Packer16

That makes more sense. Thx. Packer

I agree we may slow down but you need to look at history to see how markets have delevered. If we look at Post WWII, you see a debasing of currencies in either a sudden (Germany, Japan) or a slow fashion (US, UK). Depending on the magnitude of debasement, the market may decline or increase in nominal dollars but definately will decline in real purchasing power. The question is what is the best investment in these environments (stocks, bonds, cash, real estate or resources)? Another period to look at is 1931-34. During this time, debt was in essence monitized by going off the gold standard. In every case, you had big stock market and commodity rallies. I think real estate, resources and stocks should be preferred over bonds and cash. Leveraging real estate, resources and stock with modest low nominal IR debt may be the best strategy. The one note with resources is you need to be careful of the LT obsolesense issues (coal to NG as an example). Just my 2 cents. Packer

Is that data from a skewed population or include things like SS and Medicare because it is hard to believe the average 55 to 73 year old has a $1 million net worth. Packer

Thanks always a good read. However, this guy reminds me of the guy who used to write the Growth Stock Outlook. He was a good stock picker but ended up laging the market in 1980s ands 1990s in large part because of his large allocation to cash. I wonder if F. Martin will end up in the same camp? Packer

Japan is an interesting case study on the end of deflation and the monetization of debt. If you look at what happens when a central bank prints money to reduce the debt you see that the yen has collapsed but the Nikkei has rallied even more since the BoJ's plans have become more defined. If this happens to the US and other developed countries then FFH will lose on both ends as the stock hedges will lose money as well as the deflation hedges. Seeing this makes me even more wary of being all-in on the hedges. Packer

The hoarding thesis is interesting but how is it going to create more than a temporary spike in prices? Once prices rise won't supply follow in the next season or reproducion cycle? Packer

The third scenario is devaluation of all currencies not tied to real assets or productivity. I see the US dollar continuing to decline versus the Euro until Germany allows the prining press to run. Japan has gotten to that point today. This is the least painful way to reduce the real value of the debt. In this scenario, real assets (stocks, commodities) retain their value while debt and currencies decline in value. I see the FFH scenario playing out in Europe and Japan but not the US and maybe not Japan if they follow the US in printing their way out. You are correct if the FED stops printing the economy and markets would be in trouble but I do not see that happening over the near or mid-term. The main issue I have with the holding cash argument is the currency is going to decline faster than real assets in the economy (not a very common occurance and thus not considered). Packer

You may have inflation in silicon valley but it is no that widespread. The type of inflation that would start action is the widespread type seen in the 1970's around the country. Packer

I think they have stated they will do it until unemployment is very low (a very long time or never). The only other factor would be inflation. I do not see inflation until wages are increasing more. Every company is running lean and mean (producing the same or more output with fewer workers) so unemployment does not come down. I think Bernanke's comment on holding the securities until maturity gives you a clue on how long the QE will last. Packer

I think that depends on where you think FFH is adding the most value today and into the future (underwriting or investing). I think FFH's strength is investing with underwriting providing more of a supporting role. In addition, it is also much harder to get better underwriting than investment results. Therefore, I think they should scale back the hedges or have a scenario when that occurs if the impending decline does not materialize. Packer

What the FED is doing is financial repression (holding interest rates below inflation). It did it after WWII to monitize the debt and its doing the same now. This is a way to deal with high debt levels (both personal and gov't) and let them be manageable. It will continue until the total debt is down to more comfortable levels. It took 30 to 40 years after WWII to whittle down that level of debt so I expect it to last into the decades time frame. Given this look at the asset classes that did the best under that scenario (1940s/50s/60s and 70s) (commodities and stocks). Bonds got killed and holding shot-term paper made you no or a loss after taxes. If you can find inexpensive stocks that is the way to go. Also purchasing firms who have locked in low rates over long periods of time is also something to look for. A guess I feel bad for savers but I think today's savers save in asset classes beyond fixed income and CDs. Most of the folks I know who have saved and are in or close to retirement have other asset classes to obtain higher returns. Just like stocks over time making a safe return has gotten more difficult as there has been more competition for these safe returns. The main reason I look at the 1800s and early 1900s data is that was the first period of globalization (before half the world decided to turn communist). As to the risk free rate and comparisons that time are not as applicable as the currency was backed by gold however the trends are instructive. There is a book called The Great Wave that documents price and interest rate history going back to the 1600s. The gold standard may be different but the other behavioral aspect of market remain the same. It is a good read if you want to know what has happened in the past. Packer

As Keynes said: The grand experiment has begun. On one side you have the US and recently Japan with QE and on the other you have the EU. I agree that QE is not good long term but I think the CB has no choice. If we had gone the way of the EU, we would be in a depression-deflation spiral Irving Fisher and Prem spoke of. So far the US and Japan are in better shape than the EU. Packer

I think there is a third scenario that has not been factored into FFH's position, namely, that the Fed monitizes the debt versus real assets (the Fed's goal). To a certain extent this has already occurred but may continue. I see what is being done is similar to the UK leaving the gold standard and FFH's scenario is more likely to be seen in Europe where the firms are tied to the Euro standard. Under this scenario, equities would provide be preferred because they are the real asset as the US dollar devalues and both of FFH's positions would be losers (no deflation and appreciate of equities in nominal dollars - if the hedge were in real dollars then this would not be an issue). While the probabilities of each of the scenarios can be debated, I wonder if FFH has even considered scenario 3, as the don't mention it in their annual report. As to capital earning an adequate return I would agree with you if we had an open and free market like in the US and Europe but we do not. What do you think is going to happen when the Chinese are allowed to invest in foreign markets? A huge sucking sound out of China to the US. This is already happening in emerging markets where folks can move their capital out. The solution to this from an economic perspective is to have these markets be efficient allocators of capital but I think we are going to wait a long time for that. Just my 2c. Packer

I disagree with Schiller's approach which is based upon reversion to the mean in interest rates. I don't think this will happen as long as there is excess capital in the emerging markets and poor governance which will attract capital to the US. In the past interest rates were high due to lower debt and lack of productive capacity from the communist world who still had to eat and live and consume resources. This lower cost of capital along will keep interest rates low and we are just are in the early innings of the credit cycle (as Marks has stated) which will drive valuations up. I think FFH should consider this scenario along with their own in the hedging program. Also betting against the market as a long-term approach (which this has turned into) I think is not a winning strategy. Packer

At what point does this hedge become forecasting and market timing? If the reflation scenario plays out this could be an unnecessary drag on performance. Lets compare to 2008. I estimate that the hedges have probably lost at least another $600 million from year end (given the $1 billion decline with a 15% increase in S&P value) so the total is now $2.4 billion cum losses on an equity of $7.8 billion (about 35% of equity). At the end of 2006, the hedge losses represented 20% of equity. The other large difference is the 2008 hedges were 60% against equity and 40% against CDS (a truly overvalued asset), so the losses in bonds via CDS somewhat masked the lower yielding equity hedges. Now the mix is 80% equity hedge, 20% CPI hedge. This is bold bet or a high premium to pay that the market will decline given the % of equity it represents. In addition, you have Marks saying we are in the 5th inning of credit expansion so continued expansion (and increase in the indexes) could drag FFH down. Does anyone know under what circumstances FFH would change its hedges? At some point it may be prudent to "trim" the hedges. I also wonder if the near perfect timing of the hedges last time may be clouding FFH's judgement. From the evidence I have seen thusfar in the US and the RoW reflation versus deflation is occurring. They appear to be putting alot of their eggs in the deflation basket with both the deflation swap and equity hedges. I would agree for the EU but not the US and the RoW. Under what other scenario (beyond deflation and speculative pricing) do the equity hedges make sense? I think it would make more sense for the hedges that they think are overvalued (maybe Chinese RE) versus the overall market. Maybe I am over-reacting but FFH is passing up the equity risk premium (which is still the most material portion of returns). Packer

It depends on whether you think they can handle the debt loads. In low interest rate environment, a modest amount of debt can be better as you are borrowing cheap (in essence creating a LT call option with infinite duration - unless the there is a default). The banks we have said are cheap have much more debt and we determine cheapness on earnings to equity and book value. I have also included a measure of EV that illustrates their value on a unlevered basis. I have excluded the firms that have higher EV measures and low FCF yields for that reason. Packer

If you look at history low rates have had a tendency to linger along time after deflationary cycles. In the 1930's it lasted in the US until the inflation of WWII and in Japan it is still going on and it will be seen if they can stoke inflation with such a large debt to pay off. I am of the opinion that inflation or higher interest rates will not appear until enough debt is paid off or inflated away to create demand. With current employment situation we are still always off from that point. The Fed has monetized the debt (in essence exchanging cash for gov't securities which it plans to hold until maturity). This is what Sweden did in the 1930s and kept GDP growing. The UK did a similar thing in the 1930s when it went off the gold standard and the stock market rallied 30% plus above 1929 levels in 1936. In essence the monetization has offset the real price declines we would have seen if no stimulus was provided. I think what your seeing in Europe is the non-monetization approach. Monetization is not good but it is better than deflationary stagnation. Thanks for the OPAP idea. It is nice in that they have no debt which would encumber names like Telecom Italia and Mediaset. It is also cheaper than other players in the space like Lottomatica and Intralot who do have Euro debt. The other cheap gaming firm is Konami but they have their own issues with being in Japan and competing in other areas like video games and health clubs. Packer

Here are some fat pitches: TVL (6.2x 2-yr EBITDA, 24% 2-yr avg FCF yield), NXST (6.5x 2-yr EBITDA, 22% 2-yr avg FCF yield), TPCA (3.3 x EBITDA), HCOM (3.7x EBITDA), AIQ (3.9x EBITDA, 54% FCF yield), ATSG (4.3x EBITDA, 29% FCF yeild) and that does not even include distressed areas with more risk like OPAP (4.1x EBITDA) or Mediaset (4.8x EBITDA) and Telecom Italia (3.7x EBITDA) or some modestly undervalued financials like BAC or COF. Some of these have gone up but the cash flows appear to be increasing also. Packer

Eric, Congrats on a such a record over that period of time. I feel like an underachiever with only a 27% annual return over that same 10-yr period. I finally purchased some BAC but a little later than everyone else (Sep 2012) but better late then never. Packer

I use TD Waterhouse and have been able to buy multiples of daily volume by putting a limit order in and waiting. You can also call the broker an they can see what is available and you can set your order based upon that info. I was able to purchase a relatively large stake (about 2% of an illiquid firm this way) but I had to call the broker for few days in a row until the shares appeared. Packer

OPAP - the Greek state lottery (monopoly). It has no debt so from the liabilty side it has little devaluation risk. In addition, Baupost has taken a stake recently. Packer

I think having good performance is not good enough to find a job in money management because of the game they play. I think most out performance is from people doing what others will not and thus the game most money managers will not play. Berkowitz, Chou, Pabrai and McElvaine are outperformers and are all independent investors (they do not work for MM firms). I think the one thing you need to ask is do you want to play the MM game as you will be influenced by rules of the MM game (diversification and index huging) or do your own thing. Packer

What do you guys think of using like a 20:1 ratio for value of oil to gas reserves versus the traditional 6:1. A few producers like Devon are using this ratio now. Packer

BAC and C come to mind as spin-off/break-up candidates. Packer

I found the appeal to be the theoretical framework (mental model) for risk and the movements in markets. I suppose he could have provide some examples to illustrate his points. This has made me think seriously about position sizing, how risk is related to price and not just uncertainty of outcome and where to find bargains. Maybe this is obvious to some folks but this book has done a great job describing these aspects of investing. Packer