Viking

Real estate stats for Greater Vancouver for January are out and they are ugly. If supply continues to build in the coming months and pricing continues to soften we could be seeing the end of the great housing bubble in Canada (Vancouver anyways). Year over year, inventory up 56% and prices (for detached houses) down 9%. The threat of missing out (as prices go continually higher) may be shifting to fear of trying to catch a falling knife (as prices go lower) which may slow sales even more. Real Estate Board of GV: https://www.rebgv.org/market-watch/monthly-market-report/january-2019.html And we have a Federal election this fall. What is a politician to do? Loosten mortgage rules (allow 30 year amortizations for first time buyers so young people can ‘afford’ that + $1 million home by taking on an obsene amount of debt). https://www.theglobeandmail.com/politics/article-morneau-taking-close-look-at-return-to-30-year-insured-mortgages/ Some highlights: Supply is continuing to build - The total number of homes currently listed for sale on the MLS® system in Metro Vancouver is 10,808, a 55.6 per cent increase compared to January 2018 (6,947) Prices are starting to fall - Sales of detached homes in January 2019 reached 339, a 30.4 per cent decrease from the 487 detached sales recorded in January 2018. The benchmark price for detached homes is $1,453,400. This represents a 9.1 per cent decrease from January 2018, and an 8.3 per cent decrease over the past six months. Australia also seems to be having its own housing correction...

Shalab, the biggest driver of wealth in Canada since 2000 is the housing bubble. Real estate has fuelled a great deal of proserity in Canada over the past 18 years. 1.) People’s net worth is at record highs; this has allowed for higher consumer spending (i know of many people who are spending part of their housing gain via their line of credit). 2.) government tax revenues from housing are at all time highs (property purchase tax, taxes on real estate commissions etc). 3.) employment in real estate related parts of the economy is at record levels (as a % of GDP); these sectors pay very good wages. Look at US prosperity in 2005 and 2006. Their economy was booming. But evaluating how ‘successful’ the US was with its economy and even family wealth at that time would have been a mistake (as i am sure lots of people were sitting on significant unrealized real estate gains when calculating at their net worth); we all saw what happened to US consumers and their economy in 2008-12. We sill see how Canada fairs in the coming years. Similar to Cardboard, i have my concerns. I think bubbles can be identified; however, it is impossible to predict the timing of when they will pop.

It will be very interesting to see what they have done with the $100 billion in cash in Q4. I think the most likely meaningful stock purchases are JPM and AAPL (however, the downside with Apple is it is already such a large part of BRK that it now influences the price of BRK; i am sure Buffett does not want the price of BRK to be too closely tied to fortunes of AAPL). An update of buybacks will also be good. If it has simply grown by another $7-8 billion (with no meaningful purchases) that will be disappointing. Although i think it is fair to say winter is coming and stocks and businesses will likely be going on sale at some point in the next 12-24 months (perhaps fire sale).

Another interesting tidbit of information. It really is amazing the amount of cash BRK and Apple are sitting on. And the US financials are over capitalized, unable to aquire, and forced to return +100% of earnings to shareholders. Clearly, Buffett is hot for companies that are cash machines and return most of it to shareholders in a tax efficient way (while still growing their businesses). BRK has about $100 billion in net cash; about 20% of its market cap ($489 billion). It is generating about $25 billion in free cash flow per year. It recently raised the threshold for stock buybacks. Buffett really does need to find a use for this excess cash. BRK’s single largest equity position (worth $40 billion), Apple has $130 billion in net cash and a market cap of about $740 billion. It is earning about $55-60 billion per year. It is already buying back significant stock and this will continue. (It says it wants to get to cash neutral down the road). It is paying a dividend that is currently yielding 2%. Stock buyback = +5%? This is yielding Berkshire a total return of +7% in a very tax efficient way. Year after year. BRK’s largest equity group (worth $80 billion), the big US banks have lots of excess capital and as a result will be buying back 5-7% of shares outstanding over the next year. They all pay solid dividends in the 2-3% range. This is yielding BRK a total return of 8-10% in a very tax efficient way. Year after year. So Apple and Financials, worth about $120 billion, will be yielding BRK about 8% or $9.6 billion per year moving forward. In a very tax efficient way. Looks like Buffett likes buying cash machines that return it to shareholders mostly via buybacks and dividends. Oh, and these businesses continue to grow their top line and total profits.

Here are my guesses for BRK underperformance YTD: 1.) AAPL and financials big price decline in Q4 and upcoming substantial hit to Berkshire BV when year end results are reported in Feb. Headline will be ugly. 2.) AAPL profit warning (caused immediate decline in BRK) and concern about AAPL results going forward and potential impact on Berkshire BV. 3.) flight to safety reversing: as thepupil mentioned, BRK dramatically outperformed in the Dec panic, and now it is underperforming as investors shift to riskier stocks. The good news: 1.) since the start of the year, financials are on fire and we all know they are twice the size of AAPL in the BRK portfolio. 2.) AAPL, re-priced in the portfolio at $155, is now cheapish. It could go a little lower but the big decline is behind us. At some point in the next year or two Apple will launch a must have phone and when they do sales and profit will hit new records and the company will be valued over a billion $. At $155 this is a great long term hold for BRK. Having said that, i do think 2019 could be a very difficult year for Apple. China may be a big problem, and may persist for a year or two. And the current lineup of iPhone’s looks uninspiring with the result that people will hold on to their current phone a little longer on average (which will impact unit sales and profits. Fortunately, Apple does have a pretty good track record of recognizing mistakes with the iPhone lineup and making the proper course corrections the following year. 3.) at the end of Q3 BRK had $100 billion in cash. BRK bought $25 billion in stocks in Q3. With the decline in stocks in Q4 i would expect more than $25 billion in new stock purchases in Q4. Perhaps big additions to APPL, JPM etc. If so, this will meaningfully increase earnings power of company. 4.) BRK buying back its own stock: I expect more commentary from Buffett about this in this years annual letter. Given the size of APPL and financials, and the investment portfolio in general, we could see large swings in BV from quarter to quarter. Buffett has his own idea of intrinsic value of BRK and it obviously doesnot swing so dramatically quarter to quarter. Perhaps we will see BRK buy back its own stock at 1.4x BV when it feels the stock portfolio is being undervalued by Mr Market (resulting in BV being understated). 5.) as the US banks have communicated, the US consumer and economy continues to perform well. We can expect the Berkshire op co’s to report very strong results. 6.) tax reform: BRK was one of the big winners and the benefits of tax reform will continue into future years. The stock price today is trading close to where it was trading in Nov of 2017 when tax reform was being discussed. Bottom line is it does not look to me like Mr Market Is valuing Berkshire higher even though its future after tax earnings will be much higher as a result of tax reform. 7.) long term bond yields look like they have peaked and may be headed lower. All things being equal this will allow for a higher PE to be attached to stocks (in general). 8.) as volatility returns to the market, Mr Market may start to value ‘stalwart’ (bond like) stocks like BRK a little higher. 9.) insider buying: $20 million purchase by Jain in Dec likely around $192 is encouraging. BRK looks attractively priced at current levels. I buy it in place of holding a bond. When it runs up 5-7% i am happy to sell. Rinse and repeat.

At the end of the day you need to find a strategy that lets you sleep well at night (and have great relationships). You may find that what you have learned in the past will help you at some point in the future. Best of luck on your journey :-)

GOOG. 3 or 4 years from now he will look like a genius :-)

I recently established a position in BRK. Price is ok; not crazy cheap and not crazy expensive. I like its defensive nature (should outperform when markets sell off again). At current prices, I like Apple and the big US banks; holding BRK gives me some exposure to companies i like for the long term. Buffett having $100 billion in cash also appeals to me right now; my guess is he will make a couple of large purchases over the next year or two. I would love to see them buy a chunk of GOOG if we get another big sell off. Main risk is Buffett’s age.

Calculated Risk is my favourite go to for US economic information. Here is the link to his 2019 forecasts: https://www.calculatedriskblog.com/2018/12/ten-economic-questions-for-2019.html Here is a link to a review of his 2018 forecasts. Pretty accurate. - https://www.calculatedriskblog.com/2018/12/review-ten-economic-questions-for-2018.html

Well said. I have stayed away from Fairfax for years because of different reasons. Today: 1.) their brand of value investing (more Ben Graham - cheap - than Buffett - cheapish quality) 2.) Prem is too promotional in communication 3.) extra cash will likely be used to buy back minority stakes in subs 4.) managements focus does not appear to be shareholders, but rather empire building Having said all that, i do have Fairfax on a watch list. I am very impressed with the insurance side of the business they have built over the years. And yes, Bradstreet/bond investing has been very good.

No-free-lunch, i agree with your comments about Lynch and Buffett. I think the overlay is every investors situation is different and they therefore need to modify the teachings of the masters to fit their personal situation so it is a good fit. Canadian author David Chilton also says that wherever strategy you employ, it must allow you to sleep well at night. Lynch also says that you should own cyclicals at the start of an economic cycle, not the end.

Sorry for the updates to this post; my thumb posted it before i was done with my thoughts :-) Since February of 2018 the financial markets have been steadily weakening. However, i have been focussed on the strength of the US economy. All of the leading indicators were not even on recession watch. So i remained 100% invested, heavily skewed to US banks. I was also focussed on 10 year US treasuries, which peaked out at 3.3%, which supported the idea that the US economy was doing well. The economic data coming out of the US recently looks to be to be now flashing yellow (no recession imminent but things are trending in the wrong direction). - ISM Manufacturing Index Decreases Sharply to 54 in December: https://www.calculatedriskblog.com/2019/01/ism-manufacturing-index-decreased.html The 10 year US bond is now trading at 2.57%, which is not healthy. The bottom line is it looks like the US economy has turned (growth slowing) and the data coming out will now show declining numbers with risk to the downside. Weakness in China looks to be getting worse: https://www.theguardian.com/business/2019/jan/02/stock-markets-dive-china-manufacturing-contracts-ftse-wall-street-us-economy-business-bleak-start-to-2019 Europe is not great. Italy is a mess. The UK is a mess. Trade wars add to the complexity (and the risks). Politically, populism is just getting started; as economies slow and enter recession it makes sense to me workers will not be so patient. Politicians will fan the flames to get reelected. Nationalism will be a natural outcome. The 1930’s can perhaps provide some insight. In Washington we have a President that i have little confidence in (to be able to handle a crisis in the proper way). This simply increases the risk of a bad situation getting worse. Bottom line, i have been increasing my cash weighting. Capital preservation is more important to me in the current environment than return. I guess what i am really asking is can things get worse from here? Is this the bottom? Or are we only in the early innings of this 9 inning game? My read is we are perhaps only 33% of the way though this current weakness in financial markets (with another year or two of turbulence ahead). PS: Gundlach does his annual forecast presentation on Jan 8 and he will be going over all the US data. https://doubleline.com/latest-webcasts/

In your view, is anything at a "fire sale" price right now? If so, which companies? After Christmas I purchased BAM, AAPL, JPM, FDX and a smaller amount of GS I would love to add GOOG (below $1,000), DIS (below $103) and BRK (below $195). Facebook and Fairfax are also on my watch list.

Finished the year at -3.7%; first negative year in last 15. Not a great year to be way overweight US banks. Could have been much worse. The silver lining is there are many well run and profitable companies trading at what look to be very readonable valuations (which bodes well for 2019 returns). My big learning is to pay a little more attention to where we are in the economic cycle and modify my portfolio accordingly. My guess is the volatility we saw in 2018 will continue into 2019. The big changes are: 1.) on strength (when market gets optomistic) build cash 2.) on weakness (when market gets pessimistic) buy best in class large caps

Have cash to take advantage of market dislocations. It looks to me like the easy money has been made from the 10 year bull market in stocks and 30 year bull market in bonds. If Druckenmiller is right and liquidity matters (and is contracting) we should see continued volatility in stocks and bonds (perhaps similar to 2018). Having cash to take advantage of fire sale prices would be ideal. To keep this strategy working it will also be important to rebuild cash reserves on strength. Rinse and repeat.

Happy holidays to everyone... lots to be thankful for :-)

Agreed. Right now Mr. Market is very pessimistic. Why? Not really sure. The stock market's ability to predict the future is less than stellar. The bond market, with 10 year US yields at 2.79%, does not look overly fussed (and I think the bond market is a much better predictor than the stock market of what may be going on in the general economy). Perhaps the ending and reversing of QE is having a much, much bigger impact on financial assets (especially the stock market) than most understand or recognize. Perhaps the current sell off in stocks has little to do with trade wars or slowing economies.

The US consumer is in very good shape. House prices have increasing year over year by about 6% per year for the past few years and prices should continuee higher in 2019. This impacts an average families financial situation (wealth) much more than the stock market. Labour markets remain tight; workers are finally getting decent wage increases. It is getting easier to also find a better job. One likely effect of all the trade issues is manufacturing will be moving back to the US; we do not know how much but it may surprise to the upside. (Canada and Mexico will be short term losers; China will lose over the medium term). The Global Financial Crisis hit the US hardest. My guess is the next global recession will hit the US the least.

Agreed.

My understanding is the bond market does a much better job of communicating what might be happening in the future in the real economy... the stock market not so much. I recently re-read the Mr Market parable that Graham uses in the Intelligent Investor. I wonder what Buffett would say about the current fall in stock prices and what it was communicating about the future path of the US economy (not much is my guess) :-) Druckenmiller is a very smart guy. Humble enough to admit he is also often wrong.

The key for me is what is going on in the US economy. Growth is solid. None of the leading economic indicators are suggesting we see a recession in 2019. The Fed raising rates in Dec was pretty much baked in. They are becoming more dovish, reducing the expected increases next year from 3 to 2. If US economic data weakens i expect them to reduce this further. The one small surprise for me was regarding QE. Powell pretty much said that program is on autopilot (not data dependent). But perhaps, if we start to see weakness in US economic data, the Fed will change this to being data dependent. All in all, the more the Fed normalizes interest rates (and reduces QE) the more asset prices will reflect what is really going on in the ecomony. To Druckenmiller’s original point, free money is no way to run a capitalist economy. Yes, the market will continue to throw tantrums... as long as it does not morph into the larger economy then so be it. I remember when the Fed started raising rates 2 years ago lots of smart people called them idiots; the Fed has nailed it the past 2 years by raising rates and reversing QE. Do they need to slow? Yes. But compared to the ECB or Japan the Fed has done a much, much better job.

Yes, thanks for posting. In terms of what is a Canadian to do i liked his idea of holding US$ as this has been my hedge should we get a housing correction or bust. Bottom line is i expect the US economy to perform better than the Canadian economy moving forward. If housing in Canada gets ugly i expect this outperformance to widen.

Great second interview. So. Much to learn from these cagy old veterens; great to hear him talk for a full hour and explain his change in thinking. The internet really is an amazing thing. And free :-) “What are the qualities or characteristics that a money manager should have today” 1.) intellectually curious 2.) really open minded 3.) courage a.) bet big / concentrate b.) fight your own emotions He said this with 2 minutes left in the video. Great advice for anyone who wants to be successful at investing. And it will be very interesting to see what the Fed does tomorrow especially what they say about the path of future rate increases. If they increase rates tomorrow and stay hawkish (dot plots telegraphs 3 more increases in 2019) get ready for a shit storm in stocks. If the Fed gets more dovish then perhaps we get a short term relief rally. Very murky right now.

Dalal, i agree with your comments. However, i would also add that just because we had a big recession in 2008 it does not mean the next one will be a small one. It just might be a big one. We simply do not know. 1929 was not when things really got ugly in the Great Depression; it was 1932 when it really got really ugly. Today the central banks may have everything figured out and QE, negative interest rates in much of the world, and more and more debt may be the new normal that leads us all to a prosperous future. I am sceptical (and i am normally pretty optomistic) :-)

Gregmal “Viking I love your thought process and rationale and it resonates with me. I do have a few things hopefully you'd care to expand on. 1. Maybe the Canada housing bubble is obvious. I kind of agree. But isn't part of the bubble process widespread euphoria and enthusiasm? I've hardly seen that in the Canadian housing market, especially over the past 3 years. Almost everyone I know is negative there. 2. Why does the next recession need to be a replica if not worse of the GFC? There's plenty of reasons we could have a recession that pales in comparison to 2009. I think 2009 was a once in a lifetime series of events... I mean almost everyone was asleep at the wheel. Whereas the past decade there have been scores of people hoarding cash and waiting for the first 2% decline to scream about the next big one. Recency bias at it's best IMO” Gregmal, here are some further thoughts: 1.) i bought my house in 2010 for $600,000 and today it is worth about $1 million. During this time average incomes have grown only modestly. Affordability is as bad as it has ever been. Housing, as a % of GDP, is at all time highs. All the stats that i have seen are all flashing red (bubble territory). Perhaps the most likely scenario is prices go sideways for the next 5 or 10 years while inflation runs 2.5% and we get a silent corection in prices. However, i think there is a reasonable chance housing has a hard landing at some point in the next couple of years. Trigger? Not sure. Timing? Not sure. (Inventory is one of the keys; it is currently growing 40% year over year; if inventory continues to climb at a high rate as we get into the spring we may see prices start to correct more aggressively.) 2.) in terms of what the next recession looks like, i really have no idea. However, what is Europe going to do when it hits? They already have massive QE and negative interest rates (during the good times)? What are the Italian banks going to do? Populism is just getting started; does anyone think European governments are going to preach austerity in the next downturn? My view is we are entering uncharted territory. (Time to start reading up on what happened in the 1930’s.) i think Japan’s situation is equally precarious. My view is simply given all the risks there is a decent chance we will get a nasty recession. Too much debt is what caused the last recession. We ‘solved’ it by issuing even more debt (free money). When the next recession hits I am not sure how we will solve it. And the global rise of populism is a new wrench that will limit government options.