petec

I think you're absolutely right re the companies although I actually think ultralow rates also causes constipation - we have a lot of companies here that would be bankrupt at normalised rates and until that happens I wonder how well the economy can normalise. I hope you're right about reserve currencies! But I do keep thinking that no reserve currency (apart from gold, arguably, and I am no gold bug) has ever remained reserve currency for long.

There are?! Please do tell! BAC, Y, DNOW, HOS, AIQ, NTELOS Thanks :)

There are?! Please do tell!

Imo extremely low interests rates are engineered by central banks on behalf of governments around the world, simply because they cannot afford to pay higher interests on their debts. Period. And this might go on until prices stay very low or else go down. Higher interests rates will exacerbate the debt problem, therefore rendering the final outcome even more unpredictable and dangerous. Watsa has always said that in Japan the printing of a lot of money stopped deflation for 5 years after their stock market and real estate bubble burst… The US probably has printed even more money than Japan did! So I guess we still have to wait at least two or three years… And of course the next serious market correction! If financial assets start to go south, that would be very deflationary imo! After that, if we still have no deflation, I would simply let those CPI contracts expire. I don’t understand how the fact Sweden is the only example available means it should be relevant… But probably it is only me! :) Gio But I guess Watsa can point at a single example to make his case? What's the difference? He regularly points at two. But personally I think there's relatively little use looking at any of these examples except for context. Every economy and policy is different. There's evidence that QE has worked in the US and evidence that it is not working in Japan (other people would probably say the opposite). There's a good theoretical argument that what China needs is a tighter monetary policy, which is counterintuitive. It's useful to know that QE and its equivalents helped in Sweden (if it did - I don't know anything about that). But it's also useful to know that it's failed elsewhere and caused hyperinflation in yet more places. Analysis needs to be a lot more complete than just pointing to one example (no offence to Packer or Prem!).

I also have a nagging feeling that deflation will never make it into CPI but there is a clear mechanism for it to do so: 1. QE works by incentivising debt, which either draws forward demand or is used to build productive assets. That sets up a future period where demand is slack and there are a lot of productive assets. That is clearly deflationary and explains PPI deflation in China today and the US in the 30s. 2. QE also works by inflating asset prices to create a sense of wealth, which "ought" to feed into demand. I say "ought" because it also makes buying a house and saving for retirement more expensive, so I suspect it actually doesn't increase demand all that much. But if you do believe that QE is inflationary while it is happening, then surely it is deflationary when it stops? Unless, of course, it doesn't stop. and every bout of deflation is met with money printing. Then you will eventually see something very unpleasant: a loss of confidence in the currency. That is what causes people to sell fixed income securities in a world of excess capital: people dump bonds to buy stuff that will hold its real value, not just its nominal value. At that point, central banks levers are no longer effective in the economy, because they work through a currency that no-one wants any more. I do worry that FFH is not well protected against this possibility but it also seems distant at the moment. To summarise: QE might be very deflationary (it encourages debt and bubbles and misallocation of capital, all of which are deflationary) and it might be inflationary (if it leads to a loss of confidence in the currency). It is also possible that QE is just the tonic the economy needs, and if judiciously administered will get us to escape velocity and then be withdrawn. I hope so but I'm afraid I remain sceptical. P

Hasn't almost everything they've done in the last decade been to make themselves antifragile?

On the deflation front, I'm with Gio. Prem has called a commodity collapse very well but I don't think that's the root of his deflation thesis. He is worried about a possible deleveraging-driven deflation, which could/will happen when the capacity of borrowers to borrow is exhausted and asset prices start declining. That's why he keeps referencing Japan and the 1930s, and has said that reflating the global economy is going to be very difficult. So far I believe the evidence is in his favour: massive worldwide money printing has produced rising global debt/gdp, which has driven asset inflation, but there is precious little growth to support either. In fact, if anything, the excess capacity driven by all those new assets (factories in China especially) is deflationary. Who knows what the future holds but it has proved very difficult to reflate the global economy, and if asset prices do start falling, as Gio says, it could well trigger something very unpleasant.

I don't really understand why people are so negative on the equity hedges. Sure, the headline cost is big, but: 1) These guys are not asset managers and should not be measured as such. They are insurers who have to answer to regulators and ratings agencies and clients, and they invest most of the shareholder equity in equities. That means they can lose the company if they get the equity portion wrong. They saw market risks (and let's not forget there were genuine market risks) and hedged themselves. Effectively, they ensured that they could not lose the company while keeping exposure to any alpha they could generate (the real problem is that I don't think their equities outperformed). I hope they continue to shepherd the NPV of the insurance company they have built so wisely. 2) I also think it is worth noting that they hedged only listed equities. They also poured money into unlisted equities (like Zenith) which they did not hedge. In other words they simply removed any possibility that regulators, rating agencies, and clients could harm them in the event of a market panic. They took a lot of equity risk, just not market risk. 3) Yes, I'd be richer now if they hadn't hedged. But I didn't have to own the stock. They told us what they were doing. Anyone who owned the stock through the hedged period and now complains about the hedges hasn't got a leg to stand on imho. Credit to those who timed their ownership better, but FFH has helped me sleep at night so I'm not complaining. 4) It has been but a few years. I know we are all trained to think 5 years is a loooooong time in investing but it isn't. Big leverage cycles work out over far longer than that. P

Howard Marks...?? ;) Gio Ha ha - yeah I heard he was ok! I'm looking more for someone who actually discusses specific ideas and values them - i.e. someone I can learn the techniques from.

Reading Chou's annual report piqued my interest. Does anyone know of really good bond or distressed debt managers who write informative letters? There must be plenty but I don't know of any. Thanks in advance, Pete

If we call all QE-like actions at $5T (which many think has no effect on money-supply and only increases liquidity). If both are true then we must consider liquidity, which is an extremely interesting topic (tough to find good papers on, too), and certainly increases prices, ceteris paribus. If we are going to claim QE-like actions made capital "abundant, loose, and cheap" then we should compare it to the total US Net Wealth of ~$80T [1]. This is an increase of just 6.25%. We should really use Total US assets or global assets though. Off the top of my head, consumer mortgage debt is ~$20-30T, Govn't debt is $15T (not to open this box), and consumer debt is ~$15T. So total US assets is probably around $120T - $150T. Thus, QE only increases total US assets by 3.3% - 4.2% (spread over an unknown number of years at unknown weights). Maybe I'm drinking the koolaid but this is why I don't think we are or will see inflation due to QE. Sounds more like we are pulling growth forward and deflation may be difficult to avoid? I think you're drinking the koolaid ;) I'd compare base money before to base money now to get an idea of how much money *could* be created by fractional reserve banking if loan demand took off. Then, ask yourself whether the Fed would go about destroying all the base money it has created (which is easy enough to do) if inflation took off. That would be my framework for considering inflation. That's leaving aside the fact that we do have huge inflation today - it's just in assets, not commodities.

Actually, over time, quite possibly yes. When looking at BH I think it is worth remembering that virtuous circles can become vicious circles. At the moment Buffet's reputation attracts people who want to sell their business but stay on and run it. His reputation also allows him to leave them alone to run their business without interference (no other market CEO could get away with the statement that their management style is "lethargy bordering on sloth"). If he goes, over time, market pressure will eventually lead to tighter internal controls. BRK will very slowly ossify into a more bureauocratic, and actually less well run company. Some existing CEO's will leave. Subsidiary profitability could very possibly decline. On top of that: 1) fewer good buying opportunities will come up, because BRK will become a less attractive company to sell your business to; 2) few people can allocate capital like Buffet, and 3) BRK won't get any more Goldman/GE prefs deals just because companies want a stamp of approval from Buffet in a crisis. So it's perfectly reasonably to suppose that BRK's IV with buffet is higher than its IV without. (Not that that says anything about where the stock price is relative to that IV.)

Well I think that if would start to analyze BH I would find out about Warren and Charlie... and Ajit. Re corporate governance I just assume there's nepotism on every board. Just because the names don't match doesn't mean that the results are different and management doesn't own the board. I have yet to see an instance when the board voted down a CEO's pay package. I think the fact that BH doesn't provide insurance to its directors makes for much better governance than any chairman/CEO role split ever would. If anyone does pls let me know. I am curious. The reinsurance business is such that no amount of information short of seeing the actual contracts would help you. It really is one of those cases where you definitely bet more on the jockey than the horse. You look at the track record over very long periods and you look at management and then if you're comfortable you kinda take a leap of faith. I think that Buffett is probably the best insurance analyst on the planet and even he gets it wrong often enough (Gen Re anyone?). I do agree that BH could provide more information. I would personally like more detail on the smaller operating subs. But then would I arrive at a significantly different estimate of BH's IV? Probably not, it would just make my work a bit easier. However, I am sure that the competitors of those subs would also be highly interested in those details as well and I don't know if that would be so beneficial for BH's IV. These are both excellent posts.

That's exactly what I think you should use. So they pay £1120 and get to take out £252m of excess capital (in theory anyway) so really they paid £870 for the company itself. Which is nice...

Big +1 from me. I regard the dividend criticism correct in terms of pure financial theory but I remain a fan of the dividend in the real world of retiree owners, tax-protected accounts, alignment of staff incentives, maintenance of low pay for Prem, etc.

I don't agree that his hands are tied - to hell with the market in the short term. But keeping the dividend flat, he's been cutting its significance vs. book value dramatically over time.

+1! :) Gio +2 Except it's bigger than Zenith. 3/4s of another Odyssey...

Good discussion everyone. Yada, for what it's worth I think you're missing a few things: 1. China's potential in the long run is clearly good for the reasons you have outlined. But timing can be a bitch. They have taken on a staggering amount of debt over the last 7 years, borrowing to build stuff they don't need (there's a lot of evidence of awful capital allocation). Even if that stuff lasts until it is needed (which can be questioned given what I've heard about build quality), the key thing is when the debt comes due vs. when GDP is created to pay for it. And that seldom works out well when a lot of the debt has gone into non-productive investments (i.e. ones that don't create a lot of GDP except during the building phase). If the debt comes due before the GDP is created you might get a crisis, regardless of the long term potential. 2. You make the assumption that China is viewed as a good place for Western firms to do business. It isn't. It's viewed as a very dangerous place to put IP, and arguably to put capital, because there is not enough rule of law when it comes to respecting foreign investments. Firms have had to go there because of the growth, but governance is going to be a real problem for them if growth does slow and the psychology of "we have to be in China" changes. There are plenty of places in the world that have very cheap labour (some of it intelligent and hardworking) but which attract no investment because of poor governance. 3. You highlight the key weakness in your argument yourself. China's main competition is not the West (where some jobs will always stay because they have to be done there, or because the level of education is higher), but the other emerging markets. And the populations there are huuuuuge. There are lots of places to build a factory, many of them closer to Western markets and with better governance. That's potentially a real problem for China, especially since its labour rates have been rising sharply in the last few years and are no longer particularly cheap vs. these competitors. 3a. Demographics matter, and China's working age population peaked in 2012 and is projected to fall ~8% over the next 25 years. That's a key input for growth. India is projected to grow by >20% over the next 25 years and the US by about 7%. 4. You've failed to address the key Pettis point that for the last 7 years China's growth has not been labour intensive. Instead it has been driven by debt-fuelled investment, which in turn has been driven by suppressing household incomes (to make it cheaper for firms to borrow and do business). It is the potential bursting of that bubble over the next 5 years that is the issue, not whether China's labour pool affords it an advantage on a 30-year view. 4a. Related to this: China's GDP is 50% investment and that is the fastest growing part. It's 33% consumption and that is growing slower. Basic maths shows you that if investment slows a lot, which is a necessity given the debt dynamics and is also government policy, consumption has to rise very fast to prevent a sharp slowdown in GDP. They might succeed in rebalancing gently, or they might not. This has nothing to do with labour rates and everything to do with the fact that Chinese GDP growth has been driven by borrowing money to build an excess of stuff. 5. You say current accounts and capital flows aren't a good indicator. Pettis makes a good case that they have been, in the past. He cites several examples of very rapid unbalanced growth, with all sorts of characteristics including unbalanced capital flows that look like China does today (but generally less extreme), and none have ended well. In other words, his indicators look to me like good predictors of the future. Your one (relative labour rates) is also a good one when governance is good and there doesn't seem to be a debt bubble, but I'm not sure it can overcome poor governance and a debt bubble in the medium term. That said I think the difference in our view is largely timescale. I'll be a little surprised if China doesn't grow well on say a 20 year view. I just think there might be a severe bump on the road, driven by the inability to repay debt. What I would be really interested to see is if you would make your case on Pettis' blog. He's very active in replying and it might generate a good discussion. Pete

+ several!

Pettis covers this quite a lot, pointing out that it's usually nonsense made to fit the current facts and that the same country's culture can be blamed for failure one generation and then success the next. I'm inclined to agree with him. He also makes the point repeatedly that China's growth has been investment intensive not labour intensive. As investment slows they're going to have issues, especially since labour rates there have risen dramatically and no longer give them much of an advantage over places like Mexico. Investment will slow, because there's too much of it; that will cause GDP to slow and possibly drop, because investment is a crazy 50% of GDP; that will cause debt to look unsustainable, and he's written repeatedly that there is a lotof debt. And the debt's all local so Chinese consumers (who don't consume anyway because they're so repressed) will lose their savings. Might not be much fun. Don't know how much of Pettis' stuff you've read but I find him a pretty thorough thinker. I'm afraid hard work and cheap labour can't overcome the bursting of bubbles, as the (young and ambitious) US found in the 1930s. Pete

I think the flaw here is that those sellers may have to sell below BV one of these days in order to fund living expenses. The nice thing (from their perspective) about the divi is it's predictable and allows them to hold the shares essentially permanently. Not suggesting the firm should be run for retirees, but receiving a dividend and selling shares are not necessarily equivalent from their perspective.

Don't we all! I'm also wondering if the additional dilution offsets the lower price of the rights offering (assuming 100% uptake) but I haven't done the maths yet.

Who is to blame? The company or anyone short of cash? ;) Gio Jesus, Gio! I'm sure the majority of FFH holders have cash on hand. But I'm also sure (or I hope, anyway) that some of the company is owned by normal people patiently building a stake which they hope will make them rich over time (as has happened with so many Berkshire holders). We know, for example, that plenty of the company's employees are doing exactly that. *Those* people may well be in the difficult position of actually having to use most of their cash flow to pay the mortgage and eat. And personally, taking advantage of their inability to raise cash for a rights offering is not something I'd want to do as a (relatively) cash-rich shareholder. Again, doing a bought deal (with its advantage of speed) at a price that was a record until a month ago is just fine by me. We may have to agree to disagree on this one ;)

Of course it does! But imo rights offerings are a wonderful way to let existing shareholders invest more in their company at an attractive price. Therefore, I want the management of my investments to make use of them whenever the right opportunity comes. The company is selling new shares to existing shareholders, not to new shareholders, therefore it can sell them at a very advantageous price! And existing shareholders should recognize a bargain when their company offers one… If they don’t, and decide not to participate, who is to blame? The company or its uninterested existing shareholders? Gio I said can't, not don't want to. Anyone short of cash at that precise point in time gets shafted. I dislike that intensely.

How did you get to 1.1x? Reported BV was $395 and then I added $20 from roughly $450m of unrealised gains on equity accounted stakes. Prem gave that figure and it got me to 1.3x BV when I did the maths at CAD $670 per share. But I don't think they gave a figure for unrealised gains on consolidated stakes. Did I miss something? You've got to find another $91 in book value per share to get to 1.1x! Which would make me very happy ;) I still don't really get why people would rather a rights issue than just buying more, if it is so attractive! Fairfax reported unaudited equity figures at their Q4 announcement of $9.74B. Add in an addition 450M for the unaccounted gains in associates and you get equity of $10.19B. With 21.2M shares outstanding, you get a P/B of $480. 1.1x this figures is about $528 which is right around where it's been trading this past month. Sorry - I think you are using total equity not common shareholders' equity. In other words you should be using $8.36bn in equity not 9.74. Then you can add the $450 for unrealised gains on associates but I don't think they disclose the unrealised gains on consolidated stakes anywhere.