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Valuations are probably less relevant than the past because a lot of buying of stocks is price insensitive e.g. corporate share buybacks. When times are good and stock prices are high companies buy back far more shares than when times are bad and stock prices are low. And with ZIRP companies have been able to use financial engineering to borrow at cheap rates to buy back shares. As interest rates come back down this practice will resume. e.g. pension contributions. there is a continual inflow of money into index funds from this. e.g. switch from active to passive strategies. In the past (in theory at least) active managers used to buy undervalued stocks and sell overvalued stocks or even short them. Now the main active investors are hedge funds and retail trades both of whom favour momentum strategies and flavour of the month investments with a good story. e.g. Fed has been doing successive rounds of QE while keeping interest rates low (until recently) so if you can only earn next to nothing in cash or bonds then you tend to be a lot less discriminate when it comes to buying stocks i.e TINA. Even with higher interest rates a 4-5% long bond yield seems unappealing when investors are using to doubling their money every year in bitcoin or Big Tech and even in index funds are making double digit returns and investors are well schooled that dips are buying opportunities and the stock market always recovers quickly and without any lasting pain. Even during COVID while the market panic was scary by the end of the summer the market had already recovered made new highs. And while the 2022 bear market was more protracted than investors were used to the index only fell about 20% as confidence in a pivot and Chat GPT turned the tide and 2023 instead of being a down year saw the market recover most of its losses with the rest made up this year. And now AI has given the perfect excuse for markets to send Big Tech stocks to the moon and price in much better prospects for the rest of the economy with the idea that there will be a productivity miracle that will shock that economy out of its post-GFC doldrums and increase trend growth rate in the same way as in the mid 90s before it all went sour. Also interesting is that markets have pretty much shrugged at the good economic data and Fed talk walking down rate cuts. I suppose they have realized that the economy is a lot more resilient to higher interest rates than previously thought and Big Tech's growth prospects are being revised upwards so that even using a higher discount rate they are still worth a lot more. So I think we are only getting started. And probably the only things that will ruin the party are: a) Big Tech results disappointing and the roll-out of new AI initiatives not living up to the hype resulting in much slower adoption b) Inflation rearing its ugly head again and forcing the Fed into rate hikes or at least convincing markets in higher for longer. The V-shaped recovery carries with it the implicit assumption that the Fed was right along and inflation was transitory and the inflation shock is over. c) A hard landing with inflation not falling enough to justify a Fed rescue and earnings across the board falling.

Fairfax - Super Bowl Sunday Edition Well it’s Super Bowl Sunday - the perfect time for a football themed post. People love watching sports so much because it is fun and entertaining. The competition is real. You cheer for your team. The outcome is uncertain. There is intrigue. There is the camaraderie - you watch with family and friends. And it feels exhilarating when your team wins the big game. We love watching sports so much because it so closely mirrors what happens in real life. We love investing for many of the same reasons. “Don't worry about the horse being blind, just load the wagon.” John Madden (I have no idea what the quote means… and i love it.) ————— Fairfax is in the final stages of completing one of the great comebacks in Canadian business history. Fairfax’s recent history resembles Super Bowl LI on Feb 5, 2017, when the New England Patriots played the Atlanta Falcons. What? Yes, it is true in so many ways. Let me explain how. The set-up Both are storied franchises. The Patriots have won 6 Super Bowls, the most in football. Long-term investing performance for P/C insurance companies is measured by the growth in the share price and book value. From 1985 to 2022, Fairfax compounded book value at 17.8% per year and its share price by 16.1% per year. That performance puts the company in very elite company. ————— The first 41 minutes of the Super Bowl LI For the first 41 minutes of Super Bowl LI, the New England Patriots played very poorly. The quarterback was missing open receivers. The receivers were dropping passes. The defence was not playing to potential. And the special teams unit was not contributing as needed. Bottom line, the team was underperforming. As a result, the Patriots found themselves down 28-3 with 4 minutes left to play in the third quarter. Prior to this game, the largest comeback in Super Bowl history had been from 10 points down. So at this point in the game pretty much everybody thought it was over. Oddsmakers gave Atlanta at 99.8 chance to win. Things were looking so bad, even loyal Patriots fans had given up on their team. And the haters (of which there were many)… they were apoplectic in their glee. From 2010-2017, Fairfax had also been playing a pretty poor game - and like the Patriots, the poor performance was mostly due to self-inflicted mistakes. Equity hedges (2010-2016). Shorts (last one exited in 2020). Poor equity purchases (mostly 2014-2017). When Covid hit in 2020, the underperformance (measured through earnings) got worse. The stock hit a 11-year low of US$250 in May of 2020. In May of 2020, Fairfax shareholders felt how New England Patriots fans felt mid-way through the third quarter of the Super Bowl. Many Fairfax shareholders bailed on their team and sold their shares. Everyone was writing them off. ————— The importance of leadership and culture You learn more about teams when they go through adversity than you do when times are good. This is the same for businesses. What did both the Patriots and Fairfax have going for them? Strong leadership The Patriots had Robert Kraft, Bill Belichick, Tom Brady and a roster stacked with high character players. Fairfax had Prem Watsa supported by a strong teams at its head office, Hamblin Watsa, insurance subs and at the equity holdings. Strong culture Patriot Way: “The way that Bill coaches his team to be putting the team first, not selfish, doing what’s best for the team, putting the team’s goals in front of your own personal goals. That was Tom Brady. He was able to do that for 20 years.” Rob Ninkovich Fairfax: I think the description above probably describes Prem Watsa and the culture he has been able to establish at Fairfax. Similarly, Andy Barnard has also been able to establish a very good culture in the insurance operations. (Discussing the importance of culture at Fairfax would make a great topic for a future post). When extreme adversity hits, and your see how people respond, that is when you learn what the true character of the organization is (sports team or business). The best sports teams find a way to turn the tables and thrive when adversity hits. It is the same with the best businesses. —————— Back to the game. Silver lining For both teams - Patriots and Fairfax - there was a silver lining. Yes, they were behind by a lot on the scoreboard. But they understood the primary problem was their own performance. And their performance was within their control. The silver lining was they knew the problems were fixable. So when Atlanta went up 28-3 with four minutes left in the third quarter, the Patriots never panicked. When Covid hit in 2020 and the various businesses became stressed and the stock of the company cratered, Fairfax also did not panic - at corporate, insurance subsidiaries or the equity holdings. For Fairfax, the comeback started later in 2020. At the time, little did the team at Fairfax know that they were about to embark on one of the most improbable comebacks in Canadian business history. What happened to turn the tide? No one thing. 1.) The comeback started for the Patriots with a pass from Tom Brady to running back James White who scored their first touchdown of the game with 2 minutes left in the third quarter. However, the Patriots missed the extra point. Patriots were now down 28-9. For Fairfax, the hard market in insurance really got going in 2020 and Andy Barnard and the insurance subs went on the offensive. It has continued to today. Net written premiums are estimated to have increased about 80% from $13.3 billion in 2019 to estimated $23.7 billion in 2023. In turn, this is delivering record underwriting profit. Touchdown for Fairfax. It is not surprising that the insurance team was the unit to lead the comeback for Fairfax. 2.) At the 9 minute mark of the 4th quarter Steven Goskowski kicks a field goal to make it a 2-score game. The Patriots trail 28-12. During the market panic caused by Covid, the fixed income team at Fairfax, lead by Brian Bradstreet, went on the offensive and purchased $3.9 billion in corporate bonds with a yield of 4.1% and a term of 4 years. Field goal Fairfax. The fixed income team at Hamblin Watsa has been a historical strength for Fairfax. 3.) With 8 minutes left in the 4th quarter, the Patriots defence gets to the Falcons quarterback and forces a turnover. Donta Hightower wasn’t blocked and was able to get to Matt Ryan to get a strip-sack. In late 2020/early 2021, the team at Hablin Watsa made their own big time play. They purchased total return swaps giving them exposure to 1.96 million Fairfax shares at a cost of US$372/share. This has delivered a return of well over $1 billion since then. This was very unexpected, creative and opportunistic - classic Fairfax football. 4.) The Patriots offence gets rolling again and this time Danny Amendola scores a touchdown. Brady immediately signals to go for 2 points. Direct snap to James White and he’s in for the 2-point conversion. The score is now 28-20. The Patriots are within striking distance but they need a stop on defence to get the ball back. Brian Bradstreet and the fixed income team made a gutsy call in late 2021 that resulted in another touchdown for Fairfax by taking the fixed income portfolio to 1.2 years average duration. The $3.9 billion in corporate bonds purchased in 2020 were now sold at a 1% yield which locked in a big realized gain. This move protected the balance sheet. Unlike most other P/C insurers, Fairfax avoided booking billions in unrealized losses when interest rates spiked in 2022 and 2023. 5.) The Patriots defence steps up again and Matt Ryan is sacked for loss of 12, taking Falcons out of field goal range. Fairfax’s investment in Digit insurance in India is flourishing. Started from scratch in 2017, at a cost of $154 million, fair value increased by $1.5 billion in 2021. It is possible we see an IPO in 2024. India is expected to be top performing economy and Fairfax is positioned to benefit in the coming years. 6.) Patriots get the ball back, down by 8, with 3 minutes to go. Julian Edelman makes one of the greatest catches in Super Bowl history at midfield with 2 minutes left to keep the drive alive. The Falcons defender knocked the pass in the air and Edelman came down with it. “Thats incredible” and “amazing concentration to make a play on that.” In late 2021, in an opportunistic move, Fairfax made their own ‘circus catch’. They repurchased 2 million shares of Fairfax at $500/share. This was well below book value of $872 at Sept 30, 2023 and has delivered incredible value to shareholders. 7.) With 0.53 seconds left James White scores his second touchdown of the game. Danny Amendola is in for 2 point conversion. The game is tied 28-28. Fairfax scores its next touchdown to tie the game in 2022 when it sells its pet insurance business for $1.4 billion - which delivered in an after-tax gain of 1 billion. Most observers did not know they owned this business. Fairfax also made the two point conversion when they sold Resolute Forest Products at the top of the lumber cycle for $626 million (plus $183 million CVC). The game goes to overtime The Patriots won the coin toss and elected to receive the ball. If they score a touchdown the game is over and they win the Lombardi trophy. 7.) In overtime, the Patriots move up the field. Sideline route. What a throw to Amendola. Pass is caught. Then a run. Fake it to Hogan… toss it to White… looking for blocks… getting blocks… he is inside the 20. Out of bounds at the 15. The Patriots have a very balanced attack. Pass interference in the end zone by Atlanta’s defence puts the ball at the one yard line. First and goal for the Patriots. Toss to White. He’sssssss ……. in! Touchdown Patriots! In Q1 of 2023, the fixed income team at Fairfax extended the average duration of fixed income portfolio to 2.5 years. In October, they put the ball over the goal line and score the winning touchdown when they extend the average duration to 3.1 years (details to come when Fairfax reports Q4 earnings). This play locks in record interest income of $2 billion for years into the future. The comeback is complete! Patriots complete the historic comeback and win the Superbowl! 34-28. Their 5th championship. When they report Q4 earnings, Fairfax is poised to report record operating earnings and record book value. Fairfax shares closed Friday at US$940, which is an increase of 276% from the low of $250 in May 2020. Fairfax is in the process of completing one of the most improbable comebacks in Canadian business history. New England fans - and Fairfax shareholders - are going crazy. What a game by Bill Belichick, Tom Brady and the New England Patriots. What a performance the past three years by Prem Watsa and the entire team at Fairfax - head office, Hamblin Watsa/Fairbridge, the insurance subs and the management teams at the various equity holdings. Led by Prem, the team at Fairfax have been beasts. Summary Like the New England Patriots comeback in Super Bowl XI, Fairfax’s improbable comeback the past three years serves as the ultimate reminder that the fight is never over, as long as there is a chance to win. We are reminded, as in life, anything is possible if you never give up. And that is one of the things that makes watching sports so great. Just like investing. After the game, a jubilant Fairfax shareholder was heard to say: “Nothing will ever top this. Ever.” (I’m not so sure… I think Fairfax has much more in store for shareholders in the coming years.) ————— What turned it around for Fairfax? Leadership was the key. At the low point in 2020, Prem shone. There are numerous stories from people who work at Fairfax about Prem and how he handled the adversity: He told staff two things: He had their backs: there would be no layoffs as a result of Covid. He knew what they were capable of: ‘do your job’. And get on your front foot - this was a time to be aggressive. He delivered a similar message to equity investments. At the AGM last year, Stelco CEO Alan Kestenbaum told a story of the incredible support he got from Prem during Covid and the confidence that gave him to continue to drive the business forward. Prem also lead by example in another important way: he backed up the truck and bought $150 million in stock. Prem’s actions during the Covid lows were likely his greatest moments as CEO of Fairfax. ————— Given the success they are having, I wonder if Fairfax is going to have a booth to sell merchandise at the AGM this year? What should be in it? Below is one suggestion. Maybe a Prem hoodie too? I survived the short attack of 2023? Would love to hear what ideas others have…