vinod1
-
Posts
1,667 -
Joined
-
Last visited
-
Days Won
4
Content Type
Profiles
Forums
Events
Posts posted by vinod1
-
-
Does anyone else strike it as odd that we're not really paying for our mistakes?
The point you mentioned above, is really the key difference between bulls and bears at this time.
Almost all who are bearish at this time, Klarman, Rodriguez, Watsa, Hussman, Grant, Grantham, etc bring some version of morality/justice into their equation. For all of them it boils down to justice not being done, for the sinners (who participated in the bubble) got bailed out, the profilgate debtors who got their burden reduced by low interest rates, the prudent savers who are getting punished, the unemployed who did not benefit from fed policies while the rich investors who have stock holdings have gained massively. It does not seem fair. Watsa codes it as "7 lean years and 7 fat years", others are more direct but morality is a common ground for all these investors. Hussman in particular seems to have expected some version of great depression to play out and was caught by surprise when the historical script did not play out.
I did incline towards moralists for a long time, but I am coming to the conclusion that while Market serves lots of purposes, enforcing morality is not one of them. It is interesting that the most hyper rational investor of all, Buffett, does not ever mention any of these.
Vinod
-
That was good.
First, the Western world put them on an unsustainable growth path fueled by our debt bubble in the US and elsewhere that boosted unsustainable consumption of Chinese exports.
Second, when that blew up China has tried to maintain that growth trajectory using unsustainable domestic credit growth rate.
So what happens next?
Michael Pettis is the guy for you. He has been writing about this for quite a while.
http://blog.mpettis.com/2013/10/hidden-debt-must-still-be-repayed/
We are also not likely to see, however, the advantages of a Lehman-style crisis, and these are a relatively quick adjustment in the process of investment misallocation. I have always said that the resolution of the Chinese banking problems is far more likely to resemble that of Japan than the US, and instead of three of four chaotic years as the system adjusts quickly, and at times violently, we are more likely to see a decade or more of a slow grinding-away of the debt excesses. The net economic cost is likely to be higher in a Japanese-style rebalancing, but American-style rebalancing is risky except in countries with very flexible institutions – financial as well as political.
Another good post
http://blog.mpettis.com/2014/01/will-the-reforms-speed-growth-in-china/
Low interest rates, low wages, an undervalued currency, nearly unlimited access to credit for state-owned enterprises, a relaxed attitude to environmental degradation, and other related conditions were both the source of China’s ferocious growth as well as of China’s unprecedented economic imbalances. Reversing these conditions will rebalance the economy, but will do so while lowering growth in the obverse way that these conditions had accelerated growth.
Vinod
-
I've posted about this ROE comparison vs. margins before. I agree it's more meaningful than margins generally. But the question I have is in a world of 3% long rates is a 12-14% corporate ROE really reasonable? I think it's not regardless of historical 'average'. Separately, I think the "B (Equity or Book)" for US companies is overstated "versus history" (I think it's more accurate than historical) due to goodwill accounting (and perhaps it's understated a bit due to R&D accounting)... which means ROE is too high because of the rate environment and also apples to apples it's too high vs history.
Ben
Question is what would cause ROE's to go down? There has to be massive investment by companies take advantage of high ROE, to drive down ROE to more "acceptable" levels. We do not see that. Massive investment is also precisely what GMO says is one way to keep profit margins high!
Vinod
-
It's not an opinion that margins are high. It's a mathematical fact. Margins have traditionally reverted and have traditionally been lower than they are today. The questions isn't are margins elevated. The only question is when they will revert. 1 year? 5 years? It's really anyone's guess but I don't really think its up for debate about how richly valued the market is. It's really more of a question on how much more richly valued it could get and how long it will take to revert. The numbers simply don't lie.
Margins are high but as pointed out by Pzena, ROE are roughly in line with average. But companies and investors care more about (correctly in my view) return on equity. The fact that a company increased its margins from 5% to 10% would not automatically invite competition and drive down margins if ROE say remain only 8%. Companies had to deploy a lot more assets to generate these margins.
http://www.pzena.com/heading-our-research/investment-analysis-4q13.php
What are your views on this?
If God gave you a peek at interest rates over the next 20 years and they remain in the 2-3%, how would your view about equity valuations change, if any?
Not trying to argue with you, just trying to understand different viewpoints on this topic.
Thanks
Vinod
-
Prem made the following comment in the annual letter.
"As we did last year, we remind you that cumulative deflation in the U.S. in the 1930s and Japan in the ten years
ending 2012 was approximately 14%. It is amazing to note that including 2013, Japan has suffered deflation in most
of the last 19 years – beginning about five years after the Nikkei index and real estate values peaked."
Japanse CPI data shows a deflation of only 1.0% over the last 10 years (2003 to 2012). Even peak to bottom from 1998 to 2013 the deflation is only about 5%. Does anyone know what inflation data Prem is using for Japan?
Link to CPI data on Japan:
http://www.stat.go.jp/english/data/cpi/1588.htm
http://www.e-stat.go.jp/SG1/estat/CsvdlE.do?sinfid=000011288548
Thanks
Vinod
-
Vinod, I agree, that's why I pointed out Klarman's style. If I was investing like him, I'd probably build up huge cash positions too while waiting for big distressed debt events. His way obviously works, but I'm not sure if investors with different approaches are taking away the right things from his allocation (apples to oranges).
But it doesn't mean that we can't look at his macro comments - even if he says he doesn't act on them - to see if they are convincing. I agree we're probably overdue for a correction, but some people seem to read into his comments (and cash) that we're in very bubbly territory, and I'm not sure it's the case for reason I pointed out above.
But who knows? Maybe we're about to see a massive selloff and 30% drop...
Liberty - Completely agree with what you have posted in this thread.
Vinod
-
I think we are reading too much into Klarman's cash position. I do not think his cash position has anything to do with his macro views.
From my notes on Klarman but not sure if these are his exact words:
People like to ask: “What do you think about the dollar or the economy?” We have those views but we refuse to bet on them. Most people don’t have any edge in macro issues.
Also, it is hard to turn a macro view into a portfolio. When you go from interest rates to economy, to an industry, and to specific companies, you have to be right every step of the way and you have to be early.
When you go bottom up, all you have to do is to be right about the specific one-off situation. You can be wrong about the country, wrong about the economy, wrong about the interest rates, and still make money.
"Our 45% cash position is not a macro bet. It is just tough to find bargains now." (early 2006)
Vinod
-
You don't think Putin will harm this further one way or another? I was tempted as well.
The way I see it there are two main risks
(1) Russian government confiscating Lukoil assets
(2) Russian government imposing restrictions on foreign holders of Russian businesses
Given that we have an owner operator who has the benefit of learning from Yukos, I would think risk #1 might be somewhat low. However, if there are financial sanctions and asset freezes imposed by west due to Ukraine situation, #2 may be a significant risk.
I do not think we can really assess these risks and we just need to manage it with position sizing.
Anyway you measure it, it is trading at about 4x average earnings of the last three years. These are all in and what could be considered pretty normal level of earnings - if oil prices hold. I think the above risks are more than priced in.
Vinod
-
Is anyone buying Gazprom or Lukoil? Is the sell off warranted? Does anyone see these events impacting these two large players long-term?
Bought Lukoil. But not sure if I am investing or making a donation to Putin.
Vinod
-
They have multiple parts:
bond income
underwriting income
equities (hedged against indices)
CPI thinging
How did all four of them combine to just 2.8%?
Did capital bond losses exceed all income generated over the period?
Did equities underperform the index?
Was there no net underwriting income?
Which part was primarily responsible for dragging down the slugging percentage?
Rhetorical question?
Bonds had a $900 million loss and equities underperformed the hedges by $500 million. These pretty much accounted for the underperformance.
Vinod
-
Do you still believe in their accident year combined ratios? They have to use the most conservative level that their auditors/independent actuary will allow.
I did not quite understand why you would not believe the accident year CR. Could you please explain?
Thanks
Vinod
They sandbag the accident year reserve. If they think they are going to have losses of $100 on a policy they put $115 into the reserve. They say they are being conservative (which they very well may be, who knows what will happen between a reserve being established and claim identification/settlement. Courts could become more hostile to insurers, inflation could go up, an unforseen risk might not have been excluded from a policy). However, at a certain point you've reserved for the unknowns that I've bracketed and you are effectively setting up redundant reserves that you will bleed through calendar year combined ratios in future years.
That is what FFH is doing...it's also what BRK.b and WRB are notorious for.
Thanks! FFH in the past had to keep adding to the reserves, so I would be glad to see this change going forward.
Vinod
-
Do you still believe in their accident year combined ratios? They have to use the most conservative level that their auditors/independent actuary will allow.
I did not quite understand why you would not believe the accident year CR. Could you please explain?
Thanks
Vinod
-
I am, of course, pleased to see underwriting profits for 2013. I hope this continues into the future. This is foundational for a strong FFH.
I am not happy with their hedging strategy, of course. Quite simply, they could have just parked money in cash and lived with <1% yield. Why the urge to be in the market if they see market as highly valued? Why the urge to be buying return swaps and other instruments, when they lead to a negative sum game? If they got into cash in 2010 and missed the rally since then, they would be in the exact same boat as today; i.e. nothing gained and nothing lost.
They call these equity "hedges", but they really aren't hedges at all. They were and are directional bets. They just happened to lose the bet. If the market dropped another 50% from 2011 to 2013, they would have been slightly up, but not much. But relative to everyone else, they would have looked brilliant. They could have achieved the same result with far less stress and stayed in cash since 2010.
I really hope, at least behind closed doors, Mr Watsa and his team are reflecting on what they did and how they could have done it better. I have a lot of respect for Mr Watsa and his team. I expect them to be introspective and self-critical, if not in public, then in private.
+1
It is good to see underwriting going in the right direction, but it is aided by $440 million reserve release. Accident year CR is at 100%.
Vinod
-
I hope someone asks a question on the CPI derivatives. Despite all the hoopla about deflation in Japan, the CPI index there peak to bottom went down by less than 5%. Fairfax seems to be preparing really for a repeat of Great Depression. Otherwise CPI derivatives do not provide much bang for the amounts being invested.
Vinod
-
i just have one question: If you have a $4B portfolio and the info Prem had 4 years ago.... what would you have done to protect the capital base?
Fairfax could have done either of the following:
1. Buy puts. That would have been true insurance.
2. Had brought some protection in case stocks shoot up.
Four years ago it seemed likely that markets would go down again. Fairfax was positioned as if this is nearly certain. Fairfax bought the hedges as a protection against 1 in 100 year event. Has it been Fairfax's assessment that the market had much less than 1 in 100 chance of shooting upwards?
What kind of insurance is it that if it does not work out produces as much losses as it is supposed to protect?
Vinod
-
In hindsight, but Fairfax lost $4 billion cumulatively pre-tax over the last 4 years on equity hedges and CPI derivatives. All this to protect $4 billion in equity investments at cost.
Vinod
-
Hi Vinod,
First of all the great majority of FFH’s equity hedges are on the Russell2000, not the S&P500. And small caps are much more expensive than large caps: before the recent “correction” small caps according to GMO were priced to deliver a negative –4.9% real annual return over the next 7 years… Large caps –1.7%…
But that’s not really my point. I am not trying to defend an investment in FFH made 3 years ago… Instead, I am strongly advocating an investment in FFH today. As a new shareholder of FFH you absolutely don’t care if FFH will be right on its equity hedges in "absolute terms"… You won’t bear the cost of past protection and conservative behavior anymore! Instead, you are getting protection now! Therefore, let me reformulate: it is not that FFH will surely be right, but that FFH will surely be right for you as a new shareholder! I just don’t see how it could be otherwise…
That’s why I am only hoping to see another leg down in its share price, after FFH discloses 2013 full year results on February 14, 2014… It would be a great chance to average down! ;)
Gio
Gio,
Makes sense.
Thanks for pointing out that the hedges were on Russell 2000. Let us hope the markets cooperate in providing an opportunity.
Vinod
-
As I see it, FFH simply cannot be but right… Not only, the higher this market goes, the more correct FFH will be proven in the end.
Gio
Gio,
For me, for FFH to be "right" on the hedges, S&P 500 would have to fall significantly below (say 20% or more) the level at which they hedged (~1060). This would imply S&P 500 to go down to about the 800 level.
What is your criteria for FFH to be right on the hedges?
I say this not to disrespect Watsa in any way. They got 3 big macro calls right (Japan 1989, Tech bubble in 2000 and 2008 crisis). Even if they got this wrong, that would make 3 macro calls right out of 4. That is a pretty good ratio on such complex macro events.
Vinod
-
The fund was updated this morning. The allocation is as follows:
Company %Alctn Votes % of Member Votes
BAC 16.70% 87 49%
FIATY 13.44% 70 39%
$ Cash 9.60% 50 28%
AIG 8.64% 45 25%
SHLD 8.06% 42 24%
ALS.TO 7.10% 37 21%
GNMCA 5.76% 30 17%
BRK.B 4.99% 26 15%
IBM 4.41% 23 13%
GM 4.22% 22 12%
C 3.84% 20 11%
LUKOY 3.65% 19 11%
INLOT.AT 3.26% 17 10%
LRE.L 3.26% 17 10%
WFC 3.07% 16 9%
Ross,
Thanks for setting this up and sharing with all of us. A great idea and I really like your approach to weighting the portfolio as well.
Did you consider equal weighting for say the top 10 stocks with no cash allocation. I would think this might more clearly reflect the board's ability to pick stock vs S&P 500. This could be a separate portfolio.
The current method combines a bit of board ability to market time (due to cash) and also introduces some noise around the stock weights.
Vinod
-
"if all you have is a hammer everything looks like a nail"
I agree with Kraven, investing isn't like flying or surgery. Every company is different, do you think the same way about investing in a bank as you do an industrial manufacturer? Do you have checklists for each industry?
A checklist is great for a process or procedure that's repeatable every single time. I have used checklists extensively with things I've done professionally because the process needs to be the exact same. Checklists work, but with investing items vary each time, they're not the same.
I can see the value in a very high level macro list, but the detailed stuff seems crazy. I've seen checklists with things like "Does the CEO have a good track record of acquisition integration?" For anyone who's been a part of a merger you know that no two acquisitions are the same. Most acquisition success is related to the personalities of the people involved, not how strong willed the CEO is. I've been at companies where one acquisition worked extremely well, and one a year later failed, not due to products or the market, but all personalities involved.
Pardon me while I digress... I wonder aloud if there is a lot of thrashing in the investment world because of the personality types who are drawn to investing? This isn't an attack on anyone in this thread, but this thread has me thinking. I see a lot of people talking about maintaining massive spreadsheet watch lists, or huge checklists, or reading piles of 10-Ks so they're "prepared" for an investment. The impression I've had is that most investors are detail oriented structure type personalities. When I think about those two things it makes perfect sense. Many investors are the same people who make detailed packing lists before they go on vacation, or plan and structure their vacation down to the hour.
I am not a detail oriented person, I'm far from it, I'm big picture at best. I'm detail oriented about things I care about. If I'm researching a company I will suddenly care about the details, but I can't keep a watch list for the life of me. I like to think about the marginal return from more research. The marginal return from looking at the financial statements vs not looking at them is huge. The marginal return from reading the notes vs not reading them is smaller, but still sizable. The marginal return from reading the notes from an annual report 12 years ago is almost zero.
I'd take this level of thinking even further, if I were to look back in time I'd say the return from reading the BAC thread on this board far exceeded reading their entire 10-K. Yet many investors read the thread, then read every shred of paper out there on BAC. I don't think the additional information helped them make a better investment, but it made them feel better about it.
I think there's a sweet spot in researching, and it's finding enough information to make a great decision, but not drowning yourself in information to feel better about a stock. If the numbers are ok, and the company is ok it's not necessary to feel good about an investment. The investment itself isn't the problem, it's the emotional temperament of the investor that's the problem. I think some people assuage their doubt about an investment by over-researching the investment. Over-research can be dangerous because it can lead to someone loving a stock instead of being dispassionate about it.
The truth is that no matter how much we research and how much we know none of it makes a difference in the outcome. If I invest in a great company and spend a year researching, then the CEO has an affair with a staffer and half the execs leave I have no control or way of knowing that, or even changing it. There is so much unknown and unknowable unless one goes Philip Fisher and starts to interview employees and learn about the culture. My sense from this board is that no one does that.
To pull this full circle I think it's important to know yourself and know your flaws. If your flaw is that you continually miss the same information when you invest then maybe a checklist is important. But it's not the end-all be-all.
I'm fully aware that I've probably killed this thread, or will be ignored, but I've said my peace and now I'm content....carry on!
Fantastic post oddballstocks.
I only wish you have written this a few years back. I had come to pretty much similar conclusion but not before wasting some effort.
Thanks
Vinod
-
If we assume Chinese economy grows only 6% a year in the next decade, and the ratio of total market cap over GDP doubles from where it is now, we should expect more than 17% a year from Chinese market from today’s level.
Not quite. Growth is funded by investment and that is invariably done by issuing more stock. So while earnings would grow in line with GDP and stock market would grow in line with earnings, that does not translate into a corresponding per share growth in earnings which is what really matters to the investor.
Vinod
-
In December 2007 there was one massive defined risk to the economy and stock market: the popping of the housing induced credit bubble and its associated ripples effects.
You just listed off 10 risks that could likely be listed off every 1 out of 2 years going back to 1900. How do you act upon that list?
Could it be hindsight bias? There are risks every year, but in some years it is more pronounced than others. 2005, 2006, 2007 happened to be such years but it only materialized in 2007.
If things have played out only slightly differently (Govt stepping in for Lehman and possibly some arm twisting to get AIG CDS counter parties to back off, etc) we might have had an economic impact similar to 2000 tech bubble burst.
In hindsight it is easy to think that the financial crisis of 2008-2009 has a clear cut sign from the housing bubble. I do not think that is really the case.
Personally I was worried about housing bubble and high stock market values due to high profit margins which I thought were a near certanity to mean revert. I was very defensive but it worked out for all the wrong reasons. I had no clue about all the leverage and the risks that turned up are not remotely close to what I was worried about - except for the housing bubble.
The lesson I took from it is that when valuations are rich, bad things happen in ways we cannot anticipate and it is better to ensure that we live to fight another day i.e. no deep losses of 50% magnitude.
Vinod
-
Looking another way, how much is HWIC really being constrained if
1. They are able to invest in CDS
2. They are able to invest in deflation swaps (or whatever they are called)
3. Or in any number of distressed investments they are able to make
The primary constraints are really
1. Taking whole companies private and being able to count it towards statutory assets
2. Percentage of the shareholders equity being allocated to stocks. They have reached 80%, so the additional 20% is really the biggest drag that I see.
Vinod
-
See, I am naturally lazy. I prefer to take on non-recourse leverage (at a high "combined ratio") when selective opportunities arise. I can put all of that into equities. The prospective gains at such times far exceed the high leverage cost. And it's non-recourse. It costs more, but it's all in equities at times when they are heavily discounted (you get to choose when you have the leverage, and when you don't).
Now, if I instead switched to insurance float (as if I could just hit a switch), I would be taking on liabilities hanging over my head for years. And this float would be low cost (maybe), but I could only invest it in low-yielding bonds (they pay how much right now?).
I can't get 3x leverage (as with float), but I don't need 3x leverage. I can put a higher percentage (all of it) into very high "Beta" stocks, so even if I don't use leverage I still might cream the results of an insurance company. And then during a crash I can sprinkle a few calls in there for leverage (my high-cost float). The float costs more, but equities when heavily depressed offer a lot of return in reward.
So I sit around thinking of this stuff a lot. I'm pretty sure they held Kraft and Johnson and Johnson not because it was the best value out there at the time, but rather because they probably have to manage the investment mix to some degree keeping in mind that they have all this insurance liability.
So... these are things that spin in my head. Apparently just me?
The way I see it, Fairfax model has been to invest Float in Bonds to fund expected liabilities. It was costing 3% but they had generated close to 10% on these bonds.
Equity which is available to fund any unexpected liabilities is being invested anywhere from 45%-80% in stocks and they are able to generate 17% on the invested amount. The 17% return on stocks might be less than what HWIC is able to achieve if they are completely unconstrained in their stock allocation as you mentioned.
However, since they are able to generate above 22% returns on total equity a while back, insurance operations providing float have on the whole added to the return since their returns on stock have provided only 17% returns. Would they have been able to add 5% annually if they are completely unconstrained? I am not so sure. JNJ and Kraft might not be the cheapest at that time but in an alternate scenario where we ended up in Great Depression II or something similar, others might not have survived. Given Watsa's bearishness, I suspect even in an unconstrained stock portfolio JNJ & Kraft would have had a place.
With bond yields where they are now, I suspect insurance operations are likely going to be a drag going forward and we would likely see the scenario you suggested being played out.
Vinod
The perils of timing the market
in General Discussion
Posted
I had been in 60% or more in cash since early 2012 (reminds me of stones and glass houses...), though my stock exposure is around 80-110% due to LEAPS. So I am very much on the fence.
Vinod