petec

I agree. Ultimately I like the idea of having something I can invest if prices get better or I have a new idea. And I'm willing to sacrifice some return, frankly, for that peace of mind because it makes me sleep better and make other decisions better. But, my point is that actually Joel's models may not capture the best *theoretical* allocation for the current period. If, in fact, we are going into a long period of volatile but overall sideways markets, then an allocation to cash along the lines of his 3-year portfolio might work very well. To put it another way: these models all backtest against history. If the future rates of return and volatility are different, then the results might also be different. And given the starting levels of debt, I think the future might be different, for the couple of decades that matter to us all anyway. Pete

Racemise, Many thanks for a well written and thought-provoking essay. The key conclusion for me is that having a cash reserve does make sense in a low-cagr, high volatility environment, but makes no sense in a high cagr, low vol environment. I have a nasty feeling that with global debt levels as high as they are, the former is what we will get for the next couple of decades, but it is a very difficult call to make. What is the difference between the S500 (7.88% pretax CAGR) and the 0% cash portfolio (14.56% CAGR) in your one-year, 100% volatility increase model? Excuse me if this is a stupid question and just displays my mathematical ignorance, but I think of the CAGR as being the speed of progression from start to finish, and volatility as being the amplitude of the bumps along the way, so I don't see why increasing the volatility increases the CAGR of a 0% cash portfolio, i.e. the S&P. Pete

Is there a conflict of interest here between Fairfax India and TCIL? Given that TCIL is meant to be buying things in India on Fairfax's behalf?

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.

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.

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.

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.

I think these are only indirectly correlated to the market return, which will be determined by starting level of valuation, growth, and dividends. I agree with yadayada that now might not be a good time to buy an index fund, but a) that'll change when valuations change and b) it's still better than buying an active fund that charges a fee for hugging the index. My advice to 'laymen' friends is to put a fixed amount into index funds every month.

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.

I love your top paragraph! As for the rest, what I find fascinating is that most of what you state has been true for years. Demand has grown, decline rates have always been there (they may have risen but I have done a lot of work trying to prove this and failed), and oil producing nations have always been unstable. Yet in the last 20 years alone oil has been priced at anything from $10 to $147. Costs have moved up and down a lot too. So I don't know how to use these factors, even if they are true, to forecast the price.

Because they tend to be businesses with high fixed costs and no pricing power and will see their profits killed in a deflationary environment.

^This If you don't want to put in the work to find and follow stocks, focus on asset allocation, dollar cost averaging and rebalancing. Find a plan you and your family is comfortable with and stick to it. ETFs and index funds make this easier and cheaper than ever. Your returns will be acceptable but not outstanding. This is wise advice. Yes - but why is it wiser than doing the same thing with say 50 stocks that, after initial work, you have convinced yourself will last and continue to prosper? In other words, by creating a very high quality index for yourself rather than letting someone else create one based on size alone. If I understood the original poster correctly, there's no objection to doing *initial* work but he wants to avoid too much *ongoing* work. I don't think investing in an ETF requires any less ongoing work than investing in, say KO.

Some great companies there! Personally I'd exclude anything that hasn't been around for 50+ years, just because that tells me they have survived a lot of change, but that's just me. I like JNJ for having a 130y + summary of earnings in their annuals!

I think it is now over 20% in the US, 45% in the UK and I have read (although can't quite believe) that it is 60% in France. Supporting data on the U.S.? Google is your friend...to an extent: http://data.worldbank.org/indicator/GC.XPN.TOTL.GD.ZS says 23-25% http://en.wikipedia.org/wiki/Government_spending says 42%?!?!?!

I think it is now over 20% in the US, 45% in the UK and I have read (although can't quite believe) that it is 60% in France. So basicly if a government cannot pay up anymore, you will see GDP shrink by huge amounts, not seen before in history. That depends on whether the government in question can print money.

Yes it would. I just find it easier (in theory at least - only time will prove me right or wrong in reality) to pick a few good stocks than a few bad ones. And I have to do a lot fewer trades ;) But yes, avoiding the crap ought to guarantee outperformance, by definition.

Ha ;) In my (limited) defence, I've used this definition a) only for my PA investing and b) since I started PA investing in earnest in 2009. As far as I am concerned it is currently showing a red flag since I'm not too sure that even the 'great' stocks are priced to protect long run purchasing power. I'm certainly not using it to justify current valuations and have 50% of my money in cash and FFH.

I'll take one free lunch, please. But seriously, read your post again. I want above-average returns with near-zero risk and zero time commitment. Many people spend serious time in hopes of just improving their chances at the first 2... Just my own opinion, but you should re-consider what you are attempting with your parents' money. Your expectations seem extremely lofty and it is probably worth ~1%/year to get an independent steward who's willing to spend an adequate amount of time on due diligence. I take your point, but I don't think I agree. My entire investing philosophy is based on the following thoughts: 1. The index has a lot of crap stuff in it. 2. It also has a lot of great stuff in it. Very long run businesses serving needs that don't change much with competitive moats and that generate cash while growing slowly over the long term. Or, jockey stocks with amazing jockeys. 3. If one puts in the initial leg work to identify great stocks, and one is selective about buying them at times when their valuation is low compared to history, one ought to be able to build a portfolio that doesn't need much attention and does outperform the index (compounded from the start, not in every discrete year) with near zero real risk* over the long term. 4. I would actually go so far as to say that doing due diligence AFTER the initial purchase might be actively harmful. Once I have satisfied myself that a business has a decent probability of lasting forever and can price with inflation and grow a little in real terms, I do everything I can to forget I own it. I'm usually not successful and so I sell things based on macro analysis, and usually regret it. For starters I'd look seriously at FFH MKL BRK KO PEP DGE CL NESN and their peers, of which there are lots MMM JNJ *I think of short term risk in terms of dividend income and long term (15y+) risk in terms of purchasing power. In other words, I judge my wealth on dividend income now and capital in the very long term. I don't judge it based on what Mr. Market quotes me for my stocks today.

I think it is now over 20% in the US, 45% in the UK and I have read (although can't quite believe) that it is 60% in France.

Might be true but I don't see it as a bad thing for the global economy. The regimes that would struggle are a) unpleasant, b) unfriendly, and c) only of any importance on the global stage because of high oil prices. Let them fade into insignificance, even if it is unstable insignificance. Horrible for the people who live there, but this is a conversation about the global economy.

+1 +2 +3 Still nervous though ;)

That's what I thought would happen with shale gas. In fact, it turned out to be economic at much lower prices than this analysis suggested.

Interesting. What's in that net wealth? If it's all JGBs then it might be grossly overstated. And if it's not, what is it? Given that (as I understand it) equities and land values have collapsed and stayed down since the 1990 (ish) peak. Also is this household net wealth or total country including government and corporate?

Say 'none have materialised' to anyone who lived through the Great Depression, or any one of Japan's last few Finance ministers (turnover in this position is stupendously high so you have plenty of candidates). My point is not that the current situation is identical to either of those, but simply that progress isn't assured. Liabilities do matter, and things can go wrong. Predicting the future may be stupid, but being aware of the risks isn't.

Should probably put it on a blog, but thoughts? Im thinking that owning some gold is not such a bad idea after all. I would prefer owning stocks that provide a hedge against this though. Im thinking, pawn stocks? They do very well if gold goes up because they use gold as collateral. I was on the camp of, well we will be fine! But im not so sure anymore now. While I agree with the general gist of this, I'd argue that inflation is the only option in Japan (you can't default on debt owned by your own population; what you can do is print like crazy to buy government bonds, creating inflation to extinguish the debt while holding bond yields low - this is Abenomics by another name).