BINFF - Billionaire 'Bond King' Says Sell These Charlie Munger Must-Buy Stocks: Our Approach

2023-11-09 14:59:36 ET

Summary

• Charlie Munger recently shared some stocks that he believed investors should own in order to "get ahead."
• However, fellow billionaire Jeffrey Gundlach warned that these stocks will be the worst performers in an upcoming recession and urged investors to sell them.
• We share our approach to both of these perspectives.

Billionaire investor Jeffrey Gundlach - commonly referred to as the "Bond King" - recently urged investors to dump stocks that Charlie Munger just said investors need to own to "get ahead." In this article, we will compare the contrasting advice offered by these two legendary investors and share our approach.

Charlie Munger's Must-Buy Stocks

Mr. Munger of Berkshire Hathaway Inc. ( BRK.A , BRK.B ) fame recently told The Wall Street Journal that investors should buy at least some of the leading mega-cap stocks (often referred to as "The Magnificent Seven" for their stellar recent stock market performance) in order to "get ahead." Here are his comments:

I think that the modern investor, to get ahead, almost has to get in a few stocks that are way above average… They try and have a few Apples or Googles or so on, just to keep up, because they know that a significant percentage of all the gains that come to all the common stockholders combined is going to come from a few of these super competitors.

In addition to these comments, Mr. Munger essentially reiterated this view in a recent podcast interview, stating:

Everybody needs some significant participation in the 12 companies that do better than everybody else and you need two or three of them at least, and if you have that mindset, Apple is a logical candidate to be on the list.

These leading stocks dominate the top holdings lists in the S&P 500 ( SPY , VOO ) and Nasdaq ( QQQ ) indexes and include Apple Inc. ( AAPL ), Microsoft Corporation ( MSFT ), Amazon.com, Inc. ( AMZN ), NVIDIA Corporation ( NVDA ), Alphabet Inc. ( GOOG , GOOGL ), Meta Platforms, Inc. ( META ), and Tesla, Inc. ( TSLA ).

Mr. Munger's perspective is unsurprising given that Berkshire Hathaway has a massive stake in AAPL and a smaller one in AMZN. Moreover, Mr. Munger has made numerous other investments in very large, leading companies over the years that have mostly generated phenomenal returns for him over the long term (with his failed investment in Alibaba Group Holding Limited ( BABA ) being a notable exception).

Charlie Munger's encouragement to buy some of these market-leading stocks as a core position in an investment portfolio indicates that he believes that owning companies with exceptionally durable and powerful competitive advantages is one of the most straightforward paths to successfully compounding one's wealth over the long term, even if it means paying a premium valuation for those stocks up front. While some investors emphasize value and others emphasize growth, Mr. Munger appears to emphasize quality above all else.

Jeffrey Gundlach's Must-Sell Stocks

That being said, fellow billionaire and legendary investor Jeffrey Gundlach is taking a position on these leading stocks that is diametrically opposed to Munger's, stating recently of the Magnificent Seven:

They will obviously be the worst performers in the upcoming recession. Whatever is leading the charge going into the economic downturn invariably must lead the charge on the way down. I would get out of them.

Mr. Gundlach is clearly referring to the fact that the Magnificent Seven have massively outperformed the market for years and have held up spectacularly well in the face of rising interest rates. As a result, he believes that - from a valuation perspective - they also have the farthest to fall should the economy and the broader markets falter.

This also makes sense as price is what you pay, and value is what you get when investing. While these market leaders may generate very high-quality earnings and have stellar balance sheets and very durable competitive advantages, if the combination of your earnings yield and growth rate are too low relative to where interest rates are, your total return on your investment is unlikely to be very impressive.

Moreover, the "Bond King" is likely also incorporating the fact that a big reason why these mega-cap technology stocks have performed so well this year is due to the ongoing AI boom, from which they are expected to benefit immensely. Clear evidence of this is the fact that NVDA - the company that is most likely to benefit from AI growth among the Magnificent Seven - is also by far the top performer of the group year-to-date. Moreover, other AI companies like Palantir Technologies Inc. ( PLTR ) have also had a very impressive year-to-date performance. As a result, it stands to reason that general market bullishness on AI is driving up the entire group of mega-cap technology stocks, and once this bullish sentiment begins to fade in the face of a recession, so too will the frothy valuations on these stocks.

Our Approach

We see merits in both investors' approaches and we do not think they are necessarily mutually exclusive, as Mr. Munger's perspective is clearly long-term oriented and is not concerned about short-term macroeconomic movements. Munger and Buffett are famous for not being short-term macroeconomic investors and instead focusing on long-term trends at the company and industry level.

Meanwhile, Mr. Gundlach's analysis was based entirely on his expectation of a recession hitting in the next year, so it is therefore coming from a very different perspective than Munger's.

As for us, we tend to take a blended approach to these two philosophies. We pick each of our positions based on a company-level qualitative and quantitative analysis and invest on a value basis with a fairly long-term outlook. However, we also tend to lean our portfolio in the direction that we deem to be prudent based on our general macroeconomic outlook.

For example, we currently expect the economy to go into recession sometime in the next 3-12 months and also believe that interest rates are at or near their peak levels for this cycle. As a result, while we remain somewhat diversified and are also focused on picking undervalued individual companies that are of good to great quality, we are currently overweighting defensive businesses that have been beaten down by rising interest rates and should rebound sharply as interest rates recede moving forward. In particular, we like utilities ( XLU ) and other infrastructure companies like Brookfield Infrastructure Partners L.P. ( BIP , BIPC ), triple net lease and other defensive REITs like Realty Income Corporation ( O ), certain bonds and other fixed income instruments ( BND ), and precious metals ( GLD , SLV , GDX ).

Investor Takeaway

Part of what makes investing so challenging is that there is no standard playbook for making investment decisions and the world's greatest investors are constantly disagreeing with each other on what is the best course of action.

For us, we have found that sticking to what we know is true as our core foundation for decision-making (i.e., sufficient but not excessive portfolio diversification, insisting on quality, buying low and selling high, remaining calm during market crashes and letting the dividends flow, and weighting a portfolio in the direction of where it appears the economy is headed all enhance risk-adjusted returns) helps simplify our investment process and has delivered significant outperformance over the three years that our portfolio has been active.

In the case of comparing the latest Charlie Munger and Jeffrey Gundlach opinions on the Magnificent Seven, we tend to agree with Mr. Gundlach that now is not an opportune time to buy these stocks - and we actually own none of them given that we see greater opportunity elsewhere - but we also agree with Mr. Munger's perspective that owning these stocks for the long-term will likely still deliver decent or even very good total returns for investors as their competitive advantages and ability to leverage the exponential growth in AI and related technologies to enhance and grow their businesses will likely justify at least some of their current valuation premiums.

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