ni-co

I really recommend Michael Pettis on this subject. His writings were a real eye-opener to me especially with regard to moral, work ethics and how much they have to do with a country's economic development. A good example for debunking those work ethic myths his this piece of his: http://carnegieendowment.org/2013/05/21/excess-german-savings-not-thrift-caused-european-crisis I can't recommend enough his excellent book on the Chinese economy where he discusses at length the arguments you've just made.

I know that this sounds tin-foil-hatty. But there are quite a few great macro managers out there who expect exactly what I'm referring to, including Ray Dalio, Stanley Druckenmiller, Paul Singer, Kyle Bass and Crispin Odey or straight value guys like Seth Klarman. If you're willing to listen they all tell you different aspects of the same story. It's difficult to replicate Bridgewater but that doesn't mean the best thing might to be to ignore it. Another piece of the puzzle is China. Read Michael Pettis' book on China and you're going to realize that what they did is simply postpone the impacts of the financial crisis with massive credit expansion. Since 2008 they've intentionally produced a huge investment boom to counterbalance the foreign lack of demand, thereby crating huge imbalances in their economy. Now, guess what, they have their own real estate bubble and credit crisis and their domestic demand is vanishing rapidly. That's why the prices of most commodity of which China has consumed close to 50% have been falling like rocks. There is no "other China" to rescue them this time. Nearly the whole world is on zero interest rates. How on earth do you want to stimulate the world economy in this kind of environment?

It's a true business worry. Just to be clear, until last year I considered myself a long only concentrated value investor, interested in special situations. So I'm relatively new to the classic global macro bear argument but Ray Dalio made me think about it a lot. I agree that there is a difference between recession proof and prospering in a long term low growth environment with credit contraction. I like to own things people have to buy and therefore generate very predictable cash flows. Therefore I own LBTYA and DVA for example but I mostly hedged it against market risk for the time being. I also own Prem Watsa's India SPAC since I think India could be one of the bright spots in the next decade or two. I don't know that a deleveraging will happen, it's already happening. With regard to equity price declines I regard them as the logical conclusion. I don't know it for certain but I think it's highly probable and I won't lose money if it doesn't happen.

I think with his question Dalio is implying that Ackman is not diversified enough – and I completely agree. He doesn't mean that Ackman only holds positions in 10 different businesses – he's talking about independent revenue streams. Ackman could reduce his equity positions to 5 very good businesses and would still be reasonably diversified within equities. The problem is that in a hostile global economic environment this is essentially one single equity position. Ackman doesn't even realize that he's implicitly relying on an environment in which credit is expanding, the economy is healthy and companies are making nice profits. In such an environment you only need one really good business. Now, in 2008, you could see for a few months what it meant being 100% invested in equities. But you've only had to survive a few months and markets recovered because the FED kept the economy from collapsing. How would such a portfolio have performed if that 2008 environment had continued for 15 years? Most people think we "survived" 2008 because markets have been going up since 2009. But we haven't. The deleveraging process has only started and the FED counterbalanced its impacts with exceptionally monetary measures. This was certainly good but now it ran out of ammo. You're talking about Standard Oil as if Ackman had a portfolio composed of monopolies – which would be allowed to produce healthy profits going forward. In the 1930s, however, almost all businesses – good and bad ones (!) – got crushed. It was a complete redistribution of wealth from the haves to the have-nots. This is what's happening in a deleveraging. What I'm saying is that Dalio will have protected his capital in a Depression environment while Ackman most certainly won't because he isn't diversified enough. He doesn't think about currencies, commodities, gold and credit because for the last 80 years it didn't matter. What Dalio's saying is: Watch out, it's going to matter much more in coming years than it did in the past 80. I think not being aware of this is simply naive. Seth Klarman and Prem Watsa, for example, have realized this but Ackman hasn't.

I think cash is becoming much more valuable. You have to be more active in a classical value investor way but maybe throughout all asset classes. Dalio is predicting lower returns across all asset classes for the coming decades, though. Btw: I forgot to include dividends though, yadda rightly called my out on that in the other thread. ;)

Yes, you are right. I overlooked that. You'd have to subtract tax, though. This doesn't take away from my main point, though: People don't have large enough time horizons. We've had credit expansion since the 1930s and it's completely underestimated how much this has been adding to stock market returns. We will now have credit contraction for "a few" decades and this will subtract significantly from equity price returns – or asset price returns in general. Cash will become much more valuable when inflation isn't normal anymore.

Well, that's the case with anyone who is a value investor, isn't it? One of the core principles of value investing is to focus on micro factors and ignore macro factors. Given the extreme difficulty of predicting the macro economy, this is one of the strengths of the strategy IMO. Yep. But look at it this way: When you have zero inflation cash is inexpensive. I certainly don't agree with your worst case scenario. Take a look at this long term "S&P 500" chart in real prices: http://www.multpl.com/s-p-500-price/ from 1912 until 1954 your real return was zero. That's 42 years. No wonder people were giving up on equities. Same thing from 1929 until 1959 (30 years) or even 1983 (54 years; also interesting to think about the point in time when Buffett started his partnership). When you look at real prices there are very, very long stretches in history where you would have made zero return if you were fully invested at all times. Therefore, to me Buffett's success story doesn't mean that it always has to be this way. He's talking about how lucky he was to be born at the right place and in the right time. I think this is more than false modesty. Don't get me wrong. I think he is a genius – his success certainly isn't pure luck. But the time period in markets he's lived through has very much to do with it.

Yeah, thanks! Gundlach pointed at this index, too. When you have zero inflation cash is inexpensive. I certainly don't agree with your worst case scenario. Take a look at this long term "S&P 500" chart in real prices: http://www.multpl.com/s-p-500-price/ from 1912 until 1954 your real return was zero. That's 42 years. No wonder people were giving up on equities. Same thing from 1929 until 1959 (30 years) or even 1983 (54 years; also interesting to think about the point in time when Buffett started his partnership). When you look at real prices there are very, very long stretches in history where you would have made zero return if you were fully invested at all times. Here, I completely agree. Take a look at this: http://www.mckinsey.com/insights/economic_studies/debt_and_not_much_deleveraging

Dalio is so right in asking him this question. Ackman doesn't even think about the fact that nearly all his bets would be off if we were to enter a second Great Depression.

http://www.washingtonpost.com/blogs/wonkblog/wp/2015/02/13/inflation-is-dead-its-below-1-percent-in-the-u-s-u-k-europe-china-and-japan/ There's an argument to be made that we are still in the 2009 financial crisis, because deleveraging is still going on. What we're seeing in the commodity markets is what we should have seen in 2009: China slowing down. But last time China prevented it by inducing a domestic investment spree like there had never been one before. I think we are only beginning to realize that this time we will have a second Great Depression, because neither the US nor China won't be able to step in. There simply are no countries left that have enough monetary firepower to prevent a breakdown of the global economy. What makes me doubt my reason and my mind is that nobody (i.e. equity markets around the world) seems to care about it. Markets are acting as if it were a minor inconvenience. This is exactly what Ray Dalio has been talking about when being asked what kept him up at night.

I spent quite a lot of time with reading Michael Pettis' excellent books and blog on that subject. This clearly has to end – it's already ending. Commodity rich countries will have a very hard time after they will have been through their monetary firepower.

Australia is easing, too. We're slowly coming to the point where the whole world has zero interest rates and QE, and then it has to lose its effectiveness.

I think most people - or at least most active managers - say what you have said. However, there are two issues with your thoughts. First, there is no guarantee that active managers will outperform in the bear market. In fact a lot of them got caught in the financial positions in 2007 and got creamed on the downside compared to SP500. Second, even if they will outperform in the bear, there is no guarantee that they will outperform for the whole cycle if they are underperforming now. I think that people should be careful when repeating the "SP500 is overowned" mantra. If someone exited SP500 in 2013 or 2014 based on this "insight", they'd already have one/two years of underperformance. The critical question is: have they lost money by underperforming? Permanent loss of capital is what I'm most concerned with at this moment. There is no free lunch. But it's a logical certainty that you can't outperform the market when you don't dare to divert from it. Make it "equities and bonds" are overowned.

You can instead take the approach of Buffett. The vast majority of the businesses that Buffett bought, are resilient to all three items you mentioned above. A CEO having an affair or worse do not impact the valuation of most of the businesses in Buffett's portfolio. I do not think Buffett knows the in's and out's of Wells Fargo's or Bank of America's each operation in depth at the division level, and I do not think such knowledge is needed or necessary to invest successfully. Look at his definition of understanding a business and it tells a lot about what he focuses on: "It's a question of being able to identify businesses that you understand and you are very certain about. When I say understand–my definition of understand is that you have to have a pretty good idea of where it's going to be in ten years. I just can't get that conviction with a lot of businesses, whereas I can get them with relatively few. But I only need a few–six or eight, or something like that." or look at his definition of risk "We think first in terms of business risk. Business risk can arise in various ways. It can arise from the capital structure. When somebody sticks a ton of debt into a business, if there's a hiccup in the business, then the lenders foreclose. It can come about by their nature –there are just certain businesses that are very risky. We tend to go into businesses that are inherently low risk and are capitalized in a way that that low risk of the business is transformed into a low risk for the enterprise. The risk beyond that is that even though you identify such businesses, you pay too much for them. That risk is usually a risk of time rather than principal, unless you get into a really extravagant situation. Then the risk becomes the risk of you yourself –whether you can retain your belief in the real fundamentals of the business and not get too concerned about the stock market." I think it is better for us also to focus on such businesses where we are less exposed to risks you mentioned. Sorry for tossing Buffett quotes, you probably know most of these by heart, but they covey the message better. Vinod I actually didn't know these ones. The concept of being able to visualize where a business will be in ten years is very valuable, even if you have no intention of holding it ten years. Would have saved me from botch ups like Yellow pages, sfk, and RIMM. This seems really important in this era of creative destruction. Agree completely. This is probably one of the best filters to avoid "value traps". Vinod I agree. Buffett's saying "understanding the business" is often misunderstood and confused with "understanding every aspect of a company". I don't think that he's talking about that. What he means is that you have to take an entrepreneurial point of view: How ist this business earning its money? What are the key aspects/drivers for it? Can you foresee their development with reasonable clarity over the next 5, 10, 20 years? With regard to the "unknown unknowns": I discovered last year that I have been thinking far too little about global macro.

+1 – I agree 100%. Greenblatt makes the same point in his not so popular book "The Big Secret for the Small Investor". To beat the market you have to do something different from the market and this necessarily means that you're going to "underperform" from time to time. I think the S&P 500 is overowned. This will show as soon as the next bear market sets in. Indexing is all the rage right now. The fact that the S&P 500 – or all US equity indexes for that matter – have been so hard to beat for the last 6 years makes it all the more probable that you will outperform them for the next few years if you're willing to do things differently. This even means thinking about how much net exposure to equities you want to have (personally I want to own close to zero market risk momentarily). There is a very good interview with Kyle Bass which I already linked to in another thread. He is talking about this very point. He thinks that Calpers' decision to exit all hedge funds because, cumulatively, they haven't provided an after cost benefit compared to equity/bond funds, will mark the height (towards the end in the last 5 minutes). You can certainly say that he's talking his own book, there, but I think he is going to be proven right.

Nice interview with Kyle Bass: https://realvisiontv.com/teaser/118191235

Another interesting aspect of this discussion is that the hunt for yield is keeping your stock price high if you are perceived as a sustainable dividend payer by the market. You can see this effect by looking at the big oil companies that are very expensive compared to the oil price levels right now. It's as if the oil price rebound is already priced in. I don't believe that big oil investors have suddenly become value guys with 10 year time horizons like WEB or Jeremy Grantham, but it's the dividend yield that keeps the big oil stocks high.

I think the big picture here is that the zero interest rate environment makes it very appealing to companies to borrow money at very little cost and buy back their own shares. This is rational behavior because they perceive their own ROI as higher than the interest rate they pay on the debt they use to make the buybacks. Implicitly or explicitly, they are making a few assumptions, though, like cash flows remaining stable or interest rates remaining low. Stock buybacks increase their EPS, thereby making earnings appear to grow. You seem to observe solid earnings growth and increasing profitability – all wonderfully rectifying the high valuations. What you are not seeing by focusing on earnings growth per share is that this growth isn't based on an improving business climate but bought by deteriorating balance sheets (raising debt/equity ratios). IBM is the poster child for this behavior like Stanley Druckenmiller keeps repeating. It's quite obvious that this cannot go on forever. Companies are only able to lever up so much. At this very moment, they are extremely vulnerable to rising interest rates and/or an economic slowdown. Equities as a category are priced to perfection and levered up to the hilt right now. This is becoming an increasingly dangerous situation. Coming back to the article: the title is complete nonsense. Share buybacks are the result of ZIRP and lacking investment (capex) opportunities for the companies because demand is still lacking. I don't think that this can be resolved by deregulation like Druckenmiller seems to think. This will go on for quite some time because we are in the midst of a huge deleveraging process. This means demand from consumers is going to stay low for years to come and companies have only been buying time by levering up to justify their valuations.

As a general phenomenon I don't like companies levering up and doing buybacks when it actually worsens their capital structure (as is mostly the case). It's a bad sign for the economy as a whole that companies aren't willing to invest into capex and that the perceived IRRs on buybacks exceed the ones of additional investments into a company's business. If a company actually has too much cash on its balance sheet and no use for it, buybacks will always be preferable to dividends because of taxation. Even with overvalued stocks you as a shareholder can balance unreasonable buybacks by selling the equivalent amount of shares (but then why are you holding overvalued shares in the first place?).

Most probable is that it's going to force down US production. This should mean either higher unemployment or higher debt in the mid term.

Because it's all about the game.

Here is a link to BB's latest call: http://www.valuewalk.com/2015/02/bruce-berkowitz-sears-lifetime-opportunity/

Thanks for pointing out Pettis' book. I've only read the first two chapters but, so far, it's really great – by far the clearest view and best take on the Chinese economy I've seen.

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 I'd be careful with the conclusion of rising asset prices in the euro zone. I concede that there still is some room left but most of QE has already been anticipated. German 10y yields are below Japan's and QE hasn't really started, yet.

I don't know whether buying banks back in 2008 was smart or a crap shoot. In hindsight it appears to be smart. Yet, could you see the FED stepping in like they did at the time? Risk means more things can happen than will happen.