Corner of Berkshire & Fairfax Message Board

General Category => Fairfax Financial => Topic started by: OracleofCarolina on March 07, 2014, 03:43:44 PM

Title: Fairfax Letter March 2014
Post by: OracleofCarolina on March 07, 2014, 03:43:44 PM
http://www.fairfax.ca/files/2013%20Shareholders%20Letter%20%28final%20from%20Printers%29_v001_m402d2.pdf

Title: Re: Fairfax Letter March 2014
Post by: VersaillesinNY on March 07, 2014, 04:57:40 PM
Thanks for sharing.

Prem Watsa recommends watching the following BBC documentary:
"How China Fooled The World"
http://www.youtube.com/watch?v=HUSjMnmS5lI
Title: Re: Fairfax Letter March 2014
Post by: NormR on March 07, 2014, 05:07:25 PM
I appreciate Prem's enthusiasm!  While it's not a big thing, someone might want to kindly mention to him that less is often more when it comes to exclamation marks. 
Title: Re: Fairfax Letter March 2014
Post by: TwoCitiesCapital on March 07, 2014, 05:19:58 PM
I find the below notable:

1) Insurance and investment income  was 563M pretax in a mediocre environment (insurance market not particularly hard and interest rates relatively low). Keep in mind that the insurance end could double capacity. Insurance is going to be a much bigger piece of this company (even without hedges) and its very good progress to see these companies growing and becoming profitable

2) totally digging the increase in deflation hedges. I know this is a point of contentionon this board, and the hedges are unpopular, but this is precisely what makes my portfolio robust and anti fragile. Imagine if equity markets fell by 50-70% and Fairfax has billions in cash when it happens. the whole global QE, the moral hazard of bailouts, unprecedented amounts of debt, and the interconnectedness of the global financial system make me uneasy. Debts are generally being refinanced at lower rates which generally allows for, and encourages, more borrowing delaying the day of judgement. That just means when it does come it's that much bigger. Maybe there won't be a crisis and everybody gets along and manages massive loads of debt forever...but I guess I just don't have that much faith in people...and for good reason! I've lived my entire life surrounded by them!

3) I know it's pointless to say "what if", but had they not been hedged, they would have earned nearly $2B on a $9 billion market cap. I'm ok with those types of returns (and larger) once the generalized hedging ends. This is just a way for us to see the true earnings power that the company is capable of.

Title: Re: Fairfax Letter March 2014
Post by: Parsad on March 07, 2014, 05:27:51 PM
I appreciate Prem's enthusiasm!  While it's not a big thing, someone might want to kindly mention to him that less is often more when it comes to exclamation marks.

What do you mean, sir!!!!! 

I think he got that from me.  If he starts ending every paragraph with "cheers", then you can definitely blame me!!!!  Ooops!!  My bad!!!  Cheers!!!
Title: Re: Fairfax Letter March 2014
Post by: JoelS on March 07, 2014, 07:24:42 PM
"At the end of 2013, we had approximately $734 per share in float. Together with our book value of $339 per share and $100 per share in net debt, you have approximately $1,173 in investments per share working for your long term benefit – about 9% lower than at the end of 2012."

IF Fairfax can earn 5% on investments per share going forward and you pay today's price of $430/share, the implied return is 13.6%..

Title: Re: Fairfax Letter March 2014
Post by: Liberty on March 07, 2014, 08:36:08 PM
Thanks for posting the letter.

"Given our concern about financial markets and the excellent returns we achieved on our long term investments, we reluctantly decided to sell our long term holdings of Wells Fargo (a gain of 125%), Johnson & Johnson (a gain of 47%) and U.S. Bancorp (a gain of 135%)."

Wow. Didn't they say a couple years ago that these were core long-term holdings? Maybe I'm misremembering, I'll have to dig that up after I'm done. Still, I was surprised that they sold it all, especially Wells, a Buffett favorite.

Not necessarily bad if they redeploy the capital in even better things, but it's still surprising to me.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 07, 2014, 10:21:06 PM
They are concerned about the high stock market, so they sell things like Wells Fargo that aren't that high?
Title: Re: Fairfax Letter March 2014
Post by: karthikpm on March 07, 2014, 10:28:20 PM
The tone of this letter is the opposite of the cheery optimism Berkshire/ Warren Buffett have- is it conceivable that both could have excellent results? 

Watsa and Fairfax have a deep value approach that would make them sell at "fair value" , very different from Buffett's hold forever philosophy. They also buy very different companies .

PW was very bullish on how JNJ in the 2012 letter

"If P/E ratios revert back to their mean, shares of companies like Johnson & Johnson can provide compound
growth rates of 20%+ in the next decade"-  PE ratios arguably overcorrected- wonder if that caused them to sell these names
Title: Re: Fairfax Letter March 2014
Post by: augustabound on March 08, 2014, 12:29:28 AM
I appreciate Prem's enthusiasm!  While it's not a big thing, someone might want to kindly mention to him that less is often more when it comes to exclamation marks.

I thought I was the only one who noticed all these years.   ;D
Title: Re: Fairfax Letter March 2014
Post by: adesigar on March 08, 2014, 02:11:37 AM
Thanks for sharing.

Prem Watsa recommends watching the following BBC documentary:
"How China Fooled The World"
http://www.youtube.com/watch?v=HUSjMnmS5lI

Watched the BBC documentary. Didn't get what the point was.
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 06:07:54 AM

Little surprised they kept 2/3 of bank of ireland and let The US banks go !


Thanks for posting the letter.

"Given our concern about financial markets and the excellent returns we achieved on our long term investments, we reluctantly decided to sell our long term holdings of Wells Fargo (a gain of 125%), Johnson & Johnson (a gain of 47%) and U.S. Bancorp (a gain of 135%)."

Wow. Didn't they say a couple years ago that these were core long-term holdings? Maybe I'm misremembering, I'll have to dig that up after I'm done. Still, I was surprised that they sold it all, especially Wells, a Buffett favorite.

Not necessarily bad if they redeploy the capital in even better things, but it's still surprising to me.
Title: Re: Fairfax Letter March 2014
Post by: Packer16 on March 08, 2014, 06:40:18 AM
It is a good letter but I still feel they have not given up on the macro the market is going to fall hypothesis.  So where are we with the grand disconnect hypothesis.  The economy is getting better with unemployment below 6.7% in the US and rising real estate prices in major metro markets of the US.  I guess the disconnect is in GDP growth but what do you expect of the aircraft carrier US.  The actual investment in capital equipment has been reduced to match demand but the benefits of increasing productivity in sales and distribution continues.  These increases in productivity have led to unemployment and a pool of folks with a skills mismatch.  Part of the mismatch is the education industries customers having access to cheap funds with no underwriting standards (including expensive education in fields with very few jobs).  I think students and parents are getting it with price and the willingness and interest of the students to be there being a major factor in the education decision. 

The other factor that led to the 2008 decline was leverage in the household and private sectors.  The levels toady are much lower today.  The government sector has taken on more debt but since they control the currency and can be spender of last resort I do no have a problem with this.  I think part of the long term solution is debasement of the dollar which will be seen a modest inflation in an what would normally be a deflationary scenario.

The only exit to date from these hedges have been realized losses.  If they were to exit today the losses would $1.6 billion more than $75.5 per share the cumulative gains to date.  This also includes the gain from a once in a century adverse event.  I do not see FFH predicting this today (expect maybe in China) so where are the gains going to come from?  I could see if they were short the Chinese equity/property market but they are short a remotely correlated market at best (the US equity market).   

If they want to remove risk why don't they reduce their debt rather than hedging the both the market and any potential inflation away.  I think they should remove the rest of them today before they continue to generate losses as they sell equities.  If the modest inflation scenario plays out the losses will continue as the large decline never materializes.

Packer
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 08, 2014, 07:05:09 AM
Packer,
As they keep selling stocks, also their equity hedges keep declining… So, what you are suggesting is in fact automatically happening!
The problem is: when to aggressively invest in equities again?
Here macro imo has very little to do… You might agree with how the Shiller P/E is calculated, or you might disagree… It doesn’t really matter: as long as it keeps getting higher and higher, the disconnect between PRICES and VALUES will get larger and larger. If they think it is already too large, they will need to see a contraction in that metric (or other metrics, like P/S, Market Cap/GDP, the Q Ratio), to move again into equities aggressively.
Please note that the larger the capital you manage becomes the more you are affected by “the tide”, or by what the general market does. I don’t know how your portfolio would behave, if the general market were to correct heavily… Maybe, it would keep increasing in value nonetheless… But you know very well your portfolio is not FFH’s: they need to invest in relatively large companies to move the needle, and large companies which are deeply undervalued today are very hard to find. And large companies that in a serious market correction would behave uncorrelated to the general market are even harder to find.

Gio
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 07:27:43 AM
Packer
I believe they are betting on this one in a hundred event happening where we see deflation in Europe and China bubble burst. I can agree with him on China. I'm not sure how to look at Europe... But Prem is expecting what had happened to Japan to happen in Europe.  Now if these two does happen, then it would affect the US. The added risk here is also that after the Great Recession, there appears to be no more tools in the box for the governments around the world to deal with all this.  So this could be a big and sustained decline.

I think for some of us that risk might be tolerable. But harder for Prem / Fairfax. The bottom line is how likely will all of this unfold , and when.

The one thing I never really understood is if the QE has been helping the US or everybody ... Even economies in Europe and Asia. I mean the US is pumping money into the uS economy. But are there boarders as to how the money flows? I would imagine money flows more easily today than many decades ago when previous recessions happened.


It is a good letter but I still feel they have not given up on the macro the market is going to fall hypothesis.  So where are we with the grand disconnect hypothesis.  The economy is getting better with unemployment below 6.7% in the US and rising real estate prices in major metro markets of the US.  I guess the disconnect is in GDP growth but what do you expect of the aircraft carrier US.  The actual investment in capital equipment has been reduced to match demand but the benefits of increasing productivity in sales and distribution continues.  These increases in productivity have led to unemployment and a pool of folks with a skills mismatch.  Part of the mismatch is the education industries customers having access to cheap funds with no underwriting standards (including expensive education in fields with very few jobs).  I think students and parents are getting it with price and the willingness and interest of the students to be there being a major factor in the education decision. 

The other factor that led to the 2008 decline was leverage in the household and private sectors.  The levels toady are much lower today.  The government sector has taken on more debt but since they control the currency and can be spender of last resort I do no have a problem with this.  I think part of the long term solution is debasement of the dollar which will be seen a modest inflation in an what would normally be a deflationary scenario.

The only exit to date from these hedges have been realized losses.  If they were to exit today the losses would $1.6 billion more than $75.5 per share the cumulative gains to date.  This also includes the gain from a once in a century adverse event.  I do not see FFH predicting this today (expect maybe in China) so where are the gains going to come from?  I could see if they were short the Chinese equity/property market but they are short a remotely correlated market at best (the US equity market).   

If they want to remove risk why don't they reduce their debt rather than hedging the both the market and any potential inflation away.  I think they should remove the rest of them today before they continue to generate losses as they sell equities.  If the modest inflation scenario plays out the losses will continue as the large decline never materializes.

Packer
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 08, 2014, 07:40:43 AM
Quote
More recently, we think the intrinsic value of our company has grown much more than its underlying book value.
--Page 11

That's precisely what I have been saying for some time. ;)

Gio
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 08, 2014, 07:46:00 AM
I have been wondering how they would get out of the hedges, as the markets and economies continue to improve, and they continue to show ever-increasing losses.  Time is not on the side of the short seller.  I guess the answer is that they'll continue to sell stocks and an associated portion of the hedge, so the whole thing will unwind over time.  It is really a shame to lose so many gains, from what is probably a once in a lifetime market recovery.

Like others I completely don't understand the hedges.  To call them a hedge is a bit of a misnomer, they are really a strong bet against the markets.  If they had just wanted to be cautious, they could have held cash or decreased their overall leverage.  Holding excess cash at a time of market declines offers an opportunity to profit. But they went a step further and put on the "hedges".  Holding excess cash you miss out on gains if the market goes up, but holding hedges, you experience losses.

There may be some overvaluation in parts of the markets and some financial institutions are probably to some extent propped up by the Fed policies. But the economy is also clearly improving, slowly, across the board, and perhaps more importantly the "go-go" attitude that led to the crisis is absent.  I could see betting against a certain sector of the market or betting on volatility but betting against the broad markets at this juncture just seems nuts to me.

The rationale and execution of betting against the credit default swaps and profiting from the downturn was absolutely brilliant, but I wonder if this success unduly affected their thinking about such events.  That may have been a once in a lifetime event.  It would be a shame for them to give back those gains over subsequent years hoping to catch lightning in a bottle twice.
Title: Re: Fairfax Letter March 2014
Post by: Packer16 on March 08, 2014, 07:47:23 AM
I think the weakness in the Europe/China breakdown is why won't they debase like the US?  Let the Euro and Yuan fall like a rock along with the US by printing and allowing inflation.  The alternative of Japan is always out there to prevent tight monetary policy.  What this means in my mind is monetary inflation offset by labor and goods deflation.  Which is the scenario where FFH will underperform the worse.  My big question is why are they doing this when the don't have to.  If you have an insight on security or market segment (CDS) then you can make a bet with variables you can get comfortable understanding but when you get to the whole stock market your into way too many variables.  It appears FFH is stepping out of there circle of competence (and everybody elses too look at Ray Dalio's 2013 returns for example).  If they are using this as a hedge, I would think they would get rid of their debt first, no?

Packer 
Title: Re: Fairfax Letter March 2014
Post by: wellmont on March 08, 2014, 08:07:59 AM
I find the below notable:

 Imagine if equity markets fell by 50-70% and Fairfax has billions in cash when it happens. the whole global QE, the moral hazard of bailouts, unprecedented amounts of debt, and the interconnectedness of the global financial system make me uneasy.



ok. but this tends to happen every 30 or 40 years. And it just happened 5 years ago. So is that a wise bet? I see a two tiered market. I see massive overvaluation in a growing number of "hope and change" type companies. And I see reasonable valuation in many good companies like msft, apple, qcom, aig, lots of small financials, etc.
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 08, 2014, 08:13:05 AM
I find the below notable:

 Imagine if equity markets fell by 50-70% and Fairfax has billions in cash when it happens. the whole global QE, the moral hazard of bailouts, unprecedented amounts of debt, and the interconnectedness of the global financial system make me uneasy.

ok. but this tends to happen every 30 or 40 years. And it just happened 5 years ago. So is that a wise bet? I see a two tiered market. I see massive overvaluation in a growing number of "hope and change" type companies. And I see reasonable valuation in many good companies like msft apple qcom, etc.

Well, they think this happens anytime the disconnect between PRICES and VALUES becomes too large… It happened in 2000, it happened again in 2008… Twice in less than 10 years.

Gio
Title: Re: Fairfax Letter March 2014
Post by: wellmont on March 08, 2014, 08:14:25 AM
I don't think the overvaluation is in the big indexes. spy dia. isn't that where their shorts are? what happened in 2000 is that the crazy stuff came way down and that money went into boring, cheap, solid, dividend paying stuff. And those stocks did exceedingly well for about 3 years before hitting a speed bump.
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 08, 2014, 08:20:14 AM
I don't think the overvaluation is in the big indexes. spy dia. isn't that where their shorts are?

No, they are shorting the Russell2000.

Gio
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 08:23:29 AM
I believe they don't want to deleverage because that affects their earning power and hence intrinsic value.

The hedges can sit until they realize the gain. So if their time horizon is long ,then it makes sense they want the leverage to build up the intrinsic value and when the time is right get rid of the hedges.  I guess while he sees uncertainty in macros he's also recognizing there are cheap businesses out there to own. For example bank of ireland. And blackberry.

Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 08, 2014, 08:25:55 AM
what happened in 2000 is that the crazy stuff came way down and that money went into boring, cheap, solid, dividend paying stuff. And those stocks did exceedingly well for about 3 years before hitting a speed bump.

Yes! And that’s why the “average” stock is even more expensive today than it was in 2000… Wow!

Maybe you don’t think the S&P500 is overvalued today… Yet, its Shiller P/E has to at least stabilize… If it keeps getting higher and higher… I hope you agree with me that sooner or later we will reach the overvaluation threshold. ;)

Gio
Title: Re: Fairfax Letter March 2014
Post by: wellmont on March 08, 2014, 08:42:49 AM
what happened in 2000 is that the crazy stuff came way down and that money went into boring, cheap, solid, dividend paying stuff. And those stocks did exceedingly well for about 3 years before hitting a speed bump.

Yes! And that’s why the “average” stock is even more expensive today than it was in 2000… Wow!

Maybe you don’t think the S&P500 is overvalued today… Yet, its Shiller P/E has to at least stabilize… If it keeps getting higher and higher… I hope you agree with me that sooner or later we will reach the overvaluation threshold. ;)

Gio

not sure I agree. the spy hit 1500 in early 2000, and that was 14 years ago. It's 1880 now. So I think the indexes were valued way higher back then. I see the typical stock cheaper now, although not absolutely cheap. To me the market today is kind of "mini" version of 1998-2000. valuations of crazy stuff not as rich as late 90s. indexes not as rich. average stock not as rich. not as many ipos. But we are certainly headed in that direction of overvaluation. But still there are places to hide out, as I mentioned earlier.
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 08, 2014, 08:53:39 AM
not sure I agree. the spy hit 1500 in early 2000, and that was 14 years ago. It's 1880 now. So I think the indexes were valued way higher back then. I see the typical stock cheaper now, although not absolutely cheap. To me the market today is kind of "mini" version of 1998-2000. valuations of crazy stuff not as rich as late 90s. indexes not as rich. average stock not as rich. not as many ipos. But we are certainly headed in that direction of overvaluation. But still there are places to hide out, as I mentioned earlier.

Well… maybe!
Anyway, the question remains the same: when will FFH invest aggressively in stocks again?
And my answer is: when they will see that those metrics, which compare PRICES to VALUES for the general market (be it the Dow, the S&P, or the Russell), at least stabilize.
As long as they keep getting higher and higher, like they are still doing, I don’t think we will see FFH’s equity portfolio become larger.

Gio
Title: Re: Fairfax Letter March 2014
Post by: plato1976 on March 08, 2014, 08:56:56 AM
I am not sure if you can call qcom as cheap
I never truly understood when qcom 's patent cliff would come, and royalty is responsible for 2/3 of its earning... So it's hard to assign a PE to its current earning.

I find the below notable:

 Imagine if equity markets fell by 50-70% and Fairfax has billions in cash when it happens. the whole global QE, the moral hazard of bailouts, unprecedented amounts of debt, and the interconnectedness of the global financial system make me uneasy.



ok. but this tends to happen every 30 or 40 years. And it just happened 5 years ago. So is that a wise bet? I see a two tiered market. I see massive overvaluation in a growing number of "hope and change" type companies. And I see reasonable valuation in many good companies like msft, apple, qcom, aig, lots of small financials, etc.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 10:00:55 AM
To call them a hedge is a bit of a misnomer, they are really a strong bet against the markets. 

I see it as a weak bet because if the markets go down their gains from the hedges will be largely offset by their losses on their equities.

If they had just wanted to be cautious, they could have held cash or decreased their overall leverage.

They had some concentrated investments that would have been difficult to unload in a hurry.  They also had significant capital gains tax consequences to face.  Both problems are avoided by hedging against the index.

Besides that, holding cash wouldn't have avoided the opportunity costs -- so it would be no real advantage versus where they stand today.


Holding excess cash you miss out on gains if the market goes up, but holding hedges, you experience losses.

The losses are offset by the gains on the equities they hold.  Cash is no better.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 10:18:33 AM
They closed out JNJ.  For last 4 years, it has been hedged against offsetting Russell 2000.  The offsetting hedge was closed out when JNJ was sold.

How did that paired investment do since 2010? 
JNJ  +45.3%
Russell 2000:  +76%

It is less bad than this because of dividends, but I think JNJ did not beat the index.

WFC is up 61.83%.  Again, it was a loss versus the index.  Perhaps not much of a loss with dividends.

USB is up 64.28%.  A loss versus the index.  Dividends would have made it close.

Basically, no gains were made here since they began to hedge them in 2010.

Interesting though, I would think the gains were largely due to earnings.  Wells Fargo and USB have earned a lot of money over the last four years.  Both companies have grown their per-share earnings by quite a bit.

Put it this way, Wells Fargo is only up 61.83% versus 4 years ago.  Is that really a reason to sell today?  The stock was trading around a P/E of 10 4 years ago.  A significant amount of that gain was in the form of retained earnings.  The company is safer than 4 years ago, better loan portfolio, healthier borrowers, more capital.  Stronger per-share earnings, and we're closer to the end of deleveraging.  Yet they sell it anyhow for no gain over that period (erased by the loss they booked on the hedge).
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 10:28:06 AM
Eric
I think we must not underestimate a blow up of china and Europe same time as I noted above - these events could have a lot of impact on US financials, and the governments around the world have very few options left... Interest is already low! And we have been printing money.

Of course, Prem will look smart IF these events unfold, 

What nobody knows is WHEN

Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 10:32:50 AM
Eric
I think we must not underestimate a blow up of china and Europe same time as I noted above - these events could have a lot of impact on US financials, and the governments around the world have very few options left... Interest is already low! And we have been printing money.

Of course, Prem will look smart IF these events unfold, 

What nobody knows is WHEN

How much lending has US Bancorp done to borrowers in China?

I agree that markets will go down, but remember... it was hedged against the market.  So what's the point of selling?

The market might unwind back to 2010 level, but these banks very well might not -- there is all that retained earnings since then. 
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 10:48:53 AM
Eric
I think we must not underestimate a blow up of china and Europe same time as I noted above - these events could have a lot of impact on US financials, and the governments around the world have very few options left... Interest is already low! And we have been printing money.

Of course, Prem will look smart IF these events unfold, 

What nobody knows is WHEN

How much lending has US Bancorp done to borrowers in China?

I agree that markets will go down, but remember... it was hedged against the market.  So what's the point of selling?

The market might unwind back to 2010 level, but these banks very well might not -- there is all that retained earnings since then.

I think the question we should be asking is how much lending have US Bancorp, WFC, BAC, etc done to borrowers that have financial ties in China / Europe -  the financial system is so well connected now... the risk today is the "unknown unknowns" --

I was reading the other day how the Bank of Japan chief saw no need of intervention - he had one job and probably went to school for very long - and he missed it.  All the experts in the world missed the Great Recession.  Even Buffett has said he didn't see 08 coming so he invested in Moody's.  The greatest minds put the EU together and didn't see the mess they are in now... 

I guess that's what Prem is worried about - this 1 in a 100 year event that nobody can fathom. 

When the planes hit WTC - nobody thinks it could collapse - my structural prof told me nobody believed it could collapse.  Well - he spent the next 5 years in committees to try and figure out why it did.   And perhaps that's just Prem being cautious - he wants to prevent getting wiped out for something he or others have not been able to foresee...

Gary
Title: Re: Fairfax Letter March 2014
Post by: Packer16 on March 08, 2014, 10:54:27 AM
If Fairfax is worried about those items why don't they short China and European bank indicies?  I am sure investment banks could put together a derivative for them.  The hedge against the US indicies is worse than the Russell hedge against the US securities they hold.  I still don't understand the debt they have on the balance sheet if they are hedging market risk. 

Packer
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 10:58:22 AM
I think the question we should be asking is how much lending have US Bancorp, WFC, BAC, etc done to borrowers that have financial ties in China / Europe -  the financial system is so well connected now... the risk today is the "unknown unknowns" --

Take a US multinational company that exports to Europe, China, and other emerging markets.  They will lose sales and profits will fall.  Their record margins will contract.  So the index will fall.

However as IBM's sales suffer, their profits suffer directly.  But they are still able to pay their bank loans. 

Being a relatively less profitable exporter doesn't mean you can't still go on paying interest on your loans.
Title: Re: Fairfax Letter March 2014
Post by: beerbaron on March 08, 2014, 12:05:28 PM
The following are a bit scary:
China added 5.9 billion square metres of commercial buildings between 2008 and 2012 – the equivalent of
more than 50 Manhattans – in just five years!


Assuming 25% of China's worker are working in an office that would mean about 10 square meter per worker that has been added. I wish I had 10 square meter for my personal office.

BeerBaron
Title: Re: Fairfax Letter March 2014
Post by: TwoCitiesCapital on March 08, 2014, 12:10:39 PM
I find the below notable:

 Imagine if equity markets fell by 50-70% and Fairfax has billions in cash when it happens. the whole global QE, the moral hazard of bailouts, unprecedented amounts of debt, and the interconnectedness of the global financial system make me uneasy.



ok. but this tends to happen every 30 or 40 years. And it just happened 5 years ago. So is that a wise bet? I see a two tiered market. I see massive overvaluation in a growing number of "hope and change" type companies. And I see reasonable valuation in many good companies like msft, apple, qcom, aig, lots of small financials, etc.

It's funny that these once in 30-40 year events actually seem to happen way more regularly than that...

As Gio pointed out, 2000 there was a 50% decline due to the tech bubble. 2008 there was a 50% decline due to the housing bubble/over leveraged financial system. By most historical measures (Shiller P/E, Tobin's Q, historical margins and current P/Es, etc), we are anywhere between 30-50% overvalued.

Whose to say in 2018 there won't be a Chinese property crisis since there are literally multiple empty cities and credit has continued to expand....
 Or an escalation of Europe's problems as at the end of 2011...but without the quick resolution since the main tool proposed then has since been determined illegal. Did you know that interest rates doubled in Spain, Ireland, and Greece in a matter of weeks during this period? We are literally a matter of weeks away from these countries bleeding if rates shoot to 10% for any significant period of time.
Or anothe recession in the U.S.? Or a contagion from worsening conditions in emerging markets?

My point is, a crisis may or may not come. But there is a serious amount of risk in the system with unprecedented debt levels at the global level, unprecedented connectedness within the global financial system, an obvious capital spending bubble and debt bubble in China, Europe/U.S. constantly on the brink of 0 growth/recession, and unprecedented levels of speculative liquidity driven by central bank injections. Maybe we fly though all of this without a scratch on us. Maybe we crash and the results are devastating. Just because you made it to your destination safely doesn't mean it was stupid to wear your seatbelt. I'm just glad Fairfax is wearing their seatbelt and driving slowly.

Nobody is forcing people to buy the stock. If you don't like the current state of the hedges, don't buy it until they take them off.
Title: Re: Fairfax Letter March 2014
Post by: Packer16 on March 08, 2014, 12:26:28 PM
My question is when was there not a potential crisis?  In the "good ole days" you had the cold war with a nuclear threat that could destroy the world.  Then you had the emerging markets contagion in the 1990s.  The internet bubble, the housing bubble.   When does it end???  You just need to make an assessment is the current situation worse than the past.  I would say at this point no because the leverage in the system is to the gov't.  Look at all the $ the Fed tried to force feed the banks.  Where did it go?  Right back to the Fed as excess reserves so I don't see the leverage in the US at least. 

Frankly, I feel better the debt is on the gov't balance sheet versus household and businesses as the gov't can always print there way out of trouble but households and businesses cannot.

Packer
Title: Re: Fairfax Letter March 2014
Post by: Nnejad on March 08, 2014, 12:32:42 PM
The following are a bit scary:
China added 5.9 billion square metres of commercial buildings between 2008 and 2012 – the equivalent of
more than 50 Manhattans – in just five years!


Assuming 25% of China's worker are working in an office that would mean about 10 square meter per worker that has been added. I wish I had 10 square meter for my personal office.

BeerBaron

By commercial buildings, doesn't that include retail/industrial?
Still, this is 50 sq ft of commercial buildings per Chinese person added since 2008.
The US has total commercial building sq ft per person of 242. The US has added ~ 24 sq ft of commercial buildings per person since 2003.

i.e.
1) China has added twice as much per person over half as much time, and
2) the US includes a major boom period (2003-2008) while China is just over the subsequent bust period.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 12:42:28 PM
By most historical measures (Shiller P/E, Tobin's Q, historical margins and current P/Es, etc), we are anywhere between 30-50% overvalued.

30% overvalued means 23% decline back to fair value.
50% overvalued means 33% decline back to fair value.

However if you can expect a 7% return if you were to purchase the index for fair value, then over the course of one year going forward you can expect the following range of losses:

17.7% loss over one year if market is 30% overvalued today and it declines to fair value (and you make 7% return on fair value)
28.7% loss over one year if market is 50% overvalued today and it declines to fair value (and you make 7% return on fair value)

So you would be expecting a loss of somewhere between 17.7% to 28.7% over the course of the next year if the markets are 30% to 50% overvalued today and they merely decline to fair value.

It's interesting to calculate this out -- 30%-50% sounds a lot scarier than 17.7% to 28.7%.  But I think I got the math right.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 12:45:19 PM
The US has added ~ 24 sq ft of commercial buildings per person since 2003.

How many people have left the farms in the US over that period of time seeking jobs in the city?

I don't dispute that China has been building excess capacity, but I find it hard to compare China to the US due to the demographic migration of Chinese to cities from farms.  Having said that, I don't know if that effect was already fully completed by 2008 or if the migration is still ongoing.  And yes things can be overdone even if there was significant ongoing migration -- but it matters how long the excess capacity will remain truly excess... meaning how long will it take for that space to get filled if people are still migrating.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 12:54:00 PM
Tesla is quite likely overvalued, but I found this pretty misleading:

Tesla Motors, for example, sold 22,477 cars in 2013 but commands a market cap of
$31 billion, while Fiat, which we like, sold 4.4 million cars but has a market cap of only $14 billion.


Porsche of course sold for more than $20billion in 2012, and produced less than 140,000 cars at the time.  Compare that to Fiat which sells roughly 32x more cars and yet is valued quite a bit less than VW paid for Porsche.

Had they instead compared Porsche to Fiat in the same manner, would it not have made it sound as though Porsche was wildly overvalued in 2012?  Yet they still found a private buyer.

And yes, Tesla sells less than Porsche and is more highly valued.  I'm just saying that their wording makes it sound all that more overvalued by comparing Tesla to Fiat, instead of comparing Tesla to Porsche.  No need to exaggerate the optics with distorted comparisons.
Title: Re: Fairfax Letter March 2014
Post by: Yours Truly on March 08, 2014, 02:14:54 PM
It seems like there are a lot of experts on all things China in here!

Maybe in the future when China drowns from "excess capacity", we'll start arguing about India in a state of bubble!
Title: Re: Fairfax Letter March 2014
Post by: TwoCitiesCapital on March 08, 2014, 02:20:57 PM
My question is when was there not a potential crisis?  In the "good ole days" you had the cold war with a nuclear threat that could destroy the world.  Then you had the emerging markets contagion in the 1990s.  The internet bubble, the housing bubble.   When does it end???  You just need to make an assessment is the current situation worse than the past.  I would say at this point no because the leverage in the system is to the gov't.  Look at all the $ the Fed tried to force feed the banks.  Where did it go?  Right back to the Fed as excess reserves so I don't see the leverage in the US at least. 

Frankly, I feel better the debt is on the gov't balance sheet versus household and businesses as the gov't can always print there way out of trouble but households and businesses cannot.

Packer

Totally agree with you about Risk. I'm not telling people to hoard guns, food, and gold and pull all money out of markets. There is always risks to investing and that shouldn't stop you from investing. It's not stopping me and it's not stopping Fairfax. We're both simply being more conservative then we would generally be due to higher perceived risk. I see more risk in markets today because prices are significantly higher, debts are significantly higher, and economies are less robust in their ability to respond to crisis. On top of this, it doesn't even have to be a crisis in the America that causes an American market drop. Just look to 2011 how escalation in the European crisis dropped U.S. markets by 20%.

Secondly, I do NOT feel better about the government holding the debt. This only distances those who pay for it from the cost of supplying it. This is essentially begging for there to be greater amounts of malinvestment without prudent management - the government hasn't prudently managed its budget at any point in recent history.


By most historical measures (Shiller P/E, Tobin's Q, historical margins and current P/Es, etc), we are anywhere between 30-50% overvalued.

30% overvalued means 23% decline back to fair value.
50% overvalued means 33% decline back to fair value.

However if you can expect a 7% return if you were to purchase the index for fair value, then over the course of one year going forward you can expect the following range of losses:

17.7% loss over one year if market is 30% overvalued today and it declines to fair value (and you make 7% return on fair value)
28.7% loss over one year if market is 50% overvalued today and it declines to fair value (and you make 7% return on fair value)

So you would be expecting a loss of somewhere between 17.7% to 28.7% over the course of the next year if the markets are 30% to 50% overvalued today and they merely decline to fair value.

It's interesting to calculate this out -- 30%-50% sounds a lot scarier than 17.7% to 28.7%.  But I think I got the math right.

I think we are both reasonable enough to recognize that declines generally overshoot and don't stop once they reach averages. Plus, a lot of those figures are based off of averages inclusive of today's earnings, margins, financial asset values, etc. etc. etc. In a declining market, margins will fall, asset values will fall, and multiples will fall. A 30% overvaluation using today's figures could easily lead to a 30-50% in equity indices using newly reduced inputs to get to a present "fair value".
Title: Re: Fairfax Letter March 2014
Post by: Packer16 on March 08, 2014, 02:37:06 PM
I see price at or above average (probably lower than average given LT interest rates - all indicators that show higher than average rate use history as guide when rates were higher and are higher than most expectations going forward), debts are higher but monetization is an acceptable way to reduce debt with a little austerity (this BTW was how the Post WWII debt was reduced - the difference then was the tight labor and raw material markets because a large portion of the world was following communism so if we have excess labor then the inflation can be used to offset the deflationary forces of excess supply) and I don't see how the economies are any less robust than in the past (do you know of any specifics here beyond higher debt which can be monestized?).  TIA.


Packer
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 03:34:38 PM
Quote from: zachmansell link=topic=10537.msg161002#msg161002
Plus, a lot of those figures are based off of averages inclusive of today's earnings, margins, financial asset values, etc. etc. etc. In a declining market, margins will fall, asset values will fall, and multiples will fall. A 30% overvaluation using today's figures could easily lead to a 30-50% in equity indices using newly reduced inputs to get to a present "fair value".

No, using today's earnings levels the market is not high at all.  15x forward earnings is completely normal.  It's not 30%-50% overvalued unless you consider/believe that margins are abnormally high today.

Title: Re: Fairfax Letter March 2014
Post by: hyten1 on March 08, 2014, 06:15:49 PM
question are these net values?

we all know new things get added, but some old property get taken out or re-purpose, just wondering

hy

The following are a bit scary:
China added 5.9 billion square metres of commercial buildings between 2008 and 2012 – the equivalent of
more than 50 Manhattans – in just five years!


Assuming 25% of China's worker are working in an office that would mean about 10 square meter per worker that has been added. I wish I had 10 square meter for my personal office.

BeerBaron

By commercial buildings, doesn't that include retail/industrial?
Still, this is 50 sq ft of commercial buildings per Chinese person added since 2008.
The US has total commercial building sq ft per person of 242. The US has added ~ 24 sq ft of commercial buildings per person since 2003.

i.e.
1) China has added twice as much per person over half as much time, and
2) the US includes a major boom period (2003-2008) while China is just over the subsequent bust period.
Title: Re: Fairfax Letter March 2014
Post by: Alekbaylee on March 08, 2014, 06:23:05 PM
And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
This is really scary for the entire world...  :o
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 08, 2014, 06:26:39 PM
I'm curious how long the excess vacant space will last (not to say there isn't a bubble that will pop first... but how long will it take them to grow into these shoes):

Estimations are that Chinese cities will face an influx of another 243 million migrants by 2025

http://en.wikipedia.org/wiki/Migration_in_China


Guys, how many Manhattans is that?
Title: Re: Fairfax Letter March 2014
Post by: Green King on March 08, 2014, 06:38:15 PM
And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
This is really scary for the entire world...  :o

how does one know if that is true ? how would one know if that is happening ? i would like to know how someone measure that.Also wouldn't they just do the same thing they did here.
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 08:31:09 PM
Hot money is true. In Taiwan , especially Taipei. Real estate doubled or triples the last two years ... Just ask Zippy!

Same in Beijing, Shanghai , and HK.

Why is The HK real estate guy  lee Kai shing getting out of real estate in HK? He probably see something coming
Title: Re: Fairfax Letter March 2014
Post by: prevalou on March 08, 2014, 10:45:25 PM
And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
This is really scary for the entire world...  :o
Don ´t forget China foreign exchanges reserves are $ 3,8 trillions and it can smooth some capital withdrawals
Title: Re: Fairfax Letter March 2014
Post by: frommi on March 08, 2014, 10:52:39 PM
And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
This is really scary for the entire world...  :o

If this is true, than where has that money gone? The chinese stock market has gone sideways for more than 3 years now. Bank of America has sold its stake in china last year. It looks like they are now talking china down. http://ftalphaville.ft.com/2014/02/03/1759962/in-defence-of-chinas-shadow-banks/ (http://ftalphaville.ft.com/2014/02/03/1759962/in-defence-of-chinas-shadow-banks/)
Title: Re: Fairfax Letter March 2014
Post by: treasurehunt on March 08, 2014, 10:54:44 PM
I spent a good amount of time this weekend reading Buffett's old letters to shareholders and it struck me that it would be interesting to compare Berkshire's performance after its first 28 years to that of Fairfax (which just completed its 28th year).

Annual Increase in Book Value Per Share
Berkshire: 23.6%, Fairfax: 21.3%

Shareholders' Equity
Berkshire: $8,926 million, Fairfax: $7,187 million

Total Assets
Berkshire: $17,132 million, Fairfax: $35,959 million

Debt
Berkshire: $1,155 million, Fairfax: $2,969 million

Total Dividends Declared Per Share
Berkshire: 0, Fairfax: $70 (roughly)

Annual Increase In Shares Outstanding
Berkshire: 0.05%, Fairfax: 5.3%

Number Of Years With Declining Book Value Per Share
Berkshire: 1, Fairfax: 6

Berkshire's insurance operations did not look too good at the end of 1992; they had had underwriting losses for the previous ten years or so. Fairfax's insurance operations look just fine in comparison, I think.

Overall, Fairfax's performance doesn't quite measure up to Berkshire's but it is not very far off. One big difference is that Berkshire had an annual increase in book value per share of 27.1% between 1978 and 1992 -- the last 14 years of the 28 year period. Fairfax, on the other hand, increased book value per share by only 5.7% per year in the last 14 years. Perhaps size has become an anchor for Fairfax much faster than it did for Berkshire?

And one final thing -- Prem writes pretty good letters, but Buffett's old ones are brilliant!
Title: Re: Fairfax Letter March 2014
Post by: Liberty on March 08, 2014, 11:41:26 PM
I spent a good amount of time this weekend reading Buffett's old letters to shareholders and it struck me that it would be interesting to compare Berkshire's performance after its first 28 years to that of Fairfax (which just completed its 28th year).

Annual Increase in Book Value Per Share
Berkshire: 23.6%, Fairfax: 21.3%

One thing I wanted to do when I was reading the recent letter but haven't had time yet; calculate their CAGR if you remove the first year that is like 180%. It's an outlier with such a small amount of capital that it doesn't seem like it's useful to include.
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 08, 2014, 11:57:47 PM
I think if you adjust for inflation Buffett"s company was a lot bigger than Fairfax today.
Title: Re: Fairfax Letter March 2014
Post by: phil_Buffett on March 09, 2014, 03:53:24 AM
for me it makes absolutely no sense to sell us bank and wells Fargo and Holding bank of ireland. when a big 1 a lifetime crash Comes, ireland will be over. i would be happier to hold wells Fargo than bank of ireland. i dont believe that bank of ireland and ireland itself will survive a Crash today.
Title: Re: Fairfax Letter March 2014
Post by: Kraven on March 09, 2014, 03:57:29 AM
And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
This is really scary for the entire world...  :o

This is a seriously flawed analogy and only meant to incite fear.  It's the equivalent of showing a chart of 1929's stock market vs today's and asserting we're in for the same result.  The aggregate amount of asset backed securities was not the cause of the crisis.  Certain securitized products contributed to the crisis, but I am not even sure many of those would have been counted under the rubric of "asset backed securities" (most of which were actually perfectly fine).
Title: Re: Fairfax Letter March 2014
Post by: thefatbaboon on March 09, 2014, 04:48:40 AM
Can someone help me understand this market over-valuation hypothesis because I'm really struggling. 

Here are the worlds biggest companies:

Apple, Exxon, Microsoft, Google, Berkshire, General Electric, Johnson&Johnson, Walmart, Chevron, Wells Fargo

Do you guys think they are expensive?  (Out of the 10 names I'd say 1.5 are expensive.)

Of course there are a bunch of go-go companies like Amazon, Facebook, Tesla, Twitter etc.  But they do not dominate the overall market (a la 1999).  And, even in healthy markets there have always been pockets of speculation. 

What do the bears imagine happens if they are right and the market declines?  Will central banks raise interest rates??  I just don't follow the logic.  Interest rates are essentially zero.  How is it possible that shorting a bunch of debt-free large cap companies that are trading at 11-15 times earnings (6%-9% earnings yields) can ever be a sensible investment choice in a world of zero interest rates??  Even if the bears are right, China implodes, Europe deflates, and all the companies mentioned above lose 25% of their earning power…isn't one still better off holding companies with no debt, significant dividend capacity and 4%-7% earnings yields because the central banks are most certainly not going to greet such a crisis by raising interest rates?

Listen, I understand that a broad collapse such as this would no doubt offer up better prices than today, perhaps significantly so. But the risk/reward doesn't seem right to me.  Isn't it safer to buy some strong companies and if the global economies are ok you'll double your money over the next seven years, and if the economies collapse your companies will survive, pay you a dividend and stock prices will probably be marginally higher is seven years.  Even in a bear scenario your return will be better than buying cash or investment grade bonds today.

Personally, nothing makes me more nervous than speculating on Doom.  I don't think I could sleep at night.  Setting my sail against the immense tide of human history, a tide that only seems to have gotten stronger and quicker with every generation.  We are living at a time of the most obscene progress.  Jet airplanes, televisions, phones, computers, internet, globalized manufacture, a plethora of free and for fee entertainment, cheap furnishings, automobiles, statins, low child mortality, the longest life expectancy.  I don't know how someone can short our economy and not spend every waking minute absolutely terrified.

Title: Re: Fairfax Letter March 2014
Post by: SharperDingaan on March 09, 2014, 06:05:04 AM
You might want to keep in mind the highly likely probability that money laundering underpins much of that unused capacity.

To do money laundering you need a hot inflow, to fund an investment in country X; to borrow against, & then repatriate the inflow. You create a local bank, use it to fund construction loans to build the asset, & increase the LTV ratio to push up the collateral value of the asset. It is of course a Ponzi scheme, the last in will hold the bag, & it requires construction loans - but you don't need anyone to actually use the constructed asset.

Vegas was the early version of this, & it was strictly US mob. Dubai is a more recent version, but primarily Russian mob. China is primarily local. Country X gets a lot of new assets ready to go, with zero cost after the scheme collapses. Excess capacity that eventually displaces existing business with older & less attractive assets. Dubai becomes the next Vegas, so long as the ruler allows it to happen - & everybody wins.

SD
Title: Re: Fairfax Letter March 2014
Post by: value-is-what-you-get on March 09, 2014, 06:55:07 AM
I'm curious how long the excess vacant space will last (not to say there isn't a bubble that will pop first... but how long will it take them to grow into these shoes):

Estimations are that Chinese cities will face an influx of another 243 million migrants by 2025

http://en.wikipedia.org/wiki/Migration_in_China


Guys, how many Manhattans is that?
That would be one Manhattan per month for 11 years.  That,s a lot of subways!



Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 09, 2014, 07:45:33 AM
Ok guys, the equity hedges have been a big mistake…

Sincerely, I couldn’t care less now. Whoever reads this letter and doesn’t see the entrepreneurial global force FFH is becoming, simply lacks entrepreneurial spirit. It is so self-evident!
1) The best way to play the emerging markets story: FFH.
2) The best way to play an European recovery: FFH.
3) Even in North America, despite the headwind of high general market prices, FFH will go on purchasing whole businesses.
People have been fixating on these equity hedges and are completely missing the whole FFH story.
Nothing else to say.

Gio
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 09, 2014, 07:47:01 AM
I see a two tiered market. I see massive overvaluation in a growing number of "hope and change" type companies. And I see reasonable valuation in many good companies like msft, apple, qcom, aig, lots of small financials, etc.

I think this is basically a normal market. Overall valued reasonably, some undervaluation in areas, and some overvaluation in others. Markets are a place for speculation as well.

I remember trying to find stocks to buy in 2006 and 2007 and you couldn't find anything with a P/E of less than 20-25, even companies on the fringes of the economy like subprime lenders and money-losing startups were at huge valuations.

Today's market just doesn't seem like that. Huge banks like BAC and WFC still appear cheap even with lots of unused capital.
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 09, 2014, 07:59:27 AM
The Brookfield Asset Management 2013 letter has interesting comments about the property markets in China, which they have just started to get into.

http://brookfield.com/_Global/42/documents/relatedlinks/6190.pdf

Quote
The China Story

Our success depends on our ability to find opportunistic investments in real assets around the world, underwrite and acquire the assets, and operate them well in order to generate our targeted returns. While we have made small investments in China in the past, we were unable to find a significant opportunity where we could invest comfortably. During 2013, we found such an opportunity with a portfolio of Shanghai commercial properties.

The Chinese economy is incredibly large and diverse, and contains some economic regions that at best would be described as “pioneer,” has regions that are classically “emerging,” but most importantly has regions that are fully competitive on a global stage. Our view is that the Chinese economy will experience peaks and valleys along a rapid growth path. But by being careful with how we invest and by being integrated into the economy, these transitions will provide many opportunities for us, as they do in other countries around the world.

The misunderstanding by many Western observers lies in the premise that once China stumbles, it will fall behind, and never come back. To put this into context, one can compare China to the United States. In 1820, agriculture represented 80% of the U.S. economy. By 1920, agriculture had declined to 25%, and during this century of transition and growth there were both good and not so good economic periods. Contrast that to China, where in 1975 agriculture represented 80% of the Chinese economy and by 2030 it will represent 25%. In these 55 years of transition there were, and will be, many economic cycles. But like the U.S., we believe China will be a good place to invest over the long term.

The most commented on economic item is the impact of a Chinese slowdown on China, and the global economy. Our take is that many forget that this is largely the law of big numbers at work as the Chinese economy is now the second largest in the world. One must remember that at $8 trillion, even 6% growth creates a GDP increase which in itself is larger than most countries’ GDP, and in aggregate as large as the growth being added by the United States to the world’s economy annually.

We were fortunate to find a Chinese partner that not only recognized that our brand of institutional capital management, asset management and operations is greatly needed within China, but also owns one of the highest quality commercial property portfolios in the country. While we will only own 22% of the entity, we will be providing a number of our people into positions within the company. Our growth plans for China Xintiandi will be market and opportunity dependent, but we believe we can assist our partner in becoming one of the leading owners and operators of premier commercial properties within China.

The initial portfolio of properties owned by China Xintiandi consists of over 3.4 million square feet of premier quality office and retail assets in two truly irreplaceable locations within Shanghai. We believe Shanghai is one of the world's leading cities and we are thrilled to be able to be a part of its future.
Title: Re: Fairfax Letter March 2014
Post by: investmd on March 09, 2014, 08:17:52 AM
I spent a good amount of time this weekend reading Buffett's old letters to shareholders and it struck me that it would be interesting to compare Berkshire's performance after its first 28 years to that of Fairfax (which just completed its 28th year).

Annual Increase in Book Value Per Share
Berkshire: 23.6%, Fairfax: 21.3%

Shareholders' Equity
Berkshire: $8,926 million, Fairfax: $7,187 million

Total Assets
Berkshire: $17,132 million, Fairfax: $35,959 million

Debt
Berkshire: $1,155 million, Fairfax: $2,969 million

Total Dividends Declared Per Share
Berkshire: 0, Fairfax: $70 (roughly)

Annual Increase In Shares Outstanding
Berkshire: 0.05%, Fairfax: 5.3%

Number Of Years With Declining Book Value Per Share
Berkshire: 1, Fairfax: 6

Berkshire's insurance operations did not look too good at the end of 1992; they had had underwriting losses for the previous ten years or so. Fairfax's insurance operations look just fine in comparison, I think.

Overall, Fairfax's performance doesn't quite measure up to Berkshire's but it is not very far off. One big difference is that Berkshire had an annual increase in book value per share of 27.1% between 1978 and 1992 -- the last 14 years of the 28 year period. Fairfax, on the other hand, increased book value per share by only 5.7% per year in the last 14 years. Perhaps size has become an anchor for Fairfax much faster than it did for Berkshire?

And one final thing -- Prem writes pretty good letters, but Buffett's old ones are brilliant!

Even though BRK and FFH are based on the same principles of writing good insurance, & using the float to invest, the tone of the respective 2013 annual letters is completely different. While Buffett is clearly very optimistic about the future of America, Watsa has decided to play for the one in 50 event and admits to being very bearish.

Tough climate when 2 very similarly minded individuals think so differently. Delimma for investors who follow the two.
Title: Re: Fairfax Letter March 2014
Post by: investmd on March 09, 2014, 08:23:34 AM
Ok guys, the equity hedges have been a great mistake…

Sincerely, I couldn’t care less now. Whoever reads this letter and doesn’t see the entrepreneurial global force FFH is becoming, simply lacks entrepreneurial spirit. It is so self-evident!
1) The best way to play the emerging markets story: FFH.
2) The best way to play an European recovery: FFH.
3) Even in North America, despite the headwind of high general market prices, FFH will go on purchasing whole businesses.
People have been fixating on these equity hedges and are completely missing the whole FFH story.
Nothing else to say.
Gio

Even ignoring the equity hedge, the investment portfolio produced less than 5% return in 2013! Hard to fathom. Thoughts around the poor 5 year results on investments with or without hedging? On the other hand glad to see the insurance business is doing well with operating margins <100%.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 08:32:56 AM
I'm curious how long the excess vacant space will last (not to say there isn't a bubble that will pop first... but how long will it take them to grow into these shoes):

Estimations are that Chinese cities will face an influx of another 243 million migrants by 2025

http://en.wikipedia.org/wiki/Migration_in_China


Guys, how many Manhattans is that?
That would be one Manhattan per month for 11 years.  That,s a lot of subways!

I have an interesting game for you guys at the Fairfax dinner.  How many Manhattans can you down and remain seated in your chairs?
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 09, 2014, 08:35:56 AM
Even ignoring the equity hedge, the investment portfolio produced less than 5% return in 2013! Hard to fathom.

Profits from equity and equity related investments in 2013 were $1,445 million, while Preferred stocks + Common stocks + Investments in associates at December 31 2012 were valued at $6,359. That’s a return of 1,445 / 6,359 = 22.7% (dividends excluded and BB included ;) ).
Given the fact that $1,324 million were realized gains, the annualized return might be significantly higher, depending on when those securities have been sold. :)

Gio
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 09, 2014, 09:29:08 AM
Even ignoring the equity hedge, the investment portfolio produced less than 5% return in 2013! Hard to fathom.

Profits from equity and equity related investments in 2013 were $1,445 million, while Preferred stocks + Common stocks + Investments in associates at December 31 2012 were valued at $6,359. That’s a return of 1,445 / 6,359 = 22.7% (dividends excluded and BB included ;) ).
Given the fact that $1,324 million were realized gains, the annualized return might be significantly higher, depending on when those securities have been sold. :)

Gio

From the annual letter, he says:

In 2013, we had a total investment return of negative 4.9% (versus an average of positive 4.4% over the past five years and positive 8.9% over our 28-year history) mainly because of our 100% hedge of our common stock portfolio. If we had not hedged, our total investment return in 2013 would have been a positive 3.6%. In our 28-year history, we have had negative total investment returns in only three years: 1990 – (4.4)%; 1999 – (2.7)%; and 2013 – (4.9)%. In
the past, these returns reversed the following year, as shown in the table in the MD&A! As we said earlier, as of February 28, 2014, we had an unrealized mark to market gain in our investment portfolio of more than $1 billion – after tax, this would have eliminated our net loss in 2013.

Yes, that is total investment return. Of which the return from its equity portfolio is only a part. But total investment return suffered from $995 million unrealized bond losses... What's so hard to fathom? Practically every bonds portfolio suffered mark to market losses in 2013.

Gio
Title: Re: Fairfax Letter March 2014
Post by: frommi on March 09, 2014, 11:25:49 AM
Gio would you invest in bonds at the current rates?
I can`t really imagine how anyone can really hold bonds at the current point for the longer term. Heck i am even thinking about shorting them for a lower overall portfolio risk. (I have some REIT`s)

And i bet that FFH is already back to zero when it comes to gains this year, because the Russel has broken the top and interest rates have risen since the letter.

For me Prem`s actions look like someone who has made a macro bet, has proven to be wrong and he doesn`t correct himself. For a trader this is a no go, an investor might be getting away with  subpar returns. (look at the performance of the last 4 years) FFH looks like a giant levered long/short hedgefund which for me seems to be overvalued at current prices. What if the market repeats 2013 for the next 2-3 years like in 1997-2000?
When i read the letter correct book value has declined in 2013 from 378$ to 339$ thats -10.3%. When that repeats for 2-3 years its very hard to recover that loss and this is totally possible when the market rallies further and interest rates go back up to 4 or 5%.
Title: Re: Fairfax Letter March 2014
Post by: mcliu on March 09, 2014, 12:09:41 PM
And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
This is really scary for the entire world...  :o

If this is true, than where has that money gone? The chinese stock market has gone sideways for more than 3 years now. Bank of America has sold its stake in china last year. It looks like they are now talking china down. http://ftalphaville.ft.com/2014/02/03/1759962/in-defence-of-chinas-shadow-banks/ (http://ftalphaville.ft.com/2014/02/03/1759962/in-defence-of-chinas-shadow-banks/)

All the money's gone into factories, infrastructure and real estate, hence the huge over-capacity in most industries and double digit RE value gains across China, even in the Tier 3/4 cities. It's also why the stock market has gone nowhere since overcapacity is causing such low ROEs.

People may be underestimating the amount of fixed-asset investment in China.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 12:48:40 PM
I'm curious how long the excess vacant space will last (not to say there isn't a bubble that will pop first... but how long will it take them to grow into these shoes):

Estimations are that Chinese cities will face an influx of another 243 million migrants by 2025

http://en.wikipedia.org/wiki/Migration_in_China


Guys, how many Manhattans is that?
That would be one Manhattan per month for 11 years.  That,s a lot of subways!

It's the same pace as the past 5 years -- per the FFH letter, they've built over 50 Manhattans the past 60 months.

So if they need to keep building 1 every month for the next 11 years, then I'm scratching my head.

Is the 243 million person migration over next 11 years really happening or isn't it?
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 06:25:55 PM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.
Title: Re: Fairfax Letter March 2014
Post by: StubbleJumper on March 09, 2014, 06:31:09 PM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 06:34:30 PM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ

They need city jobs to afford housing.  Unless the city parks are large enough for their tents.

But what jobs?

I get the fact that the past migrants to the cities took factory jobs -- all that stuff at Walmart is made in China.

But have we saturated the demand for Chinese factory labor?  Is there untapped demand for manufactured goods from China?
Title: Re: Fairfax Letter March 2014
Post by: StubbleJumper on March 09, 2014, 06:39:46 PM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ

They need city jobs to afford housing.  Unless the city parks are large enough for their tents.

But what jobs?

I get the fact that the past migrants to the cities took factory jobs -- all that stuff at Walmart is made in China.

But have we saturated the demand for Chinese factory labor?  Is there untapped demand for manufactured goods from China?


That's the wrong way to think about it.  It's not that the cities are demanding labour; rather the countryside is shedding agricultural labour.  This has occurred steadily since the discovery of agriculture in Mesopotamia, but accelerated during the industrial revolution.  And, that's what is going on in the developing world.  The adoption of technology will force people to urbanize, and that is what will generate wealth (as it always has).

SJ
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 09, 2014, 06:56:04 PM
Predictions about the bandwidth required in the future have come true with recent developments and we will have to lay more fibre for the future.

But, a lot of companies that built that network went out of business in the early 2000's.

Just because there will be demand in the future, that by itself does not justify building out the infrastructure right now. You have to build it as the demand appears and the economics justify it.
Title: Re: Fairfax Letter March 2014
Post by: PJM on March 09, 2014, 07:27:13 PM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ

They need city jobs to afford housing.  Unless the city parks are large enough for their tents.

But what jobs?

I get the fact that the past migrants to the cities took factory jobs -- all that stuff at Walmart is made in China.

But have we saturated the demand for Chinese factory labor?  Is there untapped demand for manufactured goods from China?

Chinese markets are not understood properly because a lot of reports/stats are very biased to show exuberance. No denying that there may be oversupply of credit/cheap money which has lead to speculation on real estate, however Chinese problems can be fixed and I think the NPC is taking some really strategic steps which is not properly understood as people are so focussed on short-term numbers such as PMI, CPI etc

Here is an article from Andy Xie (one of the most reputed Chinese economist) who had a reputation of openly criticising the Chinese policies, but lately he has been sounding positive especially in highlighting the fact that slowing economy is a good thing for China which will help it over the long run.

http://english.caixin.com/2014-03-06/100647590.html
(When the transition to market-based resource allocation is complete, the country's per capita income will rise quickly, to US$ 20,000 from the present US$ 7,000. That is the grand prize that the country should focus on.)
Title: Re: Fairfax Letter March 2014
Post by: TwoCitiesCapital on March 09, 2014, 07:50:51 PM
Quote from: zachmansell link=topic=10537.msg161002#msg161002
Plus, a lot of those figures are based off of averages inclusive of today's earnings, margins, financial asset values, etc. etc. etc. In a declining market, margins will fall, asset values will fall, and multiples will fall. A 30% overvaluation using today's figures could easily lead to a 30-50% in equity indices using newly reduced inputs to get to a present "fair value".

No, using today's earnings levels the market is not high at all.  15x forward earnings is completely normal.  It's not 30%-50% overvalued unless you consider/believe that margins are abnormally high today.

Using the Shiller P/E or Tobins Q suggests 30-50% overvaluation BEFORE considering that margins are above historical levels. You're using one year's earnings in a time when labor is slack and interest rates are low supporting historically high margins and high multiples. The beauty of Shiller's figure is hat it is intended to take the average over the cycle...not simply at its peak. Any long term indicator suggest that we are largely overvalued at this point.

It's not an opinion that margins are high. It's a mathematical fact. Margins have traditionally reverted and have traditionally been lower than they are today. The questions isn't are margins elevated. The only question is when they will revert. 1 year? 5 years? It's really anyone's guess but I don't really think its up for debate about how richly valued the market is. It's really more of a question on how much more richly valued it could get and how long it will take to revert. The numbers simply don't lie.

Can someone help me understand this market over-valuation hypothesis because I'm really struggling. 

Here are the worlds biggest companies:

Apple, Exxon, Microsoft, Google, Berkshire, General Electric, Johnson&Johnson, Walmart, Chevron, Wells Fargo

Do you guys think they are expensive?  (Out of the 10 names I'd say 1.5 are expensive.)

Of course there are a bunch of go-go companies like Amazon, Facebook, Tesla, Twitter etc.  But they do not dominate the overall market (a la 1999).  And, even in healthy markets there have always been pockets of speculation. 

What do the bears imagine happens if they are right and the market declines?  Will central banks raise interest rates??  I just don't follow the logic.  Interest rates are essentially zero.  How is it possible that shorting a bunch of debt-free large cap companies that are trading at 11-15 times earnings (6%-9% earnings yields) can ever be a sensible investment choice in a world of zero interest rates??  Even if the bears are right, China implodes, Europe deflates, and all the companies mentioned above lose 25% of their earning power…isn't one still better off holding companies with no debt, significant dividend capacity and 4%-7% earnings yields because the central banks are most certainly not going to greet such a crisis by raising interest rates?

Listen, I understand that a broad collapse such as this would no doubt offer up better prices than today, perhaps significantly so. But the risk/reward doesn't seem right to me.  Isn't it safer to buy some strong companies and if the global economies are ok you'll double your money over the next seven years, and if the economies collapse your companies will survive, pay you a dividend and stock prices will probably be marginally higher is seven years.  Even in a bear scenario your return will be better than buying cash or investment grade bonds today.

Personally, nothing makes me more nervous than speculating on Doom.  I don't think I could sleep at night.  Setting my sail against the immense tide of human history, a tide that only seems to have gotten stronger and quicker with every generation.  We are living at a time of the most obscene progress.  Jet airplanes, televisions, phones, computers, internet, globalized manufacture, a plethora of free and for fee entertainment, cheap furnishings, automobiles, statins, low child mortality, the longest life expectancy.  I don't know how someone can short our economy and not spend every waking minute absolutely terrified.

The simple answer is this: all investments are in competition with one another. If bond rates are low, people will bid up stocks until future stock returns are low too. We're in an environment with high stock multiples that were driven up by low interest rates. This would be fine if interest remain at 2.5% forever, or go lower, but we all know they'll have to rise at some point. No one really knows when that is but it will eventually happen and multiples will have to compress so the forward expected returns on stocks is comparable relative to the rising rate of forward returns in bonds.

Compounded on this fact is that you have multiple potential causes for large, global economic shocks AND margins that are historically above average where reversion zone could lead to 20-30% declines.

So to summarize:

1) historically expensive market with no clear driver of future multiple expansion
2) several mean reverting statistics that are above trend (multiples, margins, bond prices )
3) potential of several large economic shocks that could quickly affect markets

Against all of this you simply have the hope that people will continue paying higher and higher prices and multiples. Earnings aren't growing at 5-10% a year and the market returns can not continue to outpace earnings like they have done.

It's not impossible to make money going forward, but I think that any reasonable person who knows math and history can see that returns will likely be disappointing going forward.

Title: Re: Fairfax Letter March 2014
Post by: kmukul on March 09, 2014, 08:06:01 PM
I am actually surprised to read this read on this forum :) But its not fair if Prasad or someone doesn't put the point of view of Prem. In hindsight you can see hedges had issues but then in hindsight every one is right and most likely its already reflected in FFH price , its also more of a one off thing may be next time they will be better off when they use hedges.

One thing that disappointed me more then hedges was Prems love for Tom Ward. that was also discussed a lot on this board but I don't think any conclusion was made and most likely we will have the same thing here.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 08:06:56 PM
Using the Shiller P/E or Tobins Q suggests 30-50% overvaluation BEFORE considering that margins are above historical levels.

I believe you are double counting.

The forward P/E is 15x.  That's normal.

But several years ago, earnings were far lower.  So were profit margins.  So when you start using Shiller P/E, you are mixing in many years of lower profit margins. 

In other words, you are saying "Look at how high the P/E is when you blend it with much lower profit margins".  That's what Shiller P/E is telling you.

Shiller's P/E is useful to help detect periods like this one where the forward looking P/E might be a lot higher than it looks -- because it might look low at this (potentially fleeting) moment merely due to abnormally high profit margins, or a credit bubble causing artificial demand, etc...
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 08:21:24 PM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ

They need city jobs to afford housing.  Unless the city parks are large enough for their tents.

But what jobs?

I get the fact that the past migrants to the cities took factory jobs -- all that stuff at Walmart is made in China.

But have we saturated the demand for Chinese factory labor?  Is there untapped demand for manufactured goods from China?


That's the wrong way to think about it.  It's not that the cities are demanding labour; rather the countryside is shedding agricultural labour.  This has occurred steadily since the discovery of agriculture in Mesopotamia, but accelerated during the industrial revolution.  And, that's what is going on in the developing world.  The adoption of technology will force people to urbanize, and that is what will generate wealth (as it always has).

SJ

I understood your point about needing less bodies in the fields (shedding agricultural labor).

I am wondering do they become unemployed or what do they do next?  I remember 10 years ago it was clearly cheaper to manufacture many goods in China.  But today I believe the costs gaps are much slimmer, and energy is cheaper in the US.  We're even spinning yarn in the US again.  Tesla decided it was cheaper to do some of it's manufacturing in California of all places, rather than China. 

So I'm just wondering how that all impacts the "For Hire" signs in Chinese cities.  Merely a slowing of manufacturing growth should leave an impact on the rate at which people will take up jobs in Chinese cities.

Anyways, I'm not firmly arguing these points.  Rather, these are the areas I'm confused about and I want somebody to explain why 250 million people will find city jobs -- what jobs are the Chinese cities currently trying to fill that these people are skilled for?  Are we still in a transitional phase where China is growing it's factory labor force at the same pace as the last five-ten years?

Like in the United States -- if somebody is no longer needed on a farm, it doesn't mean that for certain he is going to get a job in a city.  It could just mean that he is unemployed, right?
Title: Re: Fairfax Letter March 2014
Post by: hyten1 on March 09, 2014, 08:36:19 PM
also there are many jobs that comes with a urban setting (services folks, store clerks, janitors, window washers, gardener, trashman etc. etc.)



I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ

They need city jobs to afford housing.  Unless the city parks are large enough for their tents.

But what jobs?

I get the fact that the past migrants to the cities took factory jobs -- all that stuff at Walmart is made in China.

But have we saturated the demand for Chinese factory labor?  Is there untapped demand for manufactured goods from China?


That's the wrong way to think about it.  It's not that the cities are demanding labour; rather the countryside is shedding agricultural labour.  This has occurred steadily since the discovery of agriculture in Mesopotamia, but accelerated during the industrial revolution.  And, that's what is going on in the developing world.  The adoption of technology will force people to urbanize, and that is what will generate wealth (as it always has).

SJ

I understood your point about needing less bodies in the fields (shedding agricultural labor).

I am wondering do they become unemployed or what do they do next?  I remember 10 years ago it was clearly cheaper to manufacture many goods in China.  But today I believe the costs gaps are much slimmer, and energy is cheaper in the US.  We're even spinning yarn in the US again.  Tesla decided it was cheaper to do some of it's manufacturing in California of all places, rather than China. 

So I'm just wondering how that all impacts the "For Hire" signs in Chinese cities.  Merely a slowing of manufacturing growth should leave an impact on the rate at which people will take up jobs in Chinese cities.

Anyways, I'm not firmly arguing these points.  Rather, these are the areas I'm confused about and I want somebody to explain why 250 million people will find city jobs -- what jobs are the Chinese cities currently trying to fill that these people are skilled for?  Are we still in a transitional phase where China is growing it's factory labor force at the same pace as the last five-ten years?

Like in the United States -- if somebody is no longer needed on a farm, it doesn't mean that for certain he is going to get a job in a city.  It could just mean that he is unemployed, right?
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 09, 2014, 11:31:37 PM
I am afraid I am buying into the China thesis of Fairfax.  I have this nagging feeling that an inflection point has arrived for a while now where demand for China's exports has slowed. 

The last three paragraphs are resonating with me:

http://www.theguardian.com/business/2014/jan/05/george-soros-chinese-slowdown-biggest-worry


The financial crisis showed the weakness in the idea of becoming the workshop for the world when that world couldn't afford to go on buying. To keep the wheels turning, local authorities and other government agencies were allowed to borrow.

Last year the Chinese leadership said it recognised that plan was flawed, and public sector debt needed to be cut. But when the economy slowed dramatically after borrowing was restricted, the policy was quickly reversed. The subsequent boost looks shortlived, even if China has billions of dollars in foreign exchange reserves to soften any economic blow.

Soros said: "China's leadership was right to give precedence to economic growth over structural reforms, because structural reforms, combined with fiscal austerity, push economies into a deflationary tailspin. But there is an unresolved contradiction in China's current policies: restarting the furnaces also reignites debt growth, which cannot be sustained for much longer than a couple of years."
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 10, 2014, 01:11:36 AM
Gio would you invest in bonds at the current rates?
I can`t really imagine how anyone can really hold bonds at the current point for the longer term. Heck i am even thinking about shorting them for a lower overall portfolio risk. (I have some REIT`s)

And i bet that FFH is already back to zero when it comes to gains this year, because the Russel has broken the top and interest rates have risen since the letter.

For me Prem`s actions look like someone who has made a macro bet, has proven to be wrong and he doesn`t correct himself. For a trader this is a no go, an investor might be getting away with  subpar returns. (look at the performance of the last 4 years) FFH looks like a giant levered long/short hedgefund which for me seems to be overvalued at current prices. What if the market repeats 2013 for the next 2-3 years like in 1997-2000?
When i read the letter correct book value has declined in 2013 from 378$ to 339$ thats -10.3%. When that repeats for 2-3 years its very hard to recover that loss and this is totally possible when the market rallies further and interest rates go back up to 4 or 5%.

frommi,
I don’t share your concerns about FFH, and here is why:

Bonds:

FFH bonds portfolio was mainly assembled in 2008-2009 and, like Mr. Watsa has often reminded us:
Quote
Our Brian Bradstreet purchased $1 billion in California state government bonds in 2009, most of this position directly from the government at a 7.25% yield when California was considered to be on the verge of being non-investment grade. Those bonds are yielding 4.55% today!! Our muni bond portfolio (tax exempt and taxable) continued to do well in 2012. We have $1,279.5 million in unrealized gains in these bonds (approximately 22.9% on our cost) while earning $310 million annually in interest.
That was at the end of 2012. Today those bonds are certainly much more attractive! I am not saying they are as attractive as they were in 2009, but they are probably yielding around 6%. Not bad! Especially with the leverage FFH is able to use. Unless those bonds default, and most of them are insured by Berkshire, mark to market losses are not all that relevant, and there will be sure and substantial gains.

Equities:

Why is everyone assuming that FFH’s portfolio will go on underperforming the indices?!?! Just because it has done so last year?! FFH’s equity investments have a long history of outperforming the indices, and they will probably outperform again in the future.

What I do see:

An outstanding organization that through the opportunistic purchase of insurance companies all over the world is becoming more and more global. So many opportunities for growth. I am exited to see what they will be able to accomplish during the next 15 years.

Gio
Title: Re: Fairfax Letter March 2014
Post by: StubbleJumper on March 10, 2014, 02:24:17 AM
I've been thinking about this discussion all day.  I don't really understand how 250m people can leave the farms for the city over just 11 years unless there is an urgent need for them.  Doesn't make sense.


Something similar occurred in England during the Industrial Revolution.  Changing technologies and practices in the agriculture sector freed up significant labour that migrated to towns and cities to fuel the IR.  The scale of agriculture in China would suggest that there will be ample opportunity for the agriculture sector to shed labour over coming years.

SJ

They need city jobs to afford housing.  Unless the city parks are large enough for their tents.

But what jobs?

I get the fact that the past migrants to the cities took factory jobs -- all that stuff at Walmart is made in China.

But have we saturated the demand for Chinese factory labor?  Is there untapped demand for manufactured goods from China?


That's the wrong way to think about it.  It's not that the cities are demanding labour; rather the countryside is shedding agricultural labour.  This has occurred steadily since the discovery of agriculture in Mesopotamia, but accelerated during the industrial revolution.  And, that's what is going on in the developing world.  The adoption of technology will force people to urbanize, and that is what will generate wealth (as it always has).

SJ

I understood your point about needing less bodies in the fields (shedding agricultural labor).

I am wondering do they become unemployed or what do they do next?  I remember 10 years ago it was clearly cheaper to manufacture many goods in China.  But today I believe the costs gaps are much slimmer, and energy is cheaper in the US.  We're even spinning yarn in the US again.  Tesla decided it was cheaper to do some of it's manufacturing in California of all places, rather than China. 

So I'm just wondering how that all impacts the "For Hire" signs in Chinese cities.  Merely a slowing of manufacturing growth should leave an impact on the rate at which people will take up jobs in Chinese cities.

Anyways, I'm not firmly arguing these points.  Rather, these are the areas I'm confused about and I want somebody to explain why 250 million people will find city jobs -- what jobs are the Chinese cities currently trying to fill that these people are skilled for?  Are we still in a transitional phase where China is growing it's factory labor force at the same pace as the last five-ten years?

Like in the United States -- if somebody is no longer needed on a farm, it doesn't mean that for certain he is going to get a job in a city.  It could just mean that he is unemployed, right?


Mostly what happens is that older farmers will simply retire and not be replaced by their children (who migrate to the city).  The farm gets liquidated and assets are bought by neighbours.  My guess is that the farmer population in China is getting a little bit older every year as children move to the city and do not takeover the family farm. 

In a few cases, people stop farming due to financial failure (ie, insolvency, or inferior income prospects). It's conceivable that some of those people might just end up on welfare (because you cannot get unemployment benefits), but my observation is that people who ran their own business rarely end up on welfare.  They almost universally have enough motivation and drive to find some sort of job, even if it's just a job pumping gas in town.

In the particular case of China, I'm not sure that being on welfare is even an option.  I always assumed that the situation was basically Chinese people either need to work, leach off their family, or starve.

As a matter of interest, here's a link to a chart depicting the evolution of the US agriculture sector:

http://www.washingtonpost.com/blogs/ezra-klein/files/2012/10/number-of-farms-in-united-states.png


The interesting thing is that the US lost two-thirds of its farms over the course of 40 years.  This occurred mainly as technology was developed and mechanization was adopted in the US and western Europe.  However, in the case of China, they do not need to wait to develop new technology or farming practices, all they need to do is adopt existing western practices.  It may be that the Chinese farm consolidation could be even steeper than our experience in North America.

SJ
Title: Re: Fairfax Letter March 2014
Post by: thefatbaboon on March 10, 2014, 05:13:00 AM
Quote from: zachmansell link=topic=10537.msg161002#msg161002
Plus, a lot of those figures are based off of averages inclusive of today's earnings, margins, financial asset values, etc. etc. etc. In a declining market, margins will fall, asset values will fall, and multiples will fall. A 30% overvaluation using today's figures could easily lead to a 30-50% in equity indices using newly reduced inputs to get to a present "fair value".

No, using today's earnings levels the market is not high at all.  15x forward earnings is completely normal.  It's not 30%-50% overvalued unless you consider/believe that margins are abnormally high today.

Using the Shiller P/E or Tobins Q suggests 30-50% overvaluation BEFORE considering that margins are above historical levels. You're using one year's earnings in a time when labor is slack and interest rates are low supporting historically high margins and high multiples. The beauty of Shiller's figure is hat it is intended to take the average over the cycle...not simply at its peak. Any long term indicator suggest that we are largely overvalued at this point.

It's not an opinion that margins are high. It's a mathematical fact. Margins have traditionally reverted and have traditionally been lower than they are today. The questions isn't are margins elevated. The only question is when they will revert. 1 year? 5 years? It's really anyone's guess but I don't really think its up for debate about how richly valued the market is. It's really more of a question on how much more richly valued it could get and how long it will take to revert. The numbers simply don't lie.

Can someone help me understand this market over-valuation hypothesis because I'm really struggling. 

Here are the worlds biggest companies:

Apple, Exxon, Microsoft, Google, Berkshire, General Electric, Johnson&Johnson, Walmart, Chevron, Wells Fargo

Do you guys think they are expensive?  (Out of the 10 names I'd say 1.5 are expensive.)

Of course there are a bunch of go-go companies like Amazon, Facebook, Tesla, Twitter etc.  But they do not dominate the overall market (a la 1999).  And, even in healthy markets there have always been pockets of speculation. 

What do the bears imagine happens if they are right and the market declines?  Will central banks raise interest rates??  I just don't follow the logic.  Interest rates are essentially zero.  How is it possible that shorting a bunch of debt-free large cap companies that are trading at 11-15 times earnings (6%-9% earnings yields) can ever be a sensible investment choice in a world of zero interest rates??  Even if the bears are right, China implodes, Europe deflates, and all the companies mentioned above lose 25% of their earning power…isn't one still better off holding companies with no debt, significant dividend capacity and 4%-7% earnings yields because the central banks are most certainly not going to greet such a crisis by raising interest rates?

Listen, I understand that a broad collapse such as this would no doubt offer up better prices than today, perhaps significantly so. But the risk/reward doesn't seem right to me.  Isn't it safer to buy some strong companies and if the global economies are ok you'll double your money over the next seven years, and if the economies collapse your companies will survive, pay you a dividend and stock prices will probably be marginally higher is seven years.  Even in a bear scenario your return will be better than buying cash or investment grade bonds today.

Personally, nothing makes me more nervous than speculating on Doom.  I don't think I could sleep at night.  Setting my sail against the immense tide of human history, a tide that only seems to have gotten stronger and quicker with every generation.  We are living at a time of the most obscene progress.  Jet airplanes, televisions, phones, computers, internet, globalized manufacture, a plethora of free and for fee entertainment, cheap furnishings, automobiles, statins, low child mortality, the longest life expectancy.  I don't know how someone can short our economy and not spend every waking minute absolutely terrified.

The simple answer is this: all investments are in competition with one another. If bond rates are low, people will bid up stocks until future stock returns are low too. We're in an environment with high stock multiples that were driven up by low interest rates. This would be fine if interest remain at 2.5% forever, or go lower, but we all know they'll have to rise at some point. No one really knows when that is but it will eventually happen and multiples will have to compress so the forward expected returns on stocks is comparable relative to the rising rate of forward returns in bonds.

Compounded on this fact is that you have multiple potential causes for large, global economic shocks AND margins that are historically above average where reversion zone could lead to 20-30% declines.

So to summarize:

1) historically expensive market with no clear driver of future multiple expansion
2) several mean reverting statistics that are above trend (multiples, margins, bond prices )
3) potential of several large economic shocks that could quickly affect markets

Against all of this you simply have the hope that people will continue paying higher and higher prices and multiples. Earnings aren't growing at 5-10% a year and the market returns can not continue to outpace earnings like they have done.

It's not impossible to make money going forward, but I think that any reasonable person who knows math and history can see that returns will likely be disappointing going forward.

I'm not sure I accept the premise that interest rates have to go up.  Of course they do if inflation picks up.  But that is precisely what is NOT going to happen in the Watsa deflation hypothesis.  So, in a world of low interest rates which would only get lower in a deflationary environment, and accepting that one has to buy something with ones money (cash, re, stocks, bonds), how can one not choose reasonably valued large caps over any of the other alternatives?  It has the additional benefit of working out nicely if the deflation hypothesis is wrong too.

As for the argument about unreasonably fat margins - I am not smart enough to untangle the truth.  The American economy is completely different today compared to 30, 50, 100 years ago.  How does one compare a Nike that is based on outsourcing and branding to an old manufacturing company?  How does one compare Google and Apple to the old IBM or Ford with there hundreds of thousand of employees? How does one compare a modern biotech company to the old chemical companies?  The world changes, capital productivity changes.  Modern companies split up their businesses and outsource their low returns to low income parts of the world and keep their high return parts.  My guess would be that margins and the productivity of capital have been increasing since the Industrial Revolution.  And since globalization this has been further exaggerated by the ability to farm out low return parts of businesses to developing countries.

Like I said before I'm not talking about timing and trading here. Because we all agree that something bad might happen tomorrow in China, Ukraine or wherever and prices could come down 30%.  I'm talking as if one had to buy something today to own for the next ten years.
Title: Re: Fairfax Letter March 2014
Post by: Dazel on March 10, 2014, 06:39:40 AM

China's problems are no secret...they have been front page news for 3 years. From what I have seen Prem has no bet directly against China. He has hedged a deflationary spiral that would destroy the world's equity.

George Soros trades daily. His flip flop in theory and specific news driven headlines on the death of the Euro were all signs of a bottom. Now after its debt and markets have recovered he is happy with the euro? Great...rear view mirror is great.

Prem and Soros are hedgers...we need to except that....it does not mean we will "crash" but is protection against it. They need to explain to shareholders why in Prem's case he has lost over $3 billion hedging...because things could go very wrong if the second biggest economy crashed. He had better have been scared! I now like his position as a hedge for me...I made it clear on Gio's buying Fairfax thread that I bought a lot of Fairfax recently...happily actually...a nice gain!

Soros said China have billions in availability to repair their economy in foreign reserves. They actually have $4 trillion! They will turn up the spigot like every other country if they have to.

The united states debt has risen from $4.5 trillion to over $16 trillion since 2008. I believe Prem is worried that China would ignite  a global run....and the Fed would not have any bullets and we Know where Europe is...the Hedges are from a global perspective.

It is in the best interest of the world for all countries do well...we are interconnected and that scares Prem and it scares me...China on it's own is fine...they have to watch stimulus because they drive up commodity prices when they do it...the untied states growth is good for everyone but no one more so than China.

Dazel
Title: Re: Fairfax Letter March 2014
Post by: vinod1 on March 10, 2014, 07:31:30 AM
Prem made the following comment in the annual letter.


"As we did last year, we remind you that cumulative deflation in the U.S. in the 1930s and Japan in the ten years
ending 2012 was approximately 14%
. It is amazing to note that including 2013, Japan has suffered deflation in most
of the last 19 years – beginning about five years after the Nikkei index and real estate values peaked."


Japanse CPI data shows a deflation of only 1.0% over the last 10 years (2003 to 2012). Even peak to bottom from 1998 to 2013 the deflation is only about 5%. Does anyone know what inflation data Prem is using for Japan?

Link to CPI data on Japan:

http://www.stat.go.jp/english/data/cpi/1588.htm

http://www.e-stat.go.jp/SG1/estat/CsvdlE.do?sinfid=000011288548

Thanks

Vinod
Title: Re: Fairfax Letter March 2014
Post by: vinod1 on March 10, 2014, 07:44:30 AM
It's not an opinion that margins are high. It's a mathematical fact. Margins have traditionally reverted and have traditionally been lower than they are today. The questions isn't are margins elevated. The only question is when they will revert. 1 year? 5 years? It's really anyone's guess but I don't really think its up for debate about how richly valued the market is. It's really more of a question on how much more richly valued it could get and how long it will take to revert. The numbers simply don't lie.

Margins are high but as pointed out by Pzena, ROE are roughly in line with average. But companies and investors care more about (correctly in my view) return on equity. The fact that a company increased its margins from 5% to 10% would not automatically invite competition and drive down margins if ROE say remain only 8%. Companies had to deploy a lot more assets to generate these margins.

http://www.pzena.com/heading-our-research/investment-analysis-4q13.php

What are your views on this?

If God gave you a peek at interest rates over the next 20 years and they remain in the 2-3%, how would your view about equity valuations change, if any?

Not trying to argue with you, just trying to understand different viewpoints on this topic.

Thanks

Vinod
Title: Re: Fairfax Letter March 2014
Post by: 50centdollars on March 10, 2014, 08:09:36 AM
It's not an opinion that margins are high. It's a mathematical fact. Margins have traditionally reverted and have traditionally been lower than they are today. The questions isn't are margins elevated. The only question is when they will revert. 1 year? 5 years? It's really anyone's guess but I don't really think its up for debate about how richly valued the market is. It's really more of a question on how much more richly valued it could get and how long it will take to revert. The numbers simply don't lie.

Margins are high but as pointed out by Pzena, ROE are roughly in line with average. But companies and investors care more about (correctly in my view) return on equity. The fact that a company increased its margins from 5% to 10% would not automatically invite competition and drive down margins if ROE say remain only 8%. Companies had to deploy a lot more assets to generate these margins.

http://www.pzena.com/heading-our-research/investment-analysis-4q13.php

What are your views on this?

If God gave you a peek at interest rates over the next 20 years and they remain in the 2-3%, how would your view about equity valuations change, if any?

Not trying to argue with you, just trying to understand different viewpoints on this topic.

Thanks

Vinod

+1

Good point. If interest rates stay low for the next 5 years, you can make an argument that stocks are undervalued.
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 10, 2014, 08:22:20 AM
It is quite interesting that with the Malaysian airline , all the nations in one of the most disputed parts of the water in this world are working together ... This gives me some comfort when dooms day comes they'd be trying to figure out a solution.
Title: Re: Fairfax Letter March 2014
Post by: benhacker on March 10, 2014, 10:34:18 AM
I've posted about this ROE comparison vs. margins before.  I agree it's more meaningful than margins generally.  But the question I have is in a world of 3% long rates is a 12-14% corporate ROE really reasonable?  I think it's not regardless of historical 'average'.  Separately, I think the "B (Equity or Book)" for US companies is overstated "versus history" (I think it's more accurate than historical) due to goodwill accounting (and perhaps it's understated a bit due to R&D accounting)... which means ROE is too high because of the rate environment and also apples to apples it's too high vs history.

I personally think the aggregate market is obviously too high... but especially smaller companies (S&P100 companies seem high-ish to me, but maybe not crazy).  Looking through the top 50 Russell 2k companies is funny, sad, and instructive at the same time.  Of the top 25, 5 have negative GAAP earnings, and 7 trade above 50x GAAP.  I would bet that 10 year forward returns for the Russell will be 1-2% annualized nominal.

Just my 2 cents.  Of course buying cheap stocks is still the thing to do as always.

Ben

My non-taxable accounts (no shorting possible) are still 90-95% long... just think it's interesting to see the contortions (not referencing this thread) that many are going through to defend an obviously overvaluled market.  low rates for a generation, non-GAAP forward earnings, ignoring negative earning companies (without realizing it), etc etc etc.

Crazy...
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 10, 2014, 11:50:03 AM
I've posted about this ROE comparison vs. margins before.  I agree it's more meaningful than margins generally.  But the question I have is in a world of 3% long rates is a 12-14% corporate ROE really reasonable?  I think it's not regardless of historical 'average'.  Separately, I think the "B (Equity or Book)" for US companies is overstated "versus history" (I think it's more accurate than historical) due to goodwill accounting (and perhaps it's understated a bit due to R&D accounting)... which means ROE is too high because of the rate environment and also apples to apples it's too high vs history.

I seem to remember Buffett saying that the long term average ROE for American companies was something like 11%.  I can't remember if that accounted for leverage or not.

For example IBM's ROE is often in the 60-120 range, but they have been aggressively issuing debt and buying back stock, essentially a slow-motion LBO.  Return on capital or return on enterprise value might be a better metric.

I don't think that 14-15% is normal/sustainable, though wonder if there is some skew in those numbers.  For example a lot of businesses have not been investing much over the past 5 years and earnings have only recently recovered.  If they were waiting for earnings to increase before investing then equity might be artificially low until they start to invest.  Also tax rates may be artificially low if corporations lost money in the past 5 years and have tax credits.

BAC's ROE is something like 5%, and was running 15-20% in the 90's and early 2000's.  I'd expect other large banks to be in the same area, because they have been required to retain capital but prohibited from investing it.  So while the market average ROE might be high, there are plenty of examples of quality companies with low ROE.
Title: Re: Fairfax Letter March 2014
Post by: Kraven on March 10, 2014, 12:16:10 PM
These types of threads are interesting and frankly full of inconsistencies.  People like to proclaim that they are "bottoms up" investors, but then spend all their time attempting to figure out the macro.  It's trying to predict the unpredictable.  Even Buffett gets in on the act a bit.  He talks about the market cap/GDP indicator (a favorite of many on the board here), yet in his latest letter says "in the 54 years we [Buffett and Munger] have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions".  The latter part is particularly interesting. 

On the other hand, someone could argue that the macro is just another data point for figuring out whether a stock is cheap or not, yet Buffett says it never even comes up.  But in other places he says the market cap/GDP figure is his favorite indicator.

There is so much angst these days.  A cheap stock is a cheap stock.  If interest rates being 100 or 200 bp higher changes that determination, it wasn’t a cheap stock to begin with.  Market volatility will come and go and I’m sure we are due for a big decline at some point.  I really enjoyed the latest Buffett letter.  I liked the part about his personal investments and particularly the tribute to Ben Graham.  I think folks would do well to keep in mind his take on Mr. Market when he described a neighboring farmer standing at his property line shouting out prices every day.
Title: Re: Fairfax Letter March 2014
Post by: vinod1 on March 10, 2014, 12:34:28 PM
I've posted about this ROE comparison vs. margins before.  I agree it's more meaningful than margins generally.  But the question I have is in a world of 3% long rates is a 12-14% corporate ROE really reasonable?  I think it's not regardless of historical 'average'.  Separately, I think the "B (Equity or Book)" for US companies is overstated "versus history" (I think it's more accurate than historical) due to goodwill accounting (and perhaps it's understated a bit due to R&D accounting)... which means ROE is too high because of the rate environment and also apples to apples it's too high vs history.

Ben

Question is what would cause ROE's to go down? There has to be massive investment by companies take advantage of high ROE, to drive down ROE to more "acceptable" levels. We do not see that. Massive investment is also precisely what GMO says is one way to keep profit margins high!

Vinod
Title: Re: Fairfax Letter March 2014
Post by: turar on March 10, 2014, 12:34:39 PM
I understood your point about needing less bodies in the fields (shedding agricultural labor).

I am wondering do they become unemployed or what do they do next?  I remember 10 years ago it was clearly cheaper to manufacture many goods in China.  But today I believe the costs gaps are much slimmer, and energy is cheaper in the US.  We're even spinning yarn in the US again.  Tesla decided it was cheaper to do some of it's manufacturing in California of all places, rather than China. 

So I'm just wondering how that all impacts the "For Hire" signs in Chinese cities.  Merely a slowing of manufacturing growth should leave an impact on the rate at which people will take up jobs in Chinese cities.

One factor could be just the internal market. China has been export-oriented for the whole world, but as their population gets richer, they would be the consumers of their own manufacturing capacity?
Title: Re: Fairfax Letter March 2014
Post by: zenith on March 10, 2014, 10:27:22 PM
It looks like Seth Klarman is on the same bandwith as Prem with respect to the market valuation.
http://www.zerohedge.com/news/2014-03-08/seth-klarman-born-bulls-bitcoin-truman-show-market (http://www.zerohedge.com/news/2014-03-08/seth-klarman-born-bulls-bitcoin-truman-show-market)

He mentions the same companies as Prem does, NFLX, TWTR etc.

couple of great qoutes
"the stock market, heading into 2014, resembles a Rorschach test - "what investors see in the inkblots says considerably more about them than it does about the market."

also

"In an ominous sign, a recent survey of U.S. investment newsletters by Investors Intelligence found the lowest proportion of bears since the ill-fated year of 1987".
 
When 2 of the greatest investors say there is an issue, i think it is time to be concerned.
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 11, 2014, 12:35:10 AM
These types of threads are interesting and frankly full of inconsistencies.  People like to proclaim that they are "bottoms up" investors, but then spend all their time attempting to figure out the macro.  It's trying to predict the unpredictable.  Even Buffett gets in on the act a bit.  He talks about the market cap/GDP indicator (a favorite of many on the board here), yet in his latest letter says "in the 54 years we [Buffett and Munger] have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions".  The latter part is particularly interesting. 

On the other hand, someone could argue that the macro is just another data point for figuring out whether a stock is cheap or not, yet Buffett says it never even comes up.  But in other places he says the market cap/GDP figure is his favorite indicator.

There is so much angst these days.  A cheap stock is a cheap stock.  If interest rates being 100 or 200 bp higher changes that determination, it wasn’t a cheap stock to begin with.  Market volatility will come and go and I’m sure we are due for a big decline at some point.  I really enjoyed the latest Buffett letter.  I liked the part about his personal investments and particularly the tribute to Ben Graham.  I think folks would do well to keep in mind his take on Mr. Market when he described a neighboring farmer standing at his property line shouting out prices every day.

Kraven,
I also don’t like these kinds of threads… If you want to speak about FFH, well then speak about the company! Instead, very few people do so.

But, to be clear, imo “macro” has nothing to do with “general market valuation”. I don’t care much about macro (I wouldn’t have invested in ALS otherwise!), yet I am worried about general market prices.

General market valuation applied to the S&P500 is no different than trying to value a portfolio of 500 companies. Not easy, of course! ... I guess 500 companies are a lot even for you! But the idea is the same:
to compare prices with values.
The "headlines" Mr. Buffett speaks about are totally different things.

The short-cuts often used to value a market, and that have a long-term track record of reliability, might be somehow questionable… in the end, though, they are nothing but simple means to avoid much trouble and work: that is to value 500 companies, one by one!
And you know what? I guess that, if you’d make the effort to study and value each of those 500 companies, you would come to the conclusion that portfolio of 500 companies is not of your liking at all! ;)

Gio
Title: Re: Fairfax Letter March 2014
Post by: mals on March 11, 2014, 05:54:07 AM
If we assume for a moment, that Fairfax hedges are not entirely because of desire to make macro bets. Then here are thoughts that are worth considering.

1. Fairfax's equity hedges - Let us analyze for a moment as to why Fairfax needs / wants these hedges vs why Berkshire / Markel do not.

Berkshire is cash rick and huge. Market dislocations are unlikely to affect their liquidity in any meaningful way. Berkshire is also more US oriented - which maybe a more stable market than some that Fairfax is in - with respect to insurance and investments both.
Markel - is about the same size and therefore should also be concerned. As far as I can tell they are - lots of cash and bond tenure has been falling. Maybe Markel is simply more conservative in their ambition for returns and are content with sufficient liquidity at this point. Markel's insurance business is more specialized and has had historically good combined ratios - and so may be has to worry less about its insurance business stability. Businesses Markel owns are also more local and as far as I can tell more stable and not leveraged.

Would love to hear what others think on why the differences between their strategies?

2. Fairfax deflation hedges - why these? I would say, part business protection and part macro bet.

My understanding - deflation is a double whammy for an insurance company. Float returns diminish - as the yields go down. And more importantly, deflation happens only if the economies are depressed and so business is tepid. So as an insurance leader, if you are worried about deflation, you try to protect yourself. Add to that the fact that deflation protection was / is probably very cheap, and if you are an opportunistic investor, you go ahead and do more than just protect yourself.
So here it does appear to me that Prem Watsa is playing macro bets. But the bet is perhaps asymmetric - losses are finite if it does not work out, and possible gains are a multiple of the losses. And gains accrue at a time when the firm will likely reallyneed the gains.

Thoughts?
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 11, 2014, 07:15:26 AM
Would love to hear what others think on why the differences between their strategies?

The 2 major differences between Fairfax and Berkshire are 1) Berkshire has substantial operating (i.e. non-investment, non-insurance) earnings, and 2) Berkshire has far less leverage.

The operating earnings allow Berkshire to "coast" more and to provide it with basically an endless amount of investable funds without being entirely reliant on insurance, which by its nature is volatile.  When either insurance or investments have a bad year, or both, Berkshire will most likely still show gains and have plenty of funds to invest.  It also gets an immediate tax break when there is a large insurance loss since it always has lots of taxable income to offset.  This blunts the impact of large one-time losses such as 9/11 or hurricane Katrina.

Fairfax not only doesn't have this kind of cushion but is also more highly leveraged.  This is less true today with a debt/equity of 1/3 but 10 years ago it was closer to 2/3.

These things make Fairfax inherently more volatile.  In a sense it is a two-legged stool and it has in its history had a few precarious periods including one where they almost got into serious trouble.  I think those years influenced Watsa's thinking and led to his brilliantly executed bet against credit default swaps in 2008 and must also contribute to his very cautious/fearful stance today.  My opinion is that I would rather have operating earnings than portfolio hedges but different strokes for different folks.

Whenever you hear Buffett talk he is always the optimist, even in the dark days of the crisis, and every shareholder letter is upbeat and positive.  I think this is because he has built an investment vehicle nearly free of risk and all he has to think about is his next deal or Dilly Bar.  Fairfax's position is not so secure and needs constant attention and so from Watsa you hear a much more cautious message.
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 11, 2014, 07:18:16 AM
When 2 of the greatest investors say there is an issue, i think it is time to be concerned.

Interesting to me that both Klarman and Watsa are cautious about market valuations, but Klarman upped his cash holdings while Watsa has bet strongly against the markets.

Also Watsa bet against the markets well before valuations got high, I think he started to put on the hedges in 2010.  I don't think Klarman was so bearish back then.
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 11, 2014, 01:41:17 PM
http://www.wantchinatimes.com/news-subclass-cnt.aspx?id=20140227000006&cid=1202

Hangzhou housing prices slashed by upto 30%. Apparently this has shocked the local property market.
Title: Re: Fairfax Letter March 2014
Post by: SI on March 11, 2014, 01:59:08 PM
Klarman returned money in 2010.
Title: Re: Fairfax Letter March 2014
Post by: stahleyp on March 11, 2014, 05:43:16 PM
When 2 of the greatest investors say there is an issue, i think it is time to be concerned.

Interesting to me that both Klarman and Watsa are cautious about market valuations, but Klarman upped his cash holdings while Watsa has bet strongly against the markets.

Also Watsa bet against the markets well before valuations got high, I think he started to put on the hedges in 2010.  I don't think Klarman was so bearish back then.

Yeah, SI is right. I don't think Klarman was quite as bearish in 2010 but he was still bearish. For sure.
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 11, 2014, 06:11:47 PM
I'd just add that my contacts in china (owner / operator of a public company and a senior banker ) seems to suggest the problems in china are manageable.  Perhaps we the outsiders see this better than they can,

Also, when Buffett has an optimistic view I think it is fair to say that view is shares by Ted, Todd, and munger as well. 
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 11, 2014, 06:38:15 PM
Buffett is increasing cash - He has increased cash by $27B or 100% from 2008.

BRK should have close to $52B cash by now. That is $32B more than Buffett would like.

At $2B per month he could be upto $70B in cash by the end of the year.

Back in 2010 and 2011 cash was at $34B when BRK was only generating $1B cash per month.

In 2008 and 2009 cash was at approx $25B.

Title: Re: Fairfax Letter March 2014
Post by: jay21 on March 12, 2014, 05:35:08 AM
The most compelling thing I have seen in awhile suggesting that deflation can be a very big problem:

http://blogs.ft.com/andrew-smithers/2014/03/a-world-awash-with-debt/

Are we much more levered than we think?  I don't know much about these charts and there could be a good reason for the increasing ratio.  Maybe the charts here showing assets, liabilities, and equity to GDP show a different story?

http://www.businessinsider.com/america-is-not-drowning-in-debt-2013-4
Title: Re: Fairfax Letter March 2014
Post by: longinvestor on March 12, 2014, 07:08:12 AM
Buffett is increasing cash - He has increased cash by $27B or 100% from 2008.

BRK should have close to $52B cash by now. That is $32B more than Buffett would like.

At $2B per month he could be upto $70B in cash by the end of the year.

Back in 2010 and 2011 cash was at $34B when BRK was only generating $1B cash per month.

In 2008 and 2009 cash was at approx $25B.
No one else has that problem. Are we going to see the buy back threshold bumped up to 1.3x BV?
Title: Re: Fairfax Letter March 2014
Post by: Uccmal on March 12, 2014, 07:26:34 AM
I am just not seeing the pessimism that Watsa sees.  There are always frothy areas in the market. 

What I see is a banking system in the Us that is now over capitalized.  Many multinationals are sitting on colossal amounts of cash. 

The commodity rally is over, and has been for a couple of years at least, excluding fossil fuels. 

Governments are sitting on huge debts, but the service cost is very low.  Since they control the service costs it is not that relevant.  With job improvements, market improvements, and dividend increases everywhere tax revenues are climbing.

The notion that there are no more bullets if things turn down is wrong.  The federal reserve has already freed up 20 b per month in bullets - 240 b per year. 

As to China.  If there is really an overbuild still going on then why are commodities so cheap?  IMO their economy is internalizing as people within become more able consumers.  All that pollution is coming from somewhere. 

As Packer has stated there is always a crisis somewhere.  Since 1999 I have gone from zero to unemployed through the tech meltdown, two massive hurricane seasons, 9/11, the financial meltdown, the Near collapse of the EU etc,etc, etc. 

Finally, when calculating FFHs long term returns you need to remove the first year, at least.  That shaves at least a couple percent off.  In the end game, their returns, while respectable, are nowhere near Berkshires.  And berks cash build has to do with their size and nothing else. 
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 12, 2014, 07:42:39 AM
I agree that there are always scary headlines...  etc....

However the reason why I started hedging was because of what has been fueling things.  We are once again at a record level of margin debt.  That is something that provides fuel for a fire.  I was also impressed by the astounding amount of private debt that has been racked up in China over the past few years.  Okay, one can argue that culturally they prefer real estate to other forms of savings, but they clearly love the leverage too.  There is something going on there that looks like a stretched rubber band and that feeds on continued growth of credit -- prices should fall/weaken when that credit expansion slows.  And then you have something similar to what the US went through -- a bunch of underwater debt that has no cash flow (they aren't renting these things out).

Anyways, it's all too much for me as due to what is most probably a "Low T" diagnosis (were I to go seek one out).
Title: Re: Fairfax Letter March 2014
Post by: mcliu on March 12, 2014, 07:54:13 AM
 
I am just not seeing the pessimism that Watsa sees.  There are always frothy areas in the market. 

What I see is a banking system in the Us that is now over capitalized.  Many multinationals are sitting on colossal amounts of cash. 

The commodity rally is over, and has been for a couple of years at least, excluding fossil fuels. 

Governments are sitting on huge debts, but the service cost is very low.  Since they control the service costs it is not that relevant.  With job improvements, market improvements, and dividend increases everywhere tax revenues are climbing.

The notion that there are no more bullets if things turn down is wrong.  The federal reserve has already freed up 20 b per month in bullets - 240 b per year. 

On the other hand, if the situation is so great, why is the Fed still injecting $700 billion into the bond markets every year and being so cautious with tapering?

I guess if you believe that the current interest rate environment is normal, then there are definitely many signs of improvement.

As to China.  If there is really an overbuild still going on then why are commodities so cheap?  IMO their economy is internalizing as people within become more able consumers.  All that pollution is coming from somewhere. 

Where is the data that supports that? I'm looking at the latest GDP figures and it shows a big jump in investments from 49% of GDP to 54% while consumption only increased from 48% to 50%. Credit is still growing double digits, probably to finance the increase in investments. The Shanghai index has dropped considerably since 2009 (5 straight years of declines!) reflecting the low ROEs in corporate China. Yet, despite the low returns, overall investments has jumped by 20% yoy.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 12, 2014, 08:03:13 AM
See, here's a chart of NYSE margin debt since 1995:

http://advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php

I would love to find a longer-term chart.
Title: Re: Fairfax Letter March 2014
Post by: Cardboard on March 12, 2014, 08:10:06 AM
While I mentioned previously that I would ignore Fairfax following their non-follow through on buying out Blackberry, I still read the annual letter. Shame on me.

By the way, I don't buy the excuse of not following through because they discovered during due diligence that Blackberry could not be bought via an LBO. I mean, any decent investor with available public information could quickly calculate a reasonable amount of additional debt that could be serviced from recurring cash flows and disposable assets.

The transaction was presented as a cash offer with partners and with full reputation on the line. Once it fell apart, we are now supposed to believe that Fairfax and very capable Hamblin Watsa and Mr. Watsa himself being a director of BBRY for a long time, had to rely on outsiders or consultants if you will, to figure out that an LBO or adding a bunch of expensive debt on BBRY was impossible... You can draw your own conclusion a few different ways. One thing is certain, if I was a shareholder attending the meeting, I would question him directly about this train of thought.

Now getting back to the letter, I would point out that copper has experienced a noticeable drop recently. Unlike oil, it is not impacted much if at all from geopolitical events hence when it drops sharply as it did, it is a sign that something is amiss on the demand side. If you add this to the recent debt default in China and noticeable over-building, they may be on to something. At least, the timing now seems more right than before.

Cardboard
Title: Re: Fairfax Letter March 2014
Post by: Uccmal on March 12, 2014, 09:41:44 AM
I am just not seeing the pessimism that Watsa sees.  There are always frothy areas in the market. 

What I see is a banking system in the Us that is now over capitalized.  Many multinationals are sitting on colossal amounts of cash. 

The commodity rally is over, and has been for a couple of years at least, excluding fossil fuels. 

Governments are sitting on huge debts, but the service cost is very low.  Since they control the service costs it is not that relevant.  With job improvements, market improvements, and dividend increases everywhere tax revenues are climbing.

The notion that there are no more bullets if things turn down is wrong.  The federal reserve has already freed up 20 b per month in bullets - 240 b per year. 

On the other hand, if the situation is so great, why is the Fed still injecting $700 billion into the bond markets every year and being so cautious with tapering?

I guess if you believe that the current interest rate environment is normal, then there are definitely many signs of improvement.

As to China.  If there is really an overbuild still going on then why are commodities so cheap?  IMO their economy is internalizing as people within become more able consumers.  All that pollution is coming from somewhere. 

Where is the data that supports that? I'm looking at the latest GDP figures and it shows a big jump in investments from 49% of GDP to 54% while consumption only increased from 48% to 50%. Credit is still growing double digits, probably to finance the increase in investments. The Shanghai index has dropped considerably since 2009 (5 straight years of declines!) reflecting the low ROEs in corporate China. Yet, despite the low returns, overall investments has jumped by 20% yoy.

I never said the situation was so great.  I provided counterarguments to the same noise that comes out of FFH ever year.  They dont know any better than anyone else.  Specifically, the running out of bullets argument Is what I was talking about.  The way I see it the magazine is being refilled slowly but surely. 

Have a look at historical interest rates, going way back, if you dont believe they can stay very low for a very long time. 

Do you really believe anything you get from China at all, either the stats that FFh provides, or the ones you are providing.  We are dealing with a great big black hole over there.  And the officials in China are dealing with the same black hole.  I am real skeptical.  The only tangible thing we can see is that commodity prices (ores) have come off from the boom years.  That shows me that there aren't Manhattans being built every month. 
Title: Re: Fairfax Letter March 2014
Post by: matjone on March 12, 2014, 09:47:20 AM
See, here's a chart of NYSE margin debt since 1995:

http://advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php

I would love to find a longer-term chart.

http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=table&key=3153&category=8
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 12, 2014, 12:23:41 PM
i am wondering if there's any meaning to looking at margin debt as a ratio to the credit balance...  as oppose to looking at the margin debt alone.    i attached a graph. 

also, does anyone know what 'foreign reserve' means -- i've heard that China has a lot of foreign reserve - but in very practical terms, what does that actually do? is it like cash in the bank they can use? 

i think the one thing China has also going for them in terms of monetary policy is they control their currency exchange rate.  not sure if that's a plus or minus. not an economist here... but just thought between that and the interest rate and the foreign reserve - whatever that is - they have a few tools to play with.

thanks
Title: Re: Fairfax Letter March 2014
Post by: ourkid8 on March 12, 2014, 02:17:26 PM
Since we have all become macro investors, here is another data point which shows the US economy continues to expand and 4th quarter GDP growth maybe revised higher! For me, I continue to buy companies selling below intrinsic value.  I am not concerned what will happen to the global economy in the short term. 

http://mobile.reuters.com/article/idUSBREA2B1H020140312?feedType=RSS&irpc=935

Tks,
S
Title: Re: Fairfax Letter March 2014
Post by: TwoCitiesCapital on March 12, 2014, 05:28:52 PM
Finally, when calculating FFHs long term returns you need to remove the first year, at least.  That shaves at least a couple percent off.  In the end game, their returns, while respectable, are nowhere near Berkshires.  And berks cash build has to do with their size and nothing else.

If you remove the first year because "they're so small and results were easy" then you should adjust for the removal of the CDS gain in 2008 because they were no longer small and that required a great deal of macro-economic and investment insight. And before anyone pipes up and says it makes sense to remove that due to it's one-time nature (I typically agree), think about this: if deflation occurs anywhere near the scale that they envision, they'll be pulling in 10+ billion from their hedges and deflation bets....so maybe it's not such a one time recurring gain at all.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 12, 2014, 09:23:00 PM
I know a lot of people recoil at discussing macro...

Do you recoil at doing a credit check for somebody you intend to lend money to?

The foreign markets are the buyers of US exports, and if they slow down their buying, it's going to hurt US equities similar to if they started making lower payments on a loan.

That's what I think of it.  You have all these American brands that the Chinese love to spend their new-money wealth on.  If they have a major hiccup, like if their real estate has a 60% nose-dive, then they'll stop importing all these luxury items.  That will ripple around and impact a lot of US business.  Same with Europe etc...

So I think paying attention to the credit health of the major consumers of US exports is a bit like paying attention to the FICO score of someone you are going to lend to.

Anyways, I will make out like a bandit if the Russell 2000 crashes, and I will make out like a bandit if the shares of BAC go to $22.  So I am open to either outcomes -- each one will grow my wealth.  I am actually scared shitless for the global markets... but because we can't predict when, I'm still leaving open the upside to $22.
Title: Re: Fairfax Letter March 2014
Post by: frommi on March 12, 2014, 10:00:26 PM
Its possible that you are right and after reading these stories i am scared, too. But in the end thats always the reason why something becomes cheap, because the majority is scared that the world goes to hell. Nobody knows how this all will play out, perhaps the property market in china crashes and it doesn`t influence the stock market? Or the government/central bank does something surprising?

Shorting means to bet against the humans that are working for success in all these companies/countries, so you have a lot of headwinds. And as soon as you are in your position you are actively searching for reasons why the world has to go to hell. And you get angry when the market doesn`t react like it should.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 12, 2014, 10:07:55 PM
The Russell 2000 has compounded at 7% annualized since the peak in 2007.

The world isn't scared!  Margin borrowing is at a peak -- seriously, it is. That isn't fear -- it's trumpets.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 12, 2014, 10:10:42 PM
Shorting means to bet against the humans that are working for success in all these companies/countries, so you have a lot of headwinds.

Employees at companies are working for success.

What I'm doing is protecting myself from the presently heavily leveraged greedy humans that will get margin calls when their overvalued assets plunge a wee bit.
Title: Re: Fairfax Letter March 2014
Post by: frommi on March 12, 2014, 11:06:08 PM
This overvaluation can go away when the market just goes sideways. But you are far more successful than i am in investing, perhaps i should listen to you :).
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 12, 2014, 11:08:24 PM
http://www.bloomberg.com/video/china-has-a-real-estate-bubble-saxena-QEQyoXq4QQa~JE2wvwm9rQ.html

apparently housing in China is now valued at 400% of GDP.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 12, 2014, 11:34:15 PM
This overvaluation can go away when the market just goes sideways. But you are far more successful than i am in investing, perhaps i should listen to you :).

I am going to make a lot of money if the market doesn't crash and if BAC keeps heading higher.  But I've written $22 strike calls.  Used the proceeds to buy the IWM calls that hedge my IWM short.

Then all the BAC is hedged at $15 and $17 strike.  I've also written some SHLD puts.  I've closed out my C position and am contemplating the same for JPM. 

I believe that I won't lose much if anything if the markets merely stand still (I have decay from the puts I've written, the calls I've written, the dividends I expect to receive, and then there is decay on the calls I've purchased and the puts I've purchased.

But in short, I'm heavily leveraged on BAC to the upside, and heavily leveraged in Russell 2000 short for the downside.

I can accept either BAC trudging on, or total market wipeout.  Both are winners. 

I'm prepared for pretty much all comers.  My position is different from FFH because I've hedged against the Russell 2000 moving against me (using call options).  They've made no money in four years and I've made a killing (lucky perhaps).  If the market continues to march on, or at least if BAC does, I will still keep making terrific gains.

So, don't take my bearishness as a sign that I'm giving up all hope.  It's just that I'm taking it very seriously now whereas before I was brushing off the naysayers.
Title: Re: Fairfax Letter March 2014
Post by: JBird on March 12, 2014, 11:47:13 PM
So, don't take my bearishness as a sign that I'm giving up all hope.  It's just that I'm taking it very seriously now whereas before I was brushing off the naysayers.

Interesting. What changed your mind?
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 13, 2014, 12:07:01 AM
So, don't take my bearishness as a sign that I'm giving up all hope.  It's just that I'm taking it very seriously now whereas before I was brushing off the naysayers.

Interesting. What changed your mind?

I have a vague understanding that the astronomical increase in credit in China over the past few years (not just absolutely, but relative to their means) has been one of the horses pulling the cart (the global economy).  They create all that credit (money) and import things from all over the world. 

And look at a chart of increasing margin borrowing in the US and stock prices. 

There is like no room for bad surprises.  And the kind of bad surprise that can come out of China could very well be what tips Europe into deflation -- they are so close already.  Perhaps even the US.

Look at our profit margins... where does all that come from?  It's got to be hit pretty hard by something like decreasing demand for our exports from economies in Europe and China.

But anyways... I'm going to make about 75% gain over next two years if we muddle through and BAC goes to $22.  I'll probably do just as well, perhaps better, if Russell 2000 goes into Great Depression 2.0 mode.  So, I'll just eat popcorn and hope for the former (I don't want to live in a depressing time where we have widespread misery).
Title: Re: Fairfax Letter March 2014
Post by: tombgrt on March 13, 2014, 01:59:45 AM
So, don't take my bearishness as a sign that I'm giving up all hope.  It's just that I'm taking it very seriously now whereas before I was brushing off the naysayers.

Interesting. What changed your mind?

I have a vague understanding that the astronomical increase in credit in China over the past few years (not just absolutely, but relative to their means) has been one of the horses pulling the cart (the global economy).  They create all that credit (money) and import things from all over the world. 

And look at a chart of increasing margin borrowing in the US and stock prices. 

There is like no room for bad surprises.  And the kind of bad surprise that can come out of China could very well be what tips Europe into deflation -- they are so close already.  Perhaps even the US.

Look at our profit margins... where does all that come from?  It's got to be hit pretty hard by something like decreasing demand for our exports from economies in Europe and China.

But anyways... I'm going to make about 75% gain over next two years if we muddle through and BAC goes to $22.  I'll probably do just as well, perhaps better, if Russell 2000 goes into Great Depression 2.0 mode.  So, I'll just eat popcorn and hope for the former (I don't want to live in a depressing time where we have widespread misery).


Isn't the increased margin borrowing running parallel with increased stock portfolio values? Obviously there is higher margin borrowing at peaks than at lows when looking at it percentage wise but I wonder how big a piece of the complete picture it is.
Title: Re: Fairfax Letter March 2014
Post by: frommi on March 13, 2014, 02:44:34 AM
So you lagged into a straddle on IWM? Thats absolut brilliant! What expiration date did you use?
Title: Re: Fairfax Letter March 2014
Post by: thefatbaboon on March 13, 2014, 02:58:09 AM
I just can't for the life of me figure out what would make interest rates go up.  >:( (USD, EUR, YEN).  Spikes, sure, I can see some reasons, but sustained increases….?

It's annoying.  I feel it's blinding me to potential downsides in the market. 

Title: Re: Fairfax Letter March 2014
Post by: Cardboard on March 13, 2014, 04:47:59 AM
I really like both of your posts Frommi and Ericopoly. Shorting is certainly a tough thing to do and as you said Ericopoly recently, the power of retained earnings over just a few years can make the best actual short thesis look quite foolish quickly.

While I like my holdings, I feel like I can't count on a raging bull anymore to help them reach fair value. And if we still have a raging bull, it could be a few areas doing really well while value stays flat. So I really like the way you have hedged Ericopoly, but keep in mind that some parabolic move may still form in the more frothy areas of the market while BAC stays flat.

Staying flat while everyone is partying feels actually as bad if not worse as going down with everyone else. However, at this point, the risk of staying flat after all these years of large gains may be worth accepting.

Cardboard
Title: Re: Fairfax Letter March 2014
Post by: tiddman on March 13, 2014, 05:20:46 AM
Isn't the increased margin borrowing running parallel with increased stock portfolio values? Obviously there is higher margin borrowing at peaks than at lows when looking at it percentage wise but I wonder how big a piece of the complete picture it is.

Yes on one hand, people buy more aggressively in an up market and probably buy more stocks on margin.

On the other hand, when stock values are high, people borrow against their stocks more and use those funds for other purposes.  I know lots of people that use their taxable stock account as a sort of slush fund, and use margin to handle one-time expenses or other investments.

The bearish view is that increases in stock values are being driven primarily by margin debt.  I am not sure that's true but this probably contributes to it.  I am not sure what percentage of the overall market is represented by retail investors with margin accounts, I would guess a fairly small portion.
Title: Re: Fairfax Letter March 2014
Post by: prevalou on March 13, 2014, 06:29:31 AM
http://oldprof.typepad.com/a_dash_of_insight/2014/03/missing-indicators-and-confirmation-bias.html?utm_content=bufferfa3d9&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 13, 2014, 07:12:42 AM
So you lagged into a straddle on IWM? Thats absolut brilliant! What expiration date did you use?

The IWM $120 strike call is 2015.  Now, if this market breaks significantly either way I should be able to roll it to 2016 somewhat inexpensively (due to skewness).

Had FFH done that 4 years ago when IWM was at $65, consider how inexpensively they could have been rolling the calls along with the market up so much.  It would be practically free to roll a $65 call these days.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 13, 2014, 11:14:16 AM
Here's an analogy.

Two clydesdales are in a harness pulling a cart up a hill. A veterinarian has been blood doping them and giving them steroids, etc....  The cart is barely moving. 

One of the horses is beginning to look tired.  Do you want to be walking behind the cart?
Title: Re: Fairfax Letter March 2014
Post by: Cardboard on March 13, 2014, 01:38:13 PM
Well, that is a good one.  :)

Just don't forget that Watsa probably thought the same thing 4 or 5 years ago and back then the cart was even moving slower.

So you did the right thing by buying these protective calls against your short since who knows when the cart will go on reverse or crash down the hill!

Cardboard
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 13, 2014, 08:33:19 PM
Just don't forget that Watsa probably thought the same thing 4 or 5 years ago and back then the cart was even moving slower.

I know, but there is some legitimate measurement of why he hasn't been proven correct yet:

quoting his letter:
. Since 2009, the Chinese banks have grown by the equivalent of the entire U.S. banking system or 15% of world GDP.


Since 2009, the easing by the Federal Reserve combined with the explosive
growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China.
The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where
speculators have borrowed at low rates across the world and invested in China, almost always backed by real
estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is
estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly
enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or
approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China,
watch out!



It's rather staggering.  The very thing that has thus far worked against him is actually making the final chapter a doozy.  However, I don't know how many chapters so I hedge with calls.  I don't want to be like Kyle Bass and his clan that short JGBs and keep getting stymied for years and years.
Title: Re: Fairfax Letter March 2014
Post by: goldfinger on March 13, 2014, 09:27:40 PM
Can't the Chinese government fight the tape with almost 3.5T$ in reserves, given how interventionist it has been in the past?
Title: Re: Fairfax Letter March 2014
Post by: frommi on March 13, 2014, 09:41:23 PM
Yes they can but they devalue their currency with that action. I would say its happening right now.
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 13, 2014, 09:45:12 PM
Can't the Chinese government fight the tape with almost 3.5T$ in reserves, given how interventionist it has been in the past?

Very impressive.

Okay, I have no idea if the following is true given the source but...

Since Lehman Brothers collapsed in 2008, the level of private domestic credit in China has risen from $9 trillion to an astounding $23 trillion.  That is an increase of $14 trillion in just a little bit more than 5 years. 

In fact, it is being projected that Chinese companies will pay out the equivalent of approximately a trillion dollars in interest payments this year alone.  That is more than twice the amount that the U.S. government will pay in interest in 2014.


http://www.zerohedge.com/news/2014-01-21/guest-post-23-trillion-credit-bubble-china-starting-collapse-%E2%80%93-what-next


I don't know, maybe those high interest payment are on unproductive assets (like for example empty real estate developments).  There must be some source behind the low ROE.
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 13, 2014, 09:46:00 PM
this is a question that i've been thinking about

it seems like because the chinese government has artificially kept the chinese yuan low relative to the US dollar, over the years it had to buy US dollars (i.e., sell Chinese yuan) to keep the Yuan low....  the US dollars that they have been buying = the foreign reserve in $US.....  and all this fund belongs to the Chinese central bank...   

So in theory, if the yuan were to collapse - they could just start buying Yuan and sell US dollars....  the reserve, at $3.3 trillion US is mostly in the form of US government bonds ... so they'd start selling the bonds.... which would increase the yield on the bonds... (?)   

so our current quantitative easing is about 85B at the peak per month... so  3300B would be a 3 year QE program if that's where the Chinese government wants to start inject the money back into their economy.....     

is it this simple?

Gary

Quote
Official international reserves assets allow a central bank to purchase the domestic currency, which is considered a liability for the central bank (since it prints the money or fiat currency as IOUs). Thus, the quantity of foreign exchange reserves can change as a central bank implements monetary policy,[2] but this dynamic should be analyzed generally in the context of the level of capital mobility, the exchange rate regime and other factors. This is known as Trilemma or Impossible trinity. Hence, in a world of perfect capital mobility, a country with fixed exchange rate would not be able to execute an independent monetary policy.
A central bank that implements a fixed exchange rate policy may face a situation where supply and demand would tend to push the value of the currency lower or higher (an increase in demand for the currency would tend to push its value higher, and a decrease lower) and thus the central bank would have to use reserves to maintain its fixed exchange rate. Under perfect capital mobility, the change in reserves is a temporary measure, since the fixed exchange rate attaches the domestic monetary policy to that of the country of the base currency. Hence, in the long term, the monetary policy has to be adjusted in order to be compatible with that of the country of the base currency. Without that, the country will experience outflows or inflows of capital. Fixed pegs were usually used as a form of monetary policy, since attaching the domestic currency to a currency of a country with lower levels of inflation should usually assure convergence of prices.
In a pure flexible exchange rate regime or floating exchange rate regime, the central bank does not intervene in the exchange rate dynamics; hence the exchange rate is determined by the market. Theoretically, in this case reserves are not necessary. Other instruments of monetary policy are generally used, such as interest rates in the context of an inflation targeting regime. Milton Friedman was a strong advocate of flexible exchange rates, since he considered that independent monetary (and in some cases fiscal) policy and openness of the capital account are more valuable than a fixed exchange rate. Also, he valued the role of exchange rate as a price. As a matter of fact, he believed that sometimes it could be less painful and thus desirable to adjust only one price (the exchange rate) than the whole set of prices of goods and wages of the economy, that are less flexible.[3]
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 13, 2014, 10:58:31 PM
If the Chinese govt sells treasuries - the prices on treasuries would drop and a large amount of the reserves could disappear.

In addition, the spike in interest rates would kill any recovery that is taking place across the world.

With the total amount of debt outstanding any increase in interest rates would be damaging to any recovery.
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 13, 2014, 11:23:46 PM
http://www.bloombergview.com/articles/2014-02-17/china-digs-itself-deeper-into-dollar-trap

the dollar trap - why the Chinese reserves in US treasuries are trapped
Title: Re: Fairfax Letter March 2014
Post by: Cardboard on March 14, 2014, 08:42:02 AM
Ericopoly,

Did you buy straight IWM puts in your non-margin accounts, like retirement accounts, where you can't short to hedge? I guess in these you would not have to worry about the early taxation issue that you mentioned.

Cardboard
Title: Re: Fairfax Letter March 2014
Post by: gary17 on March 14, 2014, 09:04:16 AM

Interesting. On the other hand though the US government owns most of the treasuries.... I believe China owns a relatively small amount.

http://www.bloombergview.com/articles/2014-02-17/china-digs-itself-deeper-into-dollar-trap

the dollar trap - why the Chinese reserves in US treasuries are trapped
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 14, 2014, 09:29:45 AM
Ericopoly,

Did you buy straight IWM puts in your non-margin accounts, like retirement accounts, where you can't short to hedge? I guess in these you would not have to worry about the early taxation issue that you mentioned.

Cardboard


I don't manage any of the assets in my Roth IRA anymore (as of January).  I am leaving it for others to manage.

I have another 18.5 years until those Roth IRA assets are tax-free.

So, my intent focus is on making it another 18.5 years living solely off of my taxable funds.  I'm pretty sure it won't be an issue -- I can sustain my current rate of spend even if I don't make another dollar in returns again (I just need to match inflation and not lose money). 


Title: Re: Fairfax Letter March 2014
Post by: Cardboard on March 14, 2014, 10:30:42 AM
Hi Ericopoly,

Actually, my question was flawed: you are not using IWM to hedge at all your BAC position or essentially your long portfolio. IWM is a straight short with capped downside, while BAC is your long with capped downside using its own puts.

The other trades: sell BAC covered calls, sell SHLD puts (with high volatility and premium) are simply ways to raise cash to reduce the cost of the 2 "trades" above. The only risk left I guess, other than treading water, is for you to be forced to buy shares of SHLD or close the position at a loss. Do I now understand it all right?

That is actually brilliant and shows the power of concentrating in a few large caps: easy to hedge them with 100% correlated puts. Very useful in times like these. I can't do this with my portfolio with most being small caps that do not have options. So to get a similar "barbell" strategy I would have to short twice as much IWM as you are or find some other short/put strategy for my long exposure.

Cardboard
Title: Re: Fairfax Letter March 2014
Post by: ERICOPOLY on March 14, 2014, 10:39:42 AM
Hi Ericopoly,

Actually, my question was flawed: you are not using IWM to hedge at all your BAC position or essentially your long portfolio. IWM is a straight short with capped downside, while BAC is your long with capped downside using its own puts.

The other trades: sell BAC covered calls, sell SHLD puts (with high volatility and premium) are simply ways to raise cash to reduce the cost of the 2 "trades" above. The only risk left I guess, other than treading water, is for you to be forced to buy shares of SHLD or close the position at a loss. Do I now understand it all right?

That is actually brilliant and shows the power of concentrating in a few large caps: easy to hedge them with 100% correlated puts. Very useful in times like these. I can't do this with my portfolio with most being small caps that do not have options. So to get a similar "barbell" strategy I would have to short twice as much IWM as you are or find some other short/put strategy for my long exposure.

Cardboard

Yep, I think you summarized it well. 

I am expecting income from dividends and expiring volatility that I have sold.  Instead, of trying to live on that income, I'm spending it all on hedges.  This way, I utilize the full value of my income rather than letting a large percentage of it get confiscated by the government taxation authorities.  I want unrealized deferred capital gains, not taxable income.
Title: Re: Fairfax Letter March 2014
Post by: Phoenix01 on March 14, 2014, 06:13:25 PM

Yep, I think you summarized it well. 

I am expecting income from dividends and expiring volatility that I have sold.  Instead, of trying to live on that income, I'm spending it all on hedges.  This way, I utilize the full value of my income rather than letting a large percentage of it get confiscated by the government taxation authorities.  I want unrealized deferred capital gains, not taxable income.

That is the FFH strategy!
Title: Re: Fairfax Letter March 2014
Post by: moody202 on March 16, 2014, 12:30:40 PM

Then all the BAC is hedged at $15 and $17 strike.  I've also written some SHLD puts.  I've closed out my C position and am contemplating the same for JPM. 

What is your JPM position?
Title: Re: Fairfax Letter March 2014
Post by: wisdom on March 18, 2014, 06:31:53 AM
http://online.barrons.com/article/SB50001424053111904628504579431002134993072.html#articleTabs_article%3D1

Jeremy Grantham GMO - learning to live with a bubble
Title: Re: Fairfax Letter March 2014
Post by: obtuse_investor on March 18, 2014, 11:37:02 AM
Commodity deflation marches on...

Full article: http://www.economist.com/blogs/buttonwood/2014/03/commodities-and-economy

Excerpt:
Quote
...the aluminium price is down 10% over the last 12 months, nickel 7.9% and lead 6.3%. Compared with a year ago, metals prices are down 10.2 per cent. With the important exception of oil, commodity prices in general have been weak over the past year (although there has been a recent pick up in food prices); the Economist all-items index is down 5.3% over the last 12 months.
Title: Re: Fairfax Letter March 2014
Post by: rogermunibond on March 18, 2014, 12:18:25 PM
Hard commodities deflating. WSJ had a piece about ag commodities seeing 3.5% increases this year. Not as bad as 2008 but definitely soft commodity inflation pressures.
Title: Re: Fairfax Letter March 2014
Post by: Dazel on March 18, 2014, 01:16:08 PM
http://www.bloomberg.com/news/2014-03-18/nickel-heads-for-bull-market-as-russia-clouds-supply-outlook.html

It depends who you ask...on defaltion or inflation...whatever is the flavor of the day gets the headline.

"crash" and "bubble" have become only the words the media cares about.

Title: Re: Fairfax Letter March 2014
Post by: yitech on March 22, 2014, 05:51:30 AM
What Would You Do if You Were Prem Watsa? by Cove Street Capital
http://covestreetcapital.com/Blog/wp-content/uploads/2014/03/Cove-Street-Capital-Strategy-Letter-16-March-14.pdf
Title: Re: Fairfax Letter March 2014
Post by: cubsfan on March 22, 2014, 11:57:58 AM
What Would You Do if You Were Prem Watsa? by Cove Street Capital
http://covestreetcapital.com/Blog/wp-content/uploads/2014/03/Cove-Street-Capital-Strategy-Letter-16-March-14.pdf

That is an excellent read - thanks for posting.
Title: Re: Fairfax Letter March 2014
Post by: giofranchi on March 22, 2014, 12:22:12 PM
What Would You Do if You Were Prem Watsa? by Cove Street Capital
http://covestreetcapital.com/Blog/wp-content/uploads/2014/03/Cove-Street-Capital-Strategy-Letter-16-March-14.pdf

That is an excellent read - thanks for posting.

I agree: a good read. Though, I would say the author focused very much on what went wrong in the last 3 years, and not nearly as much on what went right... Of course, what went right has yet to produce gains and significant financial results, which imo will materialize in the future. Therefore what went wrong I think is much easier to see than what went right.

Gio