petec

I've thought about this a lot and the distinction I draw is that for a fairly brief period of time (5-8 years) Fairfax thought that a repeat of the Great Depression 90% selloff was a distinct possibility. They warned about this long and hard. They never said it would happen, but they repeatedly said that it might and repeated Ben Graham's warning about "if you weren't bearish in 1925" etc. Now, you're a levered company, with regulatory oversight and clients who need your balance sheet to be solid. You've done your research about how underwriting profits did in the GD (not well - companies kept writing at low premia to keep the cash flowing in). And you fear a really serious wipeout in the equity market. Not a 10%, or 20% drop, but a 90% drop, which because you live in a mark-to-market world would destroy your book value and therefore your company, because your book value is more or less all in equities. What can you do? You can go to cash, but that involves selling the equities you like. Or, you can pick stocks, which you're good at, and hedge out the market. In that environment, I think it's reasonable to describe a 100% hedge as protection, not a macro call. (By call I mean prediction. They were clearly calling that they saw a macro risk, but I never felt they were making a firm prediction on where the market would go.) They paid a high price for the total certainty that they wouldn't lose the company at a time when they saw a moderate possibility of a total macro catastrophe. So, the hedges seem to me to be consistent with how they have always described them, and so does removing them if you think that a new political environment reduces the risk, not of a 20% selloff, but of the 90% selloff you feared. What would NOT have been consistent is saying "we were wrong" and removing the hedges because the market had gone up, which is what many here wanted. You can't understand the hedges in terms of a market call of +/- 20%. They couldn't give a fig about that. They paid (a lot) to ensure they'd be OK in a true catastrophe. And I was very happy with that, as a shareholder who feared the same thing. Was I wrong? No. The risk was there. Do I regret the cost of the hedges? Not one iota. But about that stockpicking... Here I feel criticism is warranted. In particular I don't understand why they didn't buy all of the JNJ, KO, PEP etc. shares they could - buying such companies at the prices available in 2009-2011 would have guaranteed reasonable absolute returns if the world muddled through (which it did) but also great relative returns if we'd revisited 1933. Instead they bought BKIR which would have gone bankrupt in a 1933 revisit. Does the fact that it worked make it right? I don't think so, but no-one ever seems to mind that decision!

+1

He sounds like a cartain manic depressive fellow I want to sell some shares to... really strange. Yea - This is getting bizarre. I don't have any issues with the acquisition in and of itself, but the 180 degree turn on the U.S. markets as the result of the election with no commentary on rising rates, falling liquidity, strengthening dollar, declining corproate profits, levered corporations, and valuations that appear excessive certainly seems strange. If you read what he's said carefully, he hasn't done a 180 on the US markets but on the US economy. The hedges were not mainly explained in valuation (e.g. CAPE, Tobin's Q) terms. They were explained in terms of protecting the company from another 1929-33 type selloff, which would have destroyed the company in the absence of the hedges. They now feel that that kind of catastrophe has reduced in probability, because we have a quantum shift from a world in which politicians over-regulate and rely on central bankers to promote growth via leverage, to one in which (maybe) government gets out of the way and productivity drives gdp. So the hedges have gone. Doesn't mean they think the market goes up. All they've said on that front is that it will become a stockpicker's market again. Value starts to win again.

Haven't read this but it's take on Hoover sounds similar to Murray Rothbard's, which I found fascinating to read.

Remember you need to distinguish between the EU and the Euro. I'm not aware of an Italian party that wants to leave the EU. But the major parties that campaigned for no in this constitutional reform referendum - which therefore now have political momentum - do view the Euro unfavourably. And that's hardly surprising given that the economy is 8% smaller than 8 years ago. The Euro is having the same effect on the peripheral European states as the gold standard had in Depression America. It will be interesting to see how this evolves.

Very elegant, until the money flooding into infrastructure ensures that bad projects get done!

You guys sound perfect! You'll tell me you pronounce "herbs" with an "h" next! https://www.youtube.com/watch?v=cs5H7cgcpkg

I predict you're wrong. Bieber is Canadian. But whatever. Us Canadians are just glad he moved to the US. He's your problem now. Make with him what you wish. Sure but that won't matter after the U.S. and Canada merger in 2038. A joke I hope... or I will be getting my guns out. You can come to the UK - with any luck it will be one of the most open countries in the world by then, *and* we have socialised medicine ;) I'm in as long as I'm not expected to watch that drama you call football. :P Oh God. Worst sport ever. At least we have rugby. (We do however have language on our side, given that the word football does imply that the game is primarily played with the feet ;) )

SD - very useful, thanks. Although I am not sure I follow your last comment about the pool of $ for infrastructure?

I predict you're wrong. Bieber is Canadian. But whatever. Us Canadians are just glad he moved to the US. He's your problem now. Make with him what you wish. Sure but that won't matter after the U.S. and Canada merger in 2038. A joke I hope... or I will be getting my guns out. You can come to the UK - with any luck it will be one of the most open countries in the world by then, *and* we have socialised medicine ;)

Deflation and inflation are, ultimately, driven by the relation between how much stuff there is and how much money there is, money being created by central banks and fractional reserve banking via debt. Fairfax bet that the amount of money in the system would fall; so far it hasn't. Also worth pointing out that even Japan hasn't had much (if any) CPI deflation. The deflation there was all in the GDP deflator measure of inflation. So it's quite possible to have deflation in one metric but not in another. Similarly, any measure of inflation that included the cost to purchase a home or to fund a retirement would have shown massive inflation over the last 5 (and 15, and 25) years. In fact, if this deflation bet works, it will be because the prior period has been much more inflationary than we currently think (as for example the 1920s was). It will be interesting to look back in 30 years, but then it always is ;)

Me too. Then again, a big position in FFH was what gave me the confidence to have the rest of the portfolio in stuff that has gone up recently, so the position has done its job for me. Precisely. The hedges were always justifiable IMHO based on 1) long term equity valuations (even if they were dead wrong) and 2) protecting a levered company (they were insurance and were repeatedly explained as such). What wasn't justifiable IMHO was 3) failing to protect the upside as someone here has mentioned and 4) poor stockpicking. Coming back to this discussion after a couple of weeks away, thanks to Parsad and Bsilly for very informative comments earlier.

Short term bonds roll onto higher yields. Pricing gets easier in an inflationary environment. (This is a double-edged sword since claims also rise, but FFH's work suggests that insurecos really struggle in deflations so on balance, inflation is better).

Do you think the economy could withstand 6% rates? Do you think the Fed would let that happen? Federal debt interest expense would be something to see under that scenario!

It is a capitulation. As for why the election changes things, I'm reading across from PW's comments on Modi: he seems to be a believer in how pro-business government can spur growth (and reflation) and clearly he sees that in a Republican clean sweep (as do I, at least to a point). My bigger issue is why he hedged 100% (as opposed to 50%) of his equities to start with, but that's been discussed endlessly here. One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change. They are. Facts haven't changed! They just got it all wrong! In my view, this is latest nail in Prem's coffin and proves that he is one of the shittiest money managers in this business. Sooner they will give their investment portfolio to outside managers the better. Ha ha - trust me, there are *many* worse.

I think the reality is that they realized quite a while ago that their equity hedges were a bad decision. They just needed some event so that they could “save face”. Trump was simply a convenient excuse to reverse a decision and say “Yeah, we are removing the hedges because of Trump” instead of “Yeah, we are removing the hedges because we were wrong.” Do you have any evidence for this? I'm not disputing it, but your view (that they care about saving face) is quite important and carries much more weight if you have a reason for it than if you're sitting at home guessing (like I am). I don't have any hard evidence of this. My (Watergate-style) attempts to bug Prem's office have so far been unsuccessful. I am relying on soft evidence, such as: 1) The length of time (many years) these hedges have been turned on; they can't stay on forever; why now really? 2) The virtually indisputable reality that these hedges were a bad idea, and destroyed what could have been otherwise good results. 3) My knowledge and experience with the consistency principle; part of my job is to negotiate successful results for my clients on an almost daily basis, and I never cease to be amazed at how difficult it is for people to change their mind without some way to save face. I have developed an entire negotiation strategy centered on providing my counterpart a clear way to save face, thus easing his/her ability to change their mind to my client's benefit; it works wonders. 4) The very odd timing of this reversal, after the markets have gone UP a substantial amount. 5) The suddenness of the decision; no one really expected a Trump win, so they made this decision in a matter of a few days. Is that really a long enough time to fully evaluate the new reality; perhaps. But the suddenness seemed odd - like they were seizing the moment during all of the hysteria - knowing that the newsworthiness of removal of the hedges would get lost in a sea of post Trump election hysteria. I guess it just strike me that there was sentiment to remove these for some time; but doing so is a clear admission that they screwed up. In reality, there is probably a bit of truth to both narratives. The probably DID view the world as having changed, but I think in larger part also viewed it as a convenient way to save face. So, yeah, I am sitting at home guessing just like you. Maybe so, but it's intelligent guesswork and insightful - thanks. For me the key error wasn't having or expressing a macro view, or trying to protect the company (which was a key motivation). It was doing so in such an expensive way by failing to hedge upside cheaply too.

I don't see any economic scenario where it makes sense to remove your equity hedges at a lofty valuation but it doesn't make sense to remove your deflation hedges. It's not (or at least, it shouldn't be) about predicting an economic environment. It's about protecting yourself from a possibility that would ruin your business, at a low cost. The key difference is that the equity hedges were very, very costly. The deflation swaps are on the balance sheet for bugger all. Leave them there, would be my choice.

I think the reality is that they realized quite a while ago that their equity hedges were a bad decision. They just needed some event so that they could “save face”. Trump was simply a convenient excuse to reverse a decision and say “Yeah, we are removing the hedges because of Trump” instead of “Yeah, we are removing the hedges because we were wrong.” Do you have any evidence for this? I'm not disputing it, but your view (that they care about saving face) is quite important and carries much more weight if you have a reason for it than if you're sitting at home guessing (like I am).

Packer and rb, thanks for an interesting discussion. I'm inclined to agree with both of you, which is uncomfortable ;) Packer, while I take the point that rates are likely to stay low for a while yet, does The Great Wave give any reason for an 80-year (or rather a 160-year) cycle? We have only had one full cycle: that does not seem to me to be enough to call the average length of a cycle with *any* certainty. Also, that one cycle was on the gold standard; the new one is fiat. That could alter timelines drastically.

re deflation hedges - hope not. They have a low cost basis now and are still a good hedge.

I've been thinking the same: lower taxes and reflation = a blowoff top, soon to be punctured by rising rates. I wouldn't invest on that thesis but I wouldn't bet against it either.

It is a capitulation. As for why the election changes things, I'm reading across from PW's comments on Modi: he seems to be a believer in how pro-business government can spur growth (and reflation) and clearly he sees that in a Republican clean sweep (as do I, at least to a point). My bigger issue is why he hedged 100% (as opposed to 50%) of his equities to start with, but that's been discussed endlessly here. One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change. They are. Whether it is the right thing to do is another matter.

Agreed, Jurgis. While this has clearly been an awful hedge (I wasn't prepared to make this statement until it was closed out, although I know others were), they are at least being consistent: they have been very vocal about the impact of economic reforms in India and I think they are applying the same rule book here.

Agreed. Clearly the market is worth more if taxes get cut. And likely for a while the deflation trade doesn't work and a relation trade does. But the mid/long term consequences are unpredictable.

Thanks!