vinod1
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Posts posted by vinod1
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Is it safe to summarize your study as saying market timing does not work with the exception you mentioned as active investors with extreme volatility?
I apologize for asking this question before reading your report in detail. I took a quick look and it is very impressive.
Vinod
Yes, that's pretty much my conclusion. It also does some other tests besides market timing (e.g., hypothetical and real investor testing to determine ideal amounts of cash for non-market portfolios).
Thank you!
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race, why do you feel there's not evidence? perhaps there isn't a ton of evidence as in a lot of observable periods. However, if one looks at Buffett's market cap to to GNP (I'm looking at dshort.com), it looks like it's done fairly well as a predictor. After all, he's the one that said there's a should be a rational relationship between market cap to GNP. And sure enough, when things start getting too out of whack (an outlier from recent averages), things blow up. We had big drawdowns shortly on these outliers around 1929, 1968, 2000 (not to mention 2007, which wasn't as high as 2000...but is lower than where we are now). According to dshort.com, we are now roughly 2.5 SD away from the norm.
I haven't seen any. Can you show me a study that uses market cap to GNP to determine when to stay in the market and get out that outperforms? e.g., CAPE is predictive of future returns, but it does not appear to be usable, a priori to outperform the market. So my point is, if no one can show that whatever metric they are using to justify holding cash actually outperforms, then it is not a valid basis for holding cash. I'm happy to be proven wrong here, but I haven't seen any evidence to the contrary. Moreover, if it can be done based on something basic (e.g., GNP ratio, CAPE, P/E, etc.), then everyone should be doing it to outperform the market, right? That is just the sort of thing that would be arbitraged out of the market, because it is too easy to do. Basically, all these arguments come down to "timing the market" which is incredibly hard to do.
I'm going to crack open your study soon, but a quick question. What were your assumptions for time periods? Thanks!
I used Shiller's data from 1871-current, to avoid issues related to specific time period. For example, there are studies that I reproduced that worked in their sample period (e.g., 1970-2001), but not out of sample.
By the way, race, this is nothing personal towards you (I think you and liberty are much smarter than I am) but how long have you been investing? I just think lack of experience (if one started investing in 2008 or 2009) it gets them to take higher risk than we should.
I'm basing my statements on historical studies, not my personal history. I think if you read the essay you'll see what I'm saying. However, to answer your question directly, I've been investing since 2010, and I would fully agree that if my statements were based on that period, it should not be trusted, but that's not where I base my conclusions from.
Is it safe to summarize your study as saying market timing does not work with the exception you mentioned as active investors with extreme volatility?
I apologize for asking this question before reading your report in detail. I took a quick look and it is very impressive.
Vinod
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It should be the *result* of your usual bottom-up investment activity: Depending on the available opportunities your cash allocation goes up or down.
Then, please, answer the question I asked anders just a few posts ago...
Gio
The answer is obvious and he already gave it to you. The point is that your initial post and how it's written suggests that you positioned yourself for a crash by having a high cash allocation and limiting your spectrum of investments as opposed to allocating cash "naturally".
I would argue that I have no idea whether we are in 1996 or 1999. For all I know the market could start a 30% slide tomorrow because [reasons that will be apparent only after the fact] or keep going for years. As long as there are compelling opportunities you should seize them and avoid forming a strong opinion about the market (à la Hussman) which can put a big part of your capital on the sidelines for a long time.
I think there is a difference between having a strong view on market direction (like Hussman) and knowing where we are in the cycle (pendulum in Mark's words) and trying to adjust our portfolio accordingly. When valuations are unambiguously high, you might want to be a little bit more careful - avoiding marginal investments, selling closer to 90% of IV, invest in opportunities that benefit from a negative shocks, etc.
If someone is a truly great investor, I am sure they would still find investments selling at 50% of IV even when the market is richly priced. If I can find opportunities like that, I would be buying all day long regardless of market valuations. But IMO, those kinds of opportunities are a mirage for most investors, they are most likely overlooking some risks, if they think they found deeply undervalued securities when market is very richly priced. For most, slightly better than average investor (hopefully), it is much easier to find opportunities when there is some dislocation or market is cheap overall.
I would differentiate the above from holding off on making investments when the market is richly priced hoping for a crash.
Vinod
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There is an article where he exposes the limitations of Hussman's graphs - especially how the visual illustration makes them look more reliable then they really are.
Hussman not only prints graphs about stock market predictions and subsequent actual returns, he also give a numerical correlation. Does the blog point that out? If it doesn’t, I am already suspicious… ;)
Gio
Yes! He digs deep into the data, to point out the flaws.
As I pointed out nearly everything written by Hussman is based on two things (1) profit margins mean revert to 6% (2) stocks normal returns are 10%. He thinks these are pretty much as certain as Planck's constant. He is 100% certain that these would hold true in future. If these do not hold in future, neither does any of his estimates.
Vinod
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Hussman makes two assumptions basically in his conclusions (1) profit margins reliably mean revert around 6% (2) normal stock market returns should be 10%. Both these might change as economic conditions change.
Vinod
On profit margins, this is worth reading:
http://www.philosophicaleconomics.com/2014/05/profit-margins-dont-matter/
Businesses optimize for ROE, not for profit margins.
I did read that and it was an eye opener for me. The blog is an absolute gem.
Vinod
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Further Gio, I just stated earlier that I agree with a very conservative allocation to stocks at this point like 10% precious metals, 20% stocks, 70% cash/bonds. With the latter too high and the fact we could wait forever for a market crash, combined with my view that FFH can be viewed somewhat as cash-like for portfolio allocation purposes, I fully agree with your 30% cash, 35% FFH position for a total of 65% which is pretty damn close to where I am.
The only reason I would agree with 65-70% in cash-like investments is because I think the market is very very high on a long-term basis. The FFH piece is important because it gives you staying power with high single digit maybe double digit returns as you wait this out.
We are in total agreement but I do urge you to read that guys blog and other articles because they are just great - and very relevant, you will enjoy them and they may change some of your views to a minor degree which can be helpful.
+1
Gio,
What you state makes a lot of sense and I agree with you.
That said, as original mungerville mentioned above, reading the blog might, just might make you a bit less certain about Hussman's research. There is an article where he exposes the limitations of Hussman's graphs - especially how the visual illustration makes them look more reliable then they really are.
Hussman makes two assumptions basically in his conclusions (1) profit margins reliably mean revert around 6% (2) normal stock market returns should be 10%. Both these might change as economic conditions change.
Vinod
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Could you please share your thoughts on how you are valuing LMCA?
Hi Vinod,
please take a look at the slide in attachment.
Of course, if you think SIRI is wildly overvalued, that won’t be of great help to you… Anyway, buybacks at SIRI just keep going on (share repurchases year-to-date at the end of 2014Q3 totalled nearly $2.1 billion), and Malone is not someone who likes buybacks if he thinks the price of the shares is overvalued! ;)
Gio
Hi Gio,
Thank you! I agree, just do not have enough confidence in the extent of the undervaluation to increase the position size.
I think as with Leucadia's previous owners, it would not be possible to predict the value created by looking at just the existing individual parts.
Vinod
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gio, don't you think the various Malone securities and BH will get slaughtered in a downturn? Both got slaughtered more than the market in 2008 (granted, I don't believe Biglari was in full control at the time).
That’s why I hold lots of cash! ;)
Anyway, I don’t know of anyone better than Malone at taking advantage of any market crash that might await us. I will be much more willing to double down in the Liberty family of businesses than in any other company, because I know Malone is working on some incredible bargain. And don’t forget LMCA today is almost debt free! In 2008 it was not so, and that could be a great advantage this time around.
As far as Biglari is concerned, the fast food industry generally behaves much better than the general market in a downturn. Furthermore, he hold lots of cash, which could be deployed opportunistically. And he surely knows how to do that!
Last but not least, both LMCA and BH are among the cheapest stocks I know today (at least in the North American stock market).
Gio
I have an investment in LMCA as well. This is a small investment for me at this time as I am quite not comfortable with the valuation primarily because this is not an industry that I spent time on. It is more of a smart owner operator/capital allocator in an industry with good economics that is undergoing change.
Could you please share your thoughts on how you are valuing LMCA?
Vinod
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I read "Keynes Hayek : The Clash that Defined Modern Economics" and it has a pretty good summary of the key differences between the two approaches and their origins. I did not actively look to read about Austrian economics but I found this side by side comparision much more easy to understand.
Vinod
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For what it's worth, I reviewed Damodaran's online material, and he *does* use the PV of leases in the Invested Capital part of the ROIC calculation (along with a bunch of other stuff like capitalized R&D, advertising, etc.):
http://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/ROIC.mp4
I still don't understand the rationale of why you would put the PV of future leases into your ROIC calculation though, so I sent him an email about it. He hasn't responded yet, but I've had decent luck with talking with him in the past. We'll see what happens.
Taking on a lease is the same as taking on debt. Instead of buying machinery that has a life of 10 years you take on amortizing debt for a term of 10 years and they are essentially the same. You would have incurred a contractual liability.
Vinod
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I was re-reading Damodaran's "Investment Valuation" book the last few weeks and he emphasizes that we make the following adjustments, so when he says debt he means adjusted debt.
Adjusted Debt = Interest-bearing Debt + Present Value of Lease Commitments
vinod1, but he uses the Book Value of Debt, NOT Adjusted Debt, in the denominator of the ROIC calculation. Adjusted Debt is used in other locations, like in the EV calculation.
West,
Yes, he does mention book value of debt but I think that is because he introduces this equation on page 44 of a 992 page book. He talks about leases in detail much later in the book. He keeps hamming away throughout the book that operating leases are functionally equivalent to debt and should be treated as such. In the examples, he keeps adding PV of leases to debt.
In the section on "What is Debt?" on page 214, he makes this very clear that debt should include capitalized operating leases. To him there is no difference between the two.
Vinod
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I don't see how including debt can determine quality of business. It seems return on equity is the only measure of quality businesses. If a business earns high ROE due to debt, it's not due to the business quality but the leverage factor unless one condition is met - it can earn the same return on the debt which means incredible ability to scale up. This may be the case for the best of the best but most are just juicing the leverage factor at a much lower return than their core return.
To paraphrase Buffett, what you really want to measure is return on tangible invested capital. We can calculate invested capital either two ways (1) Net working capital + Long term tangible assets or (2) Debt + Equity. The second method is simpler.
Vinod
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I was re-reading Damodaran's "Investment Valuation" book the last few weeks and he emphasizes that we make the following adjustments, so when he says debt he means adjusted debt.
Adjusted Debt = Interest-bearing Debt + Present Value of Lease Commitments
Adjusted Operating Income = Operating Income + Operating lease expense in current year – Depreciation on leased asset
This adjustment would correct both numerator and denominator in calculating ROIC.
Vinod
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The Four Pillars of Investing by Bernstein. This is the book I recommend to most friends and by far the best book on indexing I read. The author wrote this book because his earlier book the intelligent asset allocator is hard to read for beginners.
Vinod
Yes, it's good and much easier than his other book, but I would say it still really isn't as straightforward for a beginner. I'd still go with something like the Boglehead's Book.
That probably explains why none of my friends are really indexing.
Vinod
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The Four Pillars of Investing by Bernstein. This is the book I recommend to most friends and by far the best book on indexing I read. The author wrote this book because his earlier book the intelligent asset allocator is hard to read for beginners.
Vinod
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Most deep value investors would find that there aren't many actions to be made in the market right now. Especially on the buyers side of things. Still however, human nature pushes us to be active. And recently, this is a dilemma that I've been facing as I've discovered a few compelling businesses selling for cheap. I'm sure I'm not the only one.
If, like me, your heart is telling you to buy but your brain is telling you to remain patient you may find value in re-visiting one of Benjamin Graham's lectures. Here is a short excerpt and some food for thought:
You have to wait too long for recurrent opportunities. You get tired and restless -- especially if you are an analyst on a payroll, for it is pretty hard to justify drawing your salary just by waiting for recurrent low markets to come around. And so obviously you want to do something else besides that.
The thing that you would naturally be led into, if you are value-minded, would be the purchase of individual securities that are undervalued at all stages of the security market. That can be done successfully, and should be done -- with one proviso, which is that it is not wise to buy undervalued securities when the general market seems very high. That is a particularly difficult point to get across: For superficially it would seem that a high market is just the time to buy the undervalued securities, because their undervaluation seems most apparent then. If you could buy Mandel at 13, let us say, with a working capital so much larger when the general market is very high, it seems a better buy than when the general market is average or low. Peculiarly enough, experience shows that is not true. If the general market is very high and is going to have a serious decline, then your purchase of Mandel at 13 is not going to make you very happy or prosperous for the time being. In all probability the stock will also decline sharply in price in a break. Don’t forget that if Mandel or some similar company sells at less than your idea of value, it sells so because it is not popular; and it is not going to get more popular during periods when the market as a whole is declining considerably. Its popularity tends to decrease along with the popularity of stocks generally.
These are internal demons most of us investors face since it directly contradicts his main message of ignoring Mr. Market. Keynes, Buffett and Graham himself heavily emphasize the dictum:
It is preferable to buy dollar bills at seventy cents, rather than selling them at seventy cents in the hope of subsequently repurchasing the notes at fifty cents.
Vinod
As much as Graham believed in the Mr Market parable, there was a part of him that always feared losses, even paper losses if they lasted too long, as a result of his experience during the Great Depression.
Good point.
When it comes to shaping people's outlook regarding stock market's future returns, personal experience almost always trumps centuries of historical data. - James O'Shaughnessy
Vinod
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Most deep value investors would find that there aren't many actions to be made in the market right now. Especially on the buyers side of things. Still however, human nature pushes us to be active. And recently, this is a dilemma that I've been facing as I've discovered a few compelling businesses selling for cheap. I'm sure I'm not the only one.
If, like me, your heart is telling you to buy but your brain is telling you to remain patient you may find value in re-visiting one of Benjamin Graham's lectures. Here is a short excerpt and some food for thought:
You have to wait too long for recurrent opportunities. You get tired and restless -- especially if you are an analyst on a payroll, for it is pretty hard to justify drawing your salary just by waiting for recurrent low markets to come around. And so obviously you want to do something else besides that.
The thing that you would naturally be led into, if you are value-minded, would be the purchase of individual securities that are undervalued at all stages of the security market. That can be done successfully, and should be done -- with one proviso, which is that it is not wise to buy undervalued securities when the general market seems very high. That is a particularly difficult point to get across: For superficially it would seem that a high market is just the time to buy the undervalued securities, because their undervaluation seems most apparent then. If you could buy Mandel at 13, let us say, with a working capital so much larger when the general market is very high, it seems a better buy than when the general market is average or low. Peculiarly enough, experience shows that is not true. If the general market is very high and is going to have a serious decline, then your purchase of Mandel at 13 is not going to make you very happy or prosperous for the time being. In all probability the stock will also decline sharply in price in a break. Don’t forget that if Mandel or some similar company sells at less than your idea of value, it sells so because it is not popular; and it is not going to get more popular during periods when the market as a whole is declining considerably. Its popularity tends to decrease along with the popularity of stocks generally.
These are internal demons most of us investors face since it directly contradicts his main message of ignoring Mr. Market. Keynes, Buffett and Graham himself heavily emphasize the dictum:
It is preferable to buy dollar bills at seventy cents, rather than selling them at seventy cents in the hope of subsequently repurchasing the notes at fifty cents.
Vinod
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Hi, I had a cursory look at the report and can't see what is special about it. Why is it such a good report?
thanks
I also stopped reading halfway through. Maybe the good part is the second half?
It wasn't bad, I just didn't feel he was saying much other than "JPM is a good business, it'll continue to be a good business, because we'll keep going with our long term strategy, but we'll also adapt, because we're good, etc, etc".
Yes. Read the second half. Slowly.
One of the few people who have a direct pulse on the economy due to the nature of the company. Here you have a guy who is giving his opinion, unvarnished, without hedging every sentence.
Vinod
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The math for Fairfax bond portfolio is very similar to the example above. I think Fairfax is one of the best if not the very best bond investors, but without a major dislocation in bond markets, I just cannot make the leap where Fairfax would be able to make 7% on their overall portfolio given where the bond yields are. Bond market is probably more important to Fairfax than the stock market given how they are forced to invest their portfolio due to insurance requirements. This is just not Fairfax specific, it is endemic for the P&C industry.
Vinod
Vinod,
I asked Mr. Watsa my question exactly because of that concern I share with you. As they keep buying more operating businesses, and building earning power, they might be able to transition to a balance sheet more similar to BRK’s today (where bonds amount to barely 8% of total assets). That way regulatory constrains will become less and less significant. And they have time: interest rates might not come down much more from present levels, but it is not likely they are going up soon either. Also Mr. Watsa’s answer tells me they will find good value propositions wherever they might be (more equities and/or high yield bonds): it might be done and I don’t have any reason to believe he was not in earnest while replying to my question. :)
Gio
Thank you!
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I think the fairest way to do these comparisons is to make rolling 3, 5, 10 year periods (perhaps quarterly) and show the distribution of those periods against the benchmark. For good managers, I would expect something like: 65% outperformance for 3 years, 85% outperformance for 5 years, and 99% percent outperformance for 10 years, or something along those lines.
Anyone happen to have the data for that?
Edit: I'm also curious if anyone disagrees with measurement in that fashion or thinks there is a better way. It seems to me to be the fairest since it is agnostic to particular time frames and the initial years.
Take 1990 to 2002 period. I am guessing, that the worst of the tech stock funds would have had pretty high rolling outperformance but would have had very large permanent loss of capital in the end.
I understand you are trying to come up with a mathematical way but I do not think this is the solution.
Vinod
Ah, good point, I think if we add a requirement that this is only done for long term outperformance company/investors, then it would remove the permanent loss issue. (I would generally only want to do this for something I was interested in investing in, which would only include something that is outperforming).
The main difficulty is style differences impact your returns depending where you are in the cycle. Given a sufficiently long time period covering multiple cycles this effect would be reduced but still not be accurate. Why not measure at similar points in a cycle? That would take away the biggest error term in measuring performance.
Vinod
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Ok, guys! Sorry… I have tried to answer all your points, but it is too daunting a task! I give up. Let me conclude by saying this: in the past FHH has averaged a return on their portfolio of 8.9% annual. Given the amount of float they manage today, a 7% return on their portfolio is enough to compound BV at 15% going forward. Which is 21% worse annually than what they have achieved in the past. I asked Mr. Watsa at the AM my long term concern n.1, which is that in the past FFH has benefited much from a secular bull market in bonds that is now over and won’t probably be repeated for a very long time. He answered they will be opportunistic and they might invest more in equities, in private businesses, or in high-yield bonds. Basically what I had hoped to hear. He didn’t know I was asking him such a question. Therefore, he hadn’t had the time to put together a more elaborate answer. Yet, it seems to me he was very prepared.
No one knows the future, but I decidedly like what I see. :)
Gio
Thanks for detailed and thoughtful responses. Your patience is amazing!
Fairfax is one of my first investments and following Prem has taught me a lot. So regardless of our difference in expectations regarding Fairfax, I would be rooting for both Fairfax and your investment.
You mention frequently and it is something I have not been able to make the same leap of faith as you do, is the return expectation of 7% vs the 9% historical rate. How can you just lop of 2% off historical record and say that is conservative and provides us with a margin of safety?
Take the example of a 10 year bond, as the yield went down from 5% to 2% over 5 years, the returns on that bond would be 8% annual (roughly). We cannot just say, I would chop off 4% or half of the return and conservatively expect just 4% over the next 5 years. It is not going to happen. We would just get 2% returns.
The math for Fairfax bond portfolio is very similar to the example above. I think Fairfax is one of the best if not the very best bond investors, but without a major dislocation in bond markets, I just cannot make the leap where Fairfax would be able to make 7% on their overall portfolio given where the bond yields are. Bond market is probably more important to Fairfax than the stock market given how they are forced to invest their portfolio due to insurance requirements. This is just not Fairfax specific, it is endemic for the P&C industry.
Vinod
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I am in there like a bad habit. JPMs earnings down a whopping 19% - yawn. WFc earnings up a bit on lending.
Curiously BAc should be up a bit next week on the lending side as it is most similar to WFC.
Bought WFC leaps, JPM leaps, and rejigged my BAc leaps to lower strike prices. Sold all my BAC 2016 22's at a loss, some 20's. Replaced with 15 and 17s. All before 9:45 this morning. Whew!
Al,
Which strike JPM LEAPS have you bought?
Thanks
Vinod
57.50 & 60.00 I am sort of operating with an interim target of 72 by the end of 2015 - low ball
Thank you! I started looking at JPM LEAPS and thinking of $55 strikes. You seem to prefer ones that are slightly out of money.
Vinod
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Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:
http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG
This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.
Vinod
I think the fairest way to do these comparisons is to make rolling 3, 5, 10 year periods (perhaps quarterly) and show the distribution of those periods against the benchmark. For good managers, I would expect something like: 65% outperformance for 3 years, 85% outperformance for 5 years, and 99% percent outperformance for 10 years, or something along those lines.
Anyone happen to have the data for that?
Edit: I'm also curious if anyone disagrees with measurement in that fashion or thinks there is a better way. It seems to me to be the fairest since it is agnostic to particular time frames and the initial years.
Take 1990 to 2002 period. I am guessing, that the worst of the tech stock funds would have had pretty high rolling outperformance but would have had very large permanent loss of capital in the end.
I understand you are trying to come up with a mathematical way but I do not think this is the solution.
Vinod
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Another question we could ask is how fast book value would have to grow over the next few years to bring up the average BV growth when you include the past 15 years. They say they're aiming for 15%, and I know they say results will be lumpy, but you'd need many years of 30% growth to compensate for those who bought 15 years ago..
Do not disagree at all. Looking at the way they are positioned and just looking at the returns that can be expected of stock and bond markets, I do not think Fairfax can compound at more than 10% unless there is a severe market dislocation. Bond yields in the 3-4% range would be too tough to overcome for P&C companies.
Alleghany has commented on this in their recent letter and said that going forward 7-10% returns are their target. Fairfax should do so likewise.
Vinod
Going into a stock market bubble
in General Discussion
Posted
The question is what is "very cheap"? A couple of years ago, the weighted average of my portfolio (just a rough estimate) price/IV would have been below 50%. Right now it is likely above 70%. This is even if you ignore the much higher quality of the investments available a couple of years ago.
In addition, the number of ideas that meet the criteria are below the level that would provide adequate diversification for putting 100% of the portfolio.
Would you be willing to say put near 100% of the portfolio when you have say only 3-4 ideas that are say around 75% of IV? Would love to hear your perspective on this.
Vinod