Personal Finance: Follow the sage and invest in another hobby

When Warren Buffett cannot find the stock opportunities he wants to invest in it could be time to think seriously about sitting out the rest of this bull market

This is the bad news for anyone who still wants to believe that the current bull market will go on for ever. Warren Buffett is playing a lot more bridge than he was.

By his own admission, this is not something the modern world's most accomplished stock market investor would be doing if share prices were not now so high. The chairman of Berkshire Hathaway confided to stockholders at his annual meeting this week that he is putting in around 10 hours a week into his bridge, either at the card table or (his new hobby) on the internet. His long-standing partner - Charlie Munger - is also, I can reveal, playing a good deal of golf.

Well, you may ask, so what? At 67, Mr Buffett is now past conventional retirement age while his chum Mr Munger, at 73, is even older. Why shouldn't they be having a bit of fun, as long as the shareholders are happy with it - which, judging by the ecstatic scenes at the annual meeting of Mr Buffett's company Berkshire Hathaway this week, they certainly are?

I can vouch for the fact that the annual gathering of the Buffett fans in his home town of Omaha, Nebraska, while always unconventional, has now become more of a pilgrimage than a shareholders' meeting. This year, more than 10,000 shareholders flew in from all round the world to watch a video and pay homage to the man who is routinely - and not without reason - described as the greatest stock market investor of the postwar period.

So great was the clamour to get a good seat in the sports stadium where the meeting was held that the first investor started queuing at 4.15am. By the time they opened the doors at 7am, the line of shareholders stretched more than a quarter of a mile around the vast car park. Mr Buffett himself was followed everywhere he went by a camera crew and treated more like a basketball star than the chairman of a large and successful diversified holding company - which is what, strictly speaking, he is.

The hoopla and ceremonial attending Mr Buffett's every doing has increased dramatically in the last two years and speaks volumes for the current state of popular enthusiasm for the stock market in the States, which is infectious but not without its disturbing aspects. (If you believe one recent survey, no fewer than 20 per cent of the vast new army of first- time mutual fund investors believe that returns from shares are guaranteed by the Federal Government.)

It is difficult to recall, visiting the States now, that it was only seven years ago, during its last recession, that the nation was in the throes of a crisis of confidence over what many saw as the impending Japanese takeover of their economy.

Mr Buffett himself is not joining in the general bull market euphoria. When quizzed, he sticks to a carefully worded formula about the level of the markets. Current market levels, he says, can be justified if two conditions continue to be met. One is that long-term interest rates remain at or below their current level (6 per cent for the long-bond yield). The second is that Corporate America continues to earn the unprecedented returns on equity it has experienced over the past five years. How realistic are those conditions, in Buffett's view? Answer: not very. "Two big ifs" is what he called them this week.

Interest rates certainly don't seem to be his concern. He would not have bought $6bn of long-dated Treasury bonds last year if he thought bond yields were seriously about to rise. That investment is a geared bet that interest rates will fall rather than rise. It is the second condition which worries Mr Buffett and his long-time partner Mr Munger more.

They have profited handsomely from the revival in US corporate profits in recent years, and the rise in the price that the market will pay for those profits. Mr Buffett's trademark holdings in consumer companies with strong franchises have soared in value. His investment in Coca-Cola alone is now worth the best part of $15bn.

But can the record level of profitability last? Short term, it is not impossible. A wise old bird like Mr Buffett also knows that bull markets have a life of their own in their later stages, and publicly he is not going to risk his hard-earned reputation for omniscience by trying to call the next downturn. But the odds against profits staying at current levels are quite long. As Mr Munger pointed out this week, returns on equity of 20 per cent per annum are 50 per cent above their long-run average. He and Mr Buffett think there is no margin of safety in current price levels, and are starting to act accordingly.

Last year Berkshire Hathaway started to trim its equity positions, albeit modestly, in favour of bonds and some more exotic investments, such as silver. Having made his name as a patient long-term accumulator of shares, for the past two years Mr Buffett has actually been a net seller of equities - a striking reversal of previous trends.

His close mate Mr Munger seemed to hint at one point that Mr Buffett's decision to dabble in the silver market owed as much to boredom as anything else. There is another way of looking at this, however. On the face of it, the so-called Sage of Omaha has had two quite outstanding years: +43 per cent in 1996 and +34 per cent in 1997. That, however, is only fractionally better than the US stock market as a whole over the same period. In relative terms, Mr Buffett's performance, as my chart shows, is nothing like as effortlessly superior as it once was.

That is hardly his fault: the amount of money he has to invest is now vast and the range of available opportunities is shrinking. The truth is that he needs a more testing climate in which to demonstrate his superior investment skills and a roaring bull market like the one we have had for the last couple of years is not an easy environment in which to sparkle. He is happy to sit back and enjoy his bridge while the bull thunders on, but he is certainly not in the retiring mood, just waiting for more profitable opportunities.