial jobless claims (226,000 expected; 222,000 previously); Markit manufacturing PMI, February (55.8 expected; 55.9 previously); ISM manufacturing PMI, February (58.7 expected; 59.1 previously); Auto sales, February (17.2 million vehicles annualized expected; 17.07 million vehicles annualized previously)
  • Friday: University of Michigan consumer sentiment, February (99.5 expected; 99.9 previously)

What matters to Warren Buffett

Warren Buffett’s annual letter to Berkshire Hathaway shareholders is one of the year’s most highly-anticipated pieces of investment writing.

But in his latest missive to investors, Buffett had a few glaring gaps in his discussion, not the least of which is the length of the letter itself. The 2017 edition of his letter to shareholders released on Saturday came in at 17 pages, down from 29 pages a year ago.

When it comes to what’s in the letter, Buffett passed on discussing Wells Fargo (WFC), which is Berkshire’s largest public market equity investment and which has been, to say the very least, embattled over the last 18 months.

Buffett also declined to comment on bitcoin (BTC-USD), a topic from which his vice chair and right-hand-man Charlie Munger has not shied away, as well as giving limited commentary on his view of the U.S. economy, which has been a staple of recent letters.

This more sparse edition of his letter to shareholders, however, does give us perhaps a tighter focus on what Buffett himself sees as the major drivers, or hangups, when it comes to Berkshire Hathaway’s business. And that is Berkshire’s insurance operation and Buffett’s clear frustration over what to do with the firm’s $116 billion cash pile.

Warren Buffett has $116 billion in Treasury securities and he doesn’t know what to do with them.

On the insurance side, Buffett said that hurricanes impacting Texas, Florida, and Puerto Rico in 2017 likely cost the company $3 billion, or about 3% of Buffett’s guesstimated $100 billion industry-wide loss. “I believe that percentage is also what we may reasonably expect to be our share of losses in future American mega-cats,” Buffett writes, adding that he expects Berkshire would have little trouble withstanding a mega-cat storm that inflicted $400 billion of damage on the U.S.

Buffett also detailed what he sees as the primary advantage of Berkshire’s insurance business — it’s “long tail” policies. Certain lines of insurance, like medical malpractice or product liability, have longer timeframes when payment to a claimant is required, giving Berkshire a longer lead time to earn profits from the float generated by these policies — or the insurance premiums paid to Berkshire which Buffett can then invest. Berkshire, as Buffett writes, “has been a leader in long-tail business for many years.”

And while this float may seem to be a fickle source of funding for what is essentially the Buffett-run hedge fund that operates inside the Berkshire Hathaway umbrella, this money is not like that which sits in a bank or is pledged by LPs.

“Unlike bank deposits or life insurance policies containing surrender options, p/c float can’t be withdrawn,” Buffett writes. “This means that p/c companies can’t experience massive ‘runs’ in times of widespread financial stress, a characteristic of prime importance to Berkshire that we factor into our investment decisions.”

And its this business line which Buffett expects to be the driver of Berkshire’s long-term viability after he and Munger are gone.

“Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers – or even that of friends who may be facing liquidity problems of their own,” Buffett writes. “During the 2008-2009 crisis, we liked having Treasury Bills – loads of Treasury Bills – that protected us from having to rely on funding sources such as bank lines or commercial paper. We have intentionally constructed Berkshire in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures.”

Now when it comes to acquisitions, Buffett’s frustrations are fairly straightforward: everything is too expensive.

“In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price,” Buffett writes.

“That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.”

Among Buffett’s notable one-liners in this year’s letter was an analogy between executives who want to sell their company and horny teenagers. This perhaps reflects the seriousness with which Buffett views many pitches he fielded for acquisitions over the last year.

But Buffett also makes clear that a major acquisition is a near necessity for the company.

“Berkshire’s goal is to substantially increase the earnings of its non-insurance group,” Buffett writes.

“For that to happen, we will need to make one or more huge acquisitions. We certainly have the resources to do so. At yearend Berkshire held $116.0 billion in cash and U.S. Treasury Bills (whose average maturity was 88 days), up from $86.4 billion at yearend 2016. This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.”

Of course, this eagerness to make a deal complicates Buffett’s ability to acquire a large, productive business at an attractive price.

The last major deal Berkshire Hathaway made was the $36 billion purchase of Precision Castparts which closed in early 2016.  With a $116 billion war chest, one imagines deals in excess of $40 billion are preferred to move the needle on turning this less-productive Treasury stockpile into an accretive business.

The number of potential targets at this size, however, is limited. Combine a strong economy with a strong stock market and a buyer who has made their desire to acquire a large company known, and all of a sudden Buffett has set his own market such that it does not actually exist.

It seems likely that Buffett’s frustration will continue.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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