vinod1

Eric, What broker do you use for this account? I am planning to do the same and trying to minimize the transaction costs. Thanks Vinod

The basic principle I am adhering to is that I want to own more of a particular security at a greater discount to IV than at a lower discount to IV. For example, I would want to have a 10% position when it is trading at 50% to IV and maybe a 8% position when it is trading at 70% of IV. I categorize my investments into specific types such as exceptional business (due to either a great business moat, great jockey, etc), net-nets, discount to break-up/liquidation value, arbitrage, discount to debt debt capacity, etc. The principle above is what I would apply to securities that fall under exceptional business like Berkshire. I intend to hold them forever but plan to take advantage of market fluctuations by increasing/decreasing allocation in inverse proportion to market movements (or more accurately price to IV). I would never short as it is very risky - market can remain irrational longer than I can stay solvent. I do not disagree with you at all that regarding taking action based on our expectations of Market. That is what I was asking Viking. I reduced a little bit based on above, not because I am expecting Market to go down. It seems to me that market might go down, but I do not want to take any action based on that expectation. Vinod

This is not one of his better letters. You should read "The blackstone peak and the turning of the worm" and his other letters right at the peak of both 1999 and 2007 mania's. His methodology is pretty robust and for me he ranks right up with Buffett. The main underlying principle in his method is Mean Reversion which does not seem to be inconsistent with Graham. Vinod

It would be good to have another perspective on investing. Books by William Bernstein The Intelligent Asset Allocator and Four Pillars of Investing give a pretty compelling case for indexing. It would at the very least allow to properly evaluate one's performance by comparing to a more realistic benchmark instead of S&P 500 which I find is inappropriate for many value investors. Vinod

Nice list. One method I found useful, is by reading an Audit and Accounting guide for the industry if there is one. Vinod

They are not the same! When you buy at a discount to IV, you have a margin of safety. You would do fine selling it a lower discount to IV. Say you buy at 50% discount to IV, you can choose to sell it when it is only at a 30% discount to IV and still do fine, but would not do as well as when you sell it close to IV. When you buy at a premium to IV, there is no margin of safety. You are just hoping for a greater fool to show up. Vinod

Viking, There is indeed a strong case for tailoring the approach for our own individual psychological makeup. Especially when it is working so spectacularly! I make much smaller adjustments, basically increasing decreasing individual stock allocations by a maximum of about 30-40%. Increasing allocation when discount to IV is high and vice versa. Vinod

Viking & Smazz, Are you not basically betting very heavily that the market would give you a big opportunity again? What if market does not give you an opportunity to re-enter at a good price? Why would you forgo an attractive opportunity at a high confidence level, which is what would be possible with a strict bottom up value investing to a low confidence level macro bet that a very very attractive opportunity would be made available? Would it be fair to say you are making a macro market direction call? Just trying to reconcile what has been repeatedly drilled by Graham/Buffett, et all to ignore macro and stick to bottom up with what you are proposing. Just as a thought experiment, if we imagine that the stock market has played out a little differently since the market top in 2007. Say that from the time S&P 500 topped at 1565 in 2007, it had dropped only during the last few months to where it is now (900 odd), without the intermediate dive down to 676 and back to 900. Would you be investing now because of the 40% drop (without the mind being polluted by recent memory of 676)? If so, is this not a case of "Using the Market to inform you"? I ask this not to argue but because every fibre in my body says, the market is going down, down, down and to sell so that I can invest at a lower price and I am resisting this temptation due to belief in Buffett/Graham, value investing philosophy and need for discipline. Thanks Vinod

Sold some but only because discount to IV is much lower now. If I wanted to hold $xxx amount of something at 40% of IV, I would want to hold a little less at 60% of IV. That said, I also want to free up some cash cushion to take advantage of any "shooting dead fish in a very shallow barrel with water drained" kind of opportunities that may come up. Portfolio at an allocation such that I would be happy to see either a 50% up or 50% down move. Vinod

https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIBkzeMN6maT8U1%2fTdfZFUgg1mR%2b%2f01QLADkc%2bteJzsR%2bVfcC%2fSC%2btuA%2fvERm%2f47EsGV8Aeo3YQwhCgYpJJIz2rK%2fXue%2bib4lzo%3d Good letter but he loses me when he talks about presendential cycle. Vinod

scorpioncapital - Thank you.

scorpioncapital, I see that you follow LUK. If possible, could you please share your thoughts on LUK’s IV? The way I see valuing LUK is via summing the IV of the individual investments. Mining companies are no where near my circle of competence, so I took a short cut in terms of estimating IV of individual investments at 1.5X-2X of the price paid by LUK for mining interests and using Book Value/Earnings multiple for others. Taking YE 2008 BV of $11 per share and adjusting in this manner I get IV in the $30-35 range. Any thoughts on valuing Fortescue Equity and royalty note would be most welcome. Thanks Vinod

Hard/Soft insurance markets have always been discussed in terms of the supply side i.e. funds available to the insurance companies. I have never seen a discussion in terms of the demand side. How does the demand for insurance vary with economic cycle? Is it fairly immune to economic cycle or would it be possible to have a sharp drop in demand in a depression type scenario? In this case would we not have a soft market if we assume that the supply remains constant or falls lower than the demand side? Thanks Vinod

Thanks for the writeup Mungerville. Hard/Soft insurance markets have always been discussed in terms of the supply side i.e. funds available to the insurance companies. I have never seen a discussion in terms of the demand side. How does the demand for insurance vary with economic cycle? Is it fairly immune to economic cycle or would it be possible to have a sharp drop in demand in a depression type scenario? In this case would we not have a soft market if we assume that the supply remains constant or falls lower than the demand side? Thanks Vinod

One of my favorite investment books is Triumph of the Optimists: 101 Years of Global Investment Returns. The authors did a truly outstanding study of returns from 16 countries for the years 1900-2001 and it gives a lot of food for thought. The data shows, for example, that economic growth rate is weakly negatively correlated with stock market returns. The faster the economic growth, the poorer the stock market returns. This is pretty much supports what Benhacker says above. The best predictor for stock market returns is the starting dividend yield - in other words, valuation. This admittedly crude measure of valuation is in fact the best predictor of the measures studied. An academic paper that deals with this exclusively is Jay Ritter's "Economic Growth and Equity Returns" for anyone interested in this. Vinod

I cannot recollect who said this, but using DCF is like looking through the telescope. If you move it a tiny bit, you are in a different galaxy. Changing the growth or discount rates a tiny bit can alter the values dramatically. It is best used in a negative sort of way, to try to figure out what growth rates and discount rates are being factored into current prices. Vinod

After reading the debates of several economists on various topics the conclusion I reached a few years back is this: For every economist there is an equal and opposite economist. Each is equally convinced that all the facts support only his position and does not give the least bit of credence to the other view. What this tells me is that economics as a profession is not yet mature enough and progressed far enough at this point to offer unambiguous guidance. Vinod

I have invested in the 3.6% real and 3.0% real series of I-Bonds, currently yielding in the 8-9% range. I consider them to be the gold-standard in terms of the lowest risk investment that is possible. This is a protection aganist "Risk's that I dont know that I dont know" or "Black Swans" or "Hedge" or just plan something really bad happening. I had this allocation right from the day I started investing and plan to have in future regardless of current economic events. Vinod

The simplest and most direct inflation hedge for a USD investor in a tax-deferred account would be on the run TIPS or off the run TIPS close to par (below par would be even better in a deflationary environment). For a taxable investor, I-Bonds would do the same, but not at the current rate. You would only be getting a real return of 2-3%, but as long as you are looking for a hedge, I cannot think of a better one that gives the same level of certainity (as long as you believe the CPU measurement is not being fudged). Vinod

Capitulation occurs when people start calling for death penality for Greenspan. For Ben I would just settle for cutting his beard off. ;D Vinod

Omagh - Thanks! Nodnub - I wonder if this is FFH's attempt at going green :) oec2000 - Can we read other documents besides books on Kindle? If I can read annual reports, I am going to buy one. Vinod

Anyone know why printing the AR is not being allowed from Adobe?

Mungerville, Fed model has been pretty discredited. Asness paper "Fight the fed model" (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=381480) does a pretty good job of systematically taking out its rationale. Are you sure Grantham has said that? I would be surprised if he said that. The rationale is that stocks are a claim on real assets so the earnings yield on stocks gives you the real yield vs nominal yield provided by bonds. This point is disagreed by Buffett who pointed out that despite the level of inflation the ROE of firms has consistently been in the 12% range. If inflation is purely pass through, then ROE should jump when inflation increases, yet we have not seen this in the 70s. Thanks Vinod

IMHO, it is possible to come up with a rough idea of fair value for a broad stock market. Starting with the assumption that economy is going to survive and would continue to grow at more or less as in the 20th century, we can get a rough idea of the IV of the stock market. Earnings are cyclical, they go up and down quite a bit year to year but in the long term it tends to go up at roughly the nominal growth rate of the economy. In an open free market capitalist economy, various economic, social and political forces would ensure this. Total earnings of all the companies fluctuate within a narrow range as a percentage of the economy. Smoothing out the earnings, by whatever mechanism (Shiller 10 yr avg, etc), you can find the normal sustainable earnings power. The way I define "fair value" for the stock market as a whole or a proxy like S&P 500 is the value at which the expected return over the very long term approximates the historial stock market real return of 6.5%. My calculated normal earnings power for S&P 500 is $65 in 2008. An earnings yield of 7% has historically delivered a return of 6.5% due to leakage - transaction costs, etc. This gives a fair value of somewhere in the 900-950 region for S&P 500. This tells nothing of what is going to happen in the near term but it gives a pretty good idea of your expected returns over the long term. Vinod

It looks like the letter would be out after market close this Friday. I think last year it was around 5:00 PM. Vinod