petec

So you believe that WFC is currently overvalued???? :o I doubt it but I'm not sure. Company levered 10x earns 12.7% roe and trades at 1.7x in a highly competitive industry. It's an incredible company and it's almost certainly under-earning, which makes the valuation eminently justifiable. But then it is ten times levered, and things do go wrong in banking, and I am very uncertain about the economic outlook, so I don't know how to discount the risks. More importantly for this discussion I'm trying to remember when FFGH sold it, because I'm not sure it was a lot more expensive (on book) than it is now. I'd stand by the assertion that they bought it when it was dirt cheap and sold it when it was reasonably valued which is surely what you'd expect of Graham investors. I should perhaps clarify that Fairfax has a particular purpose in my portfolio and for that reason I am more worried about whether they are internally consistent than whether they are right! I'd think very differently if it was the only stock I owned.

I hope you are right. Until then FFH has a place in my portfolio as "ready cash" or "something that zigs while others zag". Cheers, Gio Me, too.

A few thoughts... - on the issue of time horizon and the equity hedges, Prem has repeatedly quoted Graham's "if you weren't bearish in 1925 you went bankrupt in 1932" or words to that effect. You might disagree entirely with the thesis, but don't underestimate the time horizon these guys work on! - Also coming out of that, don't underestimate how bad they think things might get. They weren't short in fear of a 20% correction so don't be surprised when they don't add to equities in one! - I *totally* agree with Dazel about the quality of the equity investments. They like real crap. But then they used to like real crap in insurance too, and they learned. I suspect "Fairfax 3.0" will be quality insurance plus a core of quality equity compounders bought cheap, but we're not there yet. - One way of "squaring the circle" in terms of how they think is this: they sold their quality compounders (JNJ, WFC etc.) when they were reasonably valued and this has been proved "wrong" because QE pushed valuations above reasonable levels; and because they couldn't find quality at what they thought was the right price they switched to a barbell strategy which was Graham 50c dollars offset by hedges, which would have been fine if the 50c dollars hadn't gone to 25c while the markets went up. Essentially, for me, they failed to see what QE would do to equity markets (although they were more right than many about how hard it would be to reflate 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.

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.

Works for buyers. How do you persuade sellers that expiring money has value? Recipe for a black market!

Completely agree. Equally, if the change turns out to be temporary, we will get an inflation. Going to be an interesting 20 years.

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!

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.

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).

Contact ValueAct: http://www.valueact.com/contact.pl I made a call to them. The receptionist told me to write an email to her and she will forward it to Jeff. Let's see what happens next. :) I can already picture the press release headline: ValueAct welcomes new partner Muscleman :D And after 6 months: Ubben outmuscled - replaced by forum prodigy "It was time for that old sod to go. Clearly his best days were behind him." says Muscleman who gained influence in the firm after going against Ubben on Microsoft. Haha you guys are funny! ;D +1: my favourite post in a while!

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).

Maybe… But long-term bonds are very sensitive to interest rates… Therefore, you must have a very precise opinion about interest rates to hold them right now, especially because their yield is so low these days… And that is a macro judgement imo. Cheers, Gio Yes, that's fair. It's been a while since I looked at the bond portfolio in detail. I suppose some might be liability matched but probably not a large portion given the nature of the insurance book.

I don't think you can claim that owning bonds is a macro call for an insurance company!

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.

+2 - I'm far more worried about the stock-picking than the hedging. It wasn't hard in 2009 to load up on epically good companies and go to the beach, but they didn't. That said: they have learned to buy high quality insurance companies at a reasonable price, rather than cheap crap. I think these guys will keep getting better at what they do.

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.

+1 I also suspect that people who bought in the deflation scare in 1H are now realising that we are about to annualise the commodity bust and inflation might not remain low. I know that China and recent market drops might have driven another bout of deflation fear but I don't really think they have. I think the stock had a mini-bubble on this basis in 1H which is deflating now.

Does anyone actually know that anyone senior spent significant time on this deal?!

Ha ha, I wasn't very clear. I first invested in June 2008 (dumb luck) and have been building my stake ever since. What I meant by 'only an observer for 10 years' was that I wasn't an observer in the 1990s, so I can't comment on whether their process/mentality/confidence has changed since then.

While I hope it's true, has wasn't buying back when we were delisted and sank 20% below the current price. Maybe he had better opportunities back then, but I'd truly be surprised if he bought back here. Like TwoCitiesCapital, I also tend to think that he would not have purchased his own stock - given that he believes that the market will offer even better opportunities. In fact, perhaps it is a topic for another thread to ask long time observers as to what they think about Prem's investment process - sound as in the past or negatively affected by past successes. Many here have started believing that Prem has got carried away. I've only been an observer for 10 years. But my sense is: 1. Bond process hasn't changed and doesn't get as much attention as it should. 2. Options process hasn't really changed, they were wrong on these for a long time pre 08 but the basic idea of protecting the company from excessive global leverage has remained the same. 3. Major acquisitions philosophy *has* changed, from cheap and crappy to reasonable price for great companies. 4. Basic value-driven, against-the-herd equity philosophy hasn't changed, even if some of the investments haven't worked out (others have: Bank of Ireland, some great stuff in Greece, WFC/JNJ etc.) 5. The *tone* of commentary, very value oriented, hasn't changed. On balance the major change I see is (3) and it's positive. The macro calling/thinking hasn't changed, it's just that it's always a binary call and so far it's been wrong. Interesting though, they spent the 2000s saying they saw a once-in-50-years crash because of excessive leverage and they turned out to be absolutely right. Now there is more leverage in the world. Thinking out loud here but wouldn't it be *much* more inconsistent of them to be bullish? EDIT: not investing related, but I also find the annual reports are giving me a clearer and clearer picture of the culture - things like the stock purchase scheme, the charitable involvement, etc., all of which I believe are key for locking people in; plus the constant improvements in how the insurance business spread best practice and so on. I don't see arrogance in this stuff, so I don't assume arrogance in the investing (just honest mistakes). I firmly believe FFH is a better company than it was 10ya.

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.

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?

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

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.