Corner of Berkshire & Fairfax Message Board

General Category => Fairfax Financial => Topic started by: steph on December 01, 2014, 01:02:29 AM

Title: Deflation hedges
Post by: steph on December 01, 2014, 01:02:29 AM
Hi, Is there a way to know how the CPI hedges are doing?
Title: Re: Deflation hedges
Post by: giofranchi on December 01, 2014, 04:32:24 AM
I think each quarter Watsa comments on them, and let us know at which percentage of cost they are reported on the books.

Gio
Title: Re: Deflation hedges
Post by: petec on December 01, 2014, 04:42:01 AM
I can't find it now but someone on here has previously commented that the swaps appear to be valued as Level 3 assets by FFH, meaning they have considerable flexibility in how they value them.   IIRC the poster felt they valued them using a very conservative internal model because they often seemed to get market down very shortly after they were purchased.

In other words, you might not be able to predict the carrying value even if you can get a price quote.
Title: Re: Deflation hedges
Post by: steph on December 01, 2014, 04:56:55 AM
ok. Thank you!
Title: Re: Deflation hedges
Post by: captkerosene on December 01, 2014, 05:01:27 AM
Could lower oil prices spur deflation?
Title: Re: Deflation hedges
Post by: petec on December 01, 2014, 05:06:38 AM
Could lower oil prices spur deflation?

I believe the swaps are on the main CPI index (i.e. including fuel and food) in which case low oil price will be a deflationary factor.   
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on December 01, 2014, 07:45:01 AM
It's not just oil - many commodities are significantly off too. Unfortunately, unless if it affects housing/rents then I have a hard time seeing how it will significantly impact the index. Fuel is a low % of spending for most so it will be a low weight in the index.

I do believe that the weakness that were seeing across most industrial commodities/services is supportive of deflationary pressures - this isn't  limited to oil production shifts. Iron, copper, shipping, oil, lumber, natural gas, etc are all down significantly year over year.

Title: Re: Deflation hedges
Post by: benhacker on December 04, 2014, 01:06:42 PM
Quote
I can't find it now but someone on here has previously commented that the swaps appear to be valued as Level 3 assets by FFH, meaning they have considerable flexibility in how they value them.   IIRC the poster felt they valued them using a very conservative internal model because they often seemed to get market down very shortly after they were purchased.

That was me.

Just checked the latest filing I had, they made a $1B notional purchase for cost of $1.7m on 9/30/2014, and marked the value at $1.45m the same day.  So there model appears to be conservative (or perhaps the bid/ask on these contracts is massive)
Title: Re: Deflation hedges
Post by: ERICOPOLY on December 04, 2014, 01:30:36 PM
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.
Title: Re: Deflation hedges
Post by: ni-co on December 04, 2014, 03:06:31 PM
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

What was first, deflation or lower oil prices?
Title: Re: Deflation hedges
Post by: ERICOPOLY on December 04, 2014, 03:33:44 PM
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

What was first, deflation or lower oil prices?

Well in Japan they had deflation even with rising commodity prices.

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway   :-X
Title: Re: Deflation hedges
Post by: ni-co on December 04, 2014, 10:41:37 PM
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

What was first, deflation or lower oil prices?

Well in Japan they had deflation even with rising commodity prices.

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway   :-X

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313
He is using oil as a leading indicator for the CPI.
Title: Re: Deflation hedges
Post by: petec on December 18, 2014, 01:48:03 AM
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

What was first, deflation or lower oil prices?

Well in Japan they had deflation even with rising commodity prices.

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway   :-X

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313
He is using oil as a leading indicator for the CPI.

I recall going to a dinner arranged on this board before the 2009 annual dinner and someone asked Sam Mitchell: inflation or deflation?   He said: both, and what really matters is when one turns into the other.

I'm inclined to think he's right, and I think commodity prices coming down are deflationary at first, and that is so good for the economy that Eric's thesis plays out and we get wage growth and a little inflation.

But the third order effect is that, with those elements of the economy normalised, CBanks can and might have to raise rates, and it is quite possible that that will cause havoc.

Now, by the time you get to third order events your chance of making a correct prediction is so small as to make the exercise pointless!   But I can see how Prem's 2011 forecast of a possible decade of flattish nominal GDP with bouts of deflation might come true.

But then I suppose any forecast *might* come true ;)

Title: Re: Deflation hedges
Post by: Luckyone77 on January 07, 2015, 08:55:19 AM
So, Europe officially slips into deflation with todays news. What does it mean and how exactly can you calculate what that means to FFH's deflation plays and the value of the company? I'm a marketing major not a Finance major, so, go easy guys.

A part of me is thinking it's time to buy more of their stock but FFH's "tech stocking picks" (Dell and Blackberry) seem to be SO off the mark that it gives me pause and concern about what they're thinking at times. I've spoken with 2 highly placed tech executives or tech board members (not a Blackberry employee) who thinks there's not a happy ending there. Frankly, they just laugh it off. Of course, they could all be wrong and Watsa could have the last laugh or FFH might simply be too stubborn to admit they've got a loser on their hands. Time will tell.

Title: Re: Deflation hedges
Post by: giofranchi on January 07, 2015, 09:12:16 AM
FFH's "tech stocking picks" (Dell and Blackberry) seem to be SO off the mark that it gives me pause and concern about what they're thinking at times. I've spoken with 2 highly placed tech executives or tech board members (not a Blackberry employee) who thinks there's not a happy ending there. Frankly, they just laugh it off. Of course, they could all be wrong and Watsa could have the last laugh or FFH might simply be too stubborn to admit they've got a loser on their hands. Time will tell.

The fact investment mistakes are often made is just a part of this life… And no one can do anything about that, but accept it as a matter of fact!

Probably FFH invested a bit too much in Blackberry… and now all they are doing is trying to defend their investment as best as they can… But I would be very surprised if they deploy new capital that way from now on!

Of course, in the end what truly matters are overall results. And until now FFH has proven to be able to achieve very satisfactory overall investment results! ;)

Gio
Title: Re: Deflation hedges
Post by: meiroy on January 12, 2015, 06:03:45 PM
The US will not go into real deflation.

The crash in commodities and oil is due to oversupply and NOT a drop in real demand.

These lower costs will boost demand and growth in the US.

That's it. Add Europe and China numbers to it and the outcome is the same.

If you live in the USA this year consider yourself a lucky bastard.

Carry on.
Title: Re: Deflation hedges
Post by: One World Trader on January 12, 2015, 07:51:24 PM
Sorry I cannot believe that an increase in supply means an increase in demand. Why would anything be more "in demand" if it can be obtained more easily?? Whether I think of an example in socks or stocks it doesn't seem to add up!! :)
Title: Re: Deflation hedges
Post by: meiroy on January 12, 2015, 08:11:41 PM
Sorry I cannot believe that an increase in supply means an increase in demand. Why would anything be more "in demand" if it can be obtained more easily?? Whether I think of an example in socks or stocks it doesn't seem to add up!! :)

I wrote:
"The crash in commodities and oil is due to oversupply and NOT a drop in real demand.

These lower costs will boost demand and growth in the US."


Now that oil is much cheaper, do you think people will use more, the same, or less?

If the economy grows due to lower oil and commodities costs (and other external factors), would aggregate demand increase or decrease?




Title: Re: Deflation hedges
Post by: One World Trader on January 13, 2015, 09:59:11 AM
My friend, I don't know anyone who goes to the pump to fill up for work and has another tank of gas they fill because the stuff is selling for half price. I think people use the same amount if not a tad more.

With returns on money in the bank at .1 percent with little wage increases and inflation at 2-3 percent per year the average person is seeing their effective purchasing power decrease over the past few years. Factor the last few years of this in and people are really hurting. So the little they are saving in gas like you suggest cannot be going back into growing the economy if they have to pay off the average americans credit card debt, which is 15,611. BTW that Iignores the white houses recent push to..yup you guessed it...raise the gas tax.

 It's what they want you to believe though. :)
Title: Re: Deflation hedges
Post by: Tim Eriksen on January 13, 2015, 10:10:24 AM
My friend, I don't know anyone who goes to the pump to fill up for work and has another tank of gas they fill because the stuff is selling for half price. I think people use the same amount if not a tad more.

With returns on money in the bank at .1 percent with little wage increases and inflation at 2-3 percent per year the average person is seeing their effective purchasing power decrease over the past few years. Factor the last few years of this in and people are really hurting. So the little they are saving in gas like you suggest cannot be going back into growing the economy if they have to pay off the average americans credit card debt, which is 15,611. BTW that Iignores the white houses recent push to..yup you guessed it...raise the gas tax.

 It's what they want you to believe though. :)

I think you are missing his point.  It is a basic principle in economics that a higher price leads to decreased usage, and conversely a lower price leads to increased usage.  Not for every individual but in aggregate.  Of course you could argue that demand is the relatively the same regardless of price for certain products, but it doesn't take much increase to bring supply and demand back in line.   For oil we are talking about a 1% change in usage.  Will lower prices increase travel.  Historically it does.
 
Title: Re: Deflation hedges
Post by: One World Trader on January 14, 2015, 08:54:54 PM
I understand, though hardly agree. Its exactly what they want you to think!!! As long as we're talking about spending while Americans are in debt, we are talking good short term gains for manufacturers and stores but bad long term games for the whole economy. Let me explain:

When individuals borrow and spend to finance productivity it is beneficial for the economy. In the past, individuals borrowed to build a factory which would produce goods that were sold at a profit that would pay off the loan. Today money is spent and borrowed for consumption whereas indebtedness grows while production capacity doesn't! For example buying a dress or football game tickets. The debt doesn't go away because there are no profits to pay off the debt from the spending.

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)
Title: Re: Deflation hedges
Post by: petec on January 15, 2015, 02:23:49 AM

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.   The part you don't mention is that when people borrow to consume, someone somewhere borrows to build the plants to make the things that the consumers are consuming.   You might call this the "levering phase" and it works very well until the consumers, encumbered with debt, slow down their consumption.   Then neither group has the cash flows to pay off the loans.   Consumers consume less and start paying down loans.   Producers keep producing more and more to try to service their loans, but in the absence of demand they have to cut prices, and you get deflation.   You might call this the "delevering phase".   

If they're badly run the consuming countries will lower interest rates more and more and more to try to "stimulate demand", aka get levered consumers (or if that fails, governments) to lever more and spend more on more stuff that (mostly) doesn't produce an income.   If they're badly run the producing countries will borrow more and more to build more and more to keep headline GDP growing.   That's what China has spent the last few years doing.   Both policies just make the situation worse: more debt, more overcapacity, but no more demand.   It's extraordinary to think that global debt/GDP has gone from 175% in 2007 to 215% now.   The globe as a whole is not delevering, but the levering might be in its final phase.

I realise I'm drifting off topic here!

What is really interesting is whether Americans will spend their oil windfall, or use it to delever.   
Title: Re: Deflation hedges
Post by: ni-co on January 15, 2015, 03:13:22 AM

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.   The part you don't mention is that when people borrow to consume, someone somewhere borrows to build the plants to make the things that the consumers are consuming.   You might call this the "levering phase" and it works very well until the consumers, encumbered with debt, slow down their consumption.   Then neither group has the cash flows to pay off the loans.   Consumers consumer less and start paying down loans.   Producers keep producing more and more to try to service their loans, but in the absence of demand they have to cut prices, and you get deflation.   You might call this the "delevering phase".   

If they're badly run the consuming countries will lower interest rates more and more and more to try to "stimulate demand", aka get levered consumers (or if that fails, governments) to lever more and spend more on more stuff that (mostly) doesn't produce an income.   If they're badly run the producing countries will borrow more and more to build more and more to keep headline GDP growing.   That's what China has spent the last few years doing.   Both policies just make the situation worse: more debt, more overcapacity, but no more demand.   It's extraordinary to think that global GDP has gone from 175% in 2007 to 215% now.   The globe as a whole is not delevering, but the levering might be in its final phase.

I realise I'm drifting off topic here!

What is really interesting is whether Americans will spend their oil windfall, or use it to delever.

+1
This the right framework (http://www.economicprinciples.org) and exactly the right question.
Title: Re: Deflation hedges
Post by: One World Trader on January 15, 2015, 08:31:27 AM

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.


Actually, I do, however not in the short term!

At the end of the day, which country has the factories to produce more goods and which ones have the consumer debt? Which one has the ability to make more profit? :)

 I agree with much of your response.  End of leveraging phase...absolutely. I agree that saying the economy grows in the long term with all this borrowing is unrealistic because sooner or later the buck has to stop because many less in America will have it to spend!

In addition, the US owes around 5 trillion to China. That would be easily deleveraged and the problems you speak of be fixed by selling off fixed assets in the USA to China. That shrinks the economy. This doesn't solve the problems within their governing system. It does however, mean that our economy would shrink accordingly to pay off the 5 trillion it owes while it deleverages.

Great final word, an important question!
Title: Re: Deflation hedges
Post by: KinAlberta on January 19, 2015, 02:28:18 PM
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

What was first, deflation or lower oil prices?

Well in Japan they had deflation even with rising commodity prices.

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway   :-X

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313
He is using oil as a leading indicator for the CPI.

I recall going to a dinner arranged on this board before the 2009 annual dinner and someone asked Sam Mitchell: inflation or deflation?   He said: both, and what really matters is when one turns into the other.

I'm inclined to think he's right, and I think commodity prices coming down are deflationary at first, and that is so good for the economy that Eric's thesis plays out and we get wage growth and a little inflation.

But the third order effect is that, with those elements of the economy normalised, CBanks can and might have to raise rates, and it is quite possible that that will cause havoc.

Now, by the time you get to third order events your chance of making a correct prediction is so small as to make the exercise pointless!   But I can see how Prem's 2011 forecast of a possible decade of flattish nominal GDP with bouts of deflation might come true.

But then I suppose any forecast *might* come true ;)

I know back in 2010 or so, everyone was expecting a lot of inflation to appear by right about now.  So, since those expectations have changed quite dramatically or at a minimum those expectations have been pushed back by a few years, I would think that their hedges should be doing alright.  Am I way off base here?
Title: Re: Deflation hedges
Post by: JEast on January 23, 2015, 08:27:19 AM
FYI on 5Y5Y expectations. Hopefully we at least get our capital back in 2015 and maybe a little extra in 2016.

(http://i61.tinypic.com/5cy8w1.jpg)
Title: Re: Deflation hedges
Post by: JEast on January 29, 2015, 06:05:17 AM
It is still early, but I am hopeful that the Toronto office is now at least getting some calls on possible asking prices.

(http://i58.tinypic.com/t62c5z.jpg)
Title: Re: Deflation hedges
Post by: james22 on January 29, 2015, 11:19:32 PM
All this talk of deflate-gate got me thinking about another kind of deflation.  No, Prem Watsa (Chairman and CEO of Fairfax Financial Holdings (FRFHF)) doesn't have a put option on air pressures of footballs, but he does have a massive bet on global deflation.  It's scary how big the bet has become.

http://brooklyninvestor.blogspot.com/2015/01/watsas-massive-bet.html#comment-form
Title: Re: Deflation hedges
Post by: JEast on January 30, 2015, 05:51:17 AM
Big bet -- yes and no.  The amounts quoted are 'notional' amounts just like the previous credit default swaps.  The invested amount is but a fraction of the notional amounts reported which is roughly about $640m and worth about $110m at 3rd quarter.  A big bet, yes, but also no, wrt notional amounts.

I am hopeful that we at least get our money back with a possible option call on something more.  As an FYI, looks like 30-year Bunds are now below 1% (repeat, 30-year government debt).  Also, the Eurozone is starting to turn over as indicated below.

(http://i58.tinypic.com/288nlh1.jpg)

Title: Re: Deflation hedges
Post by: giofranchi on January 30, 2015, 06:29:53 AM
JEast,
The Brooklyn Investor ends its post saying:
Quote
This can be the trade of the century if we dip into deflation; the ultimate limited risk (don't lose much if wrong)/ high return (huge gains if right) trade.
Therefore, it seems the two of you are on the same page! ;)

Cheers,

Gio
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 02, 2015, 06:46:55 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%
Title: Re: Deflation hedges
Post by: Txvestor on February 03, 2015, 03:25:28 AM
We will only know thw impact of lower oil/gas orices on emoloyment in the coming months. I'm not as convinced that the job market will motor through this. Thw GDP print is on path for lower revisions already.
A second observation is that people are saving a disproportionate amount of the savings on gasoline, compared to the past, perhaps this change of behaviour is from being/feeling over indebted?
On the supply side, I agree with your assessments, lower input costs, productivity gains, lower credit costs, and even the stronger dollar speak to lower prices.
So with demand tepid, and supply abundant, deflation does appear possible.
Title: Re: Deflation hedges
Post by: petec on February 03, 2015, 07:39:36 AM

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.


Actually, I do, however not in the short term!

At the end of the day, which country has the factories to produce more goods and which ones have the consumer debt? Which one has the ability to make more profit? :)

 I agree with much of your response.  End of leveraging phase...absolutely. I agree that saying the economy grows in the long term with all this borrowing is unrealistic because sooner or later the buck has to stop because many less in America will have it to spend!

In addition, the US owes around 5 trillion to China. That would be easily deleveraged and the problems you speak of be fixed by selling off fixed assets in the USA to China. That shrinks the economy. This doesn't solve the problems within their governing system. It does however, mean that our economy would shrink accordingly to pay off the 5 trillion it owes while it deleverages.

Great final word, an important question!

It will be very interesting to see how this works out.   I think China is in a bigger debt bubble than the US, and that that debt has been used to build a lot of assets that will turn out to be unproductive.   It has lousy long term demographics and an economic system that is not as good at creating productivity growth.   It's also - and this worries me - the world's factory, in the same way the US was just before the great depression.   When the demand went away and the factories became empty, the impact was much worse in the US than in the 'demand' countries.   Europe owed a huge amount of money to the US in 1930, but we Europeans don't remember the depression so badly as the Americans do.   China has great potential because it is huge and poor, but its potential will not be realised if US demand for its exports fades, Chinese savings get wiped out by malinvestment, and they finally realise that $5tn of debt they've been buying is only worth what the Fed says it's worth.   I'd rather the US's problems than China's.   I found reading Micheal Pettis' books very useful on this topic.

On the topic of saving vs. spending oil windfalls, I believe Visa said on their call that they think 75% is being saved so far.

Title: Re: Deflation hedges
Post by: petec on February 03, 2015, 07:51:58 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.
Title: Re: Deflation hedges
Post by: Zorrofan on February 03, 2015, 08:15:05 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

China's currency is pegged to the US dollar, which has been rising. This results in a rising Yuan versus other Asian currencies. If China decides to loosen the peg or outright devalue we could see some serious deflation.....thoughts?

cheers
Zorro
Title: Re: Deflation hedges
Post by: giofranchi on February 03, 2015, 08:16:19 AM
Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

With Europe now truly printing money, I think a deflation scare might be averted for the next 2 years… Instead, we will probably witness a meaningful increase in European stock prices… Later, when also the ECB largesse has run its course, with high asset prices on both sides of the Atlantic, and debt levels probably still very high, deflationary forces will be back in full swing… then, watch out! ;)

Gio
Title: Re: Deflation hedges
Post by: petec on February 03, 2015, 08:19:12 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

China's currency is pegged to the US dollar, which has been rising. This results in a rising Yuan versus other Asian currencies. If China decides to loosen the peg or outright devalue we could see some serious deflation.....thoughts?

cheers
Zorro

My thought is 'yes'!

I wonder if Abenomics is the first of a wave of competitive devaluations between exporters that ends up driving deflation in the world.   Odd - I'd always assumed that printing money was deflationary but in this instance I think it is deflationary in the first instance.

China badly needs to devalue if the debt bubble there is as bad as it looks.   
Title: Re: Deflation hedges
Post by: petec on February 03, 2015, 08:22:20 AM
Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

With Europe now truly printing money, I think a deflation scare might be averted for the next 2 years… Instead, we will probably witness a meaningful increase in European stock prices… Later, when also the ECB largesse has run its course, with high asset prices on both sides of the Atlantic, and debt levels probably still very high, deflationary forces will be back in full swing… then, watch out! ;)

Gio

You might well be right but I am struck by Odey's observation that while dropping interest rates from 5% to 0% puts a lot of money into people's pockets, starting QE at 1.2% yields doesn't, and anyway that banks might not sell bonds at any positive yield if they have to park the cash at the central bank on a negative yield.   QE has always struggled to get the money printed directly into the real economy and the ECB might find it really hard.   Who knows.
Title: Re: Deflation hedges
Post by: ni-co on February 03, 2015, 11:14:18 PM
Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

With Europe now truly printing money, I think a deflation scare might be averted for the next 2 years… Instead, we will probably witness a meaningful increase in European stock prices… Later, when also the ECB largesse has run its course, with high asset prices on both sides of the Atlantic, and debt levels probably still very high, deflationary forces will be back in full swing… then, watch out! ;)

Gio

I'd be careful with the conclusion of rising asset prices in the euro zone. I concede that there still is some room left but most of QE has already been anticipated. German 10y yields are below Japan's and QE hasn't really started, yet.
Title: Re: Deflation hedges
Post by: giofranchi on February 03, 2015, 11:48:02 PM
Imo QE will do what it has always done: it will buy us some time. That’s what liquidity does. Because money flows into financial assets, making their prices rise. And almost by definition, when asset prices rise, a deflation scare is averted… or at least postponed!

The real question imo is: what will happen when financial assets finally reach prices that cannot be inflated anymore? And debt levels are still too elevated? At that point I don’t see how even liquidity could still be of any meaningful help.

Gio
Title: Re: Deflation hedges
Post by: giofranchi on February 03, 2015, 11:54:02 PM
Of course the problem is: how much time might QE actually give us?… I don’t know and I am not playing that game! ;)

Cheers,

Gio
Title: Re: Deflation hedges
Post by: original mungerville on February 04, 2015, 07:58:35 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

China's currency is pegged to the US dollar, which has been rising. This results in a rising Yuan versus other Asian currencies. If China decides to loosen the peg or outright devalue we could see some serious deflation.....thoughts?

cheers
Zorro

Yes. And I would say the Yen being so weak puts pressure on all other exporting Asian countries to also devalue. So this combined with the problems in China, and as you say the link to the $US, could be a strong combination which leads the Chinese to devalue as well in order to maintain competitiveness.

The strong $US is importing deflation into the US while the weak Euro and Yen export deflation / import inflation. So, on the assumption deflation eventually takes hold globally (ie I am talking before the central bankers really inflate / move us to a new currency regime which I see a few years out, say 2018-2020), the strong dollar creates a lag, all else being equal, in terms of Europe's deflation (ie. makes Europe's deflation less than it otherwise would be for the time being) and expedites deflationary forces in the US. The adjustment in the currencies makes Watsa's call option likely to get near to the strike price a little farther out in time than otherwise would be the case. But I think fears of global deflation could certainly increase into this year end / 2016. Volatility should increase in currencies/bonds and this should help with the pricing of the CPI calls as was alluded to by the previous poster.

Title: Re: Deflation hedges
Post by: original mungerville on February 04, 2015, 08:04:18 AM
Thanks for the breakeven maths.   Don't forget, though, that these are saleable securities.   We need a deflation scare, in which people are prepared to pay silly money to buy protection off Watsa,  more than we need deflation.

With Europe now truly printing money, I think a deflation scare might be averted for the next 2 years… Instead, we will probably witness a meaningful increase in European stock prices… Later, when also the ECB largesse has run its course, with high asset prices on both sides of the Atlantic, and debt levels probably still very high, deflationary forces will be back in full swing… then, watch out! ;)

Gio

Yes, I agree - watch out in a couple of years. High asset prices everywhere and central banks out of ammo (other than a huge bazooka: major inflation or new global currency regime). Not so sure European stock prices will rise - a better bet would be the DAX given half (or maybe less?) of exports are outside of Europe I believe.
Title: Re: Deflation hedges
Post by: ni-co on February 04, 2015, 03:33:55 PM
It will be very interesting to see how this works out.   I think China is in a bigger debt bubble than the US, and that that debt has been used to build a lot of assets that will turn out to be unproductive.   It has lousy long term demographics and an economic system that is not as good at creating productivity growth.   It's also - and this worries me - the world's factory, in the same way the US was just before the great depression.   When the demand went away and the factories became empty, the impact was much worse in the US than in the 'demand' countries.   Europe owed a huge amount of money to the US in 1930, but we Europeans don't remember the depression so badly as the Americans do.   China has great potential because it is huge and poor, but its potential will not be realised if US demand for its exports fades, Chinese savings get wiped out by malinvestment, and they finally realise that $5tn of debt they've been buying is only worth what the Fed says it's worth.   I'd rather the US's problems than China's.   I found reading Micheal Pettis' books very useful on this topic.

On the topic of saving vs. spending oil windfalls, I believe Visa said on their call that they think 75% is being saved so far.

Thanks for pointing out Pettis' book. I've only read the first two chapters but, so far, it's really great – by far the clearest view and best take on the Chinese economy I've seen.
Title: Re: Deflation hedges
Post by: KinAlberta on February 10, 2015, 11:07:51 AM
Interview:

James Grant Talks Deflation, Greece, Stocks, And Weather

http://www.valuewalk.com/2015/02/james-grant-talks-deflation-greece-stocks-weather-video/
Title: Re: Deflation hedges
Post by: DynamicPerception on February 10, 2015, 11:26:24 AM
He likes Prem's FIH-U as a long pick at the end of the 8 minute video.
Thanks for posting.
Title: Re: Deflation hedges
Post by: KinAlberta on February 10, 2015, 11:40:50 AM
^ And Golub (GBDC)
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 12, 2015, 02:51:12 PM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Deflation hedges pulled in 116.4M gain in the 4th quarter for a total of +17.7M for the year. This means that the swaps were literally up some 95% in fair market value just in the fourth quarter alone on the decline in oil. Many are expecting headline deflation in 2015 due to the slowing of economies and cheaper oil working it's way through the supply system - we don't need much to get us to breakeven on these swaps. 1-2 years of negative headline inflation in the CPI could result in a nice payday of a few hundred million.

As a reminder, every 1% beyond the 2.45% needed to breakeven in the US would result in a net gain of 527M. I wouldn't be surprised to see them continue building these positions though - they've expanded them aggressively over the past few years at prices more attractive than the original position was purchased at.

2010 - 34.2B in notional (cost 302M)
2011 - 46.5B in notional (cost 421M)
2012 - 48.4B in notional (cost 454M)
2013 - 82.9B in notional (cost 546M)
2014 - 111.8B in notional (cost 655.4M)

From the original position in 2010, Watsa has committed 116% more capital to increase the exposure by 226% AND adjust the strike price upwards. Averaging down seems to have worked out well. I'm thinking these might actually pay in the next year or two.
Title: Re: Books
Post by: kfh227 on February 18, 2015, 11:02:13 AM
Which Pettis book are we talking about?

Looks to be 4 in total:
http://www.amazon.com/s/ref=la_B001ITW1FY_rf_p_n_feature_browse-b_0?fst=as%3Aoff&rh=n%3A283155%2Cp_82%3AB001ITW1FY%2Cp_n_feature_browse-bin%3A2656022011&bbn=283155&ie=UTF8&qid=1424286067&rnid=618072011

I might grab them all.

Which are we discussing in this thread?
Any recommended order if I get them all (start with the one in this thread?)?

I havn't dug into the numbers in this thread yet.  I will at some point though.  How much coul Fairfax make if deflation takes hold (3% per annum or one quick 15% slam or etc etc etc)?
Title: Re: Books
Post by: ni-co on February 18, 2015, 11:09:19 AM
Which Pettis book are we talking about?

Looks to be 4 in total:
http://www.amazon.com/s/ref=la_B001ITW1FY_rf_p_n_feature_browse-b_0?fst=as%3Aoff&rh=n%3A283155%2Cp_82%3AB001ITW1FY%2Cp_n_feature_browse-bin%3A2656022011&bbn=283155&ie=UTF8&qid=1424286067&rnid=618072011

I might grab them all.

Which are we discussing in this thread?
Any recommended order if I get them all (start with the one in this thread?)?

I havn't dug into the numbers in this thread yet.  I will at some point though.  How much coul Fairfax make if deflation takes hold (3% per annum or one quick 15% slam or etc etc etc)?

I'd recommend "The Great Rebalancing" as a primer. It explains the whole mechanics. It's also available on Audible. In his China book he goes more into debth with regard to, well, the Chinese economy but it's the same theoretical basis. Both books are excellent.
Title: Re: Deflation hedges
Post by: kfh227 on February 18, 2015, 12:06:46 PM
Nico,
Thanks!

UPDATE: Local BAM! didn't have it so I just ordered via Amazon.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 19, 2015, 06:44:17 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Deflation hedges pulled in 116.4M gain in the 4th quarter for a total of +17.7M for the year. This means that the swaps were literally up some 95% in fair market value just in the fourth quarter alone on the decline in oil. Many are expecting headline deflation in 2015 due to the slowing of economies and cheaper oil working it's way through the supply system - we don't need much to get us to breakeven on these swaps. 1-2 years of negative headline inflation in the CPI could result in a nice payday of a few hundred million.

As a reminder, every 1% beyond the 2.45% needed to breakeven in the US would result in a net gain of 527M. I wouldn't be surprised to see them continue building these positions though - they've expanded them aggressively over the past few years at prices more attractive than the original position was purchased at.

2010 - 34.2B in notional (cost 302M)
2011 - 46.5B in notional (cost 421M)
2012 - 48.4B in notional (cost 454M)
2013 - 82.9B in notional (cost 546M)
2014 - 111.8B in notional (cost 655.4M)

From the original position in 2010, Watsa has committed 116% more capital to increase the exposure by 226% AND adjust the strike price upwards. Averaging down seems to have worked out well. I'm thinking these might actually pay in the next year or two.

French consumer prices fall 1.1% MoM and 0.4% YoY. France is the country closest to inflation breakeven for Fairfax though it's only 2.75B in notional so it won't be a game changer.
Title: Re: Deflation hedges
Post by: ok22 on February 19, 2015, 11:59:10 AM
Zachmansell:

Your table, way of thinking about and tracking the CPI/Deflation investments made by FFH and updates are very helpful.  Much appreciated.

Wondering where you are getting the data that allows you to track the CPI indices.  I found the attached CPI Index data and am having trouble replicating the CPI numbers you are using.  Biggest variance is for the UK numbers.  What am I missing? 

Is there a different CPI index that is the correct apples to apples comparison for the Fairfax deflation investments? As you know there are a bunch of variants for each CPI index (ex-energy, ex-pretty much anything you want to ex :)

Would love to keep track of the bets independently and would appreciate you directing me to the correct data source that applies to the specific FFH investment bets.

Thanks.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 19, 2015, 06:54:16 PM
Zachmansell:

Your table, way of thinking about and tracking the CPI/Deflation investments made by FFH and updates are very helpful.  Much appreciated.

Wondering where you are getting the data that allows you to track the CPI indices.  I found the attached CPI Index data and am having trouble replicating the CPI numbers you are using.  Biggest variance is for the UK numbers.  What am I missing? 

Is there a different CPI index that is the correct apples to apples comparison for the Fairfax deflation investments? As you know there are a bunch of variants for each CPI index (ex-energy, ex-pretty much anything you want to ex :)

Would love to keep track of the bets independently and would appreciate you directing me to the correct data source that applies to the specific FFH investment bets.

Thanks.

All of the CPI data and related strikes come from Fairfax regular releases. I haven't ever tried to look up, or correlate the index myself, but I would assume they're using a different index or measure of consumer prices than what you're using if the figures don't align.
Title: Re: Deflation hedges
Post by: rb on February 19, 2015, 07:49:00 PM
Zachmansell:

Your table, way of thinking about and tracking the CPI/Deflation investments made by FFH and updates are very helpful.  Much appreciated.

Wondering where you are getting the data that allows you to track the CPI indices.  I found the attached CPI Index data and am having trouble replicating the CPI numbers you are using.  Biggest variance is for the UK numbers.  What am I missing? 

Is there a different CPI index that is the correct apples to apples comparison for the Fairfax deflation investments? As you know there are a bunch of variants for each CPI index (ex-energy, ex-pretty much anything you want to ex :)

Would love to keep track of the bets independently and would appreciate you directing me to the correct data source that applies to the specific FFH investment bets.

Thanks.

All of the CPI data and related strikes come from Fairfax regular releases. I haven't ever tried to look up, or correlate the index myself, but I would assume they're using a different index or measure of consumer prices than what you're using if the figures don't align.

There are many way's to measure inflation. The Fairfax deflation investments are OTC derivatives. This means that they have to be based on a majour inflation index. But inflation can be measured in different ways, CPI, Core CPI, CPE Deflator, etc. My advice, if you want to find the right one is to go to FRED at St. Louis Fed, go to inflation and try each one until you hit the right one.

I know this may not be that much help, but short of FFH disclosing the terms of the derivatives is the most sure way to get to the right answer.

rb
Title: Re: Deflation hedges
Post by: twacowfca on February 23, 2015, 08:33:05 PM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Deflation hedges pulled in 116.4M gain in the 4th quarter for a total of +17.7M for the year. This means that the swaps were literally up some 95% in fair market value just in the fourth quarter alone on the decline in oil. Many are expecting headline deflation in 2015 due to the slowing of economies and cheaper oil working it's way through the supply system - we don't need much to get us to breakeven on these swaps. 1-2 years of negative headline inflation in the CPI could result in a nice payday of a few hundred million.

As a reminder, every 1% beyond the 2.45% needed to breakeven in the US would result in a net gain of 527M. I wouldn't be surprised to see them continue building these positions though - they've expanded them aggressively over the past few years at prices more attractive than the original position was purchased at.

2010 - 34.2B in notional (cost 302M)
2011 - 46.5B in notional (cost 421M)
2012 - 48.4B in notional (cost 454M)
2013 - 82.9B in notional (cost 546M)
2014 - 111.8B in notional (cost 655.4M)

From the original position in 2010, Watsa has committed 116% more capital to increase the exposure by 226% AND adjust the strike price upwards. Averaging down seems to have worked out well. I'm thinking these might actually pay in the next year or two.

French consumer prices fall 1.1% MoM and 0.4% YoY. France is the country closest to inflation breakeven for Fairfax though it's only 2.75B in notional so it won't be a game changer.


Realize that Prem explained that these CPI type derivatives don 't have to actually be in the money to break even. They 're like options.  When the underlying goes down, the implied volatility goes up, sometimes a lot!
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 24, 2015, 06:58:01 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Deflation hedges pulled in 116.4M gain in the 4th quarter for a total of +17.7M for the year. This means that the swaps were literally up some 95% in fair market value just in the fourth quarter alone on the decline in oil. Many are expecting headline deflation in 2015 due to the slowing of economies and cheaper oil working it's way through the supply system - we don't need much to get us to breakeven on these swaps. 1-2 years of negative headline inflation in the CPI could result in a nice payday of a few hundred million.

As a reminder, every 1% beyond the 2.45% needed to breakeven in the US would result in a net gain of 527M. I wouldn't be surprised to see them continue building these positions though - they've expanded them aggressively over the past few years at prices more attractive than the original position was purchased at.

2010 - 34.2B in notional (cost 302M)
2011 - 46.5B in notional (cost 421M)
2012 - 48.4B in notional (cost 454M)
2013 - 82.9B in notional (cost 546M)
2014 - 111.8B in notional (cost 655.4M)

From the original position in 2010, Watsa has committed 116% more capital to increase the exposure by 226% AND adjust the strike price upwards. Averaging down seems to have worked out well. I'm thinking these might actually pay in the next year or two.

French consumer prices fall 1.1% MoM and 0.4% YoY. France is the country closest to inflation breakeven for Fairfax though it's only 2.75B in notional so it won't be a game changer.


Realize that Prem explained that these CPI type derivatives don 't have to actually be in the money to break even. They 're like options.  When the underlying goes down, the implied volatility goes up, sometimes a lot!

I totally agree, but I doubt Prem is going to sell them for a moderate gain simply due to time value and a vol premium. He has more than doubled the exposure since the bet was originally made and it's because he thinks there will be deflation. I imagine he will hold these for a few years more and the time value and volatility premium will vary over the course of that time (declining to zero for both if held to maturity). For this reason, I choose to ignore them and their variations and simply focus on how much money we'll make related to the direct pricing of the underlying because that what will drive 90% of the returns for us.
Title: Re: Deflation hedges
Post by: kevin4u2 on February 25, 2015, 12:26:38 PM
I was surprised that there was no discussion of the PPI numbers from last week.  Tomorrows CPI numbers should be interesting.  Attached are the some highlights from the PPI report. 
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 26, 2015, 06:03:27 AM
http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game

Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable.

      As of 9/30/2014      
                                 U.S.   EUR   UK   FRANCE
Weighted Strike price   232.19   111.24   243.82   123.85
Nominal (in billions       52.75     36.775     3.3     2.75
Current CPI                  238.03   117.43   257.6   124.85
Delta to breakeven       -2.45%  -5.27%     -5.35%     -0.80%

Deflation hedges pulled in 116.4M gain in the 4th quarter for a total of +17.7M for the year. This means that the swaps were literally up some 95% in fair market value just in the fourth quarter alone on the decline in oil. Many are expecting headline deflation in 2015 due to the slowing of economies and cheaper oil working it's way through the supply system - we don't need much to get us to breakeven on these swaps. 1-2 years of negative headline inflation in the CPI could result in a nice payday of a few hundred million.

As a reminder, every 1% beyond the 2.45% needed to breakeven in the US would result in a net gain of 527M. I wouldn't be surprised to see them continue building these positions though - they've expanded them aggressively over the past few years at prices more attractive than the original position was purchased at.

2010 - 34.2B in notional (cost 302M)
2011 - 46.5B in notional (cost 421M)
2012 - 48.4B in notional (cost 454M)
2013 - 82.9B in notional (cost 546M)
2014 - 111.8B in notional (cost 655.4M)

From the original position in 2010, Watsa has committed 116% more capital to increase the exposure by 226% AND adjust the strike price upwards. Averaging down seems to have worked out well. I'm thinking these might actually pay in the next year or two.

French consumer prices fall 1.1% MoM and 0.4% YoY. France is the country closest to inflation breakeven for Fairfax though it's only 2.75B in notional so it won't be a game changer.

U.S. prices fall 0.7% MoM and 0.1% YoY
http://www.cnbc.com/id/102454987 (http://www.cnbc.com/id/102454987)
Title: Re: Deflation hedges
Post by: obtuse_investor on February 26, 2015, 06:12:15 AM
U.S. prices fall 0.7% MoM and 0.1% YoY
http://www.cnbc.com/id/102454987 (http://www.cnbc.com/id/102454987)

The leading indicator (http://bpp.mit.edu/usa/) seems to be indicating a -1% MoM and YoY. This will be interesting.
Title: Re: Deflation hedges
Post by: giofranchi on February 26, 2015, 08:57:07 AM
http://www.marketwatch.com/story/consumer-inflation-trend-turns-negative-for-first-time-since-2009-2015-02-26


Gio
Title: Re: Deflation hedges
Post by: ni-co on February 26, 2015, 09:28:12 AM
U.S. prices fall 0.7% MoM and 0.1% YoY
http://www.cnbc.com/id/102454987 (http://www.cnbc.com/id/102454987)

The leading indicator (http://bpp.mit.edu/usa/) seems to be indicating a -1% MoM and YoY. This will be interesting.

Take a look at this, it's more current:
http://www.pricestats.com/us-series
Title: Re: Deflation hedges
Post by: kevin4u2 on February 26, 2015, 10:44:08 AM
http://money.cnn.com/2015/02/26/news/economy/inflation-january-negative/ (http://money.cnn.com/2015/02/26/news/economy/inflation-january-negative/)

We now have official confirmation, not from the BLS but from CNN.
Title: Re: Deflation hedges
Post by: 50centdollars on May 03, 2015, 08:04:17 AM
I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

50cent
Title: Re: Deflation hedges
Post by: Jurgis on May 03, 2015, 08:57:52 AM
But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have.

Funny thing. :)

I mostly agree with you that people don't usually delay purchases because something will be cheaper tomorrow.

But of course you made a mistake asking these rhetorical (?) questions on CoBF. Cause this is the crowd that delays buying things because they will be cheaper tomorrow habitually.  8)

Yeah, I have delayed buying cars, computers, DVD players, etc. because they will be cheaper tomorrow and because of the time value of money. Many times.

But sure, we are not majority of consumers, so this is just a funny thing and it does not negate your thesis.

And, as I said, I mostly agree with you. However, there still could be deflation not because consumers wait for cheaper prices tomorrow, but because they can't buy today. That's the deflation of house prices in 2008-2009. People might have wanted to buy the house, but they couldn't and the prices dropped and dropped. So, yeah, there are situations where deflation is possible, but it's probably more likely in economic downturn. So, perhaps Europe...
Title: Re: Deflation hedges
Post by: mcliu on May 03, 2015, 02:49:55 PM
I think it may also be beneficial to think of deflation in the supply context. Even if demand is growing, if capacity and supply is growing at a faster rate, you will see deflation. That's sort of what we've been seeing, for example, in the global labour market (huge supply growth as a result of globalization) and Chinese manufacturing..
Title: Re: Deflation hedges
Post by: Zorrofan on May 03, 2015, 07:48:04 PM
I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

50cent

Take a look at Japan's 20 year struggle with deflation...people put off purchases all the time if they think something will be cheaper later.  Food? no, of course not. But larger purchases yes....and Prem is betting that deflation will be a problem as well.

cheers
Zorro
Title: Re: Deflation hedges
Post by: cwericb on May 04, 2015, 05:18:20 AM
My experience with deflation primarily involves interest rates and the real estate and construction industries. I have seen mortgage rates run from around 8% up to 20% and back down to where they are now.

When interest rates were escalating quickly, people were in a hurry to buy or build before the rates went higher. When interest rates began to  drop sharply, people would tend to put off major purchases waiting to get a better rate. It was primarily the periods where rates would temporarily stabilize that people would make their decisions.

From this experience, my take would be that if prices start to deflate people will tend to delay major purchases waiting for better prices or for prices to stabilize.
 
Of course this doesn’t apply to items like food, but it does apply to things like clothing, household appliances, vehicles, etc because people will try to get just a little more use out of what they have today before they buy.

To suggest that people do not wait for lower prices really doesn’t make much sense. How many people will wait for something to go on sale before they buy? Of course there is a certain segment of the population that is wealthy enough that they don’t have to wait - but even those people may say, well if that yacht looks like it may drop from twenty million to fifteen million if they wait a few months, well....


Title: Re: Deflation hedges
Post by: giofranchi on June 30, 2015, 02:17:41 AM
Eurozone inflation eases, reviving deflation fears

http://www.marketwatch.com/story/eurozone-inflation-eases-reviving-deflation-fears-2015-06-30?link=MW_home_latest_news


Gio
Title: Re: Deflation hedges
Post by: dartmonkey on July 03, 2015, 06:28:14 AM
I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products.

50cent


Maybe you should wait and see how you feel as a consumer when you have actually experienced deflation, instead of basing your opinion on how consumers behave when their whole life has been in times of inflation.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on July 06, 2015, 07:00:54 AM
I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products.

50cent


Maybe you should wait and see how you feel as a consumer when you have actually experienced deflation, instead of basing your opinion on how consumers behave when their whole life has been in times of inflation.

I'm sure this happens in some respect, but you can look at industries that have constant deflation to get an idea of consumer behavior. Look at electronics - we all know that the brand new flat screen TV will be cheaper in a few months and significantly cheaper when the next model comes out. Some people buy it right when it's released, others wait a few months, and others wait until the next model comes out to pick this one up on the cheap - but what doesn't happen is an entire stall in the market where nobody buys a TV simply because prices keep dropping. It takes a few months, but eventually, everyone who wanted a TV gets one at a price they were willing to pay.

I don't understand why this is worse than engineering false demand to buy something just because you think the price will go up in the future. Inflation and deflation bring with them both positive and negatives, but I don't think moderate deflation is anything of more concern than moderate inflation. It's only when you get to the extremes in either direction that you have a problem.
Title: Re: Deflation hedges
Post by: Luckyone77 on July 06, 2015, 10:50:18 AM
Eurozone inflation eases, reviving deflation fears

http://www.marketwatch.com/story/eurozone-inflation-eases-reviving-deflation-fears-2015-06-30?link=MW_home_latest_news


Gio

Wouldn't deflation have to be "significant" for all these bets to pay off in a meaningful way?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on July 06, 2015, 01:24:18 PM
Eurozone inflation eases, reviving deflation fears

http://www.marketwatch.com/story/eurozone-inflation-eases-reviving-deflation-fears-2015-06-30?link=MW_home_latest_news


Gio

Wouldn't deflation have to be "significant" for all these bets to pay off in a meaningful way? U.S. CPI is currently at 202

I think that depends on your view of what "meaningful" is. The current U.S. CPI index is in the mid-230s. It would take deflation of less than 2.5% over the next 8 years for us to break even on this position. Every % point beyond 2.5% nets $588M. Not an insignificant sum!

European figures are around 118. We need European deflation of about 6% over the next few years to breakeven. Every % past 6% nets $445M.

You can peg whatever likelihood on deflation that you want, but considering the last two prolonged deflationary episodes of developed economies lasted over a decade with cumulative deflation figures well above 2.5% and 6%, then I don't consider the current positioning to be too bad if you think that deflation has a possibility of occurring. Also, Prem has previously purchased more contracts, extended maturities, and lowered strike prices - if that trend continues, we stand to make more money (increasing notional) and increase the chances of making it (by extending duration and increasing strikes) if he is right.


Title: Re: Deflation hedges
Post by: valuesource on July 06, 2015, 08:11:44 PM
Good summary TwoCities,
I believe these contracts have about 7 yrs left on them.  It's important to reiterate this 2.5% is cumulative deflation.  Some of the contracts strike at 1% meaning cumulative deflation of less than 1% over 7 yrs is profitable.
-value
Title: Re: Deflation hedges
Post by: dartmonkey on July 07, 2015, 08:18:21 AM
Eurozone inflation eases, reviving deflation fears

http://www.marketwatch.com/story/eurozone-inflation-eases-reviving-deflation-fears-2015-06-30?link=MW_home_latest_news


Gio

Wouldn't deflation have to be "significant" for all these bets to pay off in a meaningful way? U.S. CPI is currently at 202

I think that depends on your view of what "meaningful" is. The current U.S. CPI index is in the mid-230s. It would take deflation of less than 2.5% over the next 8 years for us to break even on this position. Every % point beyond 2.5% nets $588M. Not an insignificant sum!

European figures are around 118. We need European deflation of about 6% over the next few years to breakeven. Every % past 6% nets $445M.

The 2015Q1 report says that US notional $46.2B has a weighted avg strike price of 231.32, and the index was at 236.12 on March 31st, so gains start with only a 2.0% drop in the index. Another $12.6B notional has a floor rate of 0.5% per annum, and a strike price of 238.30, with the index then at 236.12, so they are only 0.9% out of the money, and they make money if inflation is less than 0.5% beyond that strike price.

The other big chunk is on European inflation, with $39.5B notional at a strike price of 111.52, with the index now at 117.20, so in that case, we are 4.8% out of the money, meaning that we really would need a significant deflation before that part starts paying off.
Title: Re: Deflation hedges
Post by: wisdom on July 12, 2015, 11:29:48 AM
http://wealthtrack.com/recent-programs/kessler-treasury-bond-contrarian/

good interview
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on July 14, 2015, 06:19:54 AM
Deflation still very much a threat in Europe.

http://www.theguardian.com/business/2015/jul/14/zero-inflation-falling-food-clothing-prices (http://www.theguardian.com/business/2015/jul/14/zero-inflation-falling-food-clothing-prices)

Just imagine if we get to a point where deflationary trends find their way into housing...
Title: Re: Deflation hedges
Post by: KinAlberta on July 14, 2015, 02:24:18 PM
ASIAN ECONOMY
Failing on Inflation, Japan Fudges the Numbers
14 JUL 12, 2015
By William Pesek
Excerpt:

"The slew of cheerleading reports BOJ officials have started issuing are a tacit admission that Kuroda's efforts at monetary stimulus have failed. The bank has even changed its methodology for measuring inflation so the data fit the BOJ's preferred narrative."

http://www.bloombergview.com/articles/2015-07-12/failing-on-inflation-japan-fudges-the-numbers
Title: Re: Deflation hedges
Post by: kevin4u2 on August 01, 2015, 07:16:46 AM
While you do make some interesting points I would encourage you to think about one thing.  Over the past few decades has demand for computers decreased or increased.  Obviously increased, right.  Yet prices have steadily declined.  So deflation can occur even when demand is increasing.  This is totally counter to your earlier point that people don't wait for a cheaper tomorrow.  Perhaps demand has nothing to do with falling prices? 

I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

50cent
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 01, 2015, 10:03:49 AM
While you do make some interesting points I would encourage you to think about one thing.  Over the past few decades has demand for computers decreased or increased.  Obviously increased, right.  Yet prices have steadily declined.  So deflation can occur even when demand is increasing.  This is totally counter to your earlier point that people don't wait for a cheaper tomorrow.  Perhaps demand has nothing to do with falling prices? 

I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

50cent

It would be very item specific.

You aren't going to wait to buy food even if you think prices will be down 50% next year.

Computers -- it will cost you in other ways if you try to go without one.  So I don't know how good that example is.

I'm not sure if anything I buy is driven by the expectation that the price will be higher or lower -- unless it's an investment item.

However if my income was suffering and I was budgeting I would be thinking different.  So perhaps during times like that (The Great Depression) people are closely watching prices.  So maybe it's a combination of weak buying power as well as oversupply that is necessary to drive deflation that leads to people putting off purchases.  Somebody flush with excess income isn't in the mindset to pay close attention.

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 01, 2015, 07:56:33 PM
I've been thinking about this awhile and the only negative thing that I come up with in a prolonged deflationary scenario is you have fixed rate debt obligations - which every tax-paying American does on top of whatever we have individually.

The government has a massive vested interest in inflation, because we're already talking about the potential of it being broke under unfunded entitlements and that is before tax revenues start consistently shrinking. I think that there is the potential for seriously prolonged deflation though - it would take a massive change in political good will to actually enforce a policy that would be almost guaranteed to start inflation of some sort: flying around in a helicopter and raining down freshly printed dollars on the poorest of neighborhoods.

Of course, this wouldn't be productive inflation - simply goods inflation that would likely result in bubbles across different consumer products, but at least the government can start paying it's debts in devalued dollars, right?!?!?



Title: Re: Deflation hedges
Post by: KinAlberta on August 02, 2015, 06:02:51 PM
While you do make some interesting points I would encourage you to think about one thing.  Over the past few decades has demand for computers decreased or increased.  Obviously increased, right.  Yet prices have steadily declined.  So deflation can occur even when demand is increasing.  This is totally counter to your earlier point that people don't wait for a cheaper tomorrow.  Perhaps demand has nothing to do with falling prices? 

I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?
I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

50cent

It would be very item specific.

You aren't going to wait to buy food even if you think prices will be down 50% next year.

Computers -- it will cost you in other ways if you try to go without one.  So I don't know how good that example is.

I'm not sure if anything I buy is driven by the expectation that the price will be higher or lower -- unless it's an investment item.

However if my income was suffering and I was budgeting I would be thinking different.  So perhaps during times like that (The Great Depression) people are closely watching prices.  So maybe it's a combination of weak buying power as well as oversupply that is necessary to drive deflation that leads to people putting off purchases.  Somebody flush with excess income isn't in the mindset to pay close attention.

Basic economics. Lower the price and sell more.  That's bad for business though if you buy at a higher price and your inventory's market value falls before you sell it.  So with investments and investment like assets (homes etc) if you lower the price people hesitate to buy and banks hesitate to lend since someone is going to loose in the process. 
Title: Re: Deflation hedges
Post by: petec on August 03, 2015, 05:24:51 AM

Just imagine if we get to a point where deflationary trends find their way into housing...

+1+1+1

That is an absolute game changer.   The UK has 80% mortgage debt to GDP and it's all floating.   Base rates are at 0.5%.   Rates are expected to rise.   The links between rates, household cash flows, house prices, and household wealth are huge.   I think the Eurozone is different (more renting) and the US too (more fixed rate mortgages) but the effect is still there.   I think this is the key motivation for QE, actually, but I don't think that works forever.
Title: Re: Deflation hedges
Post by: nwoodman on August 03, 2015, 03:12:27 PM
Not a bad article for ZH. Does a reasonable job of summing up the deflation thesis

http://www.zerohedge.com/news/2015-08-03/largest-financial-departure-reality-human-history

Cheers
nwoodman
Title: Re: Deflation hedges
Post by: james22 on August 03, 2015, 10:28:52 PM
Likewise:

"The Worldwide Credit Boom Is Over, Now Comes The Tidal Wave Of Global Deflation"

http://www.zerohedge.com/news/2015-08-03/worldwide-credit-boom-over-now-comes-tidal-wave-global-deflation
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 03, 2015, 10:40:07 PM
People only post about Gary Shilling when he is saying something negative.  So nobody talks about him when he is less depressing -- why is that?

He started talking about a coming decade of deflation in 2003.  Too early -- then we almost got some deflation.  People posted his negative commentary and now that he's changed his tune, nobody posts about him anymore. 

Here are his latest comments:

Is the U.S. economy stuck in an endless loop of sluggish growth and high unemployment? Many distinguished economists think so, and there is some evidence to support them. But looking at much the same data, I come to the opposite conclusion: The U.S. could soon experience a period of strong economic growth once deleveraging is over.

http://garyshilling.blogspot.com/
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 04, 2015, 07:31:56 AM
People only post about Gary Shilling when he is saying something negative.  So nobody talks about him when he is less depressing -- why is that?

He started talking about a coming decade of deflation in 2003.  Too early -- then we almost got some deflation.  People posted his negative commentary and now that he's changed his tune, nobody posts about him anymore. 

Here are his latest comments:

Is the U.S. economy stuck in an endless loop of sluggish growth and high unemployment? Many distinguished economists think so, and there is some evidence to support them. But looking at much the same data, I come to the opposite conclusion: The U.S. could soon experience a period of strong economic growth once deleveraging is over.

http://garyshilling.blogspot.com/

I think it's important to note that he does qualify that by saying "once the deleveraging is over." I don't even think it's really begun yet - all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 04, 2015, 07:58:29 AM
all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

The last time I got a loan, they asked about my household debt outstanding but nobody put my government's debt outstanding into the underwriting equation.

You can stop working at 65 without worrying about whether you've paid off your government's debt.

Household debt is extremely different as compared to government debt.  IMO.
Title: Re: Deflation hedges
Post by: Txvestor on August 04, 2015, 08:05:07 AM
all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

The last time I got a loan, they asked about my household debt outstanding but nobody put my government's debt outstanding into the underwriting equation.

You can stop working at 65 without worrying about whether you've paid off your government's debt.

Household debt is extremely different as compared to government debt.  IMO.

Gov't debt creates a grey cloud, when it is excessive ala Greece. It can also lead to required cuts in gov't spending and all of this can be deflationary when it happens.
As to stop working when you're 65, even that can be negotiated!😊
Title: Re: Deflation hedges
Post by: petec on August 04, 2015, 08:07:36 AM
all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

The last time I got a loan, they asked about my household debt outstanding but nobody put my government's debt outstanding into the underwriting equation.

You can stop working at 65 without worrying about whether you've paid off your government's debt.

Household debt is extremely different as compared to government debt.  IMO.

I agree, and the end of WW2 supports this observation, in that government debt was very high but private debt was very low and you got a good boom.

That said, if his claim is true that private debt/income peaked at 130%, and is now 100%, vs. a long term average of 65%, we may only be halfway there.   And that's vs. the average, not the bottom of the leverage cycle.   Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.
Title: Re: Deflation hedges
Post by: frommi on August 04, 2015, 08:24:46 AM
I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.
Title: Re: Deflation hedges
Post by: wisdom on August 04, 2015, 09:39:42 AM
Does it really matter how we get there?

What matters is that no one knows what to expect. This will lead to volatility as adjustments happen = opportunity.

Was reading a article on real estate being 15% of Chinese GDP. Used to be 4% before the boom began.

US was around 5 or 6% before it crashed in 2008. Canada peaks at 7%. Canada is there.

According to Barclays, 50% of Chinese debt is backed by real estate - i recall, Chinese bank assets are at $25 T.

The margin of error is getting smaller for governments.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 04, 2015, 09:54:46 AM
I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

The majority of the money has been stuck as bank reserves and isn't loaned which is why after 4 rounds of QE we have paltry growth, record low monetary velocity, and had headline deflation in the first quarter.

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.
Title: Re: Deflation hedges
Post by: petec on August 04, 2015, 10:02:23 AM
I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

Not *totally* different - they changed the gold price, devaluing the currency vs. gold by 41% in 1933/4.   It wasn't a very solid gold standard!
Title: Re: Deflation hedges
Post by: petec on August 04, 2015, 10:04:15 AM
I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

The majority of the money has been stuck as bank reserves and isn't loaned which is why after 4 rounds of QE we have paltry growth, record low monetary velocity, and had headline deflation in the first quarter.

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.

Agreed.   It might even be *de* flationary if it a) drives the building of over-capacity (look at Chinese PPI), and b) encourages money to be destroyed (bridges to nowhere, asset bubbles).

Then again, if we are starting to see wage inflation (WMT, minimum wages), then...
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 04, 2015, 10:18:16 AM
Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

Yes, the zero bound is a very different picture.

Today's 30 yr amortization schedule mortgages on the books will run-off at an accelerated rate due to the fact that a low-interest loan has a very high principle component.

Take a loan at 4% with a 100,000 initial balance.  It's first monthly payment has a $144 principle component and a $333 interest payment.

Compared to a loan at 8% with a 100,000 initial balance.  It's first monthly payment has a principle component of only $67 and an interest component of $666.

So the debt runs off at twice the pace in the beginning days of a mortgage.

So the household expenditures to service the debt today are night and day apart compared to those historical periods when the household debt to GDP was lower.

Most of the household debt out there is mortgage debt. 

Not only are the household debt service ratios at historically healthy/normal levels today, but the absolute amount of the debt (which is historically high) is running off at a historically high rate.

It's not anywhere near as simple as looking at a chart.  The charts don't tell us how fast the debt is running off vs other periods in history. 

Title: Re: Deflation hedges
Post by: frommi on August 04, 2015, 10:27:03 AM
Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

Japan has not really printed that much money until the start of Abenomics?

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.

When too much debt is the problem, QE is the only workable solution isn`t it? They have to print enough money to offset the negative money velocity. And ideally the government spends more money financed by the FED. That way you simply can`t have deflation. At the moment the FED is not printing money and the government is spending less, the outcome of that is what we see at the moment.

Title: Re: Deflation hedges
Post by: Crip1 on August 04, 2015, 10:32:21 AM
Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

Yes, the zero bound is a very different picture.

Today's 30 yr amortization schedule mortgages on the books will run-off at an accelerated rate due to the fact that a low-interest loan has a very high principle component.

Take a loan at 4% with a 100,000 initial balance.  It's first monthly payment has a $144 principle component and a $333 interest payment.

Compared to a loan at 8% with a 100,000 initial balance.  It's first monthly payment has a principle component of only $67 and an interest component of $666.

So the debt runs off at twice the pace in the beginning days of a mortgage.

So the household expenditures to service the debt today are night and day apart compared to those historical periods when the household debt to GDP was lower.

Most of the household debt out there is mortgage debt. 

Not only are the household debt service ratios are historically healthy/normal levels today, but the absolute amount of the debt (which is historically high) is running off at a historically high rate.

It's not anywhere near as simple as looking at a chart.  The charts don't tell us how fast the debt is running off vs other periods in history.


I'm in the industry and know that our group has seen a higher percentage of new originations being 15 or 20 year compared to the more traditional 30 year. Again, the 30 year amortization schedule is still the norm, but 15's are gaining popularity in our shop. Project that over the industry and the run-off rate to which Eric refers is amplified.


-Crip


P. S. Seeking to see what I can get for a more holistic view of this.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 04, 2015, 10:45:35 AM
Today's environment in the US is one of:

A:  Normal household debt service ratios
B:  Existing debt running off at an accelerated pace
C:  Reasonable lending standards that suggest the economy is not being supported by a credit-driven boom 

Oh well.  I know it won't convince anyone looking for grey clouds in the household debt to GDP numbers.

Recap:
1)  Rapid legacy household debt growth created a boom that already busted. 
2)  Unwinding the remaining debt is sustainable (normal debt service levels)
3)  There isn't currently a boom in new credit (reasonable current lending standards)
Title: Re: Deflation hedges
Post by: petec on August 04, 2015, 10:49:56 AM
Today's environment in the US is one of:

A:  Normal household debt service ratios
B:  Existing debt running off at an accelerated pace
C:  Reasonable lending standards that suggest the economy is not being supported by a credit-driven boom 

Oh well.  I know it won't convince anyone looking for grey clouds in the household debt to GDP numbers.

Recap:
1)  Rapid legacy household debt growth created a boom that already busted. 
2)  Unwinding the remaining debt is sustainable (normal debt service levels)
3)  There isn't currently a boom in new credit (reasonable current lending standards)

I'd add the beginnings of wage growth to this picture.   I don't need a lot of convincing.

Against that, I'd pitch:
1. rising inflation (not in CPI but that's a very doctored measure)
2. totally abnormal interest rates (which distort your "normal debt service levels".

But it isn't the US I worry about.   I worry more about places where the bubble hasn't bust yet (EM), or where consumer debt is floating rate (UK) or where currencies are fixed (EU).
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 04, 2015, 10:57:06 AM
Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

Yes, the zero bound is a very different picture.

Today's 30 yr amortization schedule mortgages on the books will run-off at an accelerated rate due to the fact that a low-interest loan has a very high principle component.

Take a loan at 4% with a 100,000 initial balance.  It's first monthly payment has a $144 principle component and a $333 interest payment.

Compared to a loan at 8% with a 100,000 initial balance.  It's first monthly payment has a principle component of only $67 and an interest component of $666.

So the debt runs off at twice the pace in the beginning days of a mortgage.

So the household expenditures to service the debt today are night and day apart compared to those historical periods when the household debt to GDP was lower.

Most of the household debt out there is mortgage debt. 

Not only are the household debt service ratios are historically healthy/normal levels today, but the absolute amount of the debt (which is historically high) is running off at a historically high rate.

It's not anywhere near as simple as looking at a chart.  The charts don't tell us how fast the debt is running off vs other periods in history.


I'm in the industry and know that our group has seen a higher percentage of new originations being 15 or 20 year compared to the more traditional 30 year. Again, the 30 year amortization schedule is still the norm, but 15's are gaining popularity in our shop. Project that over the industry and the run-off rate to which Eric refers is amplified.


-Crip


P. S. Seeking to see what I can get for a more holistic view of this.

I find the 15 to 20 yr mortgages to be risky for the borrower and for the economy.

Just a like a business, cash flow is very important for a household. 

Suppose you lose your job -- at that very time you don't want a high monthly payment.

It's like analyzing a business -- you want more positive cash flow.  Paying a bit more interest to get a lower payment is sort of like buying yourself insurance against the "what if I lose my job" scenario.

It also takes away their spending power and puts their savings into a low-return instrument (investing in their own low-interest mortgage).

I just think a risk-averse household should go interest-only if possible rather than commit to such a high payment.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 04, 2015, 11:32:06 AM
Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

Japan has not really printed that much money until the start of Abenomics?

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.

When too much debt is the problem, QE is the only workable solution isn`t it? They have to print enough money to offset the negative money velocity. And ideally the government spends more money financed by the FED. That way you simply can`t have deflation. At the moment the FED is not printing money and the government is spending less, the outcome of that is what we see at the moment.

I would disagree. Japan originally embarked on QE in 2001 - over the course of 4 years it purchased over $30 trillion yen worth of bonds. That was equivalent to about 2-3% of GDP per year being infused into the financial system where it sat as excess reserves. Before the U.S., and other countries, started regularly running deficits of 7-8% GDP after 2008, a consistent 2-3% was considered large. Sure, Abenomics was much larger, but policy makers are already beginning to doubt its efficacy and many have deemed it a failure. In the meantime, the Japanese currency has lost half of it's purchasing power and what do the Japanese have to show for it? A GDP level that has yet to exceed the high set in Q1 2014?

The Japanese have basically had an implicit default - if you pay back all of your debt in a currency that is worth 1/2 as much, it's no different than paying only 1/2 your debt and writing off the other half. One of these is immediate - the other is drawn out. Both are defaults. So, if anything saves Japan in the future, it will be the default via a destruction of their currency and not the effects of 15 years of QE that has left them with a significantly higher debt burden.

You say that QE is the only solution. That assumes it's a solution at all - I wait for you to provide evidence of it's efficacy. Secondly, assuming supporting data exists, let's compare two scenarios:

1) Managed delevering/default cycle where debts are slowly paid off or written off over the course of a decade or more. Growth is constrained, but the balance sheet of the American consumer and government is repaired and more responsible attitudes towards debt and personal finance likely emerge from the financial strains. Also, on the moral side, the highest costs are generally borne by those most responsible OR

2) Print $4 trillion dollars to buy government debt to monetize a deficit to help facilitate a transfer of debt from consumers to the government. Consumer balance sheets are moderately repaired ONLY if you assume they never have to pay the money back via higher taxes. Best case scenario, very little headway is made in balance sheet reparation and general attitudes are little changed. Also, on the moral side, almost the entire cost is borne by a later generation that had no vote in the matter nor did they contribute to the problem that their money is required to solve.

Yea, #2 seems like the only workable solution...




Title: Re: Deflation hedges
Post by: frommi on August 04, 2015, 11:46:03 AM
Yea, #2 seems like the only workable solution...

I can`t really see how the US is able to default without creating a huge problem for retirees at the same time. And since this is a growing and voting cohort, its nearly impossible for the US to go that way. Of course printing money is a slow and long process, but its the one that can work without a revolution. Assuming we get a long period of deflation has the implicit assumption that the FED has no power/control anymore (at least over the currency). I simply don`t believe this.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 04, 2015, 12:19:15 PM
Yea, #2 seems like the only workable solution...

I can`t really see how the US is able to default without creating a huge problem for retirees at the same time. And since this is a growing and voting cohort, its nearly impossible for the US to go that way. Of course printing money is a slow and long process, but its the one that can work without a revolution. Assuming we get a long period of deflation has the implicit assumption that the FED has no power/control anymore (at least over the currency). I simply don`t believe this.

I don't think any defaults because "they can." They default because they have to. An explicit default and an implicit default are the same thing. All that changes is who pays for it and when.

Also, I'm having a hard time understanding how printing $4 trillion to buy bonds in a bid to force interest rates to 0 so would-be retirees have to save 2-3x the amount of money they needed for retirement just 8 years before so that we can stoke inflation to destroy the value of those very savings doesn't seem like a real winning strategy with retirees either....but maybe that's just me.

Also, if QE was really intended to print money and induce inflation, it's probably about the poorest mechanism one could come up with to do it. The Treasury could quite literally print $4 trillion dollars and pass it out at random and likely produce better inflation results than we've seen. Better yet, you could target it and only pay out to the bottom half of society - it's still $22,000 per individual on average. Somehow $4 trillion sitting on reserves of banks is better at inducing inflation/economic activity/dollar velocity/etc. than $4 trillion injected into the real economy?
Title: Re: Deflation hedges
Post by: petec on August 05, 2015, 03:30:25 AM
Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

Yes, the zero bound is a very different picture.

Today's 30 yr amortization schedule mortgages on the books will run-off at an accelerated rate due to the fact that a low-interest loan has a very high principle component.

Take a loan at 4% with a 100,000 initial balance.  It's first monthly payment has a $144 principle component and a $333 interest payment.

Compared to a loan at 8% with a 100,000 initial balance.  It's first monthly payment has a principle component of only $67 and an interest component of $666.

So the debt runs off at twice the pace in the beginning days of a mortgage.

So the household expenditures to service the debt today are night and day apart compared to those historical periods when the household debt to GDP was lower.

Most of the household debt out there is mortgage debt. 

Not only are the household debt service ratios at historically healthy/normal levels today, but the absolute amount of the debt (which is historically high) is running off at a historically high rate.

It's not anywhere near as simple as looking at a chart.  The charts don't tell us how fast the debt is running off vs other periods in history.

A good set of points which I hadn't thought of, partly because I live in London where house prices have just kept going up so monthly payments (for a new buyer anyway) have not fallen with interest rates, and although the interest/principal ratio may have changed, the principal has risen so fast you don't pay off any quicker.   And it's all floating rate debt...scary.

But my point about the zero bound was more that I think it makes things very unpredictable.   We've never been here before so we don't have any historical guide to how things play out.   My *guess* is that the US continues on its current path until consumer BS's are fully repaired and wages are rising, which with fixed rate mortgages sets you up for a period of great growth after which government debt/gdp will look fine.   But I can see deflation or inflation too.   My base case is it's pretty stupid to try to predict, but there's no harm in protecting yourself.
Title: Re: Deflation hedges
Post by: petec on August 05, 2015, 05:46:22 AM

Also, if QE was really intended to print money and induce inflation, it's probably about the poorest mechanism one could come up with to do it. The Treasury could quite literally print $4 trillion dollars and pass it out at random and likely produce better inflation results than we've seen. Better yet, you could target it and only pay out to the bottom half of society - it's still $22,000 per individual on average. Somehow $4 trillion sitting on reserves of banks is better at inducing inflation/economic activity/dollar velocity/etc. than $4 trillion injected into the real economy?

I'm instinctively anti-QE.   I think it's better than a depression, but I'm not sure it stopped one, and if there wasn't going to be a depression then all the moral hazard and inequality it created was for nothing.   

The one thing I am fairly sure of is that it could have been done better.   Instead of buying financial assets, I think the printed money should have been spent on infrastructure.   That employs the poor and has a productivity benefit, rather than enriching the rich and blowing asset bubbles.   The only downside I can think of is that, having bought bonds, the FED can contain inflation by selling them again (even if at a loss).   They couldn't take the money out of the system so easily if they'd built infrastructure.
Title: Re: Deflation hedges
Post by: adesigar on August 07, 2015, 07:45:41 AM
Gross Sees Global Economy Dangerously Close to Deflation

http://finance.yahoo.com/news/bill-gross-says-global-economy-133347460.html
Title: Re: Deflation hedges
Post by: james22 on August 08, 2015, 11:09:32 PM
David Stockman CNBC Interview: Tops In—–Next Comes An Epochal Deflation

http://davidstockmanscontracorner.com/david-stockman-cnbc-interview-tops-in-next-comes-an-epochal-deflation/
Title: Re: Deflation hedges
Post by: Cageyone on August 09, 2015, 09:18:14 AM
Pretty convincing support for Prem's thesis from David Stockman! So are the key questions "when?", "how bad?" and "is FFH the best place to be?"
Title: Re: Deflation hedges
Post by: Dazel on August 09, 2015, 10:46:03 AM
ww.bloomberg.com/news/articles/2015-08-09/pricier-pork-pushes-up-china-s-cpi-as-deflation-threat-abates


This another misleading headline...under it is "China's cpi lowest in 6 years!" 2009 that is...even with pork prices being up 16%!

This is Fairfax thesis and the events are going unnoticed.
Title: Re: Deflation hedges
Post by: petec on August 11, 2015, 03:19:14 AM
China devalues by 1.9% - not huge, but significant in context of prior moves and change of mindset.   What fascinates me about this is that I've read a number of forecasts of Chinese/Japanese competitive devaluations driving deflation in the West.   I feel like certain elements of the deflation thesis are playing out as expected (currencies, commodities) but that it's not being reflected in the CPI numbers because heavy weights for things like rents.   Although, owner-imputed rent is inflating a lot less than real rents from what I have read, and healthcare (inflating fast) is underweighted in the index, both of which are good for the deflation hedges.
Title: Re: Deflation hedges
Post by: Dazel on August 11, 2015, 06:03:22 AM
The china devaluation is the first in 20 years.
Not unlike the Canary in the coal mine story everyone now knows that there is big trouble and they run for the exits. China has already had $800b in outflows this year. As Prem Watsa alluded to the cds' s experience when New Century went down in 2007...the domino's fell on sub prime and the Cds' portfolio at Fairfax began to sky rocket.

The US and Europe both had deflation in the last quarter of 2014....the world still believed at that point that China would ride out their problems as did I. to some extent they still will but the surprise devaluation today shows us just how desperate things really are there at the moment. Businesses will not make the investments they were going to...projects will get cancelled as the $5 trillion in commodity wealth disappeared so will the projects that were to accompany that wealth and the growth in corporate earnings from China will get discounted....

Deflation comes from businesses and consumers doing nothing....they will wait for a better time to expand, buy that new car etc or go on that vacation...until prices come down.

its like online travel....everyone knows that during certain times you can wait until the last minute to get 50% off on the trip (deflation). Other times you are competing to get there first to get the best price because demand is high and the trip will get more expensive as the rooms fill up (inflation). As you can see it is the anticipation of deflation (falling price) or inflation (rising prices)....
The USD $ rise is relatively new and consumers businesses are now adapting...with China now proving that their GDP numbers are a off and they will no longer be driving up prices they will actually be bringing down prices globally it will change the masses buying habits...consumers will win in some cases but their employers may win or lose depending on what their business is.

either way deflation looks very likely...it will last for awhile and then the world will print enough money to get out of it. right now the FED is stuck a they can't ease...so deflation looks unavoidable.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 11, 2015, 06:26:11 AM
China devalues by 1.9% - not huge, but significant in context of prior moves and change of mindset.   What fascinates me about this is that I've read a number of forecasts of Chinese/Japanese competitive devaluations driving deflation in the West.   I feel like certain elements of the deflation thesis are playing out as expected (currencies, commodities) but that it's not being reflected in the CPI numbers because heavy weights for things like rents.   Although, owner-imputed rent is inflating a lot less than real rents from what I have read, and healthcare (inflating fast) is underweighted in the index, both of which are good for the deflation hedges.

I think the dollar strength is a more important going forward than is commodity weakness. Commodities are such a small part of the index - even oil falling by 50% didn't take us much lower in CPI regards despite the fact that it's literally used in just about everything. A strong dollar will affect the purchase of American made goods at home and abroad. It will also naturally lower the amount of international profits that a U.S. company makes. Lower profits + lower domestic economic activity + strengthening currency = deflationary environment...especially with debt loads like we have.

The real key for a sustained deflationary trend in the U.S. again is another sustained hit to housing. Housing is nearly half of the CPI index. It would be hard to see any significant, sustainable deflationary trend if half the index isn't moving downward at least somewhat.
Title: Re: Deflation hedges
Post by: petec on August 11, 2015, 06:30:54 AM

The real key for a sustained deflationary trend in the U.S. again is another sustained hit to housing. Housing is nearly half of the CPI index. It would be hard to see any significant, sustainable deflationary trend if half the index isn't moving downward at least somewhat.

Yes - housing and assets in general.

I find it hard to see a housing hit given that consumer/bank balance sheets are in much better shape.

EDIT: unless rates rise.   That's the most deflationary thing of all.   Which is why I think we might get a deflation: if things go ok, rates rise, and I don't think things stay ok for long; but if they don't (which they never do, for too many years in a row), rates can't fall.   Deflation both ways?   But then I've been thinking this (and wrong) for years.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 11, 2015, 07:32:46 AM
China devalued by 1.9% and the Aussie is down 1.6%.  Pretty close.  Wow!
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 11, 2015, 07:44:48 AM

The real key for a sustained deflationary trend in the U.S. again is another sustained hit to housing. Housing is nearly half of the CPI index. It would be hard to see any significant, sustainable deflationary trend if half the index isn't moving downward at least somewhat.

Yes - housing and assets in general.

I find it hard to see a housing hit given that consumer/bank balance sheets are in much better shape.

EDIT: unless rates rise.   That's the most deflationary thing of all.   Which is why I think we might get a deflation: if things go ok, rates rise, and I don't think things stay ok for long; but if they don't (which they never do, for too many years in a row), rates can't fall.   Deflation both ways?   But then I've been thinking this (and wrong) for years.

It's not just about consumer balance sheets - it's about incomes too. Housing prices and rents can't continue to rise without an enduring rise in wages. We're not seeing that yet which will hold housing. If a slowing economic environment causes negative wage gains, even by a small amount, I think you'll see that creep into housing.

Also, I'm not talking about a 10-20% decline in housing prices/rents. Even if it simply falls 1% a year for the next 5 years, you're going to get a pretty good deflationary print in the CPI with the falling prices of commodities, energy, and all imported goods. But if housing stays stable, or rises by 1% a year for the next 5 years, that's a pretty hard hurdle to overcome for the remainder of the index to pull down.

We get close to $600 million for every 1% of deflation below the strike price in the U.S. We don't need the CPI to collapse by 10% for these to be wonderful investments. If we get just 2% below the strikes, we'll have more than made a great return on these swaps. I can understand everyone's frustration with the equity hedges - I certainly don't understand anyone's frustration with these swaps. It's such a low bar for success with the potential for an extremely high payout simply because everyone has faith that a room full of a dozen people can control the global economy.
Title: Re: Deflation hedges
Post by: petec on August 11, 2015, 09:36:03 AM

It's not just about consumer balance sheets - it's about incomes too. Housing prices and rents can't continue to rise without an enduring rise in wages.

No, but we might be seeing the start of that with big corporations lifting bottom-end wages and minimum wages rising.   If this feeds into other wage levels then we will see how QE+policy=reinflation.

Other than that, +1! 
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 11, 2015, 10:36:30 AM

It's not just about consumer balance sheets - it's about incomes too. Housing prices and rents can't continue to rise without an enduring rise in wages.

No, but we might be seeing the start of that with big corporations lifting bottom-end wages and minimum wages rising.   If this feeds into other wage levels then we will see how QE+policy=reinflation.

Other than that, +1!

I'll believe it when the numbers show it. Real median wages haven't sustained upward momentum over the last 15 years despite periods of economic growth and minimum wage hikes. Obviously, nominal wages are the only thing that matters for CPI, but inflation has been tremendously hard to find even before the strong dollar so where is it going to come from after the strong dollar? I think real wages will be a relatively good proxy for nominal wages going in the near-mid term.

I don't expect wages to be stagnant forever. I just don't expect the problem to magically fix itself anytime soon due to minimum wage hikes...
Title: Re: Deflation hedges
Post by: gary17 on August 11, 2015, 10:43:53 AM

It's not just about consumer balance sheets - it's about incomes too. Housing prices and rents can't continue to rise without an enduring rise in wages.

No, but we might be seeing the start of that with big corporations lifting bottom-end wages and minimum wages rising.   If this feeds into other wage levels then we will see how QE+policy=reinflation.

Other than that, +1!

I'll believe it when the numbers show it. Real median wages haven't sustained upward momentum over the last 15 years despite periods of economic growth and minimum wage hikes. Obviously, nominal wages are the only thing that matters for CPI, but inflation has been tremendously hard to find even before the strong dollar so where is it going to come from after the strong dollar? I think real wages will be a relatively good proxy for nominal wages going in the near-mid term.

I don't expect wages to be stagnant forever. I just don't expect the problem to magically fix itself anytime soon due to minimum wage hikes...

I have my own theory..  and no real data to back it up , that we need to account for the fact that technology is replacing human labour... and this could affect wages, employment, etc. 

movement of stuff to the Cloud probably meant less manufacturing of paper- and general office stationary

music / movies are now cloud based...

we have self-checkout counters....

even for fighting a war we now send drones...

Self-driving vehicles probably next - could have a very huge impact !   i know mining companies will be the first to do this in their own operation where insurance is not an issue.

Interesting world to see

Title: Re: Deflation hedges
Post by: Dazel on August 11, 2015, 11:29:22 AM
Gary 17,

excellent thinking...

-i have seen the studies on this and you are dead on (comparable to the 20's innovation)...we are not going to see real wage growth in the U.S...Walmart yes..manufacturing No...oil production in the US was huge for employment as the Shale revolution were high paying jobs as were the water companies, steel pipe, trucking, housing and services etc that serviced the oil...to the trains that shipped it...these are huge losses that have not flowed through yet as everyone expected a rebound in oil...and US production was not cut it was expanded in anticipation of higher oil prices. Now the debt remains.
 
-add to that low oil evens the playing field on global production of everything being shipped....

$100 oil for example was about 12% tariff on goods being shipped from China in 2008...this helped the U.S steel's of the world who were doing well in 2008 with high oil prices.

-this will help lower end jobs greatly though as they need small deflation to survive in a low wage environment...and low interest rates are essential for everyones debt load...

-Deflation not a terrible thing if you can control it...and keep it mild and this is what the world leaders have compromised on. This will create winners and losers.

-cost of production of imports to the US will be in free fall... if oil stays here USD hold

The winners
US treasury and muni bond holders at the long end
US dollar
companies that can hold their price-Hershey was a huge winner in the 30's deflation
Gold eventually

any others? (I don't know if any other company besides Fairfax with deflation hedges)
Title: Re: Deflation hedges
Post by: gary17 on August 11, 2015, 12:04:52 PM
LOL, thanks !
i have no finance or economic background; just an observation as an engineer.

US treasury and muni bond holders at the long end
US dollar

So if I am a Canadian holding a major US Bank should I do well ????? fingers crossed....

Gary 17,

excellent thinking...

-i have seen the studies on this and you are dead on (comparable to the 20's innovation)...we are not going to see real wage growth in the U.S...Walmart yes..manufacturing No...oil production in the US was huge for employment as the Shale revolution were high paying jobs as were the water companies, steel pipe, trucking, housing and services etc that serviced the oil...to the trains that shipped it...these are huge losses that have not flowed through yet as everyone expected a rebound in oil...and US production was not cut it was expanded in anticipation of higher oil prices. Now the debt remains.
 
-add to that low oil evens the playing field on global production of everything being shipped....

$100 oil for example was about 12% tariff on goods being shipped from China in 2008...this helped the U.S steel's of the world who were doing well in 2008 with high oil prices.

-this will help lower end jobs greatly though as they need small deflation to survive in a low wage environment...and low interest rates are essential for everyones debt load...

-Deflation not a terrible thing if you can control it...and keep it mild and this is what the world leaders have compromised on. This will create winners and losers.

-cost of production of imports to the US will be in free fall... if oil stays here USD hold

The winners
US treasury and muni bond holders at the long end
US dollar
companies that can hold their price-Hershey was a huge winner in the 30's deflation
Gold eventually

any others? (I don't know if any other company besides Fairfax with deflation hedges)
Title: Re: Deflation hedges
Post by: Dazel on August 11, 2015, 05:29:30 PM
http://www.bloomberg.com/news/articles/2015-08-11/gross-says-treasuries-are-a-winner-as-china-exports-deflation

i guess Bill Gross is reading our posts! maybe my interest is so high because my Pats have a lot at stake with Deflate-Gate!
Title: Re: Deflation hedges
Post by: petec on August 12, 2015, 03:47:45 AM

It's not just about consumer balance sheets - it's about incomes too. Housing prices and rents can't continue to rise without an enduring rise in wages.

No, but we might be seeing the start of that with big corporations lifting bottom-end wages and minimum wages rising.   If this feeds into other wage levels then we will see how QE+policy=reinflation.

Other than that, +1!

I'll believe it when the numbers show it. Real median wages haven't sustained upward momentum over the last 15 years despite periods of economic growth and minimum wage hikes. Obviously, nominal wages are the only thing that matters for CPI, but inflation has been tremendously hard to find even before the strong dollar so where is it going to come from after the strong dollar? I think real wages will be a relatively good proxy for nominal wages going in the near-mid term.

I don't expect wages to be stagnant forever. I just don't expect the problem to magically fix itself anytime soon due to minimum wage hikes...

I have my own theory..  and no real data to back it up , that we need to account for the fact that technology is replacing human labour... and this could affect wages, employment, etc. 

movement of stuff to the Cloud probably meant less manufacturing of paper- and general office stationary

music / movies are now cloud based...

we have self-checkout counters....

even for fighting a war we now send drones...

Self-driving vehicles probably next - could have a very huge impact !   i know mining companies will be the first to do this in their own operation where insurance is not an issue.

Interesting world to see

Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.   I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?
Title: Re: Deflation hedges
Post by: Jurgis on August 12, 2015, 08:01:48 AM
Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.   I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?

We will need to provide means of living for 80%+ non working population.
I don't think we are prepared for that at all (intelectually, spiritually, morally, economically, politically).
Title: Re: Deflation hedges
Post by: petec on August 12, 2015, 08:51:08 AM
Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.   I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?

We will need to provide means of living for 80%+ non working population.
I don't think we are prepared for that at all (intelectually, spiritually, morally, economically, politically).

Quite.

Unless we all just retire to the beach while the machines do everything.   I'm surprisingly intellectually and spiritually prepared for that ;)
Title: Re: Deflation hedges
Post by: Jurgis on August 12, 2015, 10:38:10 AM
Unless we all just retire to the beach while the machines do everything.   I'm surprisingly intellectually and spiritually prepared for that ;)

Second!  8)
Title: Re: Deflation hedges
Post by: no_free_lunch on August 12, 2015, 11:59:18 AM
Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.   I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?

We will need to provide means of living for 80%+ non working population.
I don't think we are prepared for that at all (intelectually, spiritually, morally, economically, politically).

I acree with the intellectually/sprititually.. but not economically.  I mean if we are in a position where there are no jobs due to technical obsolescense it is because we don't need people to work.   If we don't need people to work then what is the economic issue?   However, politically it could be a bit turbulent as you will need to move towards a more socialist model. 
Title: Re: Deflation hedges
Post by: gary17 on August 12, 2015, 12:28:36 PM

You would be amazed how many things in Star Trek are coming true LOL.


Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.   I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?

We will need to provide means of living for 80%+ non working population.
I don't think we are prepared for that at all (intelectually, spiritually, morally, economically, politically).

I acree with the intellectually/sprititually.. but not economically.  I mean if we are in a position where there are no jobs due to technical obsolescense it is because we don't need people to work.   If we don't need people to work then what is the economic issue?   However, politically it could be a bit turbulent as you will need to move towards a more socialist model.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 12, 2015, 04:59:48 PM
-cost of production of imports to the US will be in free fall... if oil stays here USD hold

The winners
US treasury and muni bond holders at the long end
US dollar
companies that can hold their price-Hershey was a huge winner in the 30's deflation
Gold eventually

any others? (I don't know if any other company besides Fairfax with deflation hedges)

Okay, so... the Chinese goods on US store shelves will be cheaper now.

Therefore people who buy those goods have more remaining money in their pockets to spend at Chipotle, or Starbucks, or pretty much anywhere. 

So shouldn't a whole raft of companies benefit from this, other than Fairfax?

A US company who manufactures in China will spend less to get his product onto US shelves and it will also sell for that much less -- same profit though right?  So where do US workers have their incomes hurt because of this, and if their incomes are the same and by habit they spend it all, well then many companies will benefit since the cost of their Chinese purchases will take less out of their wallets.
Title: Re: Deflation hedges
Post by: gary17 on August 12, 2015, 05:34:03 PM

The U.S. Has an economy that's very domestically driven I believe.

But in the case of Canada. We would be hurt because we are an exporter.

How much of US gdp is export ?



-cost of production of imports to the US will be in free fall... if oil stays here USD hold

The winners
US treasury and muni bond holders at the long end
US dollar
companies that can hold their price-Hershey was a huge winner in the 30's deflation
Gold eventually

any others? (I don't know if any other company besides Fairfax with deflation hedges)

Okay, so... the Chinese goods on US store shelves will be cheaper now.

Therefore people who buy those goods have more remaining money in their pockets to spend at Chipotle, or Starbucks, or pretty much anywhere. 

So shouldn't a whole raft of companies benefit from this, other than Fairfax?

A US company who manufactures in China will spend less to get his product onto US shelves and it will also sell for that much less -- same profit though right?  So where do US workers have their incomes hurt because of this, and if their incomes are the same and by habit they spend it all, well then many companies will benefit since the cost of their Chinese purchases will take less out of their wallets.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 12, 2015, 06:04:24 PM

The U.S. Has an economy that's very domestically driven I believe.

But in the case of Canada. We would be hurt because we are an exporter.

How much of US gdp is export ?


Using this 2013 data...   https://www.quandl.com/collections/economics/exports-as-share-of-gdp-by-country

13.49% of US GDP is exports

vs

30.08% of Canada's GDP is exports
Title: Re: Deflation hedges
Post by: mcliu on August 12, 2015, 06:18:20 PM
Wouldn't the impact on domestic incomes come from domestic manufacturers?

If you produce widgets in the U.S., your overseas competitors' products just got 5% cheaper, so you would need to lower your own prices causing higher unemployment, lower wages, etc.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 12, 2015, 06:24:51 PM
Wouldn't the impact on domestic incomes come from domestic manufacturers?

If you produce widgets in the U.S., your overseas competitors' products just got 5% cheaper, so you would need to lower your own prices causing higher unemployment, lower wages, etc.

I thought US manufacturers (the domestic ones) were the ones making those widgets in Chinese factories.

Is Apple going to pass along the IPhone manufacturing savings to US consumers or will they just report fatter margins?
Title: Re: Deflation hedges
Post by: rb on August 12, 2015, 06:46:21 PM
Wouldn't the impact on domestic incomes come from domestic manufacturers?

If you produce widgets in the U.S., your overseas competitors' products just got 5% cheaper, so you would need to lower your own prices causing higher unemployment, lower wages, etc.

I thought US manufacturers (the domestic ones) were the ones making those widgets in Chinese factories.

Is Apple going to pass along the IPhone manufacturing savings to US consumers or will they just report fatter margins?
I think Ericopoly is right. I don't think at this point a lot of made in America products are in direct competition with Made in China products. So the Chinese products do not displace American products. That ship sailed long ago. Furthermore, savings from made in China products may make their way into lower prices or higher profits. As Ericoploy points out in the case of Apple, they'll sell the iPhone for the same price and pocket the extra savings. For products with higher competition you'll probably have a bit of trickle down.

Another thing to keep in mind is that generally at a minimum 70% of an economy is not tradeable. So that Chinese product that one purchases it isn't really Chines. It has a lot of local value added in it. The Chinese value add could actually be microscopic in some cases. So cheaper Chinese goods could actually (depending on the value add %) drive US growth.

I don't want to go too deep on this one, but I can elaborate if anyone cares.
Title: Re: Deflation hedges
Post by: meiroy on August 12, 2015, 07:42:03 PM

The bigger picture here is that if "faith" is lost in the RMB it means there will be runs on other currencies of EMs. Fundamentally, the export reliance on China is correct  (Australia, Brazil etc.) but the resulting outcome will go far beyond an adjustment according to fundamentals.
Might not be tomorrow, might be 5 or 10 years from now. Who knows.

This of course will have great impact on the US economy.

I think a warning about RE is due, the size of capital outflows from China will be enough to keep up bubble RE in various countries even if fundamentals say otherwise. So this is not something that I's risk shorting without serious conviction.






Title: Re: Deflation hedges
Post by: beerbaron on August 12, 2015, 07:49:23 PM
Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.

Title: Re: Deflation hedges
Post by: ERICOPOLY on August 12, 2015, 08:11:32 PM
Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.

What are the implications for the price of imported Chinese beer?
Title: Re: Deflation hedges
Post by: rb on August 12, 2015, 08:50:50 PM
Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.
I'm not saying that the Chinese devaluation is good for the US economy. I'm pretty sure it's not. My point was that I don't think that it's as bad as one might think. Things have changed a lot over the past 10-15 years. It's probably worse for other emerging economies with whom China competes directly.

Also I don't see how it's bad for the US economy is the Fed has to delay tightening.
Title: Re: Deflation hedges
Post by: petec on August 13, 2015, 01:16:23 AM
Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.
I'm not saying that the Chinese devaluation is good for the US economy. I'm pretty sure it's not. My point was that I don't think that it's as bad as one might think. Things have changed a lot over the past 10-15 years. It's probably worse for other emerging economies with whom China competes directly.

Also I don't see how it's bad for the US economy is the Fed has to delay tightening.

I'm sure it's worse for other countries but Chinese labour just got cheaper and that's a source of competition for the average US worker.   It is unquestionably deflationary for the US, but only marginal (so far).

It is all part of a currency "race to the bottom" that several observers have been predicting for years (not me - I only started to understand it recently, and I have nothing intelligent to add about how it plays out.)   Seems to me that these predictions have been right but have taken *years* to play out - they were all the rage in 2009 it seemed to me, but have become the preserve of diehard nutters since then because they played out over such a long time and the markets were rising.   Those hurt worst are probably Japan and the other Asian exporters: I recall reading (Kyle Bass or Hugh Hendry I think) arguing that RMB depreciation would be very tough for Japan to cope with.   But I can't imagine that a couple of percent does much.   What will be interesting is where the RMB is in 6/12/18/24 months.

What fascinates me is how currency races to the bottom look inflationary (everyone printing to devalue) but end up being deflationary for a while at least.

I do think it's bad if the FED can't tighten, because I think endless ZIRP a) erodes confidence that Central Banks actually have this under control b) reduces the FED's options if there is another downturn, and c) encourages malinvestment.

And I totally agree that Apple isn't a good example - commoditised companies won't be able to protect margins.

And +1 to meiroy's comment about RE if Chinese capital outflows accelerate further.

Title: Re: Deflation hedges
Post by: petec on August 13, 2015, 01:32:45 AM
Actually, let's just go with a Munger quote:

"This has basically never happened before in my whole life. I can't remember 1˝ percent rates. It certainly surprised all the economists. It surprised the people who created the life insurance industry in Japan, who basically all went broke because they guaranteed to pay a 3% interest rate. I think everybody’s been surprised by it, including all the people who are in the economics profession who kind of pretend they knew it all along. But I think practically everybody was flabbergasted. I was flabbergasted when they went low; when they went negative in Europe – I’m really flabbergasted. How many in this room would have predicted negative interest rates in Europe? Raise your hands. [No hands go up]. That’s exactly the way I feel. How can I be an expert in something I never even thought about that seems so unlikely. It’s new territory….   I think something so strange and so important is likely to have consequences. I think it’s highly likely that the people who confidently think they know the consequences – none of whom predicted this – now they know what’s going to happen next? Again, the witch doctors. You ask me what’s going to happen? Hell, I don’t know what’s going to happen. I regard it all as very weird. If interest rates go to zero and all the governments in the world print money like crazy and prices go down – of course I’m confused. Anybody who is intelligent who is not confused doesn’t understand the situation very well. If you find it puzzling, your brain is working correctly."
Title: Re: Deflation hedges
Post by: petec on August 13, 2015, 02:26:39 AM
Randomly listening to this and it is very relevant from 30 minutes in:

https://www.youtube.com/watch?v=HZB5IWFK3XA

(Russell Napier)
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 06:57:23 AM
And I totally agree that Apple isn't a good example - commoditised companies won't be able to protect margins.

The commoditized companies -- those are the ones who moved their manufacturing to China a long time ago, because they couldn't protect their margins.  Chinese manufacturing has been so cheap for so long that we've been through this cycle already.

So are there any of them left here in the US to get hurt by this? 

What I'm looking for here are companies that will be firing their US workers -- if we already went through that phase, then the US workers will not be hurt by this devaluation.  Therefore they keep their jobs and their pay, buy cheaper (deflated) commoditized Chinese goods from Walmart, and have extra disposable income left over to spend (stimulative).  That's what the Chinese want, right?  They want the overseas consumer to have extra money to buy more things from China.  But the US consumer will also spend more in restaurants.  Or on whatever.


Also, if finished goods from China are cheaper, we buy more of them -- doesn't that provide any support for the pricing of the raw materials inputs that go into those goods?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 13, 2015, 08:20:22 AM
And I totally agree that Apple isn't a good example - commoditised companies won't be able to protect margins.

The commoditized companies -- those are the ones who moved their manufacturing to China a long time ago, because they couldn't protect their margins.  Chinese manufacturing has been so cheap for so long that we've been through this cycle already.

So are there any of them left here in the US to get hurt by this? 

What I'm looking for here are companies that will be firing their US workers -- if we already went through that phase, then the US workers will not be hurt by this devaluation.  Therefore they keep their jobs and their pay, buy cheaper (deflated) commoditized Chinese goods from Walmart, and have extra disposable income left over to spend (stimulative).  That's what the Chinese want, right?  They want the overseas consumer to have extra money to buy more things from China.  But the US consumer will also spend more in restaurants.  Or on whatever.


Also, if finished goods from China are cheaper, we buy more of them -- doesn't that provide any support for the pricing of the raw materials inputs that go into those goods?

I don't think the yuan devaluation in and of itself hurt America in much of any way. I think a strong dollar in general (which a weaker yuan contributes to) hurts America. Corporate profits will be crimped in USD terms as overseas earnings translate to lower USD amounts. That may impact the hoped for rising wage argument if corporations can point to a lower bottom line even before wages have increased. Also, it's hard to sustain elevated multiples on an equity market that has shrinking earnings which has the potential to hit the so "called wealth effect" (if you actually believe that has been working). There would also be certain domestic exporters who could be majorly impacted depending on where the bulk of the currency delta is felt.

But what is probably the worst is a strong dollar's impact on oil - shale states have made up the majority of the paltry growth that we've seen over the last 5-7 years. Strong dollar, ceterus paribus, means lower oil prices and probably a negative contribution from areas/industries that have been providing the biggest boost to the U.S. economy. If we couldn't get above 2.5% GDP growth with shale booming - how high can we really go with shale collapsing? Sure it's a few bucks in the pocket of every other working American, but something has kept those working Americans from spending over the last few years and I would be seriously surprised if the answer was as simple as prices at the pump....

Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 08:36:40 AM
But what is probably the worst is a strong dollar's impact on oil - shale states have made up the majority of the paltry growth that we've seen over the last 5-7 years. Strong dollar, ceterus paribus, means lower oil prices and probably a negative contribution from areas/industries that have been providing the biggest boost to the U.S. economy. If we couldn't get above 2.5% GDP growth with shale booming - how high can we really go with shale collapsing?

Yes but 7 years ago it was 2008 and can we talk about the headwinds of what transpired during those years of epic collapse if we're going to talk about the tailwinds from shale?

It's not 2008 anymore and things are not collapsing.  And there is no more shale tailwind.

Where does that leave us?
Title: Re: Deflation hedges
Post by: merkhet on August 13, 2015, 08:59:30 AM
I must be bored because I'm wading into a macro discussion...

So, let's roll this back two years or so when oil was above $100. Shale was booming precisely because of the high oil price because a lot of it isn't economical at current prices, right? And the higher the oil price got the more shale boom we created because that's the nature of those kinds of markets.

If you think of the U.S. economy as a giant machine/system, then what is going on when oil hits $100? Well, gas prices are high across the board for consumers of oil. Where does that money go? It goes from the consumers to the producers (and the rest of the chain, refiners, etc.) --> so the question is what's the multiplier on that spending? Do the profits that are flowing into the shareholders, employees, etc. of oil producers (et. al.) get spent? Or are they saved? What's the general impact of that?

Think about it another way. Let's say oil & gas is 6% of GDP. (That 6% is energy as a whole which is over counting, but let's roll with it.) So roughly 94% of the country is pouring an elevated amount of money into the coffers of 6% of the country -- would it be better to have 94% of the country have a little more money in their pockets or better to have 6% of the country have a lot more money in their pockets? (Simplification, I know.)

Also, think about the following -- the roughnecks on these rigs are getting paid $100K+ which bumps them up into a pretty high tax bracket. The vast majority of the remaining 94% of the country are in a lower tax bracket than the roughnecks -- so not only do you think about the 94%/6% cash in pockets dynamic, you also have to consider the after-tax amounts being higher in the 94% as a whole than in the 6%.

All this is to say that I have a theory that insanely high oil prices actually choke off productive growth in the non-oil parts of the economy by siphoning money away (through COGS and lowered consumer spending) to the oil parts of the economy.
Title: Re: Deflation hedges
Post by: rpadebet on August 13, 2015, 09:39:48 AM
I am bored too...

This is too tough to predict though..

There is a race to the bottom in terms of currencies, but it is happening because of deflationary threats. Lots of people assumed when US was doing the QE that inflation would be an inevitable consequence. We saw inflation in Fixed income assets but little else. Now with potential for rising rates, lower oil, china devaluation the fear is for deflation. In a perfectly symmetrical world we should see deflation of fixed income assets and nothing much.....

however, we could also easily see wage deflation and hence consumer deflation with some asset deflation and some other asset inflation. Who knows where the deflation happens? It will most likely happen where most people are not looking right now, that I am sure of.

Bottom line world wide growth will be a function of population growth and productivity growth.

Population growth is pretty stable and wont change overnight unless there is a big war/uncontrollable disease. Last i checked it still takes at least 9 months to produce a human, so short term upside to population growth is not a concern.

We have some more things to do about the productivity growth. The last paradigm shift here was with the information revolution. I don't know what phase we are in of this revolution, but it seems to be slowing. Cloud computing, mobile computing, social sharing economy etc will continue to add some productivity growth for sometime. Maybe the next revolution is in health care, who knows, but even this takes a lot of time.

As a planet we are slowing down from the rapid pace of past 3 decades yet still growing. Some parts are growing very fast while others are rapidly declining and countries like US are somewhere near the average.

I am in the camp that we have a muddle through economy for a long long time. Inflation and Deflation will be equally threatening and rational policy makers will keep adjusting the dials.

the risk here is something irrational or out of the ordinary happening like a big war, some new very powerful technology, big disease or some crazy person/group being given the control over some significant part of the global economy. This by definition cant be predicted as it is a black swan, but I think it will eventually have to happen to disturb this uncomfortable equilibrium we are in. I don't know when.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 13, 2015, 09:48:18 AM
I must be bored because I'm wading into a macro discussion...

So, let's roll this back two years or so when oil was above $100. Shale was booming precisely because of the high oil price because a lot of it isn't economical at current prices, right? And the higher the oil price got the more shale boom we created because that's the nature of those kinds of markets.

If you think of the U.S. economy as a giant machine/system, then what is going on when oil hits $100? Well, gas prices are high across the board for consumers of oil. Where does that money go? It goes from the consumers to the producers (and the rest of the chain, refiners, etc.) --> so the question is what's the multiplier on that spending? Do the profits that are flowing into the shareholders, employees, etc. of oil producers (et. al.) get spent? Or are they saved? What's the general impact of that?

Think about it another way. Let's say oil & gas is 6% of GDP. (That 6% is energy as a whole which is over counting, but let's roll with it.) So roughly 94% of the country is pouring an elevated amount of money into the coffers of 6% of the country -- would it be better to have 94% of the country have a little more money in their pockets or better to have 6% of the country have a lot more money in their pockets? (Simplification, I know.)

Also, think about the following -- the roughnecks on these rigs are getting paid $100K+ which bumps them up into a pretty high tax bracket. The vast majority of the remaining 94% of the country are in a lower tax bracket than the roughnecks -- so not only do you think about the 94%/6% cash in pockets dynamic, you also have to consider the after-tax amounts being higher in the 94% as a whole than in the 6%.

All this is to say that I have a theory that insanely high oil prices actually choke off productive growth in the non-oil parts of the economy by siphoning money away (through COGS and lowered consumer spending) to the oil parts of the economy.

I would generally agree with you, but I could also pose the situation of diffuse cost and concentrated benefit. Let's assume I add a $0.01 tax to all transactions in the economy. Every person is going to pay an additional penny for everything and it all goes me. That would put me in an extremely high tax bracket, my after tax portion would be lower than the rest of the country's, and the benefit would be entirely concentrated on me, my neighborhood, and my local area where I'm blowing all that cash. The cost is diffuse so it doesn't impact other areas much, but the benefit is concentrated on what surrounds me without impacting the surrounding economies that much.

Now consider the exact reverse situation. Those flows reverse and everyone in the country get's a penny back on every transaction and all of that money flows out of my community. People who were looking to buy houses no longer do either because income is less secure or because they can't get a loan or because property values are falling. Some people lose their jobs, default on owed debt, and become a drag on the tax system through lower revenue as well as increased expenditures. Eventually, prices will equalize again and the area recovers with a different base to build upon, but it takes years. Also, that additional penny on each transaction doesn't really improve the surrounding economies that much.


So my question is this: Does the current situation in reflect more of your premise where the additional money is spent throughout the rest of the American economy OR is it my premise which suggests the amounts saved are small and diffuse where the cost is concentrated and large.

Oil prices have cratered - gasoline prices have fallen less so. http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EMM_EPM0U_PTE_NUS_DPG&f=M (http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EMM_EPM0U_PTE_NUS_DPG&f=M)

Gasline prices have fallen about 25%. The average American spends about $2000 a year on gas. That means that the average American is currently putting an extra $40 month in their wallet. That is likely to be the cap as many oil experts agree that current prices are unsustainable and that mid-term equilibrium is around $60-$65/barrel (from the current $40ish). So, the real question is, do American's who have an extra $40 to spend every 30 days really more than make up for concentrated loss of credit availability, stable jobs, consumer purchases, declining home values, etc. etc. etc. I don't know, but I tend to lean towards no.

If we were talking $100-$200 extra each month, I think it'd be a big deal. But $40 per month, max, doesn't seem to me to really do much for most people. It's not a car payment, it's not enough to take your family of 4 to the movies, it's barely enough to buy a family of 4 dinner at most restaurants, etc. I just don't see $40 changing consumer spending habits for all but the lowest tier of incomes.

Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 09:58:08 AM
Oil prices have cratered - gasoline prices have fallen less so.

I found this a moment ago -- I don't know if it takes more time for gasoline prices to catch up with oil prices or not:

Implied spot prices for some major gasoline markets in November and December are already trading at around $1.25 a gallon, according to Tom Kloza, global head of energy analysis at Oil Price Information Service.

http://www.cnbc.com/2015/08/11/6-reasons-gas-prices-could-fall-below-2-a-gallon.html
Title: Re: Deflation hedges
Post by: merkhet on August 13, 2015, 10:00:19 AM
I would quibble a bit with your assumptions here.

(1) I think you're assuming that you're blowing mad stacks of cash in your example, but my guess is that you're not blowing all of the $0.01 tax. First, a bunch of it is going to taxes. Second, unless you made a concerted effort to do so, you're not likely to spend all that cash. A lot of that is going into a bank account or an investment account somewhere.

(2) Thus, your concentrated effect is likely significantly lower than you think it is. And the combined aggregate effect of the $40 of after-tax spend is likely higher than you think it is.

(3) Also, you calculated $40 per person and then for some reason talked about how $40 is not enough to take a family of four to dinner. Except a family of four would save $160, so unless you're going to a really nice restaurant, I suspect you can get a few dinners and/or movies out of that.

And, remember, you're just talking about consumers right now. We haven't even broached the subject of companies that have oil as a large part of their COGS (transport, plastics, etc.) and the effect of consumer demand + additional profits that can either go into the pockets of investors or into rising wages for workers -- that's what I mean by multiplier effects. (If each incremental unit of oil price increase hires 1 roughneck @ $100k and removes 5 workers from other industries each earning $40k, then that's not a good thing for the economy.)
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 10:05:36 AM
(3) Also, you calculated $40 per person and then for some reason talked about how $40 is not enough to take a family of four to dinner. Except a family of four would save $160, so unless you're going to a really nice restaurant, I suspect you can get a few dinners and/or movies out of that.

Compare $160 to what gets spent eating out:

The average American family spends $225 a month eating away from home – dinners eaten out, quick snacks grabbed, and coffees ordered and consumed on the run.

http://www.thesimpledollar.com/trimming-the-average-budget-eating-out/
Title: Re: Deflation hedges
Post by: ni-co on August 13, 2015, 10:18:38 AM
I must be bored because I'm wading into a macro discussion...

So, let's roll this back two years or so when oil was above $100. Shale was booming precisely because of the high oil price because a lot of it isn't economical at current prices, right? And the higher the oil price got the more shale boom we created because that's the nature of those kinds of markets.

If you think of the U.S. economy as a giant machine/system, then what is going on when oil hits $100? Well, gas prices are high across the board for consumers of oil. Where does that money go? It goes from the consumers to the producers (and the rest of the chain, refiners, etc.) --> so the question is what's the multiplier on that spending? Do the profits that are flowing into the shareholders, employees, etc. of oil producers (et. al.) get spent? Or are they saved? What's the general impact of that?

Think about it another way. Let's say oil & gas is 6% of GDP. (That 6% is energy as a whole which is over counting, but let's roll with it.) So roughly 94% of the country is pouring an elevated amount of money into the coffers of 6% of the country -- would it be better to have 94% of the country have a little more money in their pockets or better to have 6% of the country have a lot more money in their pockets? (Simplification, I know.)

Also, think about the following -- the roughnecks on these rigs are getting paid $100K+ which bumps them up into a pretty high tax bracket. The vast majority of the remaining 94% of the country are in a lower tax bracket than the roughnecks -- so not only do you think about the 94%/6% cash in pockets dynamic, you also have to consider the after-tax amounts being higher in the 94% as a whole than in the 6%.

All this is to say that I have a theory that insanely high oil prices actually choke off productive growth in the non-oil parts of the economy by siphoning money away (through COGS and lowered consumer spending) to the oil parts of the economy.

This is a chicken and egg problem. Are oil prices a leading or a lacking indicator vs GDP? I tend to think of them as a leading indicator because energy demand isn't driven by private consumption but by industrial production if you look at it from a world GDP perspective. There was a slowing down of the Chinese investment boom and then, afterwards, oil prices began to tank in tandem with other commodities.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 10:19:13 AM
And don't forget that 21% of US oil is imported... none of that money made it into the US shale boom:

http://cnsnews.com/news/article/barbara-hollingsworth/forecast-2015-imported-oil-will-make-just-21-us-consumption

The drop in oil prices on that 21% is pure stimulus.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 13, 2015, 10:22:12 AM
I would quibble a bit with your assumptions here.

(1) I think you're assuming that you're blowing mad stacks of cash in your example, but my guess is that you're not blowing all of the $0.01 tax. First, a bunch of it is going to taxes. Second, unless you made a concerted effort to do so, you're not likely to spend all that cash. A lot of that is going into a bank account or an investment account somewhere.

(2) Thus, your concentrated effect is likely significantly lower than you think it is. And the combined aggregate effect of the $40 of after-tax spend is likely higher than you think it is.

(3) Also, you calculated $40 per person and then for some reason talked about how $40 is not enough to take a family of four to dinner. Except a family of four would save $160, so unless you're going to a really nice restaurant, I suspect you can get a few dinners and/or movies out of that.

And, remember, you're just talking about consumers right now. We haven't even broached the subject of companies that have oil as a large part of their COGS (transport, plastics, etc.) and the effect of consumer demand + additional profits that can either go into the pockets of investors or into rising wages for workers -- that's what I mean by multiplier effects. (If each incremental unit of oil price increase hires 1 roughneck @ $100k and removes 5 workers from other industries each earning $40k, then that's not a good thing for the economy.)

Agreed. I didn't go into the cost of oil in goods produced by other industries. I know it's a lot, but I also know the CapEx and R&D spent by oil companies is massive and is being cut. I don't have a good approach for being able to compare the two. This might also be more of a matter of timing than of actual amounts as well. A sudden stop in all Oil R&D would be impactful negatively impactful in the near term because it wouldn't be offset by the immediate offsetting rise in activity elsewhere. It'd take time for the increased activity to flow through the other industries to outweigh the impact of the oil cuts. Between uncertain amounts and uncertain timing, I have no idea how that impacts the economy.

I do take qualm with your comment about the family of 4, but it's relatively minor so I don't want to get caught up on this. I'll just say that any study that does work on how much the average American spends on gasoline, but includes people who under the driving age, is generally worthless. I'm assuming that the people who developed the study knew this and by "average American" they meant "average American driver." With that being said, anytime someone references a family of four, they're generally talking about two adults and two children - not 4 adults who all drive independently to the dinner. Savings between the two adults would range between $40-$80 depending on if both of them are primary drivers or not. $40 still doesn't buy the family a dinner at a restaurant. Anyways, that's all I'll say on this because it's such a minor argument to get caught up and I'd rather focus on the big picture.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 10:27:19 AM
Actually, the multiplier from the shale boom might have been rather large.

Instead of the oil being purchased from OPEC and other exporters, it was purchased from a new US shale producer.

So the money spent on shale oil ricocheted around within the borders of the US instead of being sent overseas.

Instead of buying oil from OPEC and losing all of the dollars in the process, you just have your left hand pay your right hand to use the oil that you've got buried in the backyard.  No leakage unless the shale oil producers in the US are foreign owned.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 10:47:21 AM
The US government could stimulate the economy by requiring employers to give paid time off:

http://www.forbes.com/sites/tanyamohn/2013/08/13/paid-time-off-forget-about-it-a-report-looks-at-how-the-u-s-compares-to-other-countries/

People spend more money when they are sitting at home bored and need something to entertain them.
Title: Re: Deflation hedges
Post by: Dazel on August 13, 2015, 11:06:01 AM

Here is what we know.
US shale producers are "all' basically headed for bankruptcy at these prices. They are levered and they are "increasing" production in the second half of 2015...They have spent an enormous amount of money on real things where the rest of the economy was not...they are in a deflationary spiral now....their cost to produce is in free fall as is their realized price for product...and that is deflation. They are unable to pay back their debt so they tread water....deflation.

2008 was housing deflation...call it what you want but that is what it was...prices fell and the debts on those assets were unbearable...
North America is aging....like Japan...so as whole we are spending less anyways...now we get lower prices...so we look for lower and lower prices...

Does that matter in Manhattan? no. It does matter in Texas and so on yes...China's move shows that their demand was somewhat fake...and now they are acknowledging it...as it will continue to drop. In North America we do not have much demand so when people decide to wait for purchases prices fall and that is deflation.


lack of demand means no wage growth and lay offs...and lower prices...deflation is terrifying ask Chesapeake and their employees!

the reason for all this is the debt over hang...in North America people are not spending their savings from oil they are
servicing and paying down debt with it. no growth...see Hoisington-Fairfax

The FED will end it with massive stimulus so long term there is not a problem...you cannot have long term deflation as it is crushing...the problem is that in downturns-crash's you "need" bankruptcy so the people, companies, countries can start over. That did not happen in 2008 we created false stimulus and real demand has never caught up  and that is why we are here...debt.

i have no idea how we will get out of it other than passing the buck to the next generation...and what are they to do with student debt living in our basements?


Title: Re: Deflation hedges
Post by: gary17 on August 13, 2015, 11:54:41 AM
People spend more money when they are sitting at home bored and need something to entertain them.

Some spend no money at home on the COBF board LOL
Title: Re: Deflation hedges
Post by: rb on August 13, 2015, 12:41:39 PM
Well if we're talking about deflation then the economy must be demand constrained. Personal debt overhang is a big part of that story. In that case aren't oil prices a good thing since it helps people pay their debt faster? As for the oil companies, yes they have been spending a lot of money, but that is actually still small compared to the whole economy and as others here mentioned it tends to be very clustered. Certain people and certain places mostly benefit.

On the RMB devaluation I don't really see this as some big race to the bottom. The RMB appreciated a lot in the past 5-6 years. Back then US economy was in the pits and China was firing on all cylinders. Now the US is recovering and China looks like is stalling. There's also large amounts of capital flight out of China. Now if the RMB was a floating currency would we not expect to see a depreciation against the USD under these circumstances?
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 01:52:55 PM
The US doesn't have consumer debt overhang in the way that matters -- monthly payments.  Lately retail sales have been strengthening which must speak to the lack of demand right???
Title: Re: Deflation hedges
Post by: rb on August 13, 2015, 02:12:41 PM
The US doesn't have consumer debt overhang in the way that matters -- monthly payments.  Lately retail sales have been strengthening which must speak to the lack of demand right???
Well if there's no debt overhang than why are people using gas savings to pay down debt in a low interest rate environment?

Also just because retail sales have been strengthening lately doesn't mean that the economy is not still demand constrained. If the economy is not demand constrained then why do you have low inflation in a zero interest rate environment? Why is anyone even mentioning deflation?
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 02:18:23 PM
The US doesn't have consumer debt overhang in the way that matters -- monthly payments.  Lately retail sales have been strengthening which must speak to the lack of demand right???
Well if there's no debt overhang than why are people using gas savings to pay down debt in a low interest rate environment?

Also just because retail sales have been strengthening lately doesn't mean that the economy is not still demand constrained. If the economy is not demand constrained then why do you have low inflation in a zero interest rate environment? Why is anyone even mentioning deflation?

Is demand falling or flat if sales are rising?

Despite paying down debt, no less.

They are buying more AND paying down debt.  Must be terrible out there.
Title: Re: Deflation hedges
Post by: rb on August 13, 2015, 02:22:17 PM
The US doesn't have consumer debt overhang in the way that matters -- monthly payments.  Lately retail sales have been strengthening which must speak to the lack of demand right???
Well if there's no debt overhang than why are people using gas savings to pay down debt in a low interest rate environment?

Also just because retail sales have been strengthening lately doesn't mean that the economy is not still demand constrained. If the economy is not demand constrained then why do you have low inflation in a zero interest rate environment? Why is anyone even mentioning deflation?

Is demand falling or flat if sales are rising?

Despite paying down debt, no less.

They are buying more AND paying down debt.  Must be terrible out there.
Is that an economic model?
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 02:25:42 PM
The US doesn't have consumer debt overhang in the way that matters -- monthly payments.  Lately retail sales have been strengthening which must speak to the lack of demand right???
Well if there's no debt overhang than why are people using gas savings to pay down debt in a low interest rate environment?

Also just because retail sales have been strengthening lately doesn't mean that the economy is not still demand constrained. If the economy is not demand constrained then why do you have low inflation in a zero interest rate environment? Why is anyone even mentioning deflation?

Is demand falling or flat if sales are rising?

Despite paying down debt, no less.

They are buying more AND paying down debt.  Must be terrible out there.
Is that an economic model?

It's a question.

I'm asking if rising sales indicates poor demand.
Title: Re: Deflation hedges
Post by: rb on August 13, 2015, 02:46:29 PM
It's a question.

I'm asking if rising sales indicates poor demand.
It's definitely a good thing. It points that the demand picture is improving, and pretty much all the other indicators prove that the picture is slowly improving.

On the other hand some improvement from a low level doesn't mean that demand is good. The economic indicators also show that the US economy is still suffering from demand deficiency. So basically demand is still bad, better then it was before, and slowly improving, but there's still a ways to go.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 03:06:07 PM
I think you need to go back to 1980 to find household debt service levels this low.  It's not the total amount of debt that matters.  It's how much money they have at their disposal after making the payment.

Instead of focusing on how much principle needs to be paid, why not instead obsess upon how little interest needs to be paid? Most of the US household debt is fixed rate, not floating. 

Debt overhang or interest payment underhang?  They cancel out and put no net undue stress on the households.  Take your pick as to why, but knowing this helps me absorb the improving retail sales without raised eyebrows.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 03:13:17 PM
So to the question of why they are paying down debt -- are they merely using their interest payment savings?  Or what?
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 03:20:45 PM
It's a question.

I'm asking if rising sales indicates poor demand.
It's definitely a good thing. It points that the demand picture is improving, and pretty much all the other indicators prove that the picture is slowly improving.

On the other hand some improvement from a low level doesn't mean that demand is good. The economic indicators also show that the US economy is still suffering from demand deficiency. So basically demand is still bad, better then it was before, and slowly improving, but there's still a ways to go.

If the demand base is still low (yet improving) then there is room to grow.  That's ideally what you want because current CPI and profits and employment are tied to the piss poor existing demand, right?

So that leaves a lot to look forward to.

It would be worse if demand were peaking with no possible improvement potential -- at that point worldwide pressures could more easily drag us back.

Better to have momentum that is strengthening.
Title: Re: Deflation hedges
Post by: rb on August 13, 2015, 03:42:03 PM
You make good points on the debt. It's basically not so much about how much debt there is and yes the service ratios are pretty good. Yet as you say, people are paying it down, when really a rational being would look at rates and conditions and load up. The overhang is not really the level of debt or the debt service. It's the fact that it is being paid down at a pretty decent clip which creates demand drag.

There's not much mystery here as the topic has been thoroughly researched. Basically what happens after an RE bubble bursts is that people's comfort level of debt declines. So if they were comfortable with X% of income in 2006, now they're comfortable with less, no matter what the rates are, so they pay down the principle until they get to their new comfort level then u get a demand constrained economy, zero interest rates and the whole jazz you see now. Hopefully there's not a lot left to go.

I disagree that this is a good place to be in (i.e. have an output gap) just because we have momentum. That's kinda like hitting yourself with a hammer cause as the paid dissipates you'll feel better so you'll have positive momentum.
Title: Re: Deflation hedges
Post by: Dazel on August 13, 2015, 03:58:49 PM


I am not saying that the debt is constraining the US consumer what I am saying is the debt "IS" there and any hiccup and the consumer gets parayzed and stops spending.

There was "no" problem in the oil patch this time last year and debt levels look very god!
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 04:03:11 PM
Except getting hit with a hammer never felt this good.  Record margins and solid employment.

Perhaps it's like that ball busting fetish -- looks painful but people seem to like it.
Title: Re: Deflation hedges
Post by: rb on August 13, 2015, 04:09:56 PM
Except getting hit with a hammer never felt this good.  Record margins and solid employment.

Perhaps it's like that ball busting fetish -- looks painful but people seem to like it.
Lol I'm not gonna debate fetishes, but that's a good one :)

The employment part is where it gets a bit murky for me. Yes, the headline unemployment rate looks good, but if you look at employment for working age population, that doesn't look so good. So that kinda signals to me that either a) the recession destroyed a lot of human capital or b) there's still a lot of discouraged workers out there and unemployment is quite a bit worse than it looks.

Not sure which one is it but I'm leaning towards b because if a was the case then we should see inflation at this unemployment level especially with zero rates.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 13, 2015, 04:37:28 PM


I am not saying that the debt is constraining the US consumer what I am saying is the debt "IS" there and any hiccup and the consumer gets parayzed and stops spending.

There was "no" problem in the oil patch this time last year and debt levels look very god!

I'm probably just extrapolating my own views on debt.  I felt like I wasn't making any headway on my mortgage back in 2001 when the rate was 8%.  I'd make a huge monthly payment and it nearly all was for interest.  It was very demoralizing.

Today my mortgage payment has a huge savings component and that really cheers me up.  I know that a much larger component of the payment is merely a form of savings (the principle).

So little of it is interest that I just don't feel that bad about all this mortgage debt.

So it bothers me far less -- it's very morale boosting to think that all these Americans now have this disciplined "savings plan".  Better than a similar sized payment with a lower savings component, IMO.
Title: Re: Deflation hedges
Post by: Dazel on August 14, 2015, 03:42:20 AM

Ericopoly,

you are the 1%...the rest of north america do "not' have much money in their retirement savings and the returns on investments are so low that they have lost hope of building up a nest egg. I agree that the forced savings and the increase of principal payments is helpful but they have other debts that they are consolidating and the debt is still "there" without a safety net of investments-cash like your self.

The downside to this is the ultra low interest rate environment punishes the savers...as they are not getting any return on their savings and therefore will not spend as much money as they normally would.

As for record margins...those with pricing power will benefit greatly in this environment.
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 14, 2015, 07:21:36 AM

Ericopoly,

you are the 1%...the rest of north america do "not' have much money in their retirement savings and the returns on investments are so low that they have lost hope of building up a nest egg. I agree that the forced savings and the increase of principal payments is helpful but they have other debts that they are consolidating and the debt is still "there" without a safety net of investments-cash like your self.

The downside to this is the ultra low interest rate environment punishes the savers...as they are not getting any return on their savings and therefore will not spend as much money as they normally would.

As for record margins...those with pricing power will benefit greatly in this environment.

I understand the interest rates punishing savers comment. 

The wealthy are earning low returns on their money and those low returns are a transfer of wealth to help out the people who are struggling to repay their debts.

Meanwhile people just gripe the wealthy don't pay enough tax -- well I guess the Occupy Wall Street people don't want to hear that low mortgage interest rates translates to a siphoning of income from the banks' net interest margins.  Oh well... sigh.


Title: Re: Deflation hedges
Post by: petec on August 17, 2015, 01:45:20 AM
I think you need to go back to 1980 to find household debt service levels this low.  It's not the total amount of debt that matters.  It's how much money they have at their disposal after making the payment.


I think it's more complex than this, at least in the long term.   I certainly look at debt vs. assets as well.   So, for example, if my house value fell below my mortgage I'd be worried, regardless of whether I had cash left after the monthly service payment.   That's where I find rising rates worrying.   If I put down 20% on a house and max out on an interest-only mortgage for the rest, then a doubling of rates would reduce what I can afford to pay for the house by 40%.   The impact is smaller for an amortising mortgage but it's still significant.   Since house prices are set by what current buyers can afford to pay, they are influenced by current interest rates.   So as rates rise, the debt:equity ratio can change for homeowners regardless of whether their debt is fixed or floating, and I think that impacts on the willingness to spend vs. pay down debt.   (The same argument could be made for holders of stocks, bonds, etc.)

Now, I don't know the US housing market enough to know whether this is a risk - you could argue that the above maths only applies if everyone is stretching to buy their houses.   Maybe most people are currently putting 40% down, or maybe they are not maxing out on their mortgage.   If so, then they have scope to pay more for homes despite rising rates.   But that is *not* the case where I live and it's not the case in several parts of the world.   And if asset prices start to fall, or even look uncertain, as rates start to rise, then I think we go into a very uncertain world.

So, while I fully agree with Ericopoly about the importance of debt service ratios when thinking about medium term consumer spending, I do think absolute debt levels play a part in economic decision-making over the longer term and I think they are a big determinant of the level of risk in the system.   We call debt leverage for a reason: it magnifies the impact of changes.   I think that's the danger of the world we live in.   House price falls wouldn't impact confidence much if the other side of the balance sheet wasn't extended, but it is.

EDIT: I realise Ericopoly's comment was specific to US consumers and again I'm not really disputing that.   This is more about my model for thinking where the whole world economy is at the moment, and I want protection against a deflationary episode because of the way the world looks not because of the way the US looks.
Title: Re: Deflation hedges
Post by: Dazel on August 17, 2015, 06:34:22 AM
http://www.telegraph.co.uk/finance/11805523/Doomsday-clock-for-global-market-crash-strikes-one-minute-to-midnight-as-central-banks-lose-control.html

Title: Re: Deflation hedges
Post by: obtuse_investor on August 17, 2015, 07:09:26 AM
http://www.telegraph.co.uk/finance/11805523/Doomsday-clock-for-global-market-crash-strikes-one-minute-to-midnight-as-central-banks-lose-control.html

I do not disagree with any of the data on that page, but I would encourage readers to pay close attention to the X-axis of all the charts. They aren't consistent... and are rather cherry picked to make things look dramatic.

Some indicators are truly near all time bottoms (eg: interest rates), but others look rather benign when the x-axis is expanded a mere few years.

caveat emptor
Title: Re: Deflation hedges
Post by: petec on August 17, 2015, 08:18:19 AM
Just noticed Japanese PPI went -ve in about April, most recent reading -3%.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 17, 2015, 08:53:33 AM
Just noticed Japanese PPI went -ve in about April, most recent reading -3%.

Because Abenomics has been SOOOOO effective...
Title: Re: Deflation hedges
Post by: Dazel on August 21, 2015, 02:42:25 AM
http://finance.yahoo.com/news/asia-slides-wall-street-caves-002345016.html


China has stalled...the market told us early...deflation hedges are likely surging in value. It may get very interesting as the market digests this.

Dazel
Title: Re: Deflation hedges
Post by: JEast on August 21, 2015, 08:30:43 AM
Noticed the five-year, five-year break-even forward for Europe is around 1.70 and the US recently dropped below 2.00.  Maybe middle of the 2nd inning or top of the 3rd so still early, but I am hopeful the office is at least getting some calls on possible asking prices.  Hopeful that we at least get our capital back.
Title: Re: Deflation hedges
Post by: KinAlberta on August 21, 2015, 09:26:30 AM
Are these hedges are like lottery tickets?  The prospect of winning big time means that they attract more attention than they deserve?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 21, 2015, 09:33:30 AM
Are these hedges are like lottery tickets?  The prospect of winning big time means that they attract more attention than they deserve?

I wouldn't call them lottery tickets. That implies the chance of winning is nearly nil - I'd say that Fairfax's has an intelligent reasoning behind the positioning and that they have been supported by economic data over the last 3-4 years. All we have to do is see if them being right on a general economic malaise actually bleeds into CPI figures that determine the payout.

You have cratering energy and commodities prices, a slowing China, devaluations of currency happening all over southeast Asia and Europe, and a significantly stronger dollar. All of those point to a lower CPI - if global aggregate demand slows (which it appears to be doing), we could see a sustained drop in CPI. The chances of this happening aren't nil - I can't tell you what they are, but I've felt that they were much more likely than the market ever gave them credit for.

The payout is extremely high and the bar for success is relatively low. We just have to make it to that bar.
Title: Re: Deflation hedges
Post by: petec on August 21, 2015, 11:13:40 AM
I agree.   I think relatively few people understand (or maybe it is just that I have only recently started to understand!) how credit bubbles inflate and deflate.   How during the leverage phase consumers and governments lever up to consume, creating demand so that producers lever up to build factories and produce more; but when consumers stop levering up more, the demand evaporates leaving lots of empty capacity.   Prices fall as inputs (commodities) collapse and as producers compete for the demand that remains.   It's fine if all the money saved on commodities gets spent on more things, but price elasticity doesn't work that way.   I don't buy twice as many clothes because cotton got cheaper.   I might go out for dinner more, but I'll also pay down some debt.   Delevering takes everything down with it.

There is a distinct possibility that the global economy is at that stage, and a distinct possibility that monetary policy isn't enough to offset it.   And Fairfax can buy protection against this turn of events for virtually nothing.   That's not a lottery ticket.   And I don't know of any other equities that would benefit, so I don't think it gets too much attention!

There's also scope for a vicious carry trade unwind: as the dollar rises, borrowing cheap dollars to fund investments (in anything) gets less attractive.   Unwinding the trade pushes the dollar up further so it's circular.   Look at currency and commodity volatility in the last year: something is happening.

I read today that:
-45% of world GDP is in commodity exporting countries.
-World exports have recently started shrinking; this usually only happens in recessions.
- $10tn of annual revenues have been lost throughout the commodity value chain.   Yes, some of that becomes demand elsewhere.   Some doesn't, it gets saved or just vanishes as debts go bad.   That's deflationary.
- EDIT: despite incredible monetary stimulation (ZIRP everywhere significant, QE in Europe and Japan, 48 Central Bank easings ytd) nominal global gdp is growing at rates normally only seen in the depths of recessions.   That thought startled me.

It's quite possible we muddle through.   It's more than usually likely that we don't.   These swaps offer protection against that.   I bought more FFH today.


Title: Re: Deflation hedges
Post by: KinAlberta on August 21, 2015, 07:08:55 PM
Sorry - I didn't mean that the contracts themselves were like lottery tickets - but that the investor interest in the potential payout is like dreaming of a lottery win in that the great potential coming out of a win receives undue attention compared to other aspects of their business. (Much like Buffett's derivatives did in early 2009 - in the opposite direction creating undue fear).  Or the way investors view micro-cap emerging companies with promising new technologies (where such companies have very long odds of success but the promise of the technology attracts all the attention).

It's just that I've noticed all the posts to this thread and possibly even a bit of excitement about Fairfax / Watsa being right - again.   


As for the contracts and cycles - I think Fairfax was intelligent taking out such insurance if that's an appropriate term for it.  I've long been interested in such macro cycles like Kondratieff's Long Wave, Jay Forester's study (at MIT Sloan) of system dynamics (technological and business cycles), etc.

BTW - Back in 2003 I was circulating Watsa's 2002 AR "perfect storm" quote to people managing money in the billions. Along with Buffett's daisy chain WMD article, the BofE governor's fears on derivatives, Grantham's multiple pre 2008 warnings, etc. 


Moreover, I created the Jeremy Grantham page on Wikipedia and later added these quotes...

Quote

To avoid the development of crises, you need a plentiful supply of foresight, imagination, and competence. A few quarters ago I likened our financial system to an elaborate suspension bridge, hopefully built with some good, old-fashioned Victorian over-engineering. Well, it wasn’t over-engineered! It was built to do just one under favorable conditions. Now with hurricanes blowing, the Corps of Engineers, as it were, are working around the clock to prop up a suspiciously jerry-built edifice. When a crisis occurs, you need competence and courage to deal with it. The bitterest disappointment of this crisis has been how completely the build-up of the bubbles in asset prices and risk-taking was rationalized and ignored by the authorities, especially the formerly esteemed Chairman of the Fed. ...[9]
   ”
“   I ask myself, ‘Why is it that several dozen people saw this crisis coming for years?’ I described it as being like watching a train wreck in very slow motion. It seemed so inevitable and so merciless, and yet the bosses of Merrill Lynch and Citi and even U.S. Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke — none of them seemed to see it coming.

I have a theory that people who find themselves running major-league companies are real organization-management types who focus on what they are doing this quarter or this annual budget. They are somewhat impatient, and focused on the present. Seeing these things requires more people with a historical perspective who are more thoughtful and more right-brained — but we end up with an army of left-brained immediate doers.

So it’s more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history, they are always going to miss it. And the three or four-dozen-odd characters screaming about it are always going to be ignored. . . .

So we kept putting organization people — people who can influence and persuade and cajole — into top jobs that once-in-a-blue-moon take great creativity and historical insight. But they don’t have those skills.[10]

https://en.wikipedia.org/wiki/Jeremy_Grantham


One last thing - I'm an Albertan and saw the 1970s oil driven boom followed by the 1980s bust and how it affected nearly everything. Consequently I saw a lot of parallels between Alberta's boom and various subsequent market bubbles over the years in various sectors.  It seems that the bubbles only get bigger, broader and potentially more scary - as is the case now with the bond market.
 
Title: Re: Deflation hedges
Post by: Dazel on August 23, 2015, 02:00:12 PM


the junk bond market is already in a correction...equities are just realizing that now...i suggest reading hoisington asset management for any who think we are in a U.S treasury bubble..they see the 30 year at 2% or below and the have been right for 10 years. U.S long dated treasuries are deflation hedges..

Dazel
Title: Re: Deflation hedges
Post by: ERICOPOLY on August 24, 2015, 11:55:40 AM
I forget... in 2008 when they dropped their equity hedges, did the gains on the hedges exceed the market drop of their equity portfolio?

Or was it mostly a wash?  I'm remembering it as mostly a wash.

Once again Original_Mungerville with his huge equity hedges!  Congrats.  I'm limping today, down about 2% at the moment versus the 3.9% that the S&P500 is down.

I'm getting better at this luck thing though -- this is the first market drop in a while where my loss doesn't exceed the market.  It's cold comfort.  Too many out-of-the-money puts that don't help much in the beginning.

EDIT:  Okay, just a few minutes later the market is down 4.35% and now I'm registering a slight gain for the day (due to a volatility spike).  This is a bizarre day.
Title: Re: Deflation hedges
Post by: petec on August 24, 2015, 02:55:14 PM
Bizarre indeed.   Just noticed Brent crude down 8%.  :o
Title: Re: Deflation hedges
Post by: original mungerville on August 25, 2015, 10:18:16 AM
I forget... in 2008 when they dropped their equity hedges, did the gains on the hedges exceed the market drop of their equity portfolio?

Or was it mostly a wash?  I'm remembering it as mostly a wash.

Once again Original_Mungerville with his huge equity hedges!  Congrats.  I'm limping today, down about 2% at the moment versus the 3.9% that the S&P500 is down.

I'm getting better at this luck thing though -- this is the first market drop in a while where my loss doesn't exceed the market.  It's cold comfort.  Too many out-of-the-money puts that don't help much in the beginning.

EDIT:  Okay, just a few minutes later the market is down 4.35% and now I'm registering a slight gain for the day (due to a volatility spike).  This is a bizarre day.

I did make money in the last couple of days/weeks, but Valeant, my main position, had a horrible week last week. Overall I am up nicely as my over-exposure to S&P puts more than bailed me out of my over-exposure to Valeant! I sold my in-the-money puts Monday morning - not at the lows, but within 25% of the lows if you take out the worst hour of the day. I still have my at-the-money puts representing 200% of notional - the next weeks/months will determine whether these work out or not. So I have by no means made a killing overall on the portfolio in the last couple weeks although it will be very hard for me not to have a good year (Valeant would really need to underperform the market from here).
Title: Re: Deflation hedges
Post by: Dazel on August 25, 2015, 07:50:48 PM


China tried again to stop the the free fall in their markets ...it did not work for them or the US markets! now what?

DEFLATION....

It will help and hurt business...Fairfax will be helped! Long term it will help the US but not before we have some tremors.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 28, 2015, 03:01:36 PM
http://www.bloomberg.com/news/articles/2015-08-28/all-of-that-dollar-borrowing-in-emerging-markets-looks-like-it-s-been-one-giant-carry-trade (http://www.bloomberg.com/news/articles/2015-08-28/all-of-that-dollar-borrowing-in-emerging-markets-looks-like-it-s-been-one-giant-carry-trade)

Quote
nce the 2008 financial crisis, companies across emerging markets have been borrowing dollars and converting them into local currencies as part of a massive carry trade...a report released by the bank in January that found firms outside the U.S. have borrowed $9 trillion in U.S. dollars, up from $6 trillion before the global financial crisis.

This seems like one of Soros' reflexive situations. It will probably only get worse if the Fed actually moves forward with hiking rates as that would likely signal the beginning of the unwind if the recent slowdown in EM hasn't already forced the hands of those who borrowed.

The dollar grows stronger -> slows growth and investment of companies that need to repay in dollars while forcing them to sell local currency -> dollar appreciates against local currency due to repurchase of dollars and relative economic growth -> restart cycle.

We might see more to this strong-dollar, deflationary thesis than I had originally anticipated as I hadn't been anticipating a multi-trillion dollar unwind.

It'd be interesting to see who the biggest borrowers were and what the maturity schedule of their debt looks like. At least it was "healthier" institutions doing this and not subprime entities that would absolutely blow up at a dollar that went 10% higher.
Title: Re: Deflation hedges
Post by: gary17 on August 29, 2015, 04:33:29 PM
So Fed, ECB and BOE all seems to think they are seeing inflation...

who is right ! LOL

http://www.bloomberg.com/news/articles/2015-08-29/fed-ecb-and-boe-policy-makers-all-say-they-see-inflation-rising


Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 31, 2015, 06:24:12 AM
So Fed, ECB and BOE all seems to think they are seeing inflation...

who is right ! LOL

http://www.bloomberg.com/news/articles/2015-08-29/fed-ecb-and-boe-policy-makers-all-say-they-see-inflation-rising

Who do you trust? A market full of intelligent participants who have money on the line banking that interest rates and deflation remain lower or a room full of people who believe they can control the actions of hundreds of millions of people through pulling financial levers that are unprecedented in size and application?
Title: Re: Deflation hedges
Post by: beerbaron on August 31, 2015, 07:01:02 AM
Last week we had a company meeting explaining that the RMB devaluation should start triggering 3% cost reduction for all our products in a mean term. All retailers are already asking for the discount.

It's fun to see the macroeconomic affect our behaviour in real life.
Title: Re: Deflation hedges
Post by: Dazel on August 31, 2015, 09:42:20 AM
http://www.marketoracle.co.uk/Article51975.html

dow theory sell signal was confirmed Monday...for those that watch technicals. I don"t but I am aware that a lot of people do.


Title: Re: Deflation hedges
Post by: Dazel on August 31, 2015, 11:17:38 AM
http://news.investors.com/083115-768893-dallas-fed-manufacturing-index-falls-with-oil-prices.htm?ven=yahoocp&src=aurlled&ven=yahoo
Title: Re: Deflation hedges
Post by: gary17 on August 31, 2015, 11:49:41 AM
Dazel
respectfully , I am wondering have you thought about what if FFH is wrong about deflation and we see Businesees continue to grow. ...   In that scenario, is it still worth owning FFH and if so , what do you think the intrinsic value of the business is ?

I read somewhere before FFH could earn 6% on the investments if they are wrong plus the insurance underwriting income.  So maybe 10%.  I wonder what P/E is fair
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 12:54:27 PM
I am really confused by the conviction on this thread that we will have deflation. Why exactly would we have that? What kind of economic catastrophe would be required to achieve that and what is its probability?

The US has had only slight deflation for about a quarter at the depths of the 08 crisis. Spain only had just a slight drop in CPI in 08-09 after which CPI started growing again and that was with 25% unemployment. So why the high confidence in deflation?
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 01:03:18 PM
I do not believe it is conviction as much as the likelihood is higher because of high debt levels and where interest rates are across the world.

Last time around virtually the whole world eased. Rates are already so low that this is going to be tougher to repeat if we have a shock or recession. A shock could be higher interest rates or it could be deflation.

History shows that initially private debt is taken on by the public and during the subsequent shock authorities struggle.

In this case a longer horizon may be better rather than just looking at how 2008 worked out - Ray Dalio's 'How the economic machine works' could be used.

It is cheap insurance if the authorities make a mistake or lose control - which does happen.

Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 01:29:37 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 01:42:36 PM
I wasn't referring to the US as much as the globe.

If USD rises due to a panic what would the impact be.

I would also refer you to slide 27 onwards
http://www.fairfax.ca/files/doc_news/2015/2015-AGM-Final-Slides-for-Website.pdf
Title: Re: Deflation hedges
Post by: Zorrofan on August 31, 2015, 01:53:35 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

From the 2014 Annual Report....

Hedging our common equity exposures has been very costly for us over the last five years – particularly in 2013.  However, we did warn you that we wanted to be safe rather than sorry – our time will come again!
We have worried about deflation in the past few years in our Annual Reports – it is now upon us! In spite of QE1, QE2 and QE3 and some twists, we saw deflation in the U.S. in the second half of 2014, as shown in the table below:
% change June –
U.S. CPI Index June   July     August September October    November December   June-Dec. 2014
                        238.3 238.3    237.9       238.0      237.4       236.2       234.8           -1.5%

We have had deflation at an annualized rate of 3% in the second half of 2014 in the U.S.! And it is not going
away. In fact, in January 2015, the U.S. reported its first year-over-year decline in the CPI index since 2009 of 0.1%. In Europe, we had deflation of 0.5% in the second half of 2014, as shown in the table below:

% change
European CPI June –
                June     July    August   September October    November December     June-Dec. 2014
              117.6    116.8     116.9     117.4         117.4      117.1        117.0              -0.5%

As of January 2015, 17 out of 19 countries in the Euro area were experiencing deflation on a year-over-year basis.


However 8 months into 2015 where is the deflation?  and at what cost?  Over $4 billion dollars plus opportunity cost.  One quick example, if FFH had not spent this money hedging it could have bought 100% of Brit, no equity issue required.

Here is a very interesting write up from Az Value, worth a read.....
http://azvalue.blogspot.ca/2014/04/fairfax-and-their-bets-now-looking-in.html

FWIW, while FFH is losing money hedging BRK is buying, investing $38 billion in PCP and another $4.4 billion in Philips 66. 

my $0.02

cheers
Zorro
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 01:55:24 PM
I am not saying it will again be so - but could you have made the same argument in 2006 about their CDS's?

Edit: I will agree with you once this busines cycle is complete and they are still falling behind.
Title: Re: Deflation hedges
Post by: Zorrofan on August 31, 2015, 02:05:46 PM
I guess what i am saying is after 5 years is FFH wrong?  Maybe they are right, i don't know. But i see BRK buying good business after good business, building the cashflow stream regardless of possible macro events. FFH could have used that money to do the same.  There is an opportunity cost to the hedging, and it is growing larger each year. I read the post by AZ Value and thought it raised some good points......

cheers
Zorro

PS Having posted this, we will likely face a huge deflationary wave shortly and FFH will make billions......
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 31, 2015, 02:23:27 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

Can you look in the rear-view mirror and point out what the second shock to Japan was that caused their two decade long deflationary trend?
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 02:59:47 PM
Wisdom,

Why are you referring to the globe since all the hedges are basically in the US and EU?

You also talk about a currency shock where the USD increases. The USD already increased a lot and inflation was steady. How much farther do you think the USD has to run? Also why will an increase in the USD deliver such a crushing blow to the US economy to put it in deflation when the US is a more local economy than most?

I've also looked at the FFH slides, they don't make a conclusive case that we are in imminent danger of deflation. Also the disinflation we saw in 2014 was a one time hit to CPI from commodity prices. Core inflation was steady. Btw, the negative CPI print we had in the US during the crisis was also commodity driven. Core inflation was not negative.

see http://data.bls.gov/timeseries/CUUR0000SA0L1E?output_view=pct_12mths

It would be nicer to create a credible economic argument (including the mechanisms) of how we're going to have an economic crisis of such a magnitude that would lead to deflation instead of just saying. Well USD shock.... deflation.

Also I don't see how the deflation hedges are anything like the mortgage CDS. With the deflation hedges you have the whole economic concept of sticky prices, a recovering economy with deleveraging going on, and a central bank that's committed to avoid deflation. With the CDS all you needed to make money was for already inflated house prices to stop rising.
Title: Re: Deflation hedges
Post by: no_free_lunch on August 31, 2015, 03:01:58 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

Can you look in the rear-view mirror and point out what the second shock to Japan was that caused their two decade long deflationary trend?

I hate to get in the middle of other people's debates but I actually do think there is a fundamental difference between US & Japan, or a secondary shock if you prefer.  It's demographcis.   A shrinking population is a major impediment to economic growth.  You could probably apply that to some European countries as well but the US has relatively good demographics due to immigration.
Title: Re: Deflation hedges
Post by: Jurgis on August 31, 2015, 03:17:31 PM
US has relatively good demographics due to immigration.

Actually US also has pretty good demographics due to the birth rate. http://www.indexmundi.com/g/r.aspx?c=us&v=25

Not exactly sure why. Europe has much better social/monetary support for having kids and yet people in US have more of them. Anecdotally even my Euro friends in US have more kids even though it makes no sense (they would be better of having kids back in Europe...).
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 03:17:52 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

Can you look in the rear-view mirror and point out what the second shock to Japan was that caused their two decade long deflationary trend?

I hate to get in the middle of other people's debates but I actually do think there is a fundamental difference between US & Japan, or a secondary shock if you prefer.  It's demographcis.   A shrinking population is a major impediment to economic growth.  You could probably apply that to some European countries as well but the US has relatively good demographics due to immigration.
I was just replying when no free lunch posted. So I'll just build on his point. Yes in Japan you had a demographic problem. But also a horrible corporate culture and zombie banks. Also Japan is and was an export driven economy with perpetually poor domestic demand. Add to that a massive appreciation on the yen and new competition in export markets from China, Korea, and other players and you have a horrible situation.

Why the Japanese example is significant is that they broke through the zero barrier in inflation. However what the 08-09 example shows us is that Japan may have been the exception rather than the rule since countries like Spain which took much more economic pain than Japan didn't break the zero bound.

Also btw, I don't know why Japan is relevant here? Fairfax doesn't have Japanese deflation hedges and the Japanese economy is very different from the western economies on which Fairfax has deflation hedges
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on August 31, 2015, 03:26:27 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

Can you look in the rear-view mirror and point out what the second shock to Japan was that caused their two decade long deflationary trend?

I hate to get in the middle of other people's debates but I actually do think there is a fundamental difference between US & Japan, or a secondary shock if you prefer.  It's demographcis.   A shrinking population is a major impediment to economic growth.  You could probably apply that to some European countries as well but the US has relatively good demographics due to immigration.

So you're saying that Japan's deflation was due to demographics and totally non-related to the real estate/equity bubble that bursted in the early 1990s? What about the deflation in the U.S. after the Great Depression?

I don't know who we can look at the trillions spent globally in fiscal and monetary stimulus, which has failed to produce any respectable amount of GDP or inflation growth, and then determine that there is absolutely no deflationary threat or support for Prem's thesis.

Then add to that the commodities are crashing. Bond yields are cratering and were at substantially negative levels just a few months back in certain European countries. Global GDP growth is slowing. The debt overhang for the developed world is massive. And despite a tightening labor market, no sustained growth in real wages has yet occurred. Somehow, we're supposed to look at all of this information and determine that deflationary fears or totally unsupported?

Maybe I'm a fear-mongerer, but it certainly seems to me that the data is showing that deflation is, and has been, the predominant threat since 2009 and that the inflationary story has been BS. The creation of credit is inflationary. The unwinding of credit is deflationary. I don't know if we're into that unwinding phase yet, but when we get there you can be guaranteed that it will be deflationary with, or without, an economic shock. Considering that the globe as a whole is carrying unprecedented amounts of debt, it could certainly be a very prolonged period. Don't fail to see the forest for the trees.


Quote
Also btw, I don't know why Japan is relevant here? Fairfax doesn't have Japanese deflation hedges and the Japanese economy is very different from the western economies on which Fairfax has deflation hedges

I would actually say that Japan is very similar to many European countries with poor demographics, birth rates, high debt, low-growth, export driven, etc. etc. etc.
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 03:29:34 PM
RB - I do not believe that deflation has to happen. I said more likely than before. I don't mean more than 50%. I hope this makes sense.

Because inflation is so low, i believe any slow down could push us under. As slow as things have been to play out, so far I am not confident that FFH is wrong.

I do have most of my money in USD because I do expect US to be relatively better, but, I cannot imagine US continuing to do well if the rest of the world struggles.

I cannot come up with a story that I will have confidence in as to why we will have deflation, but, I can see how it could happen if anything does not go to plan or as we would like it go.
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 03:33:33 PM
I see things the way two cities is describing it. He has put it better than I can.

I do not see anything that says FFH has been wrong. My read is that the majority has yet to come to the same conclusion because we are so used to inflation. It takes time for societies to notice things have changed. But, when everyone finally notices and changes behaviour is when things can get interesting.
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 03:41:21 PM
I see things the way two cities is describing it. He has put it better than I can.

I do not see anything that says FFH has been wrong. My read is that the majority has yet to come to the same conclusion because we are so used to inflation. It takes time for societies to notice things have changed. But, when everyone finally notices and changes behaviour is when things can get interesting.
Well everyone basically changed behavior and deflation didn't happen. So what you're saying is that facts don't have much impact on you.
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 03:42:47 PM
What behaviour changed? People stopped taking on debt?

What was the impact of QE? Would we have had deflation without QE?
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 03:44:42 PM
What behaviour changed? People stopped taking on debt?
Yes. Household debt is significantly below pre crisis levels. At least in the US. Didn't check all of Europe.
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 03:46:05 PM
Two cities, I will get back on your points later on tonight. Bit busy right now.
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 04:07:59 PM
Yes, but is household debt still above long term averages. What if it goes back to the long term averages?
Title: Re: Deflation hedges
Post by: Dazel on August 31, 2015, 04:28:09 PM

Gary17,

as i said...the deflation-hedges are safety if we hum along and Fairfax does 5% on investments we are looking at $1.5B pre tax..last year unwiring profit was $500m (better this year).

Markel trades at a 24.63 PE....Fairfax would be worth over $20b in USD normalized under those conditions...so the reality is  the deflation hedges are a rounding error...but they are protection against a Japanese like experience in the U.S...and if you are paying attention you can see the writing on the wall.

The fed is "going" to tighten in Sept...it will be an interesting world with higher rates. just ask the corporate bond market as it has already tightened.

Title: Re: Deflation hedges
Post by: Dazel on August 31, 2015, 04:35:45 PM


Fairfax investments are almost double the size of Markel's...and Markel's market cap is bigger than Fairfax.
Title: Re: Deflation hedges
Post by: kevin4u2 on August 31, 2015, 06:07:01 PM
What behaviour changed? People stopped taking on debt?
Yes. Household debt is significantly below pre crisis levels. At least in the US. Didn't check all of Europe.

As I have said before.  This statistic in isolation is a waste of time.  Total debt to whatever income measure you want has increased not decreased since the last financial crisis.  Only the US, UK, Spain and Ireland have experienced household deleveraging.  The McKinsey study shows 80% of countries have higher household debt. Some quotes from the study:

Seven years after the global financial crisis, no major economy and only five developing ones have reduced the ratio of debt to GDP (Exhibit 2). In contrast, 14 countries have increased total debt-to-GDP ratios by more than 50 percentage points.

Which countries have deleveraged since the last crisis?  Israel, Romania, Saudi Arabia, Egypt, and Argentina.   

The fact that there has been very little deleveraging around the world since 2007 is cause for concern. A growing body of evidence shows that economic growth prospects for countries with very high levels of debt are diminished. High levels of debt—whether government or private-sector—are associated with slower GDP growth in the long term, and highly indebted countries are also more likely to experience severe and lengthy downturns in the event of a crisis, as consumption and business investment plunge.10 Indeed, the latest research demonstrates how high levels of debt lead to a vicious cycle of falling consumption and employment, causing long and deep recessions.
Title: Re: Deflation hedges
Post by: kevin4u2 on August 31, 2015, 06:26:33 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

From the 2014 Annual Report....

Hedging our common equity exposures has been very costly for us over the last five years – particularly in 2013.  However, we did warn you that we wanted to be safe rather than sorry – our time will come again!
We have worried about deflation in the past few years in our Annual Reports – it is now upon us! In spite of QE1, QE2 and QE3 and some twists, we saw deflation in the U.S. in the second half of 2014, as shown in the table below:
% change June –
U.S. CPI Index June   July     August September October    November December   June-Dec. 2014
                        238.3 238.3    237.9       238.0      237.4       236.2       234.8           -1.5%

We have had deflation at an annualized rate of 3% in the second half of 2014 in the U.S.! And it is not going
away. In fact, in January 2015, the U.S. reported its first year-over-year decline in the CPI index since 2009 of 0.1%. In Europe, we had deflation of 0.5% in the second half of 2014, as shown in the table below:

% change
European CPI June –
                June     July    August   September October    November December     June-Dec. 2014
              117.6    116.8     116.9     117.4         117.4      117.1        117.0              -0.5%

As of January 2015, 17 out of 19 countries in the Euro area were experiencing deflation on a year-over-year basis.


However 8 months into 2015 where is the deflation?  and at what cost?  Over $4 billion dollars plus opportunity cost.  One quick example, if FFH had not spent this money hedging it could have bought 100% of Brit, no equity issue required.

Here is a very interesting write up from Az Value, worth a read.....
http://azvalue.blogspot.ca/2014/04/fairfax-and-their-bets-now-looking-in.html

FWIW, while FFH is losing money hedging BRK is buying, investing $38 billion in PCP and another $4.4 billion in Philips 66. 

my $0.02

cheers
Zorro

Zorro.  Please explain where you're getting this $4 billion cost on CPI derivatives?  Nonsense.  Your spewing incorrect numbers just like AZvalue did in his post about FFH compared to BRK.  AZvalue incorrectly calculated the change in book value per share in his comparision of FFH to BRK.  Properly calculated FFH outperforms BRK in every category except 5 years.  Try again next time. 
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 06:28:05 PM
What behaviour changed? People stopped taking on debt?
Yes. Household debt is significantly below pre crisis levels. At least in the US. Didn't check all of Europe.

As I have said before.  This statistic in isolation is a waste of time.  Total debt to whatever income measure you want has increased not decreased since the last financial crisis.  Only the US, UK, Spain and Ireland have experienced household deleveraging.  The McKinsey study shows 80% of countries have higher household debt. Some quotes from the study:

Seven years after the global financial crisis, no major economy and only five developing ones have reduced the ratio of debt to GDP (Exhibit 2). In contrast, 14 countries have increased total debt-to-GDP ratios by more than 50 percentage points.

Which countries have deleveraged since the last crisis?  Israel, Romania, Saudi Arabia, Egypt, and Argentina.   

The fact that there has been very little deleveraging around the world since 2007 is cause for concern. A growing body of evidence shows that economic growth prospects for countries with very high levels of debt are diminished. High levels of debt—whether government or private-sector—are associated with slower GDP growth in the long term, and highly indebted countries are also more likely to experience severe and lengthy downturns in the event of a crisis, as consumption and business investment plunge.10 Indeed, the latest research demonstrates how high levels of debt lead to a vicious cycle of falling consumption and employment, causing long and deep recessions.
Kevin, I've engaged with you on another thread where you were talking about a lot of different things at once. I told you that if you want to explore any of them in particular based on economic concepts I'd be glad to go into them with you. You didn't reply.

In that topic you've also referenced this McKinsey paper. It is at best a lazy paper and at worst dishonest. In it they constantly mix up rates and levels of debt. A total no-no. Also the concept that they use that higher levels of debt lead to the vicious cycle of lower economic growth and higher unemployment comes from a Reinhart & Rogoff paper that has been discredited in a very embarrassing way when it was proven that their math was wrong which led them to confuse causality with correlation.

Over here I was talking about the FFH deflation hedges that apply to US and EU, not globally. If you're going to make an economic argument for deflation you should explain how we are at risk of a massive decrease in demand or a massive increase in supply that will break sticky prices and put those economies in deflation.

By the way, a very slow overall deleveraging with the government levering up to offset private sector delevering is key to avoid deflation. So what exactly is your point?
Title: Re: Deflation hedges
Post by: no_free_lunch on August 31, 2015, 06:34:27 PM
I think there has actually been modest deleveraging in total in the US.  I think this was covered earlier in the thread.   Not to say we aren't still in a real bind, but technically the US has deleveraged.

You can look at fed release Z1, where they break out debt by sector.  Here are the numbers I see.

Total Debt including financial institutions,
2007: ~$50T
2014: ~$56T

GDP:
2007: $14.5T
2014: $18.0T

Debt / GDP:
2007:  344%
2014:  311%


http://www.federalreserve.gov/releases/z1/current/z1.pdf

Given this, my concern is when exactly will the deleverage tsunami hit?   I thought it was happening in 2008 but it just passed.  So it has been 8 years and a hell of a storm but the economy has grown and debt levels have improved marginally.  What if we just kind of keep plowing along for another 20 years?   I don't know, I am just going to buy good quality companies.  Maybe if VIX gets really low again I'll buy some puts but it's really tough to call when the house of cards collapses.
Title: Re: Deflation hedges
Post by: no_free_lunch on August 31, 2015, 06:40:40 PM
I actually think that the deleveraging is greater than the numbers show.  A big part of what has happened is debt has shifted to the government in the US.  Government debt is higher grade and thus lower interest so I think the actual interest paid (even if we were to normalize interest rates) is quite a bit less.
Title: Re: Deflation hedges
Post by: kevin4u2 on August 31, 2015, 07:06:50 PM
What behaviour changed? People stopped taking on debt?
Yes. Household debt is significantly below pre crisis levels. At least in the US. Didn't check all of Europe.

As I have said before.  This statistic in isolation is a waste of time.  Total debt to whatever income measure you want has increased not decreased since the last financial crisis.  Only the US, UK, Spain and Ireland have experienced household deleveraging.  The McKinsey study shows 80% of countries have higher household debt. Some quotes from the study:

Seven years after the global financial crisis, no major economy and only five developing ones have reduced the ratio of debt to GDP (Exhibit 2). In contrast, 14 countries have increased total debt-to-GDP ratios by more than 50 percentage points.

Which countries have deleveraged since the last crisis?  Israel, Romania, Saudi Arabia, Egypt, and Argentina.   

The fact that there has been very little deleveraging around the world since 2007 is cause for concern. A growing body of evidence shows that economic growth prospects for countries with very high levels of debt are diminished. High levels of debt—whether government or private-sector—are associated with slower GDP growth in the long term, and highly indebted countries are also more likely to experience severe and lengthy downturns in the event of a crisis, as consumption and business investment plunge.10 Indeed, the latest research demonstrates how high levels of debt lead to a vicious cycle of falling consumption and employment, causing long and deep recessions.
Kevin, I've engaged with you on another thread where you were talking about a lot of different things at once. I told you that if you want to explore any of them in particular based on economic concepts I'd be glad to go into them with you. You didn't reply.

In that topic you've also referenced this McKinsey paper. It is at best a lazy paper and at worst dishonest. In it they constantly mix up rates and levels of debt. A total no-no. Also the concept that they use that higher levels of debt lead to the vicious cycle of lower economic growth and higher unemployment comes from a Reinhart & Rogoff paper that has been discredited in a very embarrassing way when it was proven that their math was wrong which led them to confuse causality with correlation.

Over here I was talking about the FFH deflation hedges that apply to US and EU, not globally. If you're going to make an economic argument for deflation you should explain how we are at risk of a massive decrease in demand or a massive increase in supply that will break sticky prices and put those economies in deflation.

By the way, a very slow overall deleveraging with the government levering up to offset private sector delevering is key to avoid deflation. So what exactly is your point?

Why did you waste some many words?  You could have just said, "I'm smarter than everyone."  Are you an economist?

My point was there has been no, "slow overall deleveraging".  We already have deflation for everything in the CPI less shelter, see attached.  No massive changes changes needed. 
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 08:09:31 PM
So you're saying that Japan's deflation was due to demographics and totally non-related to the real estate/equity bubble that bursted in the early 1990s? What about the deflation in the U.S. after the Great Depression?

I don't know who we can look at the trillions spent globally in fiscal and monetary stimulus, which has failed to produce any respectable amount of GDP or inflation growth, and then determine that there is absolutely no deflationary threat or support for Prem's thesis.

Then add to that the commodities are crashing. Bond yields are cratering and were at substantially negative levels just a few months back in certain European countries. Global GDP growth is slowing. The debt overhang for the developed world is massive. And despite a tightening labor market, no sustained growth in real wages has yet occurred. Somehow, we're supposed to look at all of this information and determine that deflationary fears or totally unsupported?

Maybe I'm a fear-mongerer, but it certainly seems to me that the data is showing that deflation is, and has been, the predominant threat since 2009 and that the inflationary story has been BS. The creation of credit is inflationary. The unwinding of credit is deflationary. I don't know if we're into that unwinding phase yet, but when we get there you can be guaranteed that it will be deflationary with, or without, an economic shock. Considering that the globe as a whole is carrying unprecedented amounts of debt, it could certainly be a very prolonged period. Don't fail to see the forest for the trees.


Quote
Also btw, I don't know why Japan is relevant here? Fairfax doesn't have Japanese deflation hedges and the Japanese economy is very different from the western economies on which Fairfax has deflation hedges

I would actually say that Japan is very similar to many European countries with poor demographics, birth rates, high debt, low-growth, export driven, etc. etc. etc.
Two Cities, as promised, I'm coming back to you with some delay.

You bring up a lot of points so I'm going to try to address it as much as I can. So let's begin with Japan. It's harder for me to do a very deep dive with numbers on Japan because I don't have much access to Japan stats so please excuse me if I stay a bit high level. The similarities between Japan and the US are that they had real estate bubbles (in Japan it was commercial RE in the US was all RE) and that a lot of risk related to that was concentrated in the financial system. That's kind of where similarities end.

Japan's households are prodigious savers that's why Japan is dependent on exports. US households are prodigious consumers and got levered up. In the US households were levered up, in Japan corporates levered up. In the US you had trade deficits, in Japan you had big trade surpluses. In the US the government moved to clean up the banking system, in Japan you had zombie banks. I could go on but I'm starting to sound like George Carlin.

Japan had an issue where the corporates behaved like households instead of corporates, cutting investments and hoarding cash instead of issuing equity when trying to delever. Add to that the fact that they had new and fierce competition in their export markets from Korea, China and other players and you get a massive deficit in demand. The households did not step in to fill that demand gap because over there they're savers not consumers so you end up with a huge output gap and deflation. Demographics played a part too mainly on the domestic consumption side. But I'm not sure that if Japan had better demographics things would have been different. Domestic consumption over there is and has been very weak.

As you can see about the only comparison between Japan and the western economies is that they've had a bubble too. you mention the European economies that are export driven, bad demographics, high debt, etc. The European economy that comes closes to Japan is Germany and they didn't have a real estate bubble and the debt isn't very high.

Bond yields are cratering in some European countries: of note are Germany, France, Netherlands and Finland. These have more to do with the Euro crisis than inflation expectations. Basically Italians, Spaniards, and Greeks would rather have German, French, and Dutch euros rather than their own. They're willing to pay for that.

Further on, slowing GDP growth doesn't mean deflation, the sign of a tight labour market is inflation - so you don't have a tight labour market. Debt overhang leads to deflation if you have an uncontrolled deleveraging - the US has delivered a lot in a controlled way. Could it have been handled better? Yes. Is the risk much much lower today than in 08? Hell yes!

You bring up the US deflation of the 1930s. Back then the US was on the gold standard, it had a high interest rate environment in the midst of a massive economic contraction and it was running budget surpluses. Does that sound like the situation we're in today?

I'm not saying that high inflation is around the corner. I'm just saying that deflation is far away. Yes the creation of credit is inflationary and the reduction deflationary. But you have had a lot of credit reduction in the US with the government stepping in and closing that output gap with it's own credit. Also right now the US fiscal position looks pretty good. You will probably see US budget surpluses when the economy gets to full employment.

So to argue that we're at risk for inflation you have to make an economic case that there will be such a dramatic drop in demand (the kind that results in 20% unemployment or something like that) or that the US government will be forced to undergo a significant uncontrolled delevering at the sovereign level. I don't see that even remotely happening. But if you do, please make the case.
Title: Re: Deflation hedges
Post by: wisdom on August 31, 2015, 08:26:09 PM
RB do you believe that US has decoupled from the rest of the world?

If not, with inflation where it is, do you think it is possible that inflation could drop a bit lower? What if we have a recession at the same time? I do not know the answers to these and thus, cannot make a case.

Things can change quickly as it has been a while since the last slow down. I do not see what I lose by being cautious and prepared.
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 09:36:02 PM
RB do you believe that US has decoupled from the rest of the world?

If not, with inflation where it is, do you think it is possible that inflation could drop a bit lower? What if we have a recession at the same time? I do not know the answers to these and thus, cannot make a case.

Things can change quickly as it has been a while since the last slow down. I do not see what I lose by being cautious and prepared.
Wisdom,

I'm not saying that we cannot have a slow down or even a recession. It doesn't look like it's imminent, but no one knows these things. I'm also not saying that inflation may not drop from current level if something like that happens. Also I'm not one of those people that sees inflation around every corner. In fact I think that we'll be in a low inflation environment for a long time. What I'm saying is that there is a very big difference between disinflation and deflation. That zero barrier is very significant like the sound or gravity. The closer you get to it the harder it is to advance towards it. To fly you only need a small Cessna. To go into space you need a space ship.

The US also hasn't decoupled from the rest of the world more than in the past. What I was trying to convey is that the foreign sector of the US economy is not as large as for other economies. So to put it in your words I would say that the US economy is more decoupled from the rest of the world than the rest of the world is coupled to the US. Actually the way that external shocks make their way into the US is through the financial system, not through the real economy. It's true that if it's not ring fenced troubles of the financial system will make their way into the real economy but that's a whole different conversation.

Also to address your earlier post about household debt and revision to the mean. US household debt to gdp went from 98% in 2009 to 80% now. That's a large decrease. I couldn't quickly find a long term series for household debt to GDP, but from memory the long term average is lower but not much lower - around 50-60%. I think that household delevering in the US will still go on but we're probably not far from the end. You also have to keep in mind supply and demand for credit. The cost of credit (interest rates) are also lower than long term average so you should probably expect the that the equilibrium for levels of debt should also be higher than historical levels.
Title: Re: Deflation hedges
Post by: Zorrofan on August 31, 2015, 09:41:44 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

From the 2014 Annual Report....

Hedging our common equity exposures has been very costly for us over the last five years – particularly in 2013.  However, we did warn you that we wanted to be safe rather than sorry – our time will come again!
We have worried about deflation in the past few years in our Annual Reports – it is now upon us! In spite of QE1, QE2 and QE3 and some twists, we saw deflation in the U.S. in the second half of 2014, as shown in the table below:
% change June –
U.S. CPI Index June   July     August September October    November December   June-Dec. 2014
                        238.3 238.3    237.9       238.0      237.4       236.2       234.8           -1.5%

We have had deflation at an annualized rate of 3% in the second half of 2014 in the U.S.! And it is not going
away. In fact, in January 2015, the U.S. reported its first year-over-year decline in the CPI index since 2009 of 0.1%. In Europe, we had deflation of 0.5% in the second half of 2014, as shown in the table below:

% change
European CPI June –
                June     July    August   September October    November December     June-Dec. 2014
              117.6    116.8     116.9     117.4         117.4      117.1        117.0              -0.5%

As of January 2015, 17 out of 19 countries in the Euro area were experiencing deflation on a year-over-year basis.


However 8 months into 2015 where is the deflation?  and at what cost?  Over $4 billion dollars plus opportunity cost.  One quick example, if FFH had not spent this money hedging it could have bought 100% of Brit, no equity issue required.

Here is a very interesting write up from Az Value, worth a read.....
http://azvalue.blogspot.ca/2014/04/fairfax-and-their-bets-now-looking-in.html

FWIW, while FFH is losing money hedging BRK is buying, investing $38 billion in PCP and another $4.4 billion in Philips 66. 

my $0.02

cheers
Zorro

Zorro.  Please explain where you're getting this $4 billion cost on CPI derivatives?  Nonsense.  Your spewing incorrect numbers just like AZvalue did in his post about FFH compared to BRK.  AZvalue incorrectly calculated the change in book value per share in his comparision of FFH to BRK.  Properly calculated FFH outperforms BRK in every category except 5 years.  Try again next time.


From page 20 of the Fairfax 2014 annual report......

In the last five years, we have had significant losses, mostly unrealized, from our hedging program and from our CPI-linked derivative contracts, as shown below:
                                                  2010           2011       2012         2013          2014              Cumulative
Equity hedges                          (936.6)         413.9    (1,005.5)  (1,982.0)    (194.5)            (3,704.7)
CPI-linked derivative contracts     28.1        (233.9)    (129.2)     (126.9)        17.7                (444.2)
Total                                         (908.5)        180.0      (1,134.7) (2,108.9)    (176.8 )           (4,148.9)


My nonsense as you call it comes from the annual report, try reading it before attacking someone next time....and try being civil.
Title: Re: Deflation hedges
Post by: rb on August 31, 2015, 10:16:56 PM
Why did you waste some many words?  You could have just said, "I'm smarter than everyone."  Are you an economist?

My point was there has been no, "slow overall deleveraging".  We already have deflation for everything in the CPI less shelter, see attached.  No massive changes changes needed.
Kevin,

As a matter of fact I am an economist. I don't know why that's relevant though. I also didn't say I was smarter than everyone, I was just addressing the points you brought up.

You keep saying that there has not been any slow deleveraging when the data points otherwise. You claim deflation is everywhere. It's only shelter you say, but really it's commodities that caused the negative print in 2014. See my attached graph. The thing is that inflation is a rate of change so in order to keep getting that print you need for commodities to keep dropping. There is a reason why all the central banks in the world use core cpi (cpi less food and energy) for policy decision instead of cpi.
Title: Re: Deflation hedges
Post by: Dazel on September 01, 2015, 05:59:08 AM
http://www.realclearmarkets.com/articles/2015/01/20/why_did_no_one_predict_the_oil-price_collapse_101495.html

Well....Fairfax did...everyone take your models and throw in some changes. Predicting when where and how is difficult. What if the 10 year rises to 4% fro example which none of us have predicted?

For a cummulative $400m over many years (deflation hedge cost)....we hedge a $30 billion dollar investment portfolio...heads we win "big"...tails we lose a little over 1% over many years. That is "good' insurance.

We are in a taper tantrum right now higher rates hurt those with debt which is everyone. A china meltdown is happening...will they stop it? yes most likely.

where are we headed? "no one" knows for sure....

as for the equity hedges they have been a large drag...but that is why I have reinvested into Fairfax...I was bullish for the last 6 years and now I am not...but if things chug along Fairfax will do better than most because of the quality of their insurance business and their huge investment portfolio vs their market cap.

oh yeah and fully hedged....once again find me someone else in this  position and I will look at them...

P.S there should be one thread for Fairfax "earnings potential" instead of the three that are going on...putting everyones excellent thoughts into one read would be helpful for a better snap shot of where Fairfax is today.

Dazel

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 01, 2015, 06:14:47 AM
So you're saying that Japan's deflation was due to demographics and totally non-related to the real estate/equity bubble that bursted in the early 1990s? What about the deflation in the U.S. after the Great Depression?

I don't know who we can look at the trillions spent globally in fiscal and monetary stimulus, which has failed to produce any respectable amount of GDP or inflation growth, and then determine that there is absolutely no deflationary threat or support for Prem's thesis.

Then add to that the commodities are crashing. Bond yields are cratering and were at substantially negative levels just a few months back in certain European countries. Global GDP growth is slowing. The debt overhang for the developed world is massive. And despite a tightening labor market, no sustained growth in real wages has yet occurred. Somehow, we're supposed to look at all of this information and determine that deflationary fears or totally unsupported?

Maybe I'm a fear-mongerer, but it certainly seems to me that the data is showing that deflation is, and has been, the predominant threat since 2009 and that the inflationary story has been BS. The creation of credit is inflationary. The unwinding of credit is deflationary. I don't know if we're into that unwinding phase yet, but when we get there you can be guaranteed that it will be deflationary with, or without, an economic shock. Considering that the globe as a whole is carrying unprecedented amounts of debt, it could certainly be a very prolonged period. Don't fail to see the forest for the trees.


Quote
Also btw, I don't know why Japan is relevant here? Fairfax doesn't have Japanese deflation hedges and the Japanese economy is very different from the western economies on which Fairfax has deflation hedges

I would actually say that Japan is very similar to many European countries with poor demographics, birth rates, high debt, low-growth, export driven, etc. etc. etc.
Two Cities, as promised, I'm coming back to you with some delay.

You bring up a lot of points so I'm going to try to address it as much as I can. So let's begin with Japan. It's harder for me to do a very deep dive with numbers on Japan because I don't have much access to Japan stats so please excuse me if I stay a bit high level. The similarities between Japan and the US are that they had real estate bubbles (in Japan it was commercial RE in the US was all RE) and that a lot of risk related to that was concentrated in the financial system. That's kind of where similarities end.

Japan's households are prodigious savers that's why Japan is dependent on exports. US households are prodigious consumers and got levered up. In the US households were levered up, in Japan corporates levered up. In the US you had trade deficits, in Japan you had big trade surpluses. In the US the government moved to clean up the banking system, in Japan you had zombie banks. I could go on but I'm starting to sound like George Carlin.

Japan had an issue where the corporates behaved like households instead of corporates, cutting investments and hoarding cash instead of issuing equity when trying to delever. Add to that the fact that they had new and fierce competition in their export markets from Korea, China and other players and you get a massive deficit in demand. The households did not step in to fill that demand gap because over there they're savers not consumers so you end up with a huge output gap and deflation. Demographics played a part too mainly on the domestic consumption side. But I'm not sure that if Japan had better demographics things would have been different. Domestic consumption over there is and has been very weak.

As you can see about the only comparison between Japan and the western economies is that they've had a bubble too. you mention the European economies that are export driven, bad demographics, high debt, etc. The European economy that comes closes to Japan is Germany and they didn't have a real estate bubble and the debt isn't very high.

Bond yields are cratering in some European countries: of note are Germany, France, Netherlands and Finland. These have more to do with the Euro crisis than inflation expectations. Basically Italians, Spaniards, and Greeks would rather have German, French, and Dutch euros rather than their own. They're willing to pay for that.

Further on, slowing GDP growth doesn't mean deflation, the sign of a tight labour market is inflation - so you don't have a tight labour market. Debt overhang leads to deflation if you have an uncontrolled deleveraging - the US has delivered a lot in a controlled way. Could it have been handled better? Yes. Is the risk much much lower today than in 08? Hell yes!

You bring up the US deflation of the 1930s. Back then the US was on the gold standard, it had a high interest rate environment in the midst of a massive economic contraction and it was running budget surpluses. Does that sound like the situation we're in today?

I'm not saying that high inflation is around the corner. I'm just saying that deflation is far away. Yes the creation of credit is inflationary and the reduction deflationary. But you have had a lot of credit reduction in the US with the government stepping in and closing that output gap with it's own credit. Also right now the US fiscal position looks pretty good. You will probably see US budget surpluses when the economy gets to full employment.

So to argue that we're at risk for inflation you have to make an economic case that there will be such a dramatic drop in demand (the kind that results in 20% unemployment or something like that) or that the US government will be forced to undergo a significant uncontrolled delevering at the sovereign level. I don't see that even remotely happening. But if you do, please make the case.

Let's just agree to disagree. You have all your reasons for why Japan, America, and Europe are different. I have my reason for why they're the same - a decade of massive malinvestment fueled by debt that exploded. I think the other stuff is important, but not nearly as important as this later similarity which I believe has the ability to trump the other factors.

I'll make money if I'm right. I'll lose money (or opportunity cost) if I'm wrong. I'm happy with the trade off and don't really need to convince others. In fact, the fewer people are convinced, the more money I stand to make if I'm right, so I'll just leave this conversation here.

Title: Re: Deflation hedges
Post by: kevin4u2 on September 01, 2015, 06:17:37 AM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

From the 2014 Annual Report....

Hedging our common equity exposures has been very costly for us over the last five years – particularly in 2013.  However, we did warn you that we wanted to be safe rather than sorry – our time will come again!
We have worried about deflation in the past few years in our Annual Reports – it is now upon us! In spite of QE1, QE2 and QE3 and some twists, we saw deflation in the U.S. in the second half of 2014, as shown in the table below:
% change June –
U.S. CPI Index June   July     August September October    November December   June-Dec. 2014
                        238.3 238.3    237.9       238.0      237.4       236.2       234.8           -1.5%

We have had deflation at an annualized rate of 3% in the second half of 2014 in the U.S.! And it is not going
away. In fact, in January 2015, the U.S. reported its first year-over-year decline in the CPI index since 2009 of 0.1%. In Europe, we had deflation of 0.5% in the second half of 2014, as shown in the table below:

% change
European CPI June –
                June     July    August   September October    November December     June-Dec. 2014
              117.6    116.8     116.9     117.4         117.4      117.1        117.0              -0.5%

As of January 2015, 17 out of 19 countries in the Euro area were experiencing deflation on a year-over-year basis.


However 8 months into 2015 where is the deflation?  and at what cost?  Over $4 billion dollars plus opportunity cost.  One quick example, if FFH had not spent this money hedging it could have bought 100% of Brit, no equity issue required.

Here is a very interesting write up from Az Value, worth a read.....
http://azvalue.blogspot.ca/2014/04/fairfax-and-their-bets-now-looking-in.html

FWIW, while FFH is losing money hedging BRK is buying, investing $38 billion in PCP and another $4.4 billion in Philips 66. 

my $0.02

cheers
Zorro

Zorro.  Please explain where you're getting this $4 billion cost on CPI derivatives?  Nonsense.  Your spewing incorrect numbers just like AZvalue did in his post about FFH compared to BRK.  AZvalue incorrectly calculated the change in book value per share in his comparision of FFH to BRK.  Properly calculated FFH outperforms BRK in every category except 5 years.  Try again next time.


From page 20 of the Fairfax 2014 annual report......

In the last five years, we have had significant losses, mostly unrealized, from our hedging program and from our CPI-linked derivative contracts, as shown below:
                                                  2010           2011       2012         2013          2014              Cumulative
Equity hedges                          (936.6)         413.9    (1,005.5)  (1,982.0)    (194.5)            (3,704.7)
CPI-linked derivative contracts     28.1        (233.9)    (129.2)     (126.9)        17.7                (444.2)
Total                                         (908.5)        180.0      (1,134.7) (2,108.9)    (176.8 )           (4,148.9)


My nonsense as you call it comes from the annual report, try reading it before attacking someone next time....and try being civil.

Reread your post.  Where did you say you were including the equity hedges?  This is the deflation hedges thread and all you quoted and discussed was the CPI hedges.  We are 8 months into 2015 and the costs of the CPI hedges are $444 million dollars, not $4 billion.  Now you want to include the equity hedges.  Ok, whatever.   As Dazel has pointed out this is a 1% cost spread over a number of years for insurance.  Time will tell if they will pay off. 
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 09:23:45 AM
http://www.realclearmarkets.com/articles/2015/01/20/why_did_no_one_predict_the_oil-price_collapse_101495.html

Well....Fairfax did...everyone take your models and throw in some changes. Predicting when where and how is difficult. What if the 10 year rises to 4% fro example which none of us have predicted?

For a cummulative $400m over many years (deflation hedge cost)....we hedge a $30 billion dollar investment portfolio...heads we win "big"...tails we lose a little over 1% over many years. That is "good' insurance.

We are in a taper tantrum right now higher rates hurt those with debt which is everyone. A china meltdown is happening...will they stop it? yes most likely.

where are we headed? "no one" knows for sure....

as for the equity hedges they have been a large drag...but that is why I have reinvested into Fairfax...I was bullish for the last 6 years and now I am not...but if things chug along Fairfax will do better than most because of the quality of their insurance business and their huge investment portfolio vs their market cap.

oh yeah and fully hedged....once again find me someone else in this  position and I will look at them...

P.S there should be one thread for Fairfax "earnings potential" instead of the three that are going on...putting everyones excellent thoughts into one read would be helpful for a better snap shot of where Fairfax is today.

Dazel
I don't see how the deflation hedges protect you if rates go to 4%. If rates go to 4% you will have a good economy and positive inflation so you're not getting anything on the deflation hedges.
Title: Re: Deflation hedges
Post by: Dazel on September 01, 2015, 10:32:36 AM

RB,

If china was a huge seller of treasuries (as they are now) and the rest of the pack jumped in taking the rates higher to 4%.

the deflation hedges would like be worth$20 billion as the deflation in the U.S would be depression like.


Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 11:34:34 AM

RB,

If china was a huge seller of treasuries (as they are now) and the rest of the pack jumped in taking the rates higher to 4%.

the deflation hedges would like be worth$20 billion as the deflation in the U.S would be depression like.
Still don't see why China selling treasuries would push rates to 4%. Are you considering the circularity of money? China sells treasuries, they get cash USD why wouldn't that cash USD find its way back into the treasuries market? It's not an accident that China has that many treasuries. They were forced to buy them because they had USD reserves from running a trade surplus with the US. If you have USD you have to buy USD assets.

Also you assume that the fed is just gonna sit back and watch the show as interest rates rise and cause all sorts of havoc. I think it's more realistic to assume that the fed will step in and stop that.
Title: Re: Deflation hedges
Post by: roughlyright on September 01, 2015, 11:38:38 AM
If I assume that Prem's theory on deflation is going to be proven correct, how can a small investor ride the coat tails of Prem?

I cannot buy CPI linked derivatives in the Market as a small investor. What other ways can I profit from a deflationary world?
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 11:48:23 AM
If I assume that Prem's theory on deflation is going to be proven correct, how can a small investor ride the coat tails of Prem?

I cannot buy CPI linked derivatives in the Market as a small investor. What other ways can I profit from a deflationary world?
well what I've been saying is that it looks highly unlikely that we will have a deflationary world. But if you're convinced that deflation is coming there's a ton of way to profit. The simplest way would be just long treasuries. You can create your own derivative with a long/short trade with treasuries and TIPS, or you can probably make a killing with bond options. This is just off the top of my head. I'm sure there's other ways too.
Title: Re: Deflation hedges
Post by: Dazel on September 01, 2015, 12:24:44 PM


RB,

I was obviously being hypothetical  with a 4% interest rate shock and how it could freakishly happen....if I thought it was true Fairfax would  be a triple.

Title: Re: Deflation hedges
Post by: Zorrofan on September 01, 2015, 01:11:05 PM
Please explain to me how the outlook is higher now than before? The US private sector has deleveraged quite a bit and you have a decent economic recovery under way?

If you have an economic shock that doesn't mean deflation. To achieve deflation you will need another shock probably of a  higher than the one in 08. Just that fed may tighten a bit early doesn't mean automatic deflation. Those errors can also be reversed. If the economy slows down I think we can be pretty confident that you see QE4 coming in.

Given the facts it really doesn't seem like cheap insurance at all.

You say that 2008 relevant enough to draw conclusions from. Ok look long term and let me know what cases in history do you think are more pertinent to the present situation in the US. I would leave Japan out since their doesn't really look like the US.

From the 2014 Annual Report....

Hedging our common equity exposures has been very costly for us over the last five years – particularly in 2013.  However, we did warn you that we wanted to be safe rather than sorry – our time will come again!
We have worried about deflation in the past few years in our Annual Reports – it is now upon us! In spite of QE1, QE2 and QE3 and some twists, we saw deflation in the U.S. in the second half of 2014, as shown in the table below:
% change June –
U.S. CPI Index June   July     August September October    November December   June-Dec. 2014
                        238.3 238.3    237.9       238.0      237.4       236.2       234.8           -1.5%

We have had deflation at an annualized rate of 3% in the second half of 2014 in the U.S.! And it is not going
away. In fact, in January 2015, the U.S. reported its first year-over-year decline in the CPI index since 2009 of 0.1%. In Europe, we had deflation of 0.5% in the second half of 2014, as shown in the table below:

% change
European CPI June –
                June     July    August   September October    November December     June-Dec. 2014
              117.6    116.8     116.9     117.4         117.4      117.1        117.0              -0.5%

As of January 2015, 17 out of 19 countries in the Euro area were experiencing deflation on a year-over-year basis.


However 8 months into 2015 where is the deflation?  and at what cost?  Over $4 billion dollars plus opportunity cost.  One quick example, if FFH had not spent this money hedging it could have bought 100% of Brit, no equity issue required.

Here is a very interesting write up from Az Value, worth a read.....
http://azvalue.blogspot.ca/2014/04/fairfax-and-their-bets-now-looking-in.html

FWIW, while FFH is losing money hedging BRK is buying, investing $38 billion in PCP and another $4.4 billion in Philips 66. 

my $0.02

cheers
Zorro

Zorro.  Please explain where you're getting this $4 billion cost on CPI derivatives?  Nonsense.  Your spewing incorrect numbers just like AZvalue did in his post about FFH compared to BRK.  AZvalue incorrectly calculated the change in book value per share in his comparision of FFH to BRK.  Properly calculated FFH outperforms BRK in every category except 5 years.  Try again next time.


From page 20 of the Fairfax 2014 annual report......

In the last five years, we have had significant losses, mostly unrealized, from our hedging program and from our CPI-linked derivative contracts, as shown below:
                                                  2010           2011       2012         2013          2014              Cumulative
Equity hedges                          (936.6)         413.9    (1,005.5)  (1,982.0)    (194.5)            (3,704.7)
CPI-linked derivative contracts     28.1        (233.9)    (129.2)     (126.9)        17.7                (444.2)
Total                                         (908.5)        180.0      (1,134.7) (2,108.9)    (176.8 )           (4,148.9)


My nonsense as you call it comes from the annual report, try reading it before attacking someone next time....and try being civil.

Reread your post.  Where did you say you were including the equity hedges?  This is the deflation hedges thread and all you quoted and discussed was the CPI hedges.  We are 8 months into 2015 and the costs of the CPI hedges are $444 million dollars, not $4 billion.  Now you want to include the equity hedges.  Ok, whatever.   As Dazel has pointed out this is a 1% cost spread over a number of years for insurance.  Time will tell if they will pay off.

Clearly you did not read my original post, where I was clearly talking about the equity hedges and the CPI hedges.  But life is too short to waste time arguing with you. You want to ignore $3.6 billion in hedging losses, your choice......
Title: Re: Deflation hedges
Post by: no_free_lunch on September 01, 2015, 01:35:56 PM
If I assume that Prem's theory on deflation is going to be proven correct, how can a small investor ride the coat tails of Prem?

I cannot buy CPI linked derivatives in the Market as a small investor. What other ways can I profit from a deflationary world?

You would think, as rb said, that you could just buy long-dated treasuries or juice it with calls.  It makes sense but then treasury prices are flat to down since this whole thing started.   I guess China is dumping but this is just one more reason why I am suspicious of trying to time a macro event and then predict the impact on various security prices.

I guess if you want to go this route you could find an ETF which tracks commodities and buy puts.  Problem is most of these are already down a lot and the VIX is quite high now.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 01:57:36 PM
Well roughlyright is looking for a security to profit when inflation goes negative. Right now core inflation is humming along steadily. If you would move from where we are to say -1% inflation treasuries are probably gonna jump like crazy and those call will make a lot of money. Another nice thing about the treasury calls is that you don't need actual deflation to make money. If inflation just slows down say to 0.5% treasuries will do really well. I'd say the odds are way better to have a slowdown in inflation rather than outright deflation.
Title: Re: Deflation hedges
Post by: wisdom on September 01, 2015, 02:11:43 PM
rb - FFH can do the same with deflation hedges. They do not need outright deflation, just the perception in the market.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 02:12:39 PM
rb - FFH can do the same with deflation hedges. They do not need outright deflation, just the perception in the market.
Aren't the derivatives linked to CPI?
Title: Re: Deflation hedges
Post by: wisdom on September 01, 2015, 02:28:55 PM
That does not stop them from selling them - just like any other derivative. People buy and sell them based on their expectations of the future.
Title: Re: Deflation hedges
Post by: kevin4u2 on September 01, 2015, 02:32:37 PM
rb - FFH can do the same with deflation hedges. They do not need outright deflation, just the perception in the market.
Aren't the derivatives linked to CPI?

The latest contracts only need CPI to be 0.5%. 

And no, the contracts do not need outright deflation, just like credit default swaps don't need a default.  Market perceptions will greatly influence the price. 
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 02:51:58 PM
rb - FFH can do the same with deflation hedges. They do not need outright deflation, just the perception in the market.
Aren't the derivatives linked to CPI?

The latest contracts only need CPI to be 0.5%. 

And no, the contracts do not need outright deflation, just like credit default swaps don't need a default.  Market perceptions will greatly influence the price.
Great! so if CPI growth drops to 0.5% they'll stop loosing money.
Title: Re: Deflation hedges
Post by: Cardboard on September 01, 2015, 03:13:40 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard
Title: Re: Deflation hedges
Post by: wisdom on September 01, 2015, 03:21:02 PM
I am just saying that I do not have as much confidence in authorities as you guys. I do not mind having insurance in place especially when 7 years of money printing and low rates still have not increased inflation.

I am fairly sure if we get a recession or slow down those hedges will be in the money pretty quick. We would not require actual deflation to take place.

YOu are saying you are sure we will not have deflation.

I am saying I am sure that we will have a dlow down at some point and FFH is likely to do well.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 03:40:44 PM
I am just saying that I do not have as much confidence in authorities as you guys. I do not mind having insurance in place especially when 7 years of money printing and low rates still have not increased inflation.

I am fairly sure if we get a recession or slow down those hedges will be in the money pretty quick. We would not require actual deflation to take place.

YOu are saying you are sure we will not have deflation.

I am saying I am sure that we will have a dlow down at some point and FFH is likely to do well.
Actually only 11% of the notional CPI derivatives require less than 0.5% inflation to pay out. The rest require outright deflation to pay out. So wisdom please make the case of how they get in the money pretty quick. What kind of recession do you need for that to happen? How do we get that kind of a recession given current conditions?

Up to now your argument is basically that the deflation hedges will pay out because you say so.

Title: Re: Deflation hedges
Post by: kevin4u2 on September 01, 2015, 03:43:42 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard

China is doing a great job of keeping their economy from unraveling.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 03:50:58 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard

China is doing a great job of keeping their economy from unraveling.
Right China is having an economic slow down and their stock market dropped to the level it was in February. Behold the unraveling!
Title: Re: Deflation hedges
Post by: wisdom on September 01, 2015, 04:00:07 PM
I don't think I have said that. Yor are mistaking what I have said with other posters.
Title: Re: Deflation hedges
Post by: wisdom on September 01, 2015, 04:05:29 PM
One way of thinking about it may be:
http://www.bloomberg.com/news/articles/2015-09-01/morgan-stanley-central-banks-are-playing-a-game-of-chess-that-results-in-an-endless-cycle-of-easing
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 04:11:52 PM
I don't think I have said that. Yor are mistaking what I have said with other posters.
I know you didn't say that. But those numbers are still a fact. So if you need negative inflation for the CPI derivatives to pay out and right now you have positive inflation so you're moving away from the strike how are the contracts supposed to get into the money pretty quickly? You're not talking about a slowdown or a recession you are talking about a crushing economic catastrophe the kind that would push unemployment to 20% or higher. It would be nice if you could explain how we get there from where we are today and what the probability of it happening are.

By the way, to address your earlier point about money printing and why it hasn't caused inflation. It is pretty standard economic theory that increasing the monetary base in a deleveraging cycle with zero interest rates doesn't cause a lot of inflation. That's the whole idea behind the concept that you need fiscal stimulus in depressed economies.
Title: Re: Deflation hedges
Post by: mcliu on September 01, 2015, 04:34:58 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard

My question is, if monetary policy is so powerful and printing money is so easy, why did Japan have such a hard time getting out of deflation?

Japanese M2 is up almost 30% since 2007 and BOJ balance sheet has tripled, but CPI has essentially gone nowhere.

Is the BOJ so incompetent that they just can't print enough money to revive inflation? and are the other central banks around the world more competent than the BOJ?
Title: Re: Deflation hedges
Post by: JoelS on September 01, 2015, 05:08:10 PM
What would you expect to happen to the price index given the following conditions over a ten year period?..

Population increases by 26%
Fuel consumption doubles.
Real value of manufacturing output increases by 2/3rds.
Volume of grains and cotton consumed increases 50%.
Exports of wheat increase 3 fold, corn 4 fold, cotton 60%.
Employment increases at a rate of 3% per year.

This was the period 1870-1880 in the USA and the wholesale price index fell by 25%. In the 1880's deflation continued at about half that rate, before flattening out at zero inflation in the 1890's. Note that from 1875-1900, money supply doubled.

Companies that were hit hard by the this adjustment were those that had heavy fixed interest and dividend obligations, without a locked in revenue stream (railways, financials..)

The lesson for me is - anything can happen & i'm not smart enough to know what will happen. My response is to look for companies that throw off predictable cash-flow with built in price increases.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 06:12:24 PM
What would you expect to happen to the price index given the following conditions over a ten year period?..

Population increases by 26%
Fuel consumption doubles.
Real value of manufacturing output increases by 2/3rds.
Volume of grains and cotton consumed increases 50%.
Exports of wheat increase 3 fold, corn 4 fold, cotton 60%.
Employment increases at a rate of 3% per year.

This was the period 1870-1880 in the USA and the wholesale price index fell by 25%. In the 1880's deflation continued at about half that rate, before flattening out at zero inflation in the 1890's. Note that from 1875-1900, money supply doubled.

Companies that were hit hard by the this adjustment were those that had heavy fixed interest and dividend obligations, without a locked in revenue stream (railways, financials..)

The lesson for me is - anything can happen & i'm not smart enough to know what will happen. My response is to look for companies that throw off predictable cash-flow with built in price increases.
Joel, I don't know if you are just misinformed or disingenuous. The period you mention 1870-1880 is called the long depression. It was called the great depression before the 1930s came around. During that time you have what is still the longest contraction in US history at 65 months (50% longer than the 1930s contraction). In that time you have a catastrophic uncontrolled deleveraging, financial panic, bank runs and outright chaos. There were massive waves bankruptcies including hundreds of banks and 10 states. From the end of the initial recession in 1879 the economy continued to be shaky until the 1900 with the US economy being in recession for 114 out of 253 months. (source: NBER).

It sounds like a lovely economic period. Also back then there was no central bank. All of this was caused by a massive monetary tightening in 1873. It has since been referred as the crime of 1873. As congress passed legislation to loosen the money supply deflation eased.

It really sound just like the situation we're in today.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 06:24:58 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard

My question is, if monetary policy is so powerful and printing money is so easy, why did Japan have such a hard time getting out of deflation?

Japanese M2 is up almost 30% since 2007 and BOJ balance sheet has tripled, but CPI has essentially gone nowhere.

Is the BOJ so incompetent that they just can't print enough money to revive inflation? and are the other central banks around the world more competent than the BOJ?
Well as I said before there are certain fundamental differences between the western economies and Japan. One of them being that the Japanese are prodigious savers and not very consumerist. The Americans are about the opposite of that. This results in chronically weak domestic demand in Japan. If you want to disregards that fact go ahead.

There is more to creating inflation than printing money. You need to have people that want to spend it. You have more of those in America than Japan. It's also easier to prevent an economy from going into deflation than to pull it out.

On weather the BoJ is incompetent, I don't know about now but it certainly was massively incompetent in the past. It was very shy about QE, failed to supervise its banks, failed to clean them out after the crisis, and it let its economy fall into deflation. And yes, there are certain central banks that are more competent than others. The fed was definitely the most competent in the 08 crisis. The Bank of England was next. ECB and Bank of Canada weren't that good. It seems that the ECB got way better under Draghi but it's hampered by a lot of rules he has to dance around.
Title: Re: Deflation hedges
Post by: kevin4u2 on September 01, 2015, 06:47:39 PM
I am just saying that I do not have as much confidence in authorities as you guys. I do not mind having insurance in place especially when 7 years of money printing and low rates still have not increased inflation.

I am fairly sure if we get a recession or slow down those hedges will be in the money pretty quick. We would not require actual deflation to take place.

YOu are saying you are sure we will not have deflation.

I am saying I am sure that we will have a dlow down at some point and FFH is likely to do well.

Actually only 11% of the notional CPI derivatives require less than 0.5% inflation to pay out. The rest require outright deflation to pay out. So wisdom please make the case of how they get in the money pretty quick. What kind of recession do you need for that to happen? How do we get that kind of a recession given current conditions?

Up to now your argument is basically that the deflation hedges will pay out because you say so.

The people working at AIG had the same mentality.  They too never thought they would never have payout on the CDS they wrote.  For the most part they were right but unfortunately on a mark to market basis they were bankrupt in the meantime, despite many of the contracts expiring worthless. 

So no, you do not need deflation for the hedges to pay out.  It is no different than making money on out of the money stock options or warrants.  The underlying value of the contract has value depending on market perceptions.

FFH didn't hold their CDS position to maturity either.  If they had, they majority of them would have expired worthless too.  They sold the majority of their CDS positions during the meltdown, long before maturity and for a huge profit.  The remaining 5.9 billion notional effectively expired worthless.   

They do not need to hold the deflation hedges to maturity either.  It wouldn't take much of a recession at this time for deflation expectations to change big time.   
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 06:51:03 PM
So kevin, basically your economic argument and investment thesis is fingers crossed?
Title: Re: Deflation hedges
Post by: eggbriar on September 01, 2015, 10:00:34 PM

Well as I said before there are certain fundamental differences between the western economies and Japan. One of them being that the Japanese are prodigious savers and not very consumerist. The Americans are about the opposite of that. This results in chronically weak domestic demand in Japan. If you want to disregards that fact go ahead.


[/quote]

not anymore:

http://www.nytimes.com/2015/03/20/business/international/japans-recovery-is-complicated-by-a-decline-in-household-savings.html?_r=0

"The country’s savings rate, long one of the highest in the world, is now below zero. In short, Japan’s citizens are spending more than they earn. By comparison, the rate in the United States, where consumers have a reputation for living beyond their means, is on the rise, hitting 5.5 percent in January."

Title: Re: Deflation hedges
Post by: mcliu on September 01, 2015, 10:06:02 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard

My question is, if monetary policy is so powerful and printing money is so easy, why did Japan have such a hard time getting out of deflation?

Japanese M2 is up almost 30% since 2007 and BOJ balance sheet has tripled, but CPI has essentially gone nowhere.

Is the BOJ so incompetent that they just can't print enough money to revive inflation? and are the other central banks around the world more competent than the BOJ?
Well as I said before there are certain fundamental differences between the western economies and Japan. One of them being that the Japanese are prodigious savers and not very consumerist. The Americans are about the opposite of that. This results in chronically weak domestic demand in Japan. If you want to disregards that fact go ahead.

There is more to creating inflation than printing money. You need to have people that want to spend it. You have more of those in America than Japan. It's also easier to prevent an economy from going into deflation than to pull it out.


Is that true though? Velocity of M2 shows a different story.

https://research.stlouisfed.org/fred2/series/M2V/

I would recommend reading this piece: https://www.stlouisfed.org/On-The-Economy/2014/September/What-Does-Money-Velocity-Tell-Us-about-Low-Inflation-in-the-US

So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 10:10:50 PM

Well as I said before there are certain fundamental differences between the western economies and Japan. One of them being that the Japanese are prodigious savers and not very consumerist. The Americans are about the opposite of that. This results in chronically weak domestic demand in Japan. If you want to disregards that fact go ahead.



not anymore:

http://www.nytimes.com/2015/03/20/business/international/japans-recovery-is-complicated-by-a-decline-in-household-savings.html?_r=0

"The country’s savings rate, long one of the highest in the world, is now below zero. In short, Japan’s citizens are spending more than they earn. By comparison, the rate in the United States, where consumers have a reputation for living beyond their means, is on the rise, hitting 5.5 percent in January."
[/quote]
eggbriar, thanks for posting this. I'm not following Japan that closely these days. It is definitely encouraging to see the savings rate in japan go down. Maybe they'll have a resurgence in domestic demand. We'll see. Interesting stuff.
Title: Re: Deflation hedges
Post by: rb on September 01, 2015, 10:44:15 PM
A major conflict or maybe even WW3, will happen well before any of this deflation thing plays out.

Then you have the Helicopter Ben theory.

Do you guys really think that world powers will let their economies unravel like Japan did for years without doing anything even if it is dangerous and stupid?

Cardboard

My question is, if monetary policy is so powerful and printing money is so easy, why did Japan have such a hard time getting out of deflation?

Japanese M2 is up almost 30% since 2007 and BOJ balance sheet has tripled, but CPI has essentially gone nowhere.

Is the BOJ so incompetent that they just can't print enough money to revive inflation? and are the other central banks around the world more competent than the BOJ?
Well as I said before there are certain fundamental differences between the western economies and Japan. One of them being that the Japanese are prodigious savers and not very consumerist. The Americans are about the opposite of that. This results in chronically weak domestic demand in Japan. If you want to disregards that fact go ahead.

There is more to creating inflation than printing money. You need to have people that want to spend it. You have more of those in America than Japan. It's also easier to prevent an economy from going into deflation than to pull it out.


Is that true though? Velocity of M2 shows a different story.

https://research.stlouisfed.org/fred2/series/M2V/

I would recommend reading this piece: https://www.stlouisfed.org/On-The-Economy/2014/September/What-Does-Money-Velocity-Tell-Us-about-Low-Inflation-in-the-US

So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it.
What are we doing here mcliu? Playing gotcha games with strawmen?

You've asked for a comparison of why things in the US would be different than Japan. Japan has a massive savings rate and thus a weak domestic demand BEFORE they even hit any crisis. In the US you had no such thing. The US households decided to start savings not by choice but because they found themselves overlevered. Did the US savings rate increase? Yes. I've pointed out above on this board that the US households went through a significant delevering. Would that fact be reflected in M2 velocity? Of course. Did the US have a deleveraging-deflation spiral? No because the government stepped in to close the demand gap and control that deleveraging.

I've also mentioned in my post that there is no immaculate relationship between money printing and inflation at zero lower bound. I see that you have decided to not include that in your quote. That is what you see in the M2 velocity. So what is your point?

Yes the US households have been saving, yes they have delevered, yes the M2 velocity has decreased, yes the debt overhang over US households is lower, yet no deflation.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 03, 2015, 06:05:45 AM
http://www.reuters.com/article/2015/09/03/us-ecb-policy-idUSKCN0R30O120150903 (http://www.reuters.com/article/2015/09/03/us-ecb-policy-idUSKCN0R30O120150903)

Euro area to cut inflation expectations through 2017. Seems like QE was only good for a few months and the disappointment is already setting in. What's the over-under on ECB doubling down and expanding the current program?
Title: Re: Deflation hedges
Post by: no_free_lunch on September 04, 2015, 07:41:11 PM
Despite all the market turmoil Fairfax stock (in CAD) is down just a couple percent over the past month.  I am trying to understand if that is because the deflation hedges are overwhelming losses in the stock portfolio -or- is the market assigning a higher cost to the defensive benefits of fairfax?
Title: Re: Deflation hedges
Post by: rb on September 04, 2015, 07:43:49 PM
I think it's more about the equity hedges. They are really a more substantial portion. With markets going down they're gonna recoup some money off of that. For better or for worse it's money in.
Title: Re: Deflation hedges
Post by: no_free_lunch on September 08, 2015, 06:43:32 PM
I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.   You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.   Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

http://www.tradingeconomics.com/japan/consumer-price-index-cpi
Title: Re: Deflation hedges
Post by: vinod1 on September 08, 2015, 07:30:08 PM
I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.   You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.   Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

I looked at official Japanese data as well and it also does not indicate the amount of deflation that Fairfax was referencing in their AR. Fairfax used World Bank or some other global org data (I cannot recollect) which showed a much higher deflation amount than official Japanese figures. Do not know why.

Vinod
Title: Re: Deflation hedges
Post by: no_free_lunch on September 08, 2015, 07:42:56 PM
I wasn't aware that they were referencing other numbers, good to know.  I guess the problem then is they are bench-marked to the official CPI numbers where the government is motivated to be cautionary.  Even if the real deflation is -1 or -2%, if the official CPI number is 0 then that is what the hedges work off of.

I have been thinking about this deflation debate in general and it seems to me that deflation is what would happen if the government didn't interfere.  In 08/09 it sure looked like deflation was going to happen and when it didn't the deflationists blamed it on government cronyism, can kicking, deficit spending, propping up failed banks, etc.  I think the deflationists were right on the theory but ignored that government wouldn't stand idly by.  That same issue will exist going forward.  It just seems governments have so many tools to fight deflation, they can run deficits, the federal reserve can print money, they can lower taxes, enact stimulus programs, etc.   All of these things are arguably bad in the long-run but I think we have enough evidence now that that is the way it will go.  If the government can just make money appear, is that not all inflationary and shouldn't that at some point push up prices?

Title: Re: Deflation hedges
Post by: Dazel on September 09, 2015, 02:45:25 AM
The most bullish guy on Wall Street since March 2009 has been Jeff Saut of Raymond James his weekly commentary is always very interesting...I strongly recommend reading it. He discusses  hedging even though he has been a long term  bull. His comments are relevant to where we are today...the commentary link is here but interestingly he adds two charts on the Velocity of money and the labour participation rate in the U.S (which he called down right scary!). Hoisington (Fairfax) constantly use these  charts in their thesis on deflation and low bond yields. Fairfax unlike the others he described hedged and likely covered some equity shorts during the commodities rout we have seen. Jeff Saut uses Talib Nassim in his letter to describe why hedge are needed and how random events could change his views...including the "dow theory sell signal" we had on August 24th which had him turn bearish In Oct 1999 and in Nov 2007!!!!!...

It is for this reason that I believe the delation contracts market prices will differ from actual cpi numbers. why? Oil was $148 dollars and we had huge inflation in June 2008...only to see massive deflation in 2009!! It is not where we are...it is where we are going...No one's hedges worked even Ray Dalio got smoked in August...Einhorn, Ackman etc...so the interest in another way to hedge is certainly on the table globally.

http://www.raymondjames.com/images/inv_strat/150908_1.png
http://www.raymondjames.com/images/inv_strat/150908_2.png

http://www.raymondjames.com/inv_strat.htm
Title: Re: Deflation hedges
Post by: petec on September 09, 2015, 03:46:33 AM
I wasn't aware that they were referencing other numbers, good to know.  I guess the problem then is they are bench-marked to the official CPI numbers where the government is motivated to be cautionary.  Even if the real deflation is -1 or -2%, if the official CPI number is 0 then that is what the hedges work off of.

I have been thinking about this deflation debate in general and it seems to me that deflation is what would happen if the government didn't interfere.  In 08/09 it sure looked like deflation was going to happen and when it didn't the deflationists blamed it on government cronyism, can kicking, deficit spending, propping up failed banks, etc.  I think the deflationists were right on the theory but ignored that government wouldn't stand idly by.  That same issue will exist going forward.  It just seems governments have so many tools to fight deflation, they can run deficits, the federal reserve can print money, they can lower taxes, enact stimulus programs, etc.   All of these things are arguably bad in the long-run but I think we have enough evidence now that that is the way it will go.  If the government can just make money appear, is that not all inflationary and shouldn't that at some point push up prices?

The referencing can go both ways: CPI is dramatically understating real inflation at the moment (partly because real rents are outstripping the imputed owner's rent nonsense) and I wonder if FFH have built this into their thesis.   Understating CPI is part of the reason the Fed can get away with being so easy with money.

I agree that the government is what's stopping deflation.   For me the risks are:

1. What happens if they run out of tools?   They've failed to get the fractional reserve banking system to create money, so they've had to do it themselves.   The channels for that are: buy assets and stick them on the central bank balance sheet, putting cash into the hands of the seller; fund government spending with newly printed money; or throw the stuff out of helicopters.   All three of these almost certainly have political limits.   What happens if those limits are reached?

2. To keep inflating you need to keep adding debt.   (Borrowing creates money; paying debt back destroys it.   When there is more money, money is worth less; and when there is less, it is worth more.)   But eventually people want to stop borrowing because their balance sheet looks too uncomfortable.   So what happens when, on aggregate, the world reaches that point?   Emerging markets went on a borrowing spree which stopped the world deflating from 2009-2014.   Who is going to take up the baton and drive debt ever higher?   Because if there isn't anyone, deflation is a serious possibility.

I don't predict or expect deflation.   But it's quite possible and I like having the insurance!

That said, I am for the first time considering some sort of gold exposure to hedge the other way.
Title: Re: Deflation hedges
Post by: petec on September 09, 2015, 03:53:45 AM
The US households decided to start savings not by choice but because they found themselves overlevered. Did the US savings rate increase? Yes. I've pointed out above on this board that the US households went through a significant delevering. Would that fact be reflected in M2 velocity? Of course. Did the US have a deleveraging-deflation spiral? No because the government stepped in to close the demand gap and control that deleveraging.


Absolutely right and I wonder where it ends.   *Overall* US debt:gdp is up significantly, although the rate is lower and the tenor longer because it is government not personal debt, but it ultimately still has to be serviced by the people.   Two possibilities:

1. The people delever to the point where they can spend again and gdp grows and suddenly government debt:gdp doesn't look so bad (this happened after WW2); or

2. The people don't take up the demand slack, the government has to keep spending, the gdp doesn't grow very fast, and the debt:gdp rises inexorably.

For the US I am squarely in camp 1, but I think Japan went to camp 2 and it's not impossible.
Title: Re: Deflation hedges
Post by: no_free_lunch on September 09, 2015, 12:01:20 PM
It is for this reason that I believe the delation contracts market prices will differ from actual cpi numbers. why? Oil was $148 dollars and we had huge inflation in June 2008...only to see massive deflation in 2009!! It is not where we are...it is where we are going...No one's hedges worked even Ray Dalio got smoked in August...Einhorn, Ackman etc...so the interest in another way to hedge is certainly on the table globally.

We really didn't have massive deflation in 2009.  There was a spike up during 2008 of about 5%, which completely reversed by the end of the year.    2009 saw the CPI end within a fraction of a percent of where it started.

Here are the end of year CPI numbers for the US:

2007: 210
2008: 210.3
2009: 215.9
2010: 219.1
2011: 225.7
2012: 229.6
2013: 233.0
2014: 234.8

I guess I can't say with absolute certainty we won't have deflation but we really didn't have any sustained deflation during the 08/09 crisis and there wasn't any in japan over the past 20 years.   That is all I am saying, we have to really get speculative that this will happen. 
Title: Re: Deflation hedges
Post by: rb on September 09, 2015, 09:09:36 PM
I have been thinking about this deflation debate in general and it seems to me that deflation is what would happen if the government didn't interfere.  In 08/09 it sure looked like deflation was going to happen and when it didn't the deflationists blamed it on government cronyism, can kicking, deficit spending, propping up failed banks, etc.  I think the deflationists were right on the theory but ignored that government wouldn't stand idly by.  That same issue will exist going forward.  It just seems governments have so many tools to fight deflation, they can run deficits, the federal reserve can print money, they can lower taxes, enact stimulus programs, etc.   All of these things are arguably bad in the long-run but I think we have enough evidence now that that is the way it will go.  If the government can just make money appear, is that not all inflationary and shouldn't that at some point push up prices?
Lunch,

I don't see why it's a shock that governments stepped in? They basically came it to prop up demand and smooth the deleveraging. What should they have done? Sit back and let their economies implode? Why was that a rational expectation? The fact is that the governments haven't done enough. They had all the data but determined that doing more was not politically feasible. That's either a cop out or a sad state of society.

Don't take this the wrong way because I've seen a lot of stuff you posted and you're a smart guy so don't take what I say to heart. The truth is that macro is hard. The idea that "All of these things are arguably bad in the long-run" is wrong. That was the liquidationist view of the 1930s which was the dominant view back then. The thinking was that the government shouldn't step in because negate the good work that depression do. That worked out brilliantly!

The thing is that the economics profession has learned a lot from the 1930s and we've (less Europe) been lucky enough to have people at helm that know those lessons. The downside is that the measures implemented have only gone half way because of political reasons. What is disturbing is that the reasons against government intervention today are the same as the ones that popped up during the 1930s and which have been proven totally wrong. But I think it could have easily been worse.
Title: Re: Deflation hedges
Post by: rb on September 09, 2015, 09:20:48 PM
It is for this reason that I believe the delation contracts market prices will differ from actual cpi numbers. why? Oil was $148 dollars and we had huge inflation in June 2008...only to see massive deflation in 2009!! It is not where we are...it is where we are going...No one's hedges worked even Ray Dalio got smoked in August...Einhorn, Ackman etc...so the interest in another way to hedge is certainly on the table globally.

We really didn't have massive deflation in 2009.  There was a spike up during 2008 of about 5%, which completely reversed by the end of the year.    2009 saw the CPI end within a fraction of a percent of where it started.

Here are the end of year CPI numbers for the US:

2007: 210
2008: 210.3
2009: 215.9
2010: 219.1
2011: 225.7
2012: 229.6
2013: 233.0
2014: 234.8

I guess I can't say with absolute certainty we won't have deflation but we really didn't have any sustained deflation during the 08/09 crisis and there wasn't any in japan over the past 20 years.   That is all I am saying, we have to really get speculative that this will happen.
There are some very good points here. In economics there is the headline CPI and Core CPI which is CPI excluding food and energy. In economics you learn pretty quick that for monetary policy reasons you discard CPI and focus on Core CPI. One of the reasons for that is that food and energy prices are really volatile. The other is that it would lead to bad decisions. From the point of view of a central bank to keep the economy humming and have smooth inflation at some target rate. If you have a big jump in the oil price that is a negative supply shock. But it will cause a jump in the headline CPI so if you were focused on that you'd raise rates and hit the economy with a negative demand shock. Great you've just battered your economy.

If you ignore headline CPI and look at core CPI you'd see that it didn't really go negative in 08-09 so it was a lot to do with the price of commodities. There is also the concept of sticky prices that everyone ignores around here. But the fact is that it's hard to break through the zero barrier of inflation.
Title: Re: Deflation hedges
Post by: no_free_lunch on September 09, 2015, 09:27:11 PM
The fairfax hedges are on the headline CPI so it is good to know that it is more volatile.  So this is slightly to fairfax's advantage I guess.  It is possible you could have some quick deflation before the fed can react.  However, if headline CPI dipped and fairfax didn't sell their options it could all disappear when the CPI reverts back up.  In 08 they probably wouldn't have made money because I don't think it fell enough that they would have sold.

I would prefer a fairfax that just equity hedges.
Title: Re: Deflation hedges
Post by: rb on September 09, 2015, 09:43:00 PM
The fairfax hedges are on the headline CPI so it is good to know that it is more volatile.  So this is slightly to fairfax's advantage I guess.  It is possible you could have some quick deflation before the fed can react.  However, if headline CPI dipped and fairfax didn't sell their options it could all disappear when the CPI reverts back up.  In 08 they probably wouldn't have made money because I don't think it fell enough that they would have sold.

I would prefer a fairfax that just equity hedges.
You're kind of on the right track on the CPI stuff. inflation in a rate of change so if you put the hedges at the right time and headline CPI drops because of a decline in oil (which would be a one time shock to cpi)  then you need to sell right after to get your gains otherwise the regular inflation takes you above the strike again.

So it would work if you were market timing commodities. They're not doing that though. So I don't see how that works well.

You do, but I also don't like the equity hedges - and those have been the bigger problem. That's also a market timing issue. Why focus so much on that instead of using your vast stock picking (or valuation) skills to build value? Do good underwriting, make money, invest that money - make more money and so on. Worked pretty well for Berkshire.

As I've said in another post between the equity and deflation hedges they booked losses equal to roughly half the book value of the company - most of that came from the equity hedges. They've argued that it was in order to protect the company. I'm sure that someone will come and explain to me how it's great that they've done so because we're about to have a nuclear winter. But booking losses that are worth half your book value doesn't seem to me like such a great thing.
Title: Re: Deflation hedges
Post by: petec on September 10, 2015, 12:33:07 AM
Don't take this the wrong way because I've seen a lot of stuff you posted and you're a smart guy so don't take what I say to heart. The truth is that macro is hard. The idea that "All of these things are arguably bad in the long-run" is wrong. That was the liquidationist view of the 1930s which was the dominant view back then. The thinking was that the government shouldn't step in because negate the good work that depression do. That worked out brilliantly!

The thing is that the economics profession has learned a lot from the 1930s and we've (less Europe) been lucky enough to have people at helm that know those lessons. The downside is that the measures implemented have only gone half way because of political reasons. What is disturbing is that the reasons against government intervention today are the same as the ones that popped up during the 1930s and which have been proven totally wrong. But I think it could have easily been worse.

Count me as a deep sceptic.   Jim Grant's book comparing the 1921 depression (government did not intervene, slump corrected itself in 18 months) to the 1929 depression (government intervened heavily, counter to popular wisdom, and it lasted a decade) is interesting.   What developed through the late 1920s and out of the GD was the idea that every mild setback should be met with ever easier money.   That has encouraged the accumulation of records amounts of debt.   Some say that does not matter.   Some say it does.   My point is, we do not yet know whether what we learned from the 1930s was how to avoid a crisis, or simply how to create a different kind of crisis.   I'm going to wait another 50 odd years before declaring victory for modern economics ;)
Title: Re: Deflation hedges
Post by: petec on September 10, 2015, 12:40:17 AM
I would prefer a fairfax that just equity hedges.


I'm the other way on.   The deflation bet is a cheap bit of insurance against an unlikely event that has disastrous consequences.   The equity hedge was an expensive bet against an unlikely event (markets were still cheap in 2010) that would have had disastrous consequences (for a levered insureco).

That said, I'm not in the camp that criticises them for the equity hedges.   Whether or not a nuclear winter is coming, they always had an offsetting long position so what they did was lock in alpha at a time when they were uncertain about the markets.   They were wrong.   But they run a highly levered company in a market where regulators and clients scrutinise capital levels carefully, and in which equity investing is not the prime value creator.   They wanted to minimise their risk and they did.   I don't fault them for that.
Title: Re: Deflation hedges
Post by: mals on September 10, 2015, 04:35:11 AM
Here is my view on why deflation is possible. I am no expert - just trying to see if I can wrap my arms around what is going on - directionally (not trying to predict timing).

I think that
Change in Prices to consumers are a function of change in
  a) RM cost +
  b) apportioned capital cost +
  c) labor component ( of mining/growing, manufacturing and transportation and retail) +
  d) return on capital (profit) +
  e) temporary / rapid currency fluctuations +
  f) money in circulation +
  g) unexplained factors  ;)

If I think about it in this manner, here is what I conclude (based on facts as I know them)
  a) is severely downwards - i understand that the input value in the overall consumer basket might be a smaller portion as basic RM goes through many value addition steps.
  b) if massively surplus capacity - then this should also trend downwards (production to cover variable cost?)
  c) labor component - US labor mildly upwards perhaps, the rest of the world not quite.
  d) if surplus capacity, then this should also trend downwards
  e) negative effect on all import prices - at least for the US and perhaps Europe also
  f) my understanding is that the increase in circulation is not quite happening - low velocity of money (as i understand)
  g) ??

So my question - is the above equation too simplistic or wrong? Are there a big factors i.e. g), that I have missed out altogether, and are they such that they negate the other factors for long enough?
And please note, this is without assuming major recessions or anything - just basing it on factors observed so far this year.
Title: Re: Deflation hedges
Post by: petec on September 10, 2015, 05:44:19 AM
I think generally that's a great framework - but I think (f) is the key and understanding 1) why fractional reserve banking isn't creating money and 2) what central banks can, and can't, do about that is key to the debate.   

I'd also add that (g) might be an unexpected asset price (stocks/bonds/houses) fall that makes people nervous.

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 10, 2015, 06:05:17 AM
http://www.ft.com/intl/cms/s/0/18c672e6-5793-11e5-a28b-50226830d644.html#axzz3lFWM9CIY (http://www.ft.com/intl/cms/s/0/18c672e6-5793-11e5-a28b-50226830d644.html#axzz3lFWM9CIY)

Food Prices Record Largest Monthly Drop in 7 Years

Quote
The FAO’s monthly food index in August fell 5.2 per cent from the month before, the steepest monthly drop since December 2008. The index is now at its lowest level since April 2009.

So - it's just the drop in energy right? That's all that's driving CPI and inflation expectations? We can ignore the drop in nearly all global commodities and food as coincidence? I think it's more of the canary in the coal mine.
Title: Re: Deflation hedges
Post by: mals on September 10, 2015, 07:09:53 AM
I think badly that's a great framework - but I think (f) is the key and understanding 1) why fractional reserve banking isn't creating money and 2) what central banks can, and can't, do about that is key to the debate.   

I'd also add that (g) might be an unexpected asset price (stocks/bonds/houses) fall that makes people nervous.

  f) money in circulation
so money gets into circulation when somebody spends it. and people and corporations have not increased spending as much as in past such cycles. perhaps scared of debt, corporations cautious, or that demand elasticity is low in developed world (outside of luxury and entertainment).

 g) other factors
stock market shock can indeed cause people to spend less - not so for Main Street though.

Anyhow, since there are many who believe deflation likelihood is low, would be great to hear their rationale as it might translate to this "Change in price = a + b + ... + g" framework.
Title: Re: Deflation hedges
Post by: petec on September 10, 2015, 09:36:04 AM
f) money in circulation

so money gets into circulation when somebody spends it. and people and corporations have not increased spending as much as in past such cycles. perhaps scared of debt, corporations cautious, or that demand elasticity is low in developed world (outside of luxury and entertainment).


Less to do with spending and more to do with borrowing.   Central banks create base money.   They (in simplified terms) deposit this with commercial banks.   When there is loan demand, it gets lent out, less a reserve that must be kept back.   As soon as it gets lent it gets deposited again, which means it can be lent again, and so on.   In other words, for any given amount of base money, the amount of money circulating can expand and contract hugely depending on the demand for loans.

The deflationists aver that the world has reached the end of a leveraging phase, and that it will start to de-lever.   Loan demand will fall, and therefore the amount of money in circulation will fall.   That means prices will fall (money gets more valuable as there is less and less of it).

The central banks are combating this by printing more money.   Since they can't force people to borrow, they are buying assets.   This puts cash into the hands of the sellers (largely governments but also private bond owners and, in Japan, private equity owners) and increases the amount of money circulating.   In theory they could carry on doing this until they own everything on earth, but that's politically impossible!

So far three things have prevented deflation, I would argue:
1. Central banks buying assets.
2. Governments borrowing faster, partly enabled by (1).
3. China and EM's in general borrowing *very* fast.

I think (3) is stopping.   Interesting to see whether (1) and (2) hit political limits.   If world debt stops rising, we get deflation.

On the reflation side of the argument, maybe US consumers decide they have paid down enough and start borrowing again.

But I do think the key driver is this factor, your (f).   Ultimately in inflationary periods consumers borrow to spend and producers borrow to expand capacity, and this creates a lot of money; when the process reverses, you get deflation.   It's all about the ratio of "money" to "stuff you can spend money on"!

I'd also argue that asset price falls have a significant impact on Main Street spending on anything remotely discretionary, especially when Main Street has debt.

P

Title: Re: Deflation hedges
Post by: petec on September 10, 2015, 09:41:50 AM
I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.   You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.   Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

Thanks for this - really interesting.   In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'.   But it doesn't tally with his 'cumulative 14%' deflation claim.

However, look at the GDP deflator graph on the same page.   That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change).

So...this tests my knowledge of these statistics to their limits!   Does anyone know why the GDP deflator would differ so much from CPI?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 10, 2015, 10:47:58 AM
I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.   You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.   Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

Thanks for this - really interesting.   In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'.   But it doesn't tally with his 'cumulative 14%' deflation claim.

However, look at the GDP deflator graph on the same page.   That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change).

So...this tests my knowledge of these statistics to their limits!   Does anyone know why the GDP deflator would differ so much from CPI?

I thought through this and it seems that they should be measuring the same thing; however, a quick Google search does suggest there are some differences. The GDP deflator only measures domestic goods consumption and ignores the price differential of imports that are subtracted out of the calculation of GDP. Also, CPI only measures consumer prices (which is why we also have PPI). The deflator will capture both.

So the GDP deflator could drop massively and the CPI could remain the prices you had import inflation while the business investment/PPI falls off a cliff. The opposite could also hold true where the GDP deflator remains stable and CPI falls off a cliff if you import deflation via a stronger currency (the current situation of the U.S.).

In Japan's case, their currency appreciated massively between 1990 and 1995. Given that it was an export based economy - that is going to blow a whole in your business investment, CapEx for export purposes, etc. but it may not flow directly through to domestic consumer spending because that's not where the massive excess in capacity was targeted. Also, the "bubble" in real estate was largely contained to Tokyo - not a national trend. So the only part of CPI that would have been decelerating massively is the % of the entire index that went to housing further segregated by the % of that figure that is Tokyo. Most other assets, outside of stocks, were untouched by the disaster in 1990.
Title: Re: Deflation hedges
Post by: wisdom on September 10, 2015, 10:22:50 PM
http://video.cnbc.com/gallery/?video=3000419287

David Tepper had interesting stuff to say - there are about 6 or 7 videos.
Title: Re: Deflation hedges
Post by: petec on September 11, 2015, 02:49:52 AM
I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.   You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.   Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

Thanks for this - really interesting.   In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'.   But it doesn't tally with his 'cumulative 14%' deflation claim.

However, look at the GDP deflator graph on the same page.   That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change).

So...this tests my knowledge of these statistics to their limits!   Does anyone know why the GDP deflator would differ so much from CPI?

I thought through this and it seems that they should be measuring the same thing; however, a quick Google search does suggest there are some differences. The GDP deflator only measures domestic goods consumption and ignores the price differential of imports that are subtracted out of the calculation of GDP. Also, CPI only measures consumer prices (which is why we also have PPI). The deflator will capture both.

So the GDP deflator could drop massively and the CPI could remain the prices you had import inflation while the business investment/PPI falls off a cliff. The opposite could also hold true where the GDP deflator remains stable and CPI falls off a cliff if you import deflation via a stronger currency (the current situation of the U.S.).

In Japan's case, their currency appreciated massively between 1990 and 1995. Given that it was an export based economy - that is going to blow a whole in your business investment, CapEx for export purposes, etc. but it may not flow directly through to domestic consumer spending because that's not where the massive excess in capacity was targeted. Also, the "bubble" in real estate was largely contained to Tokyo - not a national trend. So the only part of CPI that would have been decelerating massively is the % of the entire index that went to housing further segregated by the % of that figure that is Tokyo. Most other assets, outside of stocks, were untouched by the disaster in 1990.

Great stuff, thanks.   Doesn't fill me with joy re: the deflation hedges.
Title: Re: Deflation hedges
Post by: Dazel on September 16, 2015, 06:22:28 AM

http://finance.yahoo.com/news/u-consumer-prices-post-first-123518143.html

Now imagine a recession! Fairfax has good insurance here and that is all I am looking for...if we muddle along ...the operating companies will do extremely well and likely far out perform a windfall from the deflation hedges.
Title: Re: Deflation hedges
Post by: Dazel on September 16, 2015, 06:32:43 AM


how does the insurance look now?

http://www.theglobeandmail.com/report-on-business/international-business/european-business/euro-zone-inflation-slows-raises-expectations-of-more-qe/article26376905/

http://www.theguardian.com/business/live/2015/sep/15/chinese-stocks-fall-again-uk-inflation-markets-live
Title: Re: Deflation hedges
Post by: kevin4u2 on September 23, 2015, 04:54:21 PM
Interesting graphic, see below.  Something changed in China this year.  The steel picture looks the same. 

Food prices just saw there biggest one month drop according to the UN.  Every commodity seems to be in free fall, not just oil.
Title: Re: Deflation hedges
Post by: gary17 on September 23, 2015, 05:17:47 PM
I would love it if we have a huge deflation in Vancouver real estate.
Title: Re: Deflation hedges
Post by: beerbaron on September 23, 2015, 06:24:28 PM
Interesting graphic, see below.  Something changed in China this year.  The steel picture looks the same. 

Food prices just saw there biggest one month drop according to the UN.  Every commodity seems to be in free fall, not just oil.

The graph has a truncated scale which gives the impressions that cement is almost zero. Actually cement is only about 75% of the peak of the last 4 years... I would not call this a free fall.

BeerBaron
Title: Re: Deflation hedges
Post by: 50centdollars on September 23, 2015, 07:25:49 PM

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

Let's look at the first issue.  The people who talk about deflation say, "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the future value of bread than the fact you are hungry.

And this applies to larger purchases as well. People buy cars, washing machines, air conditioners, refrigerators, computers, or a pair of blue jeans because their existing product has worn out.  They don't sit around like economists and make predictions about the prices of products in the future for the simple reason that most people have no clue how prices are trending.   If your car needs an engine overhaul, chances are, you are in the market for a new (or newer) car.   You don't buy a car on the premise that you'd "better buy now because they'll be more expensive tomorrow!" and you don't throw a rebuilt engine into a junker because "you might as well wait, as prices will be lower tomorrow!"

In fact, it works just the opposite.  During the last recession, when prices of cars were flat, and the prospect of higher prices seemed dim, people threw money at their older cars to fix them because they could not afford a new or newer car.   When the economy recovered, people bought new cars (and boy did they buy new cars!) because their old clunkers were really past their prime.  That is what drove sales, not some theoretical philosophy about price trending.

The idea that the average consumer can perceive price trends and then act in accordance with them is just nonsense.  People buy goods because they need them, for the most part, or they want them and believe they can afford them.   Future Values just don't register in their brains.

The second half of the equation is that deflation just isn't going to happen.   Yes, the cost of producing a lot of goods has decreased over the last few decades, thanks to China.   But the cost of energy has kept up with this pace, and as a result, prices keep going up every year.   And those folks in China, India, and other 3rd world (or 2nd or 1st?) countries who are working for low wages, are starting to demand increases and thus the cost of such goods cannot remain low indefinitely.

Yes, the growth in the population has slowed.   But it is still growing.   And that means that demand for every product, from corn to iPhones, is on the rise, which means that prices will continue to rise, albeit more slowly.   Deflation?  Maybe if a plague cuts the world population in half.  Maybe.

 
Title: Re: Deflation hedges
Post by: kevin4u2 on September 23, 2015, 07:46:25 PM
Interesting graphic, see below.  Something changed in China this year.  The steel picture looks the same. 

Food prices just saw there biggest one month drop according to the UN.  Every commodity seems to be in free fall, not just oil.

The graph has a truncated scale which gives the impressions that cement is almost zero. Actually cement is only about 75% of the peak of the last 4 years... I would not call this a free fall.

BeerBaron

You are quite right, but cement has been almost straight line down since the start of 2014. 

How much are steel prices down year over year?  That isn't a rhetorical question.  The CRU number from today saw HR coil fall 15/ton week over week, absolutely huge.  New 52 week low.   

If it weren't for trade protectionism, there would be a US steel mill closing every week.  You can pretend like this isn't a big deal, that's fine.   

http://news.yahoo.com/world-food-prices-plunge-seven-low-fao-084147343.html (http://news.yahoo.com/world-food-prices-plunge-seven-low-fao-084147343.html)
Title: Re: Deflation hedges
Post by: kevin4u2 on September 23, 2015, 08:48:52 PM

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

Let's look at the first issue.  The people who talk about deflation say, "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the future value of bread than the fact you are hungry.

I have never heard that definition before.  Do you think FFH is investing hundreds of millions based on your theory of deflation?

Prices fall because of increasing supply or declining demand.  The prices for every commodity around the world is falling.  It appears that a lot of people have been putting off purchasing decisions.  I don't see huge investments in O&G, steel mills, precious metals, mines, potash, etc.  In fact, falling prices has caused a decline of incomes.  The aggregate decline in incomes represents a further decline in demand.

Rapidly increasing credit worldwide has kept demand robust, but that appears to be unwinding particularly in China.  Keep in mind that what is required to reverse deflationary pressures is increasing credit, but banks tend to tighten credit when unemployment is rising and asset prices are falling.  I can guarantee you there are a lot of O&G companies that don't want to talk with their banker this fall about the value of a their assets.       

Just as a side note.  I was talking with someone from steel tubing company a couple weeks ago and he was telling me how many companies in Alberta have gone to 3-4 day work weeks, while some have kept 5 day work weeks but at a 50% decrease in pay.  I wonder what the unemployment rate would be in Alberta if these partial layoffs were reported as full time equivalents.  He also expects a lot more to come near the end of the year as people throw on the long awaited recovery.  When I was there this summer, everyone was still in denial about how long the low oil prices would persist. 

So, when CNRL cuts wages 10% across the board, what is the effect on the unemployment rate?  What is the effect on the economy? 

To answer your straw man, yes people will buy bread but why are grain prices at seven year lows, falling over 5% last month, if demand is so inelastic as you seem to think? 

Where is the demand response to falling prices?  To QE infinity and beyond.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 24, 2015, 06:46:45 AM

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

Let's look at the first issue.  The people who talk about deflation say, "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the future value of bread than the fact you are hungry.

And this applies to larger purchases as well. People buy cars, washing machines, air conditioners, refrigerators, computers, or a pair of blue jeans because their existing product has worn out.  They don't sit around like economists and make predictions about the prices of products in the future for the simple reason that most people have no clue how prices are trending.   If your car needs an engine overhaul, chances are, you are in the market for a new (or newer) car.   You don't buy a car on the premise that you'd "better buy now because they'll be more expensive tomorrow!" and you don't throw a rebuilt engine into a junker because "you might as well wait, as prices will be lower tomorrow!"

In fact, it works just the opposite.  During the last recession, when prices of cars were flat, and the prospect of higher prices seemed dim, people threw money at their older cars to fix them because they could not afford a new or newer car.   When the economy recovered, people bought new cars (and boy did they buy new cars!) because their old clunkers were really past their prime.  That is what drove sales, not some theoretical philosophy about price trending.

The idea that the average consumer can perceive price trends and then act in accordance with them is just nonsense.  People buy goods because they need them, for the most part, or they want them and believe they can afford them.   Future Values just don't register in their brains.

The second half of the equation is that deflation just isn't going to happen.   Yes, the cost of producing a lot of goods has decreased over the last few decades, thanks to China.   But the cost of energy has kept up with this pace, and as a result, prices keep going up every year.   And those folks in China, India, and other 3rd world (or 2nd or 1st?) countries who are working for low wages, are starting to demand increases and thus the cost of such goods cannot remain low indefinitely.

Yes, the growth in the population has slowed.   But it is still growing.   And that means that demand for every product, from corn to iPhones, is on the rise, which means that prices will continue to rise, albeit more slowly.   Deflation?  Maybe if a plague cuts the world population in half.  Maybe.

You're missing the second side of the equation - too much supply. There's a pretty good argument to be made that 20 years of excess supply in credit inflated people's consumption abilities which leads companies to over-invest in capacity which is a major problem when the credit stops flowing and people have to consumer below their means as they delever. 

Capacity utilization in the U.S. is still running below it's 40-45 year average. This is 6 years into a supposed recovery where tens of trillions have been spent globally on stimulus, we have "normalized" unemployment rate, and the consumer balance sheet has healed due to a transfer to the public balance sheet.

Also, you have to consider that if China/EM is really going down hard, which appears to be the case, that people will flee to safe haven assets denominated in USD, euro, and yen. As the USD appreciates, all imports get cheaper. For an economy that is a net importer, that is deflationary in and of itself. Every 1% tick up in the dollar brings down inflation readings by some fraction of that. A slow, sustained rise in the dollar brings a slow, sustained, deflationary pressure on top of the of the excess capacity which will result in companies cutting prices to get rid of inventories.
Title: Re: Deflation hedges
Post by: Dazel on September 24, 2015, 07:00:54 AM


Does anyone have access to a pricing quote for the deflation contract or one similar to what Fairfax holds?
I don "t really care about the economic theory  I do care what the contracts are worth...and we know the value is going up. Fairfax has called what is happening...and bought insurance. What is the price of that insurance now? I am betting a lot of companies would like to purchase it as a hedge...
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 25, 2015, 06:38:58 AM
Japan announced that inflation was negative for August. Stripping out fresh foods, core inflation was was also negative at -0.1% - the first negative print in core inflation since the beginning of the current QE program started in 2013.

Abe-nomics isn't working just like none of the other QE programs in Japan ever worked. Sure, someone will probably have the excuse that China's weakening yuan is wreaking havoc on Japan's export economy. I'd just add that there always seems to be some good excuse for why any individual QE program doesn't work, but I've yet to hear a good excuse that explains why they have all collectively failed without a single instance of success in stimulating "normalized" growth and inflation.

We're not there in Japan after nearly 10 rounds of QE. We're not there in the U.S. after 4 rounds of QE. We're not there in Europe during the first round of QE. Hey, I know what we need! MORE QE!!!!
Title: Re: Deflation hedges
Post by: obtuse_investor on September 25, 2015, 07:00:13 AM
Quote
"I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail." -- Abraham Harold Maslow (1966)
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 29, 2015, 12:15:54 PM
Deflation in Germany again
http://www.bloomberg.com/news/articles/2015-09-29/german-inflation-turns-negative-for-first-time-since-january (http://www.bloomberg.com/news/articles/2015-09-29/german-inflation-turns-negative-for-first-time-since-january)

Oversupply of housing in North Dakota will lead to lower rents/sales prices in the area. Will this happen in other shale states? This could be the first creep of deflation into housing in U.S. CPI.
http://www.bloomberg.com/news/articles/2015-09-29/man-camp-exodus-spurs-real-estate-crisis-across-u-s-shale-towns (http://www.bloomberg.com/news/articles/2015-09-29/man-camp-exodus-spurs-real-estate-crisis-across-u-s-shale-towns)

Title: Re: Deflation hedges
Post by: Jurgis on September 29, 2015, 12:22:37 PM
Quote
"I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail." -- Abraham Harold Maslow (1966)

I suppose it is tempting, if you only hold FFH, to treat everything as if it were deflation.

 ;)
Title: Re: Deflation hedges
Post by: ERICOPOLY on September 29, 2015, 12:41:00 PM
Japan announced that inflation was negative for August. Stripping out fresh foods, core inflation was was also negative at -0.1% - the first negative print in core inflation since the beginning of the current QE program started in 2013.

Abe-nomics isn't working just like none of the other QE programs in Japan ever worked. Sure, someone will probably have the excuse that China's weakening yuan is wreaking havoc on Japan's export economy. I'd just add that there always seems to be some good excuse for why any individual QE program doesn't work, but I've yet to hear a good excuse that explains why they have all collectively failed without a single instance of success in stimulating "normalized" growth and inflation.

We're not there in Japan after nearly 10 rounds of QE. We're not there in the U.S. after 4 rounds of QE. We're not there in Europe during the first round of QE. Hey, I know what we need! MORE QE!!!!

You cannot say it failed to work.  You don't know how much worse deflation would be in the absence of it.  Therefore, how do you know?

For example, perhaps it might be a roaring success if you achieved 1% deflation instead of an otherwise 4% number.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on September 29, 2015, 12:42:38 PM
Japan announced that inflation was negative for August. Stripping out fresh foods, core inflation was was also negative at -0.1% - the first negative print in core inflation since the beginning of the current QE program started in 2013.

Abe-nomics isn't working just like none of the other QE programs in Japan ever worked. Sure, someone will probably have the excuse that China's weakening yuan is wreaking havoc on Japan's export economy. I'd just add that there always seems to be some good excuse for why any individual QE program doesn't work, but I've yet to hear a good excuse that explains why they have all collectively failed without a single instance of success in stimulating "normalized" growth and inflation.

We're not there in Japan after nearly 10 rounds of QE. We're not there in the U.S. after 4 rounds of QE. We're not there in Europe during the first round of QE. Hey, I know what we need! MORE QE!!!!

You cannot say it failed to work.  You don't know how much worse deflation would be in the absence of it.  Therefore, how do you know?

For example, would be perhaps be a roaring success if you achieved 1% deflation instead of an otherwise 4% number.

And the same argument would apply to you - you can't say that it worked because you don't know what inflation/deflation would have been without it. We could have ended in the exact same place. But I do think it's clear that the results have not been what was targeted by any of the policy makers that implemented it, which is a better gauge of failure than people who claim it was a success have.
Title: Re: Deflation hedges
Post by: rb on September 29, 2015, 12:43:18 PM
You cannot say it failed to work.  You don't know how much worse deflation would be in the absence of it.  Therefore, how do you know?

For example, perhaps it might be a roaring success if you achieved 1% deflation instead of an otherwise 4% number.
+1. Refreshing. A rare sane comment on this topic.
Title: Re: Deflation hedges
Post by: ERICOPOLY on September 29, 2015, 12:44:07 PM
Japan announced that inflation was negative for August. Stripping out fresh foods, core inflation was was also negative at -0.1% - the first negative print in core inflation since the beginning of the current QE program started in 2013.

Abe-nomics isn't working just like none of the other QE programs in Japan ever worked. Sure, someone will probably have the excuse that China's weakening yuan is wreaking havoc on Japan's export economy. I'd just add that there always seems to be some good excuse for why any individual QE program doesn't work, but I've yet to hear a good excuse that explains why they have all collectively failed without a single instance of success in stimulating "normalized" growth and inflation.

We're not there in Japan after nearly 10 rounds of QE. We're not there in the U.S. after 4 rounds of QE. We're not there in Europe during the first round of QE. Hey, I know what we need! MORE QE!!!!

You cannot say it failed to work.  You don't know how much worse deflation would be in the absence of it.  Therefore, how do you know?

For example, would be perhaps be a roaring success if you achieved 1% deflation instead of an otherwise 4% number.

And the same argument would apply to you - you can't say that it worked because you don't know what inflation/deflation would have been without it. We could have ended in the exact same place. But I do think it's clear that the results have not been what was targeted by any of the policy makers that implemented it, which is a better gauge of failure than people who claim it was a success have.


Yet I don't argue that it succeeded.  Nor do I argue it failed.  I just know that we don't know.
Title: Re: Deflation hedges
Post by: rb on September 29, 2015, 12:47:29 PM
Just to add that the only actually properly done QE to date has been QE3 in the US. The rest have been quite poor. Japan in particular with fits and starts of smallish amounts. The last one had promise it remains to be seen if BOJ stays the course.
Title: Re: Deflation hedges
Post by: Crip1 on October 01, 2015, 09:52:06 AM
Some key data that flies in the face of the deflation thesis...


http://finance.yahoo.com/news/why-buffalo-wild-wings-prices-are-going-up-nov--1st-152124092.html


 ;)


-Crip
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 01, 2015, 10:43:42 AM
Some key data that flies in the face of the deflation thesis...


http://finance.yahoo.com/news/why-buffalo-wild-wings-prices-are-going-up-nov--1st-152124092.html


 ;)


-Crip

 Prem better cover his derivatives now!!!!!
Title: Re: Deflation hedges
Post by: Dazel on October 01, 2015, 10:50:42 AM


or buy another restaurant chain as a hedge!

shareholder discount anyone?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 01, 2015, 10:56:00 AM


or buy another restaurant chain as a hedge!

shareholder discount anyone?

No. People want him to fry bigger fish. Not hot wings!
Title: Re: Deflation hedges
Post by: Jurgis on October 01, 2015, 11:36:10 AM
Some key data that flies in the face of the deflation thesis...


http://finance.yahoo.com/news/why-buffalo-wild-wings-prices-are-going-up-nov--1st-152124092.html


 ;)


-Crip

That's funny.

It does seem that prices in restaurants are going up pretty much.
Title: Re: Deflation hedges
Post by: rukawa on October 01, 2015, 08:25:13 PM
Quote
I have never heard that definition before.  Do you think FFH is investing hundreds of millions based on your theory of deflation?

I think they are investing hundreds of millions of dollars based on the idea that the US is in a Great Depression scenario which I think is wrong. You don't get much deflation from a consumer credit crisis. Because you can't fire your wife. You get deflation from business/financial credit crisis. During both the Great Depression and the Japanese credit crisis it was businesses that held huge debts. The deflation during the Great Depression was due to bank failures and businesses firing workers and lowering prices. This was explained competely by Irving Fisher. This is completely different than the current situation because the Fed bailed out the banks and the businesses were not heavily in debt to begin with. So you were never going to get huge deflation. Plus the retirement of the baby boomers is an inflationary tailwind. The whole thesis never made sense.

Title: Re: Deflation hedges
Post by: wisdom on October 01, 2015, 09:46:49 PM
7 years of money printing across the world and we are still talking about the first interest rate hike. Does that sound like inflation? I wonder what happens when the next slow down hits or all the misallocated capital over the last 8 years results in losses. I guess that may lead to inflation. 
Title: Re: Deflation hedges
Post by: goldfinger on October 01, 2015, 09:51:23 PM
Ask Europe where they think they are going as we speak. Ask Japan where they are and have been for a long time. 10y treasury yields at 2% in the US, inflation close to 0 after a few rounds of QE american style...
Title: Re: Deflation hedges
Post by: Zorrofan on October 02, 2015, 04:41:59 AM
Quote
I have never heard that definition before.  Do you think FFH is investing hundreds of millions based on your theory of deflation?

I think they are investing hundreds of millions of dollars based on the idea that the US is in a Great Depression scenario which I think is wrong. You don't get much deflation from a consumer credit crisis. Because you can't fire your wife. You get deflation from business/financial credit crisis. During both the Great Depression and the Japanese credit crisis it was businesses that held huge debts. The deflation during the Great Depression was due to bank failures and businesses firing workers and lowering prices. This was explained competely by Irving Fisher. This is completely different than the current situation because the Fed bailed out the banks and the businesses were not heavily in debt to begin with. So you were never going to get huge deflation. Plus the retirement of the baby boomers is an inflationary tailwind. The whole thesis never made sense.

Wouldn't the retirement of baby boomers be deflationary?  Smaller retirement incomes mean less spending.....

cheers
Zorro
Title: Re: Deflation hedges
Post by: barsax on October 02, 2015, 05:44:48 AM
Wow!!  That US jobs report was pitiful.  Rates aren't going up for some time, bonds are still the best asset class...deflation anyone?
Title: Re: Deflation hedges
Post by: NewbieD on October 02, 2015, 06:06:58 AM


Wouldn't the retirement of baby boomers be deflationary?  Smaller retirement incomes mean less spending.....

cheers
Zorro

Especially the dying of baby boomers should be deflationary.. :D
Title: Re: Deflation hedges
Post by: obtuse_investor on October 02, 2015, 06:05:55 PM
An article on US Inflation in the latest Economist.

The lowdown
Persistent low inflation results from more than cheap oil and a strong dollar
http://www.economist.com/news/united-states/21669952-persistent-low-inflation-results-more-cheap-oil-and-strong-dollar-lowdown

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 02, 2015, 08:21:28 PM
An article on US Inflation in the latest Economist.

The lowdown
Persistent low inflation results from more than cheap oil and a strong dollar
http://www.economist.com/news/united-states/21669952-persistent-low-inflation-results-more-cheap-oil-and-strong-dollar-lowdown

Stop posting your deflationistic propaganda. You can't possibly imagine that deflation is a real threat can you? I mean, the Fed would never let it happen! After the energy dip rolls off and all of the companies/states we've been dependent on for minuscule growth roll over on a YoY basis, the U.S. economy and inflation will come roaring back to life. 
Title: Re: Deflation hedges
Post by: rukawa on October 02, 2015, 08:40:49 PM
Quote
Wouldn't the retirement of baby boomers be deflationary?

No. People who retire spend, but don't work. They draw down savings and spend their pensions. This reduces labour supply much more than it reduces consumption. For instance a person making $100000 retires with pension of $20000. Lets say they spend $100000 when they were working and now spend $20000 in retirement. Retirement has reduced consumption by $80000 but reduced production by $100000. These assumptions of course are very conservative because typically people save money pre-retirement and spend down savings post retirement.

Baby boomers are not being replaced by new workers. This labour supply is going down. You can already see this occurring in the labour participation rate. Right now unemployment is 5.1. Wages will start rising. I expect profit margins will shrink and when they can't shrink any more inflation will start.
Title: Re: Deflation hedges
Post by: Zorrofan on October 03, 2015, 08:14:15 AM
Quote
Wouldn't the retirement of baby boomers be deflationary?

No. People who retire spend, but don't work. They draw down savings and spend their pensions. This reduces labour supply much more than it reduces consumption. For instance a person making $100000 retires with pension of $20000. Lets say they spend $100000 when they were working and now spend $20000 in retirement. Retirement has reduced consumption by $80000 but reduced production by $100000. These assumptions of course are very conservative because typically people save money pre-retirement and spend down savings post retirement.

Baby boomers are not being replaced by new workers. This labour supply is going down. You can already see this occurring in the labour participation rate. Right now unemployment is 5.1. Wages will start rising. I expect profit margins will shrink and when they can't shrink any more inflation will start.

Very interesting....thanks for your reply.  Couple this with the roll off from the oil price collapse (as pointed out by TwoCitiesCapital) and we could see some interesting results over the next few years.....
Title: Re: Deflation hedges
Post by: wisdom on October 04, 2015, 03:26:17 PM
http://www.ft.com/intl/cms/s/0/2968bc5e-68fe-11e5-a57f-21b88f7d973f.html?ftcamp=traffic/partner/feed_headline/us_yahoo/auddev#axzz3ndhwzhHT

Deflation in asia
Title: Re: Deflation hedges
Post by: petec on October 05, 2015, 02:07:31 AM
You don't get much deflation from a consumer credit crisis. Because you can't fire your wife. You get deflation from business/financial credit crisis. During both the Great Depression and the Japanese credit crisis it was businesses that held huge debts. The deflation during the Great Depression was due to bank failures and businesses firing workers and lowering prices. This was explained competely by Irving Fisher.

Was it?   I've just finished reading Murray Rothbard's excellent book on the Great Depression which gives an entirely different set of explanations.   

I happen to disagree with everything you've said but I won't bore everyone debating line by line.   What I will say is that the economics world is largely in the grip of one set of ideas based on one interpretation of history.   That might be the right set of ideas and the right interpretation.   But there are other ideas, and other interpretations, that have been coherently argued by intelligent people (Rothbard being one, Jim Grant another in his recent book on the 1921 depression - I'd recommend both).

It is quite possible that in 20 or 30 years' time we will look back on monetarism and think it as deluded as most people now think pro-austerity Austrian-school economists are.   Only time will tell and in the meantime I'm with Munger: anyone who is intelligent who is not confused doesn't understand the situation very well.
Title: Re: Deflation hedges
Post by: petec on October 05, 2015, 02:34:49 AM
Quote
Wouldn't the retirement of baby boomers be deflationary?

No. People who retire spend, but don't work. They draw down savings and spend their pensions. This reduces labour supply much more than it reduces consumption. For instance a person making $100000 retires with pension of $20000. Lets say they spend $100000 when they were working and now spend $20000 in retirement. Retirement has reduced consumption by $80000 but reduced production by $100000. These assumptions of course are very conservative because typically people save money pre-retirement and spend down savings post retirement.

Baby boomers are not being replaced by new workers. This labour supply is going down. You can already see this occurring in the labour participation rate. Right now unemployment is 5.1. Wages will start rising. I expect profit margins will shrink and when they can't shrink any more inflation will start.

I haven't fully thought this through but I find this odd given that aging has often been cited as a cause of deflation in Japan.

If the labour force shrinks, then GDP will shrink unless there is productivity growth.   If GDP shrinks, and debts stay fixed, that will eventually be deflationary.   If productivity grows, then isn't your argument invalidated?   Because I would think growing productivity could offset the declining labour force, so spending would drop faster than production.   Again, deflationary.

Much more importantly, retirees spend savings.   Any savings in the forms of deposits are inflationary, as they boost the money supply.   As they get withdrawn, the money supply shrinks, and that is very deflationary.   The real drivers of inflation and deflation are changes in the money supply.   What matters is whether governments, desperate to keep the money supply up via fiscal and monetary means, will win their battle with the free markets, which seem to want to reduce the money supply by paying down loans.
Title: Re: Deflation hedges
Post by: james22 on October 05, 2015, 03:25:25 AM
The world has been in a deflationary cycle since the collapse of Lehman Brothers Holdings Inc., evidenced by the euro, crude oil and a gauge of average commodities futures prices all peaking out in 2008, while risk-asset prices are merely buoyed by aggressive global monetary easing, Wakabayashi said.

As the accommodative policy has failed to end global deflation and artificially inflated risk-asset values are running out of steam, the dollar’s strength is reminiscent of the yen’s appreciation that hurt the Japanese economy during decades of price declines, he said.

“The U.S. will have to eventually resort to a weak dollar policy as deflation deepens,” Wakabayashi said.

The Federal Reserve has held rates near zero since December 2008 to boost the economy through the worst recession since the Great Depression.

“It’s obvious the U.S. is headed for deep deflation, hurt by the strong dollar,” said Wakabayashi, 72. “The Fed raising rates in this environment is not only ridiculous but harmful. U.S. stocks are plunging, not because of the prospect of a Fed rate hike, but to prevent it.”


http://www.bloomberg.com/news/articles/2015-10-01/strategist-known-as-mad-dog-says-yen-can-climb-to-100-per-dollar
Title: Re: Deflation hedges
Post by: rb on October 06, 2015, 12:05:19 PM
Much more importantly, retirees spend savings.   Any savings in the forms of deposits are inflationary, as they boost the money supply.   As they get withdrawn, the money supply shrinks, and that is very deflationary.   The real drivers of inflation and deflation are changes in the money supply.   What matters is whether governments, desperate to keep the money supply up via fiscal and monetary means, will win their battle with the free markets, which seem to want to reduce the money supply by paying down loans.
Pease explain why withdrawals from savings accounts will reduce the money supply?
Title: Re: Deflation hedges
Post by: petec on October 07, 2015, 06:59:49 AM
Much more importantly, retirees spend savings.   Any savings in the forms of deposits are inflationary, as they boost the money supply.   As they get withdrawn, the money supply shrinks, and that is very deflationary.   The real drivers of inflation and deflation are changes in the money supply.   What matters is whether governments, desperate to keep the money supply up via fiscal and monetary means, will win their battle with the free markets, which seem to want to reduce the money supply by paying down loans.
Pease explain why withdrawals from savings accounts will reduce the money supply?

D'oh - they don't.   Apologies - I wrote that when I was very tired and entirely failed to say what I meant to say, which was:

People heading for retirement pay down debt which reduces the money supply (all else being equal obviously).
Title: Re: Deflation hedges
Post by: Dazel on October 13, 2015, 03:23:03 AM
http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html


so for all of you naysayers.....how do we like the UK deflation hedges?

:)
Title: Re: Deflation hedges
Post by: giofranchi on October 13, 2015, 04:28:33 AM
http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html


so for all of you naysayers.....how do we like the UK deflation hedges?

:)

Dazel,
you know I have never been a naysayer! On the contrary, I have always said I believe FFH’s macro thesis will ultimately be proven right.
I had sold some months ago simply because I think it is easier to make money selling smartphones, selling pharmaceutical products, selling software, or selling aerospace components… than making macro forecasts! Won’t you agree?
This being said, I have recently bought back a meaningful amount of FFH, because I think it might be a good idea to use it as “ready cash”, especially now that their macro thesis is beginning to be proven right.

Cheers,

Gio
Title: Re: Deflation hedges
Post by: petec on October 13, 2015, 05:13:10 AM
Won’t you agree?


These ways of making money are easier 99% of the time.   But the macro stuff is, very very very occasionally, the only way to survive.   Which is why I like the insurance of owning FFH (and I know you agree).
Title: Re: Deflation hedges
Post by: petec on October 13, 2015, 05:15:13 AM
http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html


so for all of you naysayers.....how do we like the UK deflation hedges?

:)

Inflation came in at -0.1pc in September.....oh the humanity. This thread is like CNBC when the market goes down. The world is ending because gas prices fell.

I know what you mean - it does make me laugh that this thread lights up whenever the market falls 5%.   But I do think that the world today looks like it needs more or less continual QE in order not to fall into deflation, which is interesting and worrying.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 13, 2015, 05:23:30 AM
http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html


so for all of you naysayers.....how do we like the UK deflation hedges?

:)

Inflation came in at -0.1pc in September.....oh the humanity. This thread is like CNBC when the market goes down. The world is ending because gas prices fell.

I know what you mean - it does make me laugh that this thread lights up whenever the market falls 5%.   But I do think that the world today looks like it needs more or less continual QE in order not to fall into deflation, which is interesting and worrying.

I think that's the crux of the deflation camps thesis. A lot of people seem to write off deflation as a stupid concern because we haven't had prolonged deflation in the Western world in decades, but I look at policy makers doing trillions in quantitative easing and trillions in deficits and still see deflationary prints and it makes me think that policy makers don't have anywhere near the control that most people thought they had in controlling the economy.

It's not so much that -0.1% is significant in and of itself - it's that we're getting -0.1% despite policy makers doing everything in their power to get to 2-2.5% and we're still getting deflation in return....
Title: Re: Deflation hedges
Post by: giofranchi on October 13, 2015, 05:30:10 AM
(and I know you agree).

Yes, I do.

Cheers,

Gio
Title: Re: Deflation hedges
Post by: Dazel on October 13, 2015, 07:00:22 AM




Gio...I was kidding about naysayers!...all I care about is who is right...the money has already been made by those that believed like a few of us in the summer that things were "not' good...could not give a shit less about the headlines now....the market, bond rates...and now cpi will confirm what we were saying...no idea how far it goes and "no one does".

The market was more hedged last week (thank you we went very long in the fear) then anytime in history...so whatever price people had for Fairfax CPI deflation contracts I would suspect they are higher...but the CNBC headlines will tell everyone that in month or so!!!!

50 cent...as long as you know where you sit at the poker table...I will gladly take your criticism!


;)
Title: Re: Deflation hedges
Post by: Luckyone77 on October 15, 2015, 06:18:18 AM
 

"It's not so much that -0.1% is significant in and of itself - it's that we're getting -0.1% despite policy makers doing everything in their power to get to 2-2.5% and we're still getting deflation in return...."
[/quote]

That truly is the scary part of all this. What is real GDP around the world if you took the massive amount of QE by all parties out of the equation? Ray Dalio calls it beautiful deleveraging. Maybe he's right. Something, however, just feels very wrong about it all. Right or wrong, hence my investment in Fairfax. Protection.
Title: Re: Deflation hedges
Post by: james22 on October 24, 2015, 11:01:52 PM
The velocity of money has turned lower… and since 2008 and 2009 when we started to see deflation, the Fed and other central banks have declared war, hell bent on wiping out deflation and foregoing debt deleveraging through massive QE.

As of last month, inflation is zero.

Some war!


http://www.businessinsider.com/us-on-fast-track-to-deflation-2015-10
Title: Re: Deflation hedges
Post by: petec on October 28, 2015, 06:37:34 AM
The velocity of money has turned lower… and since 2008 and 2009 when we started to see deflation, the Fed and other central banks have declared war, hell bent on wiping out deflation and foregoing debt deleveraging through massive QE.

As of last month, inflation is zero.

Some war!


http://www.businessinsider.com/us-on-fast-track-to-deflation-2015-10

Money velocity today is 1.5 - the chart in this link is a bit out of date.   Amazing that it's only been below 1.5 twice in 115 years!
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 28, 2015, 08:12:42 AM
The velocity of money has turned lower… and since 2008 and 2009 when we started to see deflation, the Fed and other central banks have declared war, hell bent on wiping out deflation and foregoing debt deleveraging through massive QE.

As of last month, inflation is zero.

Some war!


http://www.businessinsider.com/us-on-fast-track-to-deflation-2015-10

Money velocity today is 1.5 - the chart in this link is a bit out of date.   Amazing that it's only been below 1.5 twice in 115 years!

The velocity of money has been my main indicator for the deflationary thesis - there are two pieces to this that we should understand though. GDP and the M2 monetary base. Theoretically, dividing GDP by the M2 monetary base gives you the velocity of money. ($17.9 T/$12.02 T = 1.49).

There is only 1 way for this ratio to fall - if the growth rate of the monetary base exceeds GDP growth. Generally, if there is more money to circulate, more money gets circulated and GDP increases at the same, or a higher rate, than the monetary base (because each $1 can be spent more than once). What we have seen over the last decade is that there is far more money to be circulated but we're generating far less activity with every $1 of it.

This is a fundamental change in consumer behavior. The M1 money supply has grown by about 1.65 trillion since 2008. The M2 money supply has grown by about 4 trillion since 2008. These figures do not count the reserves held by the banks at the Fed and are happening despite tighter lending standards which should constrain the money supply growth in a fractional reserve system. Individuals and companies are hoarding 2x as much in the way of demand deposits as they were pre-crisis. Including non-demand deposits (CDs, Money Market funds, etc.), we're holding 50% more than pre-crisis. People and companies are not spending money - they're "hoarding" it. Even when accounting for the demographic shifts of boomers who should be spending more of their savings.

Why they're hoarding it is anyone's guess. Companies may have been scarred by a near death experience in 2008. Those who experienced layoffs may have seen that their cash savings weren't adequate and are now changing their behavior to ensure it doesn't happen again. Investors may be scarred by the 50+% drop in equities twice in a single decade. Near retirees may realize they had been slacking on their savings to survive a 2% interest rate environment. The list goes on and on, but these types of economic occurrences scar people and change their behavior. There's a reason that depression-era grandparents have very different savings/spending attitudes than our parents. This is also why some forecast that a Depression-like economic scenario needs to happen once every 3 generations or so.

As they save more cash, people will be buying less as a % of their income. Until they hit that savings goal, as an aggregate population, we'll continue to see more money being withheld from economic circulation which means less purchases as a % of income which means we may need less capacity than we have traditionally needed which means that production should fall to balance demand or prices should fall to increase the demand - sometimes both.

I think this is the main deflationary force at work - the change in consumer behavior. The velocity of money shows a non-temporary change in behavior that the CPI fails to capture. The Federal Reserve can't do much about the velocity of money because they can't force transactions. Even having a negative interest rate on consumer deposits would likely just mean people hoard cash in safes and remove it from the financial system - it doesn't mean they'd just go spend it all and jump start the economy. That being said, it doesn't guarantee deflation as we have seen by the CPI - what it does mean is that it's far easier to get a deflationary event in the past because people, whose transactions account for the majority of economic activity, have a much higher propensity to save and that can be accelerated by any hint of another downturn in economic activity.

At least, that has been my thinking for the past 2 or 3 years.



Title: Re: Deflation hedges
Post by: gary17 on October 28, 2015, 08:17:11 AM
so instead of printing money they should consider printing pseudo monies with an expiration date -    let's give everybody $500 for the year 2016 and 2017 each to spend , but you must spend it within the calendar year...  :)
Title: Re: Deflation hedges
Post by: petec on October 28, 2015, 08:19:34 AM
There's a reason that depression-era grandparents have very different savings/spending attitudes than our parents....Until they hit that savings goal, as an aggregate population, we'll continue to see more money being withheld from economic circulation...I think this is the main deflationary force at work - the change in consumer behavior.

Completely agree.

Equally, if the change turns out to be temporary, we will get an inflation.   

Going to be an interesting 20 years.
Title: Re: Deflation hedges
Post by: petec on October 28, 2015, 08:20:53 AM
so instead of printing money they should consider printing pseudo monies with an expiration date -    let's give everybody $500 for the year 2016 and 2017 each to spend , but you must spend it within the calendar year...  :)

Works for buyers.   How do you persuade sellers that expiring money has value?   Recipe for a black market!
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 28, 2015, 08:31:03 AM
There's a reason that depression-era grandparents have very different savings/spending attitudes than our parents....Until they hit that savings goal, as an aggregate population, we'll continue to see more money being withheld from economic circulation...I think this is the main deflationary force at work - the change in consumer behavior.

Completely agree.

Equally, if the change turns out to be temporary, we will get an inflation.   

Going to be an interesting 20 years.

Both measures have been declining for many years. I think we're well past the point of being able to call this temporary. The real question is when does the decline stop? When do we get to the point where people have saved enough to be comfortable to start spending a larger portion of their income again and the velocity of money stabilizes and/or grows again? That's the real question - as it stands, the increase in the M1 money supply over the past 7 years is "only" about $5,000 per person.

If you were someone who was long-term unemployed, you know that $5,000 doesn't necessarily take you very far if you have kids, a house, food, and a car to pay for. If you were someone who lost your house, $5,000 may not be enough for your next down payment. If you lost 50% of your home value, $5,000 probably isn't anywhere near enough to make you feel like you're getting back to positive equity (though rising home values certainly have helped here). Of course, this is obviously extrapolating using the average figure to individual cases which is mostly inappropriate to do. In reality, these are the people savings more than $5,000 while others are hoarding less, but I guess my point is that a $5,000 increase in savings really isn't that much in the scheme of things.
Title: Re: Deflation hedges
Post by: Luckyone77 on October 28, 2015, 08:44:58 AM
Great post, TwoCities. Seth Klarman commented back in 09 or so that one of the reasons he was so skeptical on the market was because of the lack of the Depression mentality after such a market shock. Once the government stepped in and essentially put all the bad private debt onto the books on the government (instead of letting Capitalism do it's cleansing), people said..."Well, that was a bad few weeks. Carry on." Lesson not learned.

I can only speak for myself but the reason that I'm sitting on so much cash is simply because I don't trust this academic economic experiment of printing gazillions of dollars all over the world. Make no mistake, I've been wrong up to this point. I'm just not smart enough to know exactly when the music stops in this game of musical chairs. Maybe it never will but this paper currency in my wallet has to mean something. Just feel like the day of reckoning has been postponed not avoided. It's been an expensive miscalculation so far. For Fairfax as well actually. Let's see how the story ends.
Title: Re: Deflation hedges
Post by: petec on October 28, 2015, 09:18:23 AM

If you were someone who was long-term unemployed, you know that $5,000 doesn't necessarily take you very far if you have kids, a house, food, and a car to pay for. If you were someone who lost your house, $5,000 may not be enough for your next down payment. If you lost 50% of your home value, $5,000 probably isn't anywhere near enough to make you feel like you're getting back to positive equity (though rising home values certainly have helped here). Of course, this is obviously extrapolating using the average figure to individual cases which is mostly inappropriate to do. In reality, these are the people savings more than $5,000 while others are hoarding less, but I guess my point is that a $5,000 increase in savings really isn't that much in the scheme of things.

Once again I agree with the thinking - although I need to think about the validity of equating M1 with savings in a QE environment.

That said, there seem to be the green shoots of wage growth and that might be the start of an acceleration in confidence/money velocity/inflation.   I have a huge deflation protection position in FFH (which I also expect to compound healthily in the long term regardless of whether the deflation bet works) but it's protection, not prediction.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 28, 2015, 09:38:11 AM

If you were someone who was long-term unemployed, you know that $5,000 doesn't necessarily take you very far if you have kids, a house, food, and a car to pay for. If you were someone who lost your house, $5,000 may not be enough for your next down payment. If you lost 50% of your home value, $5,000 probably isn't anywhere near enough to make you feel like you're getting back to positive equity (though rising home values certainly have helped here). Of course, this is obviously extrapolating using the average figure to individual cases which is mostly inappropriate to do. In reality, these are the people savings more than $5,000 while others are hoarding less, but I guess my point is that a $5,000 increase in savings really isn't that much in the scheme of things.

Once again I agree with the thinking - although I need to think about the validity of equating M1 with savings in a QE environment.

That said, there seem to be the green shoots of wage growth and that might be the start of an acceleration in confidence/money velocity/inflation.   I have a huge deflation protection position in FFH (which I also expect to compound healthily in the long term regardless of whether the deflation bet works) but it's protection, not prediction.

You can correct me if I am wrong, but I was pretty sure that excess reserves, which is where most of money from QE has gone, are excluded from M1 and M2 measures which should just be physical currency, demand deposits, and time deposits (maybe a few other knick-knacks here and there). So realistically, M1 and M2 should both be a measure of cash savings with M2 reflecting the larger cash positioning of a lot of investments accounts and large corporations regardless of what the Fed is doing with QE since little of that money is even finding its way into the real economy.
Title: Re: Deflation hedges
Post by: petec on October 28, 2015, 09:45:03 AM

You can correct me if I am wrong, but I was pretty sure that excess reserves, which is where most of money from QE has gone, are excluded from M1 and M2 measures which should just be physical currency, demand deposits, and time deposits (maybe a few other knick-knacks here and there). So realistically, M1 and M2 should both be a measure of cash savings with M2 reflecting the larger cash positioning of a lot of investments accounts and large corporations regardless of what the Fed is doing with QE since little of that money is even finding its way into the real economy.

Yes, that sounds right.   Although (separate discussion) I questions whether investments accounts and corporations are *net* cash-heavy.   A lot of the evidence I have seen suggests otherwise.   

My other point would be that clearly bond, equity, and bull markets will make people feel they have 'saved' more than the cash figures alone suggest.   Problem is, that can reverse.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on October 28, 2015, 10:32:24 AM

You can correct me if I am wrong, but I was pretty sure that excess reserves, which is where most of money from QE has gone, are excluded from M1 and M2 measures which should just be physical currency, demand deposits, and time deposits (maybe a few other knick-knacks here and there). So realistically, M1 and M2 should both be a measure of cash savings with M2 reflecting the larger cash positioning of a lot of investments accounts and large corporations regardless of what the Fed is doing with QE since little of that money is even finding its way into the real economy.

Yes, that sounds right.   Although (separate discussion) I questions whether investments accounts and corporations are *net* cash-heavy.   A lot of the evidence I have seen suggests otherwise.   

My other point would be that clearly bond, equity, and bull markets will make people feel they have 'saved' more than the cash figures alone suggest.   Problem is, that can reverse.

Absolutely. I think we're on the same page then. People have been saving way more heavily than they were pre-crisis. This makes the economy deflation prone. There is the possibility for a correction in financial markets, or in real economic activity, that could exacerbate the issue.

I would also add that growing debt levels could hurt as well given that increased debt could lead to increased debt service with any appreciable rise in rates. It's certainly been an interesting decade and I think it will only get more interesting. I'm expecting one more large correction to shake out the excess and to really set the mood for the next generation.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on January 11, 2016, 03:27:06 PM
http://www.bloomberg.com/news/articles/2016-01-11/bank-of-america-rail-traffic-is-saying-something-worrying-about-the-u-s-economy (http://www.bloomberg.com/news/articles/2016-01-11/bank-of-america-rail-traffic-is-saying-something-worrying-about-the-u-s-economy)

Rail activity suggests U.S. economy is slowing down. Even outside of oil/energy/industrial volumes.

What happens when you have a recession with CPI already printing paltry inflation of just 0.5% YOY in November?
Title: Re: Deflation hedges
Post by: petec on January 12, 2016, 01:47:28 AM
http://www.bloomberg.com/news/articles/2016-01-11/bank-of-america-rail-traffic-is-saying-something-worrying-about-the-u-s-economy (http://www.bloomberg.com/news/articles/2016-01-11/bank-of-america-rail-traffic-is-saying-something-worrying-about-the-u-s-economy)

Rail activity suggests U.S. economy is slowing down. Even outside of oil/energy/industrial volumes.

What happens when you have a recession with CPI already printing paltry inflation of just 0.5% YOY in November?

Ha ha: I was wondering how many days of red screens it would take for this thread to fire up again.   But I do agree.   WSBASE dipping, all sorts of pieces of data pointing to an economic slowdown, rates rising (although my guess is they stop here).   

Then again: some evidence of rising wages, and eventually commodities get low enough that people start buying things.   

Who knows.

Either way, can't be a bad time for Fairfax's derivatives book with deflation fears rising and the Russell teetering on the brink of technical bear market territory (down 195% from the highs).
Title: Re: Deflation hedges
Post by: Jurgis on January 12, 2016, 05:23:31 AM
(down 195% from the highs).

That's how my portfolio feels. /nods

 ;)
Title: Re: Deflation hedges
Post by: petec on January 12, 2016, 05:31:03 AM
Ha!    Oh the difference a little dot makes.

19.5%!
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on January 12, 2016, 08:40:49 AM
http://www.bloomberg.com/news/articles/2016-01-11/bank-of-america-rail-traffic-is-saying-something-worrying-about-the-u-s-economy (http://www.bloomberg.com/news/articles/2016-01-11/bank-of-america-rail-traffic-is-saying-something-worrying-about-the-u-s-economy)

Rail activity suggests U.S. economy is slowing down. Even outside of oil/energy/industrial volumes.

What happens when you have a recession with CPI already printing paltry inflation of just 0.5% YOY in November?

Ha ha: I was wondering how many days of red screens it would take for this thread to fire up again.   But I do agree.   WSBASE dipping, all sorts of pieces of data pointing to an economic slowdown, rates rising (although my guess is they stop here).   

Then again: some evidence of rising wages, and eventually commodities get low enough that people start buying things.   

Who knows.

Either way, can't be a bad time for Fairfax's derivatives book with deflation fears rising and the Russell teetering on the brink of technical bear market territory (down 195% from the highs).

I wasn't firing this thread up due to the market declines. It was prompted by the article suggesting that there's more to the slow-down than simply energy and economists can no longer hide behind winter weather that happens nearly every winter...

If we can only get 0.5% when times are "good", I'm pretty sure you can get sustained negative prints for a year or two minimum of you have a recession of any significance.

I tend to think the stock market will go down as well, but my expectations for the stock market are removed from that of the expectations for the economy which is more impactful for the deflation hedges. I think stocks are likely to go down recession or not.
Title: Re: Deflation hedges
Post by: JEast on January 17, 2016, 08:09:26 AM
From about this time a year ago I commented that It is still early, but I am hopeful that the Toronto office is now at least getting some calls on possible asking prices. Maybe the calls have not come in yet, but at least the trend is favorable.  Just hopeful that we get our capital back.

(http://i67.tinypic.com/2e4dhjr.png)
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on January 20, 2016, 08:21:23 AM
http://www.cnbc.com/2016/01/20/bridgewaters-dalio-feds-next-move-toward-qe-not-tightening.html (http://www.cnbc.com/2016/01/20/bridgewaters-dalio-feds-next-move-toward-qe-not-tightening.html)

Quote
The risks are asymmetric on the downside. The next move in Fed policy will be quantitative easing and not tightening.



Title: Re: Deflation hedges
Post by: Cardboard on January 20, 2016, 12:35:27 PM
Peter Schiff said that a long time ago  ;)

Cardboard
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on January 20, 2016, 12:37:46 PM
Peter Schiff said that a long time ago  ;)

Cardboard

Sure, and Peter Schiff has been performing terribly. But Dalio has generally performed in the pure Alpha funds no matter what the market environment is so it's probably worth listening to him, no?

The man has been wrong before, but he didn't build a $160B hedge fund by being wrong often and letting it impair returns.
Title: Re: Deflation hedges
Post by: Jurgis on January 20, 2016, 01:02:29 PM
Peter Schiff said that a long time ago  ;)

Cardboard

Sure, and Peter Schiff has been performing terribly. But Dalio has generally performed in the pure Alpha funds no matter what the market environment is so it's probably worth listening to him, no?

The man has been wrong before, but he didn't build a $160B hedge fund by being wrong often and letting it impair returns.

Hah, in a rare occasion I'll agree with TwoCitiesCapital: Dalio knows what he does. The only risk to listening to him is that he runs a huge huge predictive operation and what he says is (a) oversimplification of what his team and machines churn out; (b) data & results might change and he won't tell you when it does. ;)
Title: Re: Deflation hedges
Post by: giofranchi on January 22, 2016, 02:09:58 AM
Soros sounds more and more in Watsa's camp:

http://www.marketwatch.com/story/george-soros-says-too-early-to-buy-stocks-after-shorting-sp-500-2016-01-21

Cheers,

Gio
Title: Re: Deflation hedges
Post by: JEast on January 22, 2016, 06:25:20 AM
With tongue in cheek, hope those calls are coming in so we can at least mark-to-market for the 1st quarter :)

(http://i64.tinypic.com/zub9f.png)
Title: Re: Deflation hedges
Post by: Sharad on January 22, 2016, 10:10:39 AM
With tongue in cheek, hope those calls are coming in so we can at least mark-to-market for the 1st quarter :)

(http://i64.tinypic.com/zub9f.png)

Here are the four webpages I use to track the four major CPI indices that Prem is shorting. They may not all be 100% accurate to the indices that he has shorted via puts/swaps, but I hope this helps. Another important note is that we only know the average CPI put rates, and some may be in the money and some may not be.

France: http://www.insee.fr/en/bases-de-donnees/bsweb/serie.asp?idbank=000641194
UK (Retail Price Index appears to tie to 2014 Annual Report information):  https://ycharts.com/indicators/uk_retail_price_index
EU: http://www.tradingeconomics.com/euro-area/consumer-price-index-cpi
US: http://inflationdata.com/Inflation/Consumer_Price_Index/HistoricalCPI.aspx?reloaded=true

I hope this helps everyone in gauging the CPI indices we, as FFH shareholders, should be assessing.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 08, 2016, 10:57:35 AM
I'm pleasantly surprised that Fairfax has been totally immune to recent market weakness. I knew it was a possibility, but I thought it would be more likely that it would decline with the general market as it did in 2008.

I'm waiting for the rest of the quarter to play out and to get the end results of what may be a phenomenal quarter, but I actually may end up reducing my holdings a little bit after that to re-balance the portfolio more towards the names that have been absolutely trashed in the last 4-6 months.
Title: Re: Deflation hedges
Post by: petec on February 09, 2016, 01:42:03 AM
I'm pleasantly surprised that Fairfax has been totally immune to recent market weakness.

Me, too.

Do let us know what you're buying ;)
Title: Re: Deflation hedges
Post by: giofranchi on February 09, 2016, 02:54:55 AM
I'm pleasantly surprised that Fairfax has been totally immune to recent market weakness.

Me, too.

+1!

Cheers,

Gio
Title: Re: Deflation hedges
Post by: giofranchi on February 09, 2016, 06:01:23 AM
I'm waiting for the rest of the quarter to play out and to get the end results of what may be a phenomenal quarter, but I actually may end up reducing my holdings a little bit after that to re-balance the portfolio more towards the names that have been absolutely trashed in the last 4-6 months.

Instead, I think I am adding some more: it is trading at 1.31xBVPS, with a BVPS of 400USD as of last September. If Fairfax has made some money during the last three months of 2015, it is trading for a lower multiple. Moreover, the first three months of 2016 look great until now… therefore, it might actually be trading closer to 1.2xBVPS.
As cash comes in I am still cautious to invest it in faster growing businesses. And I think I’ll park it momentarily in Fairfax, waiting for more bargains to appear.

Cheers,

Gio
Title: Re: Deflation hedges
Post by: giofranchi on February 11, 2016, 05:05:42 AM
With bond yields that keep falling, Q1 2016 is getting more and more profitable for Fairfax. If Fairfax announces slightly disappointing Q4 2015 results, and consequently its stock trades lower, there might be a good opportunity to buy more.

Cheers,

Gio
Title: Re: Deflation hedges
Post by: petec on February 11, 2016, 05:16:24 AM
Excellent summary of China from Kyle Bass:

http://finance.yahoo.com/news/kyle-bass-china-running-money-202853355.html

Conclusion (as you might have guessed) is that China has no choice but to weaken its currency, which will be very deflationary for the US and Europe.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 11, 2016, 06:22:26 AM
With bond yields that keep falling, Q1 2016 is getting more and more profitable for Fairfax. If Fairfax announces slightly disappointing Q4 2015 results, and consequently its stock trades lower, there might be a good opportunity to buy more.

Cheers,

Gio

Anyone know off the top of their heads the breakout of their bond portfolio. How much in Treasuries, muni's, etc.? I know that falling yields is obviously good, but trying to figure out how much widening muni/credit spreads are going to offset that.

Thanks!
Title: Re: Deflation hedges
Post by: giofranchi on February 11, 2016, 06:58:23 AM
I know that falling yields is obviously good, but trying to figure out how much widening muni/credit spreads are going to offset that.

Hard to tell… I was only suggesting that in a very difficult environment a bad earnings report could cause the stock to fall, even if Q1 2016 looks very profitable until now… How much profitable is anyone's guess!

Cheers,

Gio
Title: Re: Deflation hedges
Post by: biaggio on February 11, 2016, 07:08:42 AM
http://business.financialpost.com/investing/investing-pro/will-prem-watsas-650-million-bet-pay-off-if-it-does-fairfax-makes-109-billion

"Will Prem Watsa’s $650-million bet pay off? If it does, Fairfax makes $109 BILLION"

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 11, 2016, 07:17:19 AM
http://business.financialpost.com/investing/investing-pro/will-prem-watsas-650-million-bet-pay-off-if-it-does-fairfax-makes-109-billion

"Will Prem Watsa’s $650-million bet pay off? If it does, Fairfax makes $109 BILLION"

I hate these articles. I saw this exact same thing in Motley fool Canada that suggested Fairfax could make 109B too - the only way that happens is if the world ends and money means nothing....

Realistically, even in a very, very favorable scenario for Fairfax, they'd only make 15-20B over the course of several years. That's assuming we get the same amount of deflation that was seen over the decade following the Great Depression. No way he makes anywhere near $109B... I think what we'll see is that he makes WAY more money from the TRS hedges than he does from the deflation swaps, but the deflation swaps could still turn out to be great investments even if they only return 1-2B given the cost basis being $650M and a current carrying value half of that.

It just blows my mind how clear and open he's been with the details of these swaps and yet the media still misunderstands them years and years later.

Title: Re: Deflation hedges
Post by: Uccmal on February 11, 2016, 07:22:58 AM
http://business.financialpost.com/investing/investing-pro/will-prem-watsas-650-million-bet-pay-off-if-it-does-fairfax-makes-109-billion

"Will Prem Watsa’s $650-million bet pay off? If it does, Fairfax makes $109 BILLION"

I hate these articles. I saw this exact same thing in Motley fool Canada that suggested Fairfax could make 109B too - the only way that happens is if the world ends and money means nothing....

Realistically, even in a very, very favorable scenario for Fairfax, they'd only make 15-20B over the course of several years. That's assuming we get the same amount of deflation that was seen over the decade following the Great Depression. No way he makes anywhere near $109B... I think what we'll see is that he makes WAY more money from the TRS hedges than he does from the deflation swaps, but the deflation swaps could still turn out to be great investments even if they only return 1-2B given the cost basis being $650M and a current carrying value half of that.

It just blows my mind how clear and open he's been with the details of these swaps and yet the media still misunderstands them years and years later.

The financial post article is the same article as Motley Fool.  The Financial Post is a shadow of its former self, years ago.  Mostly regurgitated hooey from Bloomberg these days. 
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 11, 2016, 07:31:49 AM
http://business.financialpost.com/investing/investing-pro/will-prem-watsas-650-million-bet-pay-off-if-it-does-fairfax-makes-109-billion

"Will Prem Watsa’s $650-million bet pay off? If it does, Fairfax makes $109 BILLION"

I hate these articles. I saw this exact same thing in Motley fool Canada that suggested Fairfax could make 109B too - the only way that happens is if the world ends and money means nothing....

Realistically, even in a very, very favorable scenario for Fairfax, they'd only make 15-20B over the course of several years. That's assuming we get the same amount of deflation that was seen over the decade following the Great Depression. No way he makes anywhere near $109B... I think what we'll see is that he makes WAY more money from the TRS hedges than he does from the deflation swaps, but the deflation swaps could still turn out to be great investments even if they only return 1-2B given the cost basis being $650M and a current carrying value half of that.

It just blows my mind how clear and open he's been with the details of these swaps and yet the media still misunderstands them years and years later.

The financial post article is the same article as Motley Fool.  The Financial Post is a shadow of its former self, years ago.  Mostly regurgitated hooey from Bloomberg these days.

I sent the dude an e-mail. Maybe we can get this corrected :/
Title: Re: Deflation hedges
Post by: Cageyone on February 11, 2016, 01:52:27 PM
FFH up again today in a down market! So is it becoming the "all-weather" stock we've all been waiting for?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 11, 2016, 02:03:06 PM
FFH up again today in a down market! So is it becoming the "all-weather" stock we've all been waiting for?

Fingers crossed - I imagine it'd still get caught up in a massive sell-off in which everything is liquidated indiscriminately, but the behavior we've seen YTD is suggesting this won't be a 2008 scenario where they're minting billions that you can buy for 50% off.
Title: Re: Deflation hedges
Post by: petec on February 12, 2016, 02:35:49 AM
FFH up again today in a down market! So is it becoming the "all-weather" stock we've all been waiting for?

Fingers crossed - I imagine it'd still get caught up in a massive sell-off in which everything is liquidated indiscriminately, but the behavior we've seen YTD is suggesting this won't be a 2008 scenario where they're minting billions that you can buy for 50% off.

Agreed.   So far I've broken even (in sterling, not dollars) in this selloff because of Fairfax.   I'm mildly nervous that won't continue.   
Title: Re: Deflation hedges
Post by: giofranchi on February 12, 2016, 04:39:47 AM
Agreed.   So far I've broken even (in sterling, not dollars) in this selloff because of Fairfax.   I'm mildly nervous that won't continue.

I think what people want, and almost never get, in investing is clarity: will I make money, or will I lose money. And if I’ll make money, how? I think in a difficult environment the way Fairfax makes money is clear to most people. Therefore, if some forced selling happens to Fairfax as well, I think it will probably be short lived.

Many other company that I know of and follow will probably go on being profitable even in a very difficult environment. For instance, for Berkshire to stop being profitable a really catastrophic event should occur. But people don’t know how much Berkshire will earn in a difficult environment, and they are probably guessing Berkshire will earn much less in a difficult environment than what it has earned until now. Furthermore, while everyone knows a difficult environment doesn’t last forever, no one really is sure how long it could last: some months, one year… two? Of course it makes a lot of difference!

With Fairfax, instead, it is different because people think that it will make more money in a difficult environment than it did until now. Therefore, the psychology is reversed imo.

At least for me it surely works that way.

Cheers,

Gio
Title: Re: Deflation hedges
Post by: dartmonkey on February 16, 2016, 04:31:36 PM
http://business.financialpost.com/investing/investing-pro/will-prem-watsas-650-million-bet-pay-off-if-it-does-fairfax-makes-109-billion

"Will Prem Watsa’s $650-million bet pay off? If it does, Fairfax makes $109 BILLION"

I hate these articles. I saw this exact same thing in Motley fool Canada that suggested Fairfax could make 109B too - the only way that happens is if the world ends and money means nothing....

Realistically, even in a very, very favorable scenario for Fairfax, they'd only make 15-20B over the course of several years. That's assuming we get the same amount of deflation that was seen over the decade following the Great Depression. No way he makes anywhere near $109B... I think what we'll see is that he makes WAY more money from the TRS hedges than he does from the deflation swaps, but the deflation swaps could still turn out to be great investments even if they only return 1-2B given the cost basis being $650M and a current carrying value half of that.

It just blows my mind how clear and open he's been with the details of these swaps and yet the media still misunderstands them years and years later.


Obviously the suggested $109B gain for Fairfax, in the event of deflation, is ridiculous, but I asked myself the same question: for a given level of inflation, how much will the notional $109B return? For instance, if we get a drop to the CPI level where the positions were opened (about 2-3% below today's levels), and then another 10% drop, can we assume that we will get 10% (pre-tax) of the $109B notional exposure? In other words, is the return linear? I would assume so, but I could not find anything in Fairfax's reports that actually estimate how these things work. Brooklyinvestor (https://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwi84em8xf3KAhVovIMKHVO7CpwQFggkMAE&url=http%3A%2F%2Fbrooklyninvestor.blogspot.com%2F2015%2F01%2Fwatsas-massive-bet.html&usg=AFQjCNH7gf6kiJGUKy3Mt8ScoQ64ST4PIg&sig2=eoSYaTP3cOjT5v2el_7I3w&bvm=bv.114195076,d.amc) seems to be assuming it is linear, but doesn't say how he knows; does anyone have anything more definitive?

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 16, 2016, 06:08:38 PM
http://business.financialpost.com/investing/investing-pro/will-prem-watsas-650-million-bet-pay-off-if-it-does-fairfax-makes-109-billion

"Will Prem Watsa’s $650-million bet pay off? If it does, Fairfax makes $109 BILLION"

I hate these articles. I saw this exact same thing in Motley fool Canada that suggested Fairfax could make 109B too - the only way that happens is if the world ends and money means nothing....

Realistically, even in a very, very favorable scenario for Fairfax, they'd only make 15-20B over the course of several years. That's assuming we get the same amount of deflation that was seen over the decade following the Great Depression. No way he makes anywhere near $109B... I think what we'll see is that he makes WAY more money from the TRS hedges than he does from the deflation swaps, but the deflation swaps could still turn out to be great investments even if they only return 1-2B given the cost basis being $650M and a current carrying value half of that.

It just blows my mind how clear and open he's been with the details of these swaps and yet the media still misunderstands them years and years later.


Obviously the suggested $109B gain for Fairfax, in the event of deflation, is ridiculous, but I asked myself the same question: for a given level of inflation, how much will the notional $109B return? For instance, if we get a drop to the CPI level where the positions were opened (about 2-3% below today's levels), and then another 10% drop, can we assume that we will get 10% (pre-tax) of the $109B notional exposure? In other words, is the return linear? I would assume so, but I could not find anything in Fairfax's reports that actually estimate how these things work. Brooklyinvestor (https://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwi84em8xf3KAhVovIMKHVO7CpwQFggkMAE&url=http%3A%2F%2Fbrooklyninvestor.blogspot.com%2F2015%2F01%2Fwatsas-massive-bet.html&usg=AFQjCNH7gf6kiJGUKy3Mt8ScoQ64ST4PIg&sig2=eoSYaTP3cOjT5v2el_7I3w&bvm=bv.114195076,d.amc) seems to be assuming it is linear, but doesn't say how he knows; does anyone have anything more definitive?

They return 1% of notional for every 1% below the CPI strike price headline inflation is. I believe the lump sum would be paid at maturity. Both these and the TRS hedges are linear in return profile.
Title: Re: Deflation hedges
Post by: Sharad on February 17, 2016, 09:54:36 AM
While UK headline inflation was 0.3%, I believe that the retail price index is the one being weighted for Fairfax's CPI puts (please correct me if I am wrong), and this index shows a monthly decline in January 2016, and a .5% increase from December 2014. Historically, it appears that there is a monthly decline from December to January every year, so the next few months will be more telling.

https://ycharts.com/indicators/uk_retail_price_index
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on February 29, 2016, 10:49:51 AM
http://www.bloomberg.com/news/articles/2016-02-29/euro-area-consumer-prices-fall-most-in-year-as-ecb-mulls-easing (http://www.bloomberg.com/news/articles/2016-02-29/euro-area-consumer-prices-fall-most-in-year-as-ecb-mulls-easing)

Deflation still a very real threat in Europe.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 01, 2016, 06:24:20 AM
http://www.bloomberg.com/news/articles/2016-03-01/euro-area-factories-cut-prices-at-fastest-pace-since-2013 (http://www.bloomberg.com/news/articles/2016-03-01/euro-area-factories-cut-prices-at-fastest-pace-since-2013)

Producer prices falling at the fastest rate in 3 years.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 07, 2016, 12:44:43 PM
http://www.valuewalk.com/2016/03/corporate-profit-margins-trends/ (http://www.valuewalk.com/2016/03/corporate-profit-margins-trends/)

S&P margins have been in decline for the last 12 months. NIPA margins have been in decline for much longer. Can we maintain high equity multiples if profits begin to fall?

Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 15, 2016, 02:23:04 PM
http://www.bloomberg.com/news/articles/2016-03-15/wholesale-prices-in-u-s-decreased-in-february-on-fuel-food (http://www.bloomberg.com/news/articles/2016-03-15/wholesale-prices-in-u-s-decreased-in-february-on-fuel-food)

Wholesale prices in the U.S. fell in February. CPI also expected to be negative when released later this week.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 18, 2016, 06:05:32 AM
http://www.bloomberg.com/news/articles/2016-03-15/wholesale-prices-in-u-s-decreased-in-february-on-fuel-food (http://www.bloomberg.com/news/articles/2016-03-15/wholesale-prices-in-u-s-decreased-in-february-on-fuel-food)

Wholesale prices in the U.S. fell in February. CPI also expected to be negative when released later this week.

CPI in the U.S. fell to 1.0% from 1.4% in January.


http://www.ft.com/fastft/2016/03/18/german-producer-prices-drop-3-in-february/ (http://www.ft.com/fastft/2016/03/18/german-producer-prices-drop-3-in-february/)

German producer prices drop 3% in February on top of a 2.4% annualized drop in January.

Quote
German factory gate prices dropped for a 31st consecutive month in February on an annualised basis, as deflationary pressures from falling energy prices continues to bite.


Year-on-year producer prices fell 3 per cent, worse than expectations of a 2.6 per cent drop. Prices had slipped 2.4 per cent in January. Price rises in non-durable consumer goods, capital goods and durable consumer goods couldn’t offset the 9.4 per cent fall in energy prices and 2.2 per cent fall in prices of intermediate goods.
Title: Re: Deflation hedges
Post by: giofranchi on March 29, 2016, 02:15:19 AM
ECB's Gloomy Price Outlook to Be Confirmed Just as QE Grows

http://www.bloomberg.com/news/articles/2016-03-28/ecb-s-gloomy-price-outlook-to-be-confirmed-just-as-qe-expands

Cheers,

Gio
Title: Re: Deflation hedges
Post by: Luckyone77 on April 09, 2016, 08:34:49 AM
http://www.theguardian.com/business/2016/apr/08/yen-us-dollar-deflation-bank-japan
Title: Re: Deflation hedges
Post by: wisdom on April 14, 2016, 10:39:06 PM
https://www.project-syndicate.org/commentary/china-risk-global-deflation-imbalances-by-arvind-subramanian-2016-04

http://www.bloombergview.com/articles/2016-04-14/disguised-outflows-show-money-s-still-leaving-china

http://finance.yahoo.com/news/chinas-stock-market-turning-dumping-175200914.html

Interesting articles on China
Title: Re: Deflation hedges
Post by: wisdom on April 19, 2016, 02:36:47 PM
http://www.theglobeandmail.com/globe-investor/investment-ideas/chinas-credit-fuelled-growth-gives-reason-to-doubt-market-recovery/article29676216/

Good write up on China and debt.
Title: Re: Deflation hedges
Post by: Zorrofan on April 29, 2016, 07:04:31 AM
Eurozone inflation continues to grind lower.....

http://www.ft.com/fastft/2016/04/29/eurozone-inflation-falls-short/

cheers
Zorro
Title: Re: Deflation hedges
Post by: Cardboard on April 29, 2016, 07:12:23 AM
Core inflation which excludes energy and food was up 0.8%. What do you think is going to happen to overall inflation with oil now going up?

Cardboard
Title: Re: Deflation hedges
Post by: Zorrofan on April 29, 2016, 07:29:36 AM
that's the $64,000 question isn't it - will oil continue to strengthen or will it roll over as Iran ramps up production, US shale drops off further etc....on the other hand Japan has had deflation for over 20 years regardless of oil.  European demographics , China overcapacity etc etc......this is why WEB ignores macro

cheers
Zorro
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on April 29, 2016, 08:17:15 AM
Core inflation which excludes energy and food was up 0.8%. What do you think is going to happen to overall inflation with oil now going up?

Cardboard

The rally in all commodities since mid-February has been driven by a weaker dollar given the dovish Fed. The markets are literally pricing in 0 rate hikes for the remainder of 2016. Now, how many rate hikes we get is up for debate - I couldn't care less.

The fact of the matter is that the U.S. economy remains in a much better position than either Europe or Japan from a growth perspective (even though growth here is pitiful). Our rates are also significantly higher than both countries making us even more appealing for foreign capital. My guess is that the U.S. dollar begins to rally again some time this year and we'll see additional weakness in commodities and emerging market currencies.

That being said, I'm still heavily invested in them simply due to the value available and so I can still profit from being wrong to offset my U.S. equity market hedges.

And, ultimately, it doesn't matter if see deflation in the U.S if it happens in Europe instead - which is the base case if the dollar remains where it's at or gets weaker. We have protection in both areas. The real question simply seems to be a matter of who bears the load of the deflation - does the U.S. import deflation via a stronger dollar and bear some of that load or does it remain in Europe/Japan.


 

Title: Re: Deflation hedges
Post by: wisdom on March 03, 2020, 01:14:17 PM
bump - how are these doing in this market?
Title: Re: Deflation hedges
Post by: StubbleJumper on March 03, 2020, 01:36:15 PM
bump - how are these doing in this market?


They might actually end up having some value, if this keeps up....
Title: Re: Deflation hedges
Post by: Redskin212 on March 03, 2020, 08:52:15 PM
I just checked last years annual report - they should still have an average life of about 2.5 years.  Lots of time!
Title: Re: Deflation hedges
Post by: WneverLOSE on March 03, 2020, 11:19:03 PM
It would really be a shame if they (i.e me as a shareholder) held those hedges for so many years with such great cost to shareholders and we get deflation as soon as those hedges expire
Title: Re: Deflation hedges
Post by: omagh on March 04, 2020, 08:35:36 AM
bump - how are these doing in this market?
Inflation has been ticking along, so it would take a big deflation thump to move the indices. 

source: https://inflationdata.com/Inflation/Consumer_Price_Index/HistoricalCPI.aspx?reloaded=true
YEAR   JAN            FEB   MAR   APR           MAY   JUN           JUL           AUG   SEP           OCT   NOV   DEC   AVE.
2020   257.971                                               
2019   251.712   252.776   254.202   255.548   256.092   256.143   256.571   256.558   256.759   257.346   257.208   256.974   255.657
2018   247.867   248.991   249.554   250.546   251.588   251.989   252.006   252.146   252.439   252.885   252.038   251.233   251.107
2017   242.839   243.603   243.801   244.524   244.733   244.955   244.786   245.519   246.819   246.663   246.669   246.524   245.120
2016   236.916   237.111   238.132   239.261   240.229   241.018   240.628   240.849   241.428   241.729   241.353   241.432   240.008
2015   233.707   234.722   236.119   236.599   237.805   238.638   238.654   238.316   237.945   237.838   237.336   236.525   237.017
2014   233.916   234.781   236.293   237.072   237.900   238.343   238.250   237.852   238.031   237.433   236.151   234.812   236.736
2013   230.280   232.166   232.773   232.531   232.945   233.504   233.596   233.877   234.149   233.546   233.069   233.049   232.957
2012   226.665   227.663   229.392   230.085   229.815   229.478   229.104   230.379   231.407   231.317   230.221   229.601   229.594
2011   220.223   221.309   223.467   224.906   225.964   225.722   225.922   226.545   226.889   226.421   226.230   225.672   224.939
2010   216.687   216.741   217.631   218.009   218.178   217.965   218.011   218.312   218.439   218.711   218.803   219.179   218.056
2009   211.143   212.193   212.709   213.240   213.856   215.693   215.351   215.834   215.969   216.177   216.330   215.949   214.537
2008   211.080   211.693   213.528   214.823   216.632   218.815   219.964   219.086   218.783   216.573   212.425   210.228   215.303
2007   202.416   203.499   205.352   206.686   207.949   208.352   208.299   207.917   208.490   208.936   210.177   210.036   207.342
2006   198.300   198.700   199.800   201.500   202.500   202.900   203.500   203.900   202.900   201.800   201.500   201.800   201.600
2005   190.700   191.800   193.300   194.600   194.400   194.500   195.400   196.400   198.800   199.200   197.600   196.800   195.300
Title: Re: Deflation hedges
Post by: Xerxes on March 05, 2020, 04:40:56 PM
I think like options, these hedges have time premium, and with just couple of years left, that premium has mostly collapsed. Said differently, the downturn needs to be far severe today, to get a homerun, then had it happened say 6 years ago.
Title: Re: Deflation hedges
Post by: Xerxes on March 12, 2020, 09:23:19 AM
It would be the ultimate letdown if the deflation hedges don’t produce meaningful results.
Title: Re: Deflation hedges
Post by: petec on March 12, 2020, 01:05:13 PM
It would be the ultimate letdown if the deflation hedges don’t produce meaningful results.

For the reasons given above, they won’t. Not a cat’s chance in hell they are going to end up in the money so they’re worthless.
Title: Re: Deflation hedges
Post by: Santayana on March 12, 2020, 01:16:10 PM
Except that inflation usually happens gradually, but when deflation happens it comes on fast due to a systemic shock.  I don't think they'll pay off, but the way markets are acting, who knows.
Title: Re: Deflation hedges
Post by: petec on March 12, 2020, 01:21:46 PM
Except that inflation usually happens gradually, but when deflation happens it comes on fast due to a systemic shock.  I don't think they'll pay off, but the way markets are acting, who knows.

Is that right? I’d have thought the other way on. Inflation accelerates like a mad thing when people lose confidence in the value of money and get rid of it as fast as possible, driving velocity up. Deflation I think of as a gradual thing as banks shrink their balance sheets and (all else equal) money supply drops.
Title: Re: Deflation hedges
Post by: Santayana on March 12, 2020, 01:29:53 PM
There are hyper-inflationary events, but in general inflation is a slow steady slog.
Title: Re: Deflation hedges
Post by: StubbleJumper on March 12, 2020, 01:34:37 PM
Except that inflation usually happens gradually, but when deflation happens it comes on fast due to a systemic shock.  I don't think they'll pay off, but the way markets are acting, who knows.


Interesting question.  Will the deflation hedges pay off, meaning, "Will they end up in-the-money" at the end of the contract?  I would propose that it is not necessary for the contracts to end up in-the-money, but rather FFH could re-coup a bit of its capital if it can sell the contracts some fearful buyer who is willing to pay for a bit of deflation protection and is prepared to accept the risk that they might not end up in the money. 

On this one, how would we define "victory" at this point?  If FFH could sell those contracts for US$50m, would that constitute a "victory" at this stage of the game? What about US$75m, would that be enough to declare victory?  Frankly, if they could sell them for $75m or $100m, I would be happy to have recouped even that much capital....  Even if they could sell half of the protection for $50m, that would recoup a bit of capital and would still leave a large value of notional protection...


SJ
Title: Re: Deflation hedges
Post by: Santayana on March 12, 2020, 02:04:15 PM
Isn't that how they profited on the CDS bet?  it's different in that those were in the money, but I think they realized the value by selling them before expiration.
Title: Re: Deflation hedges
Post by: StubbleJumper on March 12, 2020, 02:14:41 PM
Isn't that how they profited on the CDS bet?  it's different in that those were in the money, but I think they realized the value by selling them before expiration.


Oh, that's definitely how FFH profited from CDS, they definitely did not hold them until expiry.  My musings about the definition of a "victory" are really a question of what kind of offer would FFH need to salvage some useful amount of capital?  I was of the view that the contracts should have been sold 15 months ago when they had a market value of about $25m, but maybe that was hasty?


SJ
Title: Re: Deflation hedges
Post by: Xerxes on March 12, 2020, 03:22:43 PM
Side question :

How much of the $40B portfolio can they realistically deploy if they see good names ?
With indiscriminate selling I would think they wouldn’t have to “try to hard” to find investing opportunities like in the past.

I understand their need to buyback some of the minority positions, recap the insurance side to take advantage of the hard market and maybe buy back shares with left overs take priority; but all these are being funded through corporate earning. Correct ?

Title: Re: Deflation hedges
Post by: petec on March 12, 2020, 04:06:50 PM
Side question :

How much of the $40B portfolio can they realistically deploy if they see good names ?
With indiscriminate selling I would think they wouldn’t have to “try to hard” to find investing opportunities like in the past.

I understand their need to buyback some of the minority positions, recap the insurance side to take advantage of the hard market and maybe buy back shares with left overs take priority; but all these are being funded through corporate earning. Correct ?

They cannot redeploy a meaningful amount into equities.

They can’t recap the subs in any meaningful way and if the equities remain depressed may not be able to grow into a hard market.

They certainly don’t have the capacity to grow and buy back stock.

The only opportunity is in the bond portfolio - but that could be huge.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 12, 2020, 06:43:49 PM
Side question :

How much of the $40B portfolio can they realistically deploy if they see good names ?
With indiscriminate selling I would think they wouldn’t have to “try to hard” to find investing opportunities like in the past.

I understand their need to buyback some of the minority positions, recap the insurance side to take advantage of the hard market and maybe buy back shares with left overs take priority; but all these are being funded through corporate earning. Correct ?

They cannot redeploy a meaningful amount into equities.

They can’t recap the subs in any meaningful way and if the equities remain depressed may not be able to grow into a hard market.

They certainly don’t have the capacity to grow and buy back stock.

The only opportunity is in the bond portfolio - but that could be huge.

Yea - if credit spreads explode, they don't necessarily need rates to rise to make decent on the bond portfolio. We're already past the peaks of 2016 and 2018 for the widening of credit spreads.

Fingers crossed for 8-10% on high yield and 4-5% on IG corporate. Fairfax is tempting at these prices, but without a meaningful chance to make money on rates we need a larger dislocation to make it up on credit.
Title: Re: Deflation hedges
Post by: petec on March 12, 2020, 06:46:47 PM
Fingers crossed for 8-10% on high yield and 4-5% on IG corporate. Fairfax is tempting at these prices, but without a meaningful chance to make money on rates we need a larger dislocation to make it up on credit.

That would meaningfully improve the outlook for FFH.
Title: Re: Deflation hedges
Post by: petec on March 12, 2020, 06:59:55 PM
TCC which spreads are you seeing being higher than 2016? I’m not seeing that for most of the obvious candidates.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 12, 2020, 07:48:24 PM
TCC which spreads are you seeing being higher than 2016? I’m not seeing that for most of the obvious candidates.

Just the average spreads on the indices as reported by Bloomberg/Barclays. OAS for HY is over 6.5% at this point. For IG it's over 2%.

Both are elevated relative to the highs for both 2015/2016 and in 2018 - of course neither of those last two was an official recession. In 2019, HY spreads were as high ~15% so we could have a ways to go, but I think this will likely be more mild.

I'm probably a buyer of high yield bonds in excess of 8% spreads and I imagine Fairfax could put some money to work opportunistically in HY, IG, and preferreds @ that time too

Title: Re: Deflation hedges
Post by: Xerxes on March 12, 2020, 08:00:58 PM
Just to understand what is being explained :

Is the opportunity for FFH to liquidate it’s current bond portfolio with a capital gain as yield crater or is the opportunity for them locking at higher rate on corporate bonds due to widening spread ?

Or both
Title: Re: Deflation hedges
Post by: StubbleJumper on March 12, 2020, 08:03:20 PM
Just to understand what is being explained :

Is the opportunity for FFH to liquidate it’s current bond portfolio with a capital gain as yield crater or is the opportunity for them locking at higher rate on corporate bonds due to widening spread ?

Or both


The latter.  The time to reach for yield is when you are paid for the risk.  There's starting to be a bit more reward for risk in the market.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 12, 2020, 08:51:15 PM
Just to understand what is being explained :

Is the opportunity for FFH to liquidate it’s current bond portfolio with a capital gain as yield crater or is the opportunity for them locking at higher rate on corporate bonds due to widening spread ?

Or both


The latter.  The time to reach for yield is when you are paid for the risk.  There's starting to be a bit more reward for risk in the market.

Yea, I'd say both if they hadn't dumped all of their duration back in 2016, but short-term bonds aren't going to go up much - even if the Fed cuts rates to zero. Best case scenario is you get a few percentage points as a one time gain and that's it because yields are back to 0%.

The higher credit spreads allow them to sustainably lock in higher yields for the long-term even if interest rates aren't cooperating - this was not an avenue that was available to them a month ago. 
Title: Re: Deflation hedges
Post by: StubbleJumper on March 12, 2020, 08:54:55 PM
Just to understand what is being explained :

Is the opportunity for FFH to liquidate it’s current bond portfolio with a capital gain as yield crater or is the opportunity for them locking at higher rate on corporate bonds due to widening spread ?

Or both


The latter.  The time to reach for yield is when you are paid for the risk.  There's starting to be a bit more reward for risk in the market.

Yea, I'd say both if they hadn't dumped all of their duration back in 2016, but short-term bonds aren't going to go up much - even if the Fed cuts rates to zero. Best case scenario is you get a few percentage points as a one time gain and that's it because yields are back to 0%.

The higher credit spreads allow them to sustainably lock in higher yields for the long-term even if interest rates aren't cooperating - this was not an avenue that was available to them a month ago.


A month ago?  Just last Saturday when I was commenting on the AR I trotted out some silliness about "IMO, this is not the time to reach for yield..."  Here I am five days later noting that maybe it's time to start looking for opportunities to reach for yield!  It has been a hell of a wild week....


SJ
Title: Re: Deflation hedges
Post by: petec on March 13, 2020, 02:26:53 AM
Just to understand what is being explained :

Is the opportunity for FFH to liquidate it’s current bond portfolio with a capital gain as yield crater or is the opportunity for them locking at higher rate on corporate bonds due to widening spread ?

Or both


The latter.  The time to reach for yield is when you are paid for the risk.  There's starting to be a bit more reward for risk in the market.

Exactly - with the possibility that if spreads compress again when coronavirus turns out not to have killed everyone and when central banks really turn on the taps, they get a nice boost to BV. So it could be both, but one after the other.
Title: Re: Deflation hedges
Post by: Xerxes on March 13, 2020, 05:20:01 AM
As a side note given Prem nose for bearishness (notwithstanding his 180 degree in 2017), it would be hard to imagine him not taking advantage of what the virus could mean for equities heading into late February.

I am myself am too lazy and slow to buy put options on obvious things like airlines or related industries, but I hope he could squeeze a bit of juice through shorts and puts to add to BK
Title: Re: Deflation hedges
Post by: petec on March 13, 2020, 06:50:48 AM
As a side note given Prem nose for bearishness (notwithstanding his 180 degree in 2017), it would be hard to imagine him not taking advantage of what the virus could mean for equities heading into late February.

I am myself am too lazy and slow to buy put options on obvious things like airlines or related industries, but I hope he could squeeze a bit of juice through shorts and puts to add to BK

There is little space to add to equities, but you might be right that there is space to do a few options. I would guess they are more likely tp go long than short though, at this point.
Title: Re: Deflation hedges
Post by: wisdom on March 13, 2020, 10:37:02 AM
They like debt with warrants. You can play both sides that way.
Title: Re: Deflation hedges
Post by: petec on March 13, 2020, 11:00:24 AM
They like debt with warrants. You can play both sides that way.

Yes, but that’s more something they issue than something that might represent a good opportunity because of a sell off.
Title: Re: Deflation hedges
Post by: omagh on March 16, 2020, 09:55:24 AM
Dalio with his thoughts.  To be clear, he is talking his book, so a grain of salt is required.
https://www.linkedin.com/pulse/implications-hitting-hard-0-interest-rate-floor-ray-dalio/?published=t
Long-term interest rates hitting the hard 0% floor means that virtually all asset classes go down because the positive effects of interest rates falling won’t exist (at least not much). Hitting this 0% floor also means that virtually all the reserve country central banks’ interest rate stimulation tools (including cutting rates and yield curve guidance) won’t work. The printing of money and buying of debt assets that central banks are now allowed to buy almost certainly won’t work much (because bonds can’t be pushed much higher and they are also less likely to be sold to buy other assets of entities that are in financial trouble). Further, with this hard 0% interest rate floor, real interest rates will likely rise because there will be disinflation or deflation resulting from lower oil and other commodity prices, economic weakness, and more credit problems. If that plays out in the typical way, rising credit spreads will raise debt service payments to weaker credits at the same time as credit lending shrinks, which will intensify the credit tightening, deflationary pressures, and negative growth forces. God help those countries that have these things and a rising currency, too.
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 16, 2020, 10:25:54 AM
Dalio with his thoughts.  To be clear, he is talking his book, so a grain of salt is required.
https://www.linkedin.com/pulse/implications-hitting-hard-0-interest-rate-floor-ray-dalio/?published=t
Long-term interest rates hitting the hard 0% floor means that virtually all asset classes go down because the positive effects of interest rates falling won’t exist (at least not much). Hitting this 0% floor also means that virtually all the reserve country central banks’ interest rate stimulation tools (including cutting rates and yield curve guidance) won’t work. The printing of money and buying of debt assets that central banks are now allowed to buy almost certainly won’t work much (because bonds can’t be pushed much higher and they are also less likely to be sold to buy other assets of entities that are in financial trouble). Further, with this hard 0% interest rate floor, real interest rates will likely rise because there will be disinflation or deflation resulting from lower oil and other commodity prices, economic weakness, and more credit problems. If that plays out in the typical way, rising credit spreads will raise debt service payments to weaker credits at the same time as credit lending shrinks, which will intensify the credit tightening, deflationary pressures, and negative growth forces. God help those countries that have these things and a rising currency, too.

Crazy that his book was down 20%....
Title: Re: Deflation hedges
Post by: mcliu on March 16, 2020, 11:41:23 AM
Wasn't he also saying "Cash is trash" like a week before everything blew up?
Title: Re: Deflation hedges
Post by: TwoCitiesCapital on March 16, 2020, 11:45:27 AM
Wasn't he also saying "Cash is trash" like a week before everything blew up?

Yea, but his comments like that are typically meant to be understood systematically.

He's already on record saying he believes the next decade will be a paradigm shift from disinflation/deflation to something more inflationary.

So when he says says cash is trash, he means holding an allocation to cash for the next 10-years will be a mistake. Not that holding cash for the next 10-weeks is to be understood that way.