petec

House prices and rates will rise together when the economy is doing well - what central bank raises rates when it isn't (apart from a Volcker-inspired one)? What's more important is what happens to house prices *after* rates have been rising for a while. For example, the article gives Q32006 as the last interest rate peak. IIRC house prices dipped after that... The inescapable maths is that when rates double, a buyer putting 20% down and paying for the rest with an interest-only mortgage finds his buying power drops by 40% for the same repayment. Clearly the effect isn't as drastic for bigger deposits or for amortising mortgages, but the guy I have just described is probably the marginal buyer. So, the only ways house prices can be unaffected by rate rises are a) if households are not close to maxed out on their mortgage payments, or b) if wages rise with rates. Otherwise, after a period of rising rates, house prices must respond to lower marginal buying power. Sure there's a lag, because psychology lags reality, but it'll happen. Edit: I would also argue that the article covers short periods of rising rates that fall almost entirely within a secular period of falling rates. The effect might be very different from what'll happen during a period of secularly rising rates (not that I expect that any time soon).

I wonder. It doesn't exist in Canada, and it doesn't exist in the UK. I suspect that's because there isn't actually a market clearing price. The price the banks need to cover their risks just doesn't look attractive enough next to the rates you pay for 10-year fixed or 30-year floating, and I don't think they ever will because I think most people think 5-10 years ahead and not 30. I think the 30 year future is just too murky (whether it be job security or inflation, you don't know what's going to happen). The only taker of a 30-year fixed loan at market rates will be someone who thinks that inflation's going to be higher than the banks think it's going to be. There will be very few of those people at a time like this. Sadly, you might well find that there's a lot of demand for those loans when rates have been rising for 10 years and are at 15% again ;)

Seems to me that there is a very simple way to reconcile Eric and Gio's views. Eric believes that the market will not attribute a 'seer' premium to HWIC and Fairfax. I agree with this and don't expect to be able to sell my shares at 1.5 or 2x bv any time soon (although there are periods when maybe the market has attributed a 'seer' premioum, such as the late '90's p/bv ratios). Gio believes that although the market might not attribute a 'seer' premium, 'seer' returns are likely on the investment portfolio (according to his analysis) and therefore he will make a good return buying at this price. I agree with this, too.

That's exactly right. Double counting. Ok, now I have understood what you mean. But I am not trying to do what you suggest. Instead, I am only trying to compute the true value of what I own today. In doing so I don’t see why I should strip-out goodwill, if PW hasn’t paid more than IV. Then, I am trying to figure out the value of what I could be owning 30 years from now, if the value of what I own today compounds at 15% annual. Then, I discount it back to the present. That’s all I am doing. Where is the double counting? Gio I think you have to justify why the goodwill will compound at 15%. *Or* you actually have to do a DCF and value it as P/PV, but not P/BV.

That's exactly right. Double counting. Understood. FWIW, I'd pay a significant premium to TBV for the assets PW has assembled.

I'm not sure I understand this. In the case of Zenith for example, I suspect PW could sell it for more than he paid so the intangibles have value to me under all scenarios and holding periods. Or have I misunderstood?

My views for what they are worth: I agree with Gio that goodwill should not be stripped out unless you think PW overpaid, but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith. In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith. (Obviously this argument diminishes over time as Zenith'as earnings get capitalised, but this will be seen as goodwill decreasing as a % of Fairfax's BV unless more acquisitions are done.) Sorry if I have misrepresented your views Eric. On the issue of whether market holdings should be valued at market I also take a halfway position. Clearly they should be valued at market because I could laboriously replicate the portfolio if I wanted, but equally I'm willing to pay not to have to do that, and for Watsa's ability to buy things for less than they are worth. So I'll pay a small premium to book value for those securities, but not a big one because if I paid a big one I'd be paying up front and in full for future anticipated gains as Eric says. I'm broadly of the opinion that today's BV is roughly fair value and beyond that I don't care much. I think IV will rise over time, and rise a lot if there is a crisis, so I'm happy to keep adding on dips. I'd love to say that I value it more thoroughly than that, but I don't. My investing philosophy suits my mentality and it is to buy compounders for the very long term at roughly fair value and keep some cash for the occasional epic 5-year value trade when I see one.

+1 My thoughts exactly. Besides, I find it amazing that BRK continues to be misunderstood. Undervalued that is. This has gone on and off over the past 40 years. Mark my word, BRK during the recent financial crisis was trading at levels that will not happen in my remaining lifetime. Mother of all value investments and sound sleep comes attached. Completely agree and I also own BRK, although a) it is not now cheap like it was then and b) I know which will do better if there is a crisis!

I agree 100%. I guess probably in Europe we are still feeling a pain that in the US was only briefly experienced in 2009-2010… That’s why rising stock prices don’t make us feel so much comfortable… In Italy, and maybe also in England (at least in part!), we feel first-hand the irrationality of asset prices that go up almost every day with tons of qualified people that remain without a job… The piece of news industrial production in Italy declined again last July is just out, the biggest construction companies in Italy have all practically left the country, our debt is the third largest in the world… and yet the Italian government can borrow at a lower cost than the US! Isn’t this irrational enough? Believe me, if you live it each day, it surely is! Gio Absolutely. The UK is arguably in a better state than Italy - until you consider what you have to spend to buy a house in London. These prices are not right. I have been saying so, and been wrong, for several years, but the more they go up the more I think I'm right. Overall, with the exception of the (admittedly very important) US consumer, the world is still leveraging up, not deleveraging, and in debt cycles the way up tends to be a much smoother ride than the way down. Protection is just fine by me.

what I should add is that if FFH are proven right, it might well be a case of a broken clock. They clearly mistimed their bet, so maybe it is luck and not judgement. But there is some judgement in ensuring that you will be lucky, and have a lot of cash to invest, just when everything is cheap!

+1. That is the reason I sold as well. I am not comfortable investing alongside someone who believes they can consistently make good investments based on the macro. Also, I see his current bets on a stock market crash as very different from his subprime mortgage bets. With his CDS bets there was an identifiable irrationality you could point to - lots of money being loaned to people with terms such that they were very unlikely to repay the loans, and with some foresight you could say that "this is going to end badly". Certainly we should give Prem credit for seeing this. But his new bets are just macro bets plain and simple, with no irrationality you can really point to, except perhaps for deficit spending, which has been going on for decades. With Blackberry, I seriously doubt that he would have invested if Blackberry was headquartered in Dallas, TX. Thus in my mind the Blackberry investment signals a bit of hubris - that he felt he should go in and save the Canadian technology company. Investing in tech turnarounds is not how Prem made his fortune, and every experienced value investor knows what a dicey proposition it is. Hopefully Fairfax has learned from its mistakes. I wish like you that they would fess up to their mistakes, as acknowledging one's mistakes is the best way to avoid future ones. FWIW I disagree fairly profoundly with both these views. Broadly I agree on BBRY - hasn't worked as they have hoped, but then not every investment does and they may still make money so let's wait and see. I agree that they would not have invested in BBRY if it had been in Dallas, but more because they wouldn't have known it so well. I don't see it as hubris - there must have been dozens of Canadian bankruptcies that Prem did not try to save, including the last 'Canadian tech company' - but I suspect that because it was so close, he knew a lot of people involved and thought he had an edge. He may yet be proved right. The bigger issue for everyone seems to be the macro. They have done two big things here. The first is protect what is a very levered (with float) balance sheet in the event of an epic crash. Would you really rather they had left the company exposed? OK, so there are other ways of doing it such as holding cash, but if they'd done that we'd all still be saying ooh look how wrong they've been. The second is they have made a macro call. The CDS bet when they made it was very controversial - it was not obvious to most people that there was an "identifiable irrationality you could point to - lots of money being loaned to people with terms such that they were very unlikely to repay the loans". It certainly wasn't obvious to me. However, having lived through that, I think I can identify another one today. China's banking assets went from $9trn in 2009 to $23bn in 2013, an increase of $14trn vs. a total US commercial banking asset base of $15trn. In 2011+12 they made as much cement as the US made in the 20th century. I would suggest that there is a very strong possibility they are borrowing money they can't afford to repay to build things they don't need (and that GDP is unsustainable in absolute terms as a result, with investment at 50% of GDP and quite capable of halving). If China does go bang - and it is only an if, but a big if - I think that will be reflected in global asset prices, at least for a time. So here's the thing: why is it more of a macro call to say "I see serious imbalances in the world, and I will both protect myself against them and make a bet to benefit if I am right that they are unsustainable" than it is to say "I see serious imbalances in the world, but I can't predict macro because everyone tells me macro is unpredictable, so I'll just carry on regardless, risk my company, and not make any money if I am right"? Or to put it very simply: I don't want these guys to admit they've made a mistake because I think what they have done is stick to what they believe in. I invest in them precisely because they stick to what they believe in, and because it has worked over time. If I saw them wavering because the short term (and yes, I do view 5 years as short term) didn't work in their favour I'd be *very* worried. I have listened to Prem saying: the world may muddle through, and these investments may not pay off, and that'll be fine; but if they do, we'll do very well when everyone else is on their knees. He *knows* he might be wrong, but wants the protection because he knows being wrong about holding protection is far less painful than being wrong about not holding it. And I am delighted that he runs his company that way. Thanks for reading, P

Watsa? It depends whether you trust them. I would far rather have a man I trust (both to create value and in the ethical sense) have control than not, even if he doesn't own 50%. And If I don't trust him, I don't want to invest alongside him no matter how much he owns.

+1! ;) Gio +2 :)

One of the big memes driving the speculation in the 80's was precisely the exodus of millionaires from Hong Kong, as it became clear that the British lease would not be renewed. Plus ca change... Plus, all those Chinese departing will only help the *Chinese* RE bubble burst, which will have knock-on impacts elsewhere, possibly bursting bubbles all over the shop including in Canadian (and, closer to home for me, London) housing.

Feels that way, and a lot of commodities point that way too. The options are a way off strike, but my understanding is that their price can rise in the market regardless.

It is not new that a machine becomes able to do a thing a human can do, but better and cheaper. That has always been a good thing as it allows humans to focus on other things that add more value. But it would be new if machines get to the point where they can do *everything* that humans can do better and cheaper. Or, more likely, and recognising that not all humans have the same abilities, it would be new if machines get to the point where they can do what most humans can do, but better and cheaper. That is what the video is arguing will happen, and it would be very new. It would not matter then that there is an infinite amount of things to do because machines would do all of the new things. This change would not free humans to go and do something more value-added. It would render them economically useless. And that would be catastrophic, since demand (and societies) would collapse.

+1 GooooooooooooooooooooooodmorningVietnaaaaaaaaaaaaaaaaaaaaaaaam :) RIP

I divide my investments into two: 1) 5-7 year winners, businesses that are undervalued now and have good prospects but that I don't want to own for the very long term. 2) Businesses that I want to own for the very long term. These have been around for decades, are in industries that change slowly, have exceptional financial characteristics, and usually have a particular culture. With the first set, I try to be very rational about value. With the second set, I actively try to build an emotional bond. I try to fall in love with these stocks. I read company histories and note down anecdotes, and if I had space I would keep annual reports because I know I will find it difficult to sell stocks where I have a row of 20 annuals on the shelf. This emotional bond may seem crazy but it stops me from wanting to sell because of macro or the market's siren call. I think I would still be able to sell, or at least reduce, if these stocks themselves were significantly overvalued, but... ...the third part of my strategy is to know that I have ways of making good money off the bottom if there is a selloff, which makes me less likely to try to call tops and raise cash. I always have 10% cash or thereabouts, and I tell myself I will buy options etc. at the bottom to lever my returns. That stops me feeling I need 80% cash at the 'top' (which of course never turns out to be the top!). I am sure this is not very rational but it seems to work for me! Pete

I clearly need to research Soros vs. BoE! What interests me about this is Richard Koo's argument, that in a balance sheet recession monetary policy is powerless because management teams are focussed on balance sheets. I would imagine that is the case for banks in the Eurozone: overlevered and facing a weak economy and rising regulation of balance sheets, will a tiny cost of deposit at the central bank make them lend into the economy? I am sceptical, but we certainly live in interesting times.

Crip, I really wish I knew how to jump in and out of stocks… But I don’t think I can… I sell a great business (...to correctly recognize a great business is already hard enough!) only if it is wildly overvalued… at 1.3 – 1.4 x BV FFH imo is still undervalued… ;) Cheers, Gio Me too. With Fairfax, you've got increasingly good insurance businesses and a good investment team. That ought to be valued at >1x bv. How much > is hard to say but if they can do 13% average RoE, and I don't see why that would be hard LT, you're still paying only 10x. Plus, you have some exceptional optionality if Prem's macro thesis plays out. This combination of attributes is pretty rare if you ask me, and it is certainly a very different company than it was through most of the 2000's when it traded on a lower multiple. I'm a happy holder at these levels and considering continuing to add.

IMHO there is nothing impulsive at all about acting fast when something you know a lot about offers an opportunity. Prem obviously knows India backwards, with strong personal and professional links. What on earth is impulsive about announcing a fund to make investments there, when a reformist government has won a landslide? To me that shows great planning and preparation, combined with a willingness to act at key moments. The worst case is that India carries on as normal and a good value investor gets to hunting there; and the best case is that India reforms, providing a nice tailwind for that value investor.

History is not on China's side. This speed of debt build up, this magnitude of debt build up, all sots of skewed incentives to misallocate capital, these levels of foreign reserves...we have seen it all before. That's not to say history repeats exactly, but it rhymes, and incidentally the Soviet Union and Nazi Germany were amongst the historical peer group so command vs. market economy is not necessarily the key difference. Michael Pettis' recent book is very good on this. History is pretty clear that China will have a job to keep 7.5% growth going. Moody's suggests that 23% of GDP is building, outfitting, and selling flats and Prem Watsa says 60m flats were under construction at the start of the year vs. a peak in the US of what, 2m? What happens when that slows? Predictions are a mug's game, but protecting yourself from this wouldn't be stupid.

16%

Absolutely. FT this morning claims that China produced as much cement in 2011 and 2012 as the US did in the 20th century. real estate sales are down 8% y/y and new projects are down 22%. China has had 25 months of consecutive PPI falls. Deflation is not a stupid thing to protect yourself against, despite the money printing.

Yup - all depends on whether you're a low cost player (and can remain so) or not. Even the pick and shovel mfrs had better have a sustainable competitive advantage or they just pass profits on as lower prices. National Oilwell might be a good one there.