Viking

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.

Haven't people been saying this since basically 2011? Why this time? The recovery has been extremely slow and shallow, unlike traditional recoveries, and we've had a bunch of corrections and sector bear markets since (I was just noticing today that the DJ Diversified Industrials is down over 33% from peak) and international markets are already in bear declines, yet everybody seems to talk like it's been only up and to the right since 2009 so we must be getting close to some big thing... You could be right, but it seems hard to time the market like that. I'd rather own good companies that can benefit from dislocation and let them cleverly deploy capital if things go south, and otherwise keep creating value if they don't. But that's just what I'm comfortable with. Liberty, buying great companies when they are on sale and holding them for the long term is a proven winning strategy. I applaud those who are able to execute that strategy. I have, for the most part, been able to ignore ‘macro’ for the past 5 years and it has worked out very well. Having said that, i have been getting more cautious as the year has gone on. The biggest single reason is liquidity. Back when the Fed initiated QE it had a large positive impact on the stock market. Today we have the opposite going on; the Fed is trying to unwind QE. It makes sense to me that it will have a negative impact on the stock market. The Fed is also raising interest rates quite quickly and this is/will also negatively impact the stock market. If the Fed next week backs of future rate hikes and/or slows QE unwind i may become more constructive on stocks moving forward. However, if the Fed raises rates next week and sticks with 3 forecasted rate increases next year and sticks with QE unwind i think stocks will sell off more. In the last 5 years zero interest rates has resulted in pretty much everyone levering up. When the next global recession happens i think there is a good chance it will be as bad as 2008. Europe is a mess and they have no ammo to deal with a recession; their banks are also a mess so there is a very real possible trigger. Japan is also a mess. China is a wild card; they spent like drunken sailors back in 2008 and 2009 but i am not sure they can do the same thing again. Canada has a housing bubble waiting to pop. Of all the regions, i like the US the most but if Europe or Japan or China contract i think it will hit the US as well. There is much too much complacency right now. People have been conditioned by the past 8 years of slow but steady growth. But it has been juiced by an explosion in cheap debt. Now maybe the economies of the world can keep growing debt and continue the party. The only thing i am sure of is we will be getting a recession. When? No idea. All i know is when it hits i do not want to be fully invested in stocks (or bonds yielding +2%). Cash will be king. What will the trigger be (that will be ‘the cause’ of the next recession). No idea. But it will be pretty obvious after the fact. Buffett’s line about we will see who has been swimming naked once the the tide goes out. If i had to guess i would say debt will be the trigger. Here in Canada we have a housing bubble waiting to pop. In the US it sounds like corporate debt is a likely trigger. In Europe the banks are not in great shape (i.e. DB or Italian banks). These things tend to get started in one area and then they morph and get ugly.

I think what we are seeing right now is simply foreplay. Yes, volatility is coming back. When the global economy enters the next recession (in another 12-24 months?) we will all be reminded what a real bear market looks like. When unemployment is balooning higher. When consumer and business confidence collapses. When panic is everywhere. When my neighbours swear off stock investing because they are tired of losing gobs of money. When the nighly news is reporting daily on the fall of the stock market. Stocks averages will likely be down +40% from their highs. When you wonder if capitalism is going to survive. That is when you will know you are in a real bear market. My plan is to continue raising cash on strength. And i am slowly re-training my brain to stop buying the dips. Capital preservation (and locking in the gains from the past decade) is my current top priority. I would be happy to be 100% cash at some point in 2019. But i will be patient on the sell side. If i am wrong i will miss some gains. If i am right i will set my portfolio up for the next 10-15 years. PS: i think there is a scenario where the Fed backs off rate hikes in 2019; this may lead to lower interest rates and this may juice the economy (and stock market) one more time. We can only hope :-)

I think the Fed should hike in Dec and then reduce probability to one or two hikes next year. I agree with Druckenmiller: there has to be a hurdle rate for money. If it is free it will result in lots of mal-investment. This then creates an even bigger future issue (spike in debt, much of it used poorly). Wages will be interesting to watch in 2019; they are slowly ticking up. If employment gains in the US continue at +150,000 in 2019 wages will likely continue to slowly tick up.

BAC; down 11% in 2 days... Trading at about 10X 2018 earnings. Perhaps the end is coming... I doubt it :-)

November real estate stats are out for greater Vancouver: https://www.rebgv.org/monthly-reports/november-2018 “The total number of homes currently listed for sale on the MLS® system in Metro Vancouver is 12,307, a 40.7 per cent increase compared to November 2017 (8,747) and a 5.2 per cent decrease compared to October 2018 (12,984).” If inventory continues to grow at such a rapid pace (40%) it will get interesting to see what happens to prices... It certainly is not a pretty picture and the macro backdrop (rising interest rates, tighter lending standards, higher taxes, higher hurdles for foreign buyers, clamping down on Air BNB rentals etc) Will not help.

Gundlach has posted his most recent presentation Nov 13: https://doublelinefunds.com/webcasts/ A few takeaways (in no particular order): 1.) leading economic indicators are not indicating US economy will see recession in next year 2.) corporate bonds yields are too low; quantity is at extreme levels; much of it is mis rated; much that is investment grade should be rated junk 3.) stock market averages are likely peaking for the cycle

Cash

Liberty, i enjoyed your article. Thanks for posting. My personal experience is much more dynamic that what you suggest (with a slow start the first 5 years and lots of zigs and zags, regressions and spikes). Fortunately i learned about Buffett when i was in my 20’s. However, at the time i had little cash, little time and little understanding of investing. The investing books i really liked back then were One Up On Wall Street, The Warren Buffet Way, the Intelligent Investor and A Random Walk Down Wall Street. I took bits and pieces from each author and slowly developed my investment process. I then found this board (2002 or 2003?) and my style was influenced by Prem. For the next 7 years i made a chunk of money trading Fairfax and the subs. Post 2008 and with FFH delisted from NYSE the volitility trade ended. By now i was semi retired and i started rereading all the classics again and began to rethink my investment process. I found the old titles to be just as valuable; however, i took away different bits and pieces. I felt i was pretty good at buying but not as good at selling (often way too soon). Over the last 6 years Apple, being in US$ and the big US banks have each been great investments. I am now rereading the investment classics again (to help at the high school literacy club i am running) and i am finding them very valuable at reinforcing very important ideas (and i find i sometimes drift a little and need to be reminded of some important topics). My situation today is very different from when i started: a big portfolio, time and a pretty good understanding of investing. Capital preservation is much more important for me. I find my mentors to be just as valuable and relevant today as when i first read them. Yes, some have faded in importance (Prem) but that is more a function of fit: his stlye is not a fit for my current life situation (not that his stlye will not work). As your life changes what you need from your mentors will also change.

My understanding is that when QE was implemented it resulted in more liquidity which found its way into finacial assets. At the same time we had negative interest rates and this also pushed prices of financial assets higher (as interest rates fall bonds increase in value; when the 10 year US treasury yielded less than 2% this supported a higher PE multiple for the stock market). We now have the opposite happening. The Fed is reversing QE, and it appears the ECB will stop QE at year end. Combined, this will result in less liquidity. At the same time we have interest rates increasing. From a QE and interest rate perspective, as long as the current policy continues, it looks to me like we will see lower prices for finacial assets moving forward.

if rates are too low (especially when they are negative real rates) the result will be much more debt. The longer you wait to normalize rates the bugger the debt bubble gets. It then becomes impossible to raise rates to normal levels due to the impact it would have on all of the debt. Canada is in a bit of a pickle. And add in the challenges currently facing Alberta and the oil patch and it certainly is hard to see how rates in Canada move much higher...

Yes, Happy Thanksgiving to our US members. Lots to be thankful for :-)

Yeah, I believe Fed will break things again as usual. My god, the Fed chairmen have been really clueless since Volker. Although Bernanke did well with saving the economy and financial markets, he has missed the housing bubble and said some really crazy things in the past such as U.S. having a savings glut problem. These guys live in ivory towers. The new guy is just as bad. He is saying there's no heightened financial risks even at a time when nearly every asset is overvalued and risk premium pricing is insanely mispricing risk. Italian bonds were cut above junk and just yielding 4% or something like that. Insane. My current macro thesis is based on what we seen with near end QEx. Every time QE1,2,3 was about to end, markets almost plummeted into near bear market territories. We'll see how it goes, but I think when 10 yr hits 4%, watch out below. In the post from Liberty, Druckerman really does a good job of explaining the issues. With real interest rates below zero for years it has created a free money scenario and resulted in an explosion of bad debt (hello emerging markets). He mentioned Argentina’s issuance a couple of years ago of 100 year bonds at 7%. He thinks corporate bonds are another bomb waiting to go off (i think Gundlach is in this camp as well). He thinks there is a lot of junk corporate debt masquerading as investment grade. The longer the central banks take to normalize interest rates the more bad debt will get issued. The problem now is there is so much debt that as the central banks raise rates it will now create a larger crisis (then if they would have raised rates 4or 5 years ago). (Druckenmiller quotes Buffett and said we will find out who has been swimming naked... i.e. where all the shitty loans are hiding). The ECB and Bank of Japan are so screwed (they haven’t even started normalizing). The central banks have a situation where they have two bad options. Keep raising rates and cause a recession. Don’t normalize rates and watch debt and financial markets explode even higher. Hard to see how things don’t get very messy at some point in time. The challenge is timing... nobody knows when we will reach the tipping point (and the smaller bombs going off become a much larger bomb).

Opihiman2, while i am not 100% cash i am looking to raise cash. Will the US ever have another recession? I think so. When? No idea. It makes sense to me that higher interest rates from the Fed and a reversing of QE is going to negatively impact equity markets. The volatility we have seen in January and for much of 2018 is likely just a precursor of what is to come. It appears the Fed will continue raising rates until something breaks. Every increase from this point forward is going to get more and more interesting for stock markets.

Liberty, i owe you a beer somewhere some day :-) Thank you for posting the link. A number of things have been rattling around in my head this year. Most importantly, i have been trying to reconcile the end of QE (and reversal in US) and much higher interest rates (from the Fed) with what happens to the stock market. Druckenmiller says the Fed will continue raising rates until there is a major event (a big stock market correction or worse). The Fed really has no choice. I have been trying to raise cash; it has been a slow process because the market has been weak (especially financials). Perhaps i need to accelerate the process a little. Capital preservation is the key to successful investing. The markets are flashing yellow right now (looking at things with a 10 time frame). Will the light turn red next month when the Fed raises rates or not until 2019 or even 2020? Does it matter? Does one really need to be so precise?

Petec, You said “More broadly a lot of Fairfax’s investments are fundamentally jockey businesses”. This is true. But some purchases like Blackberry were complete dogs; i was invested in Blackberry when FFH was just getting started and by the third conference call i understood that Baisilie was a complete ding dong. He was great for Blackberry when it was getting started and when they dominated but when the market was pivoting to Apple/Samsung he was completely lost. (Fortunately i sold my complete position at a loss of 15%,i think, which would have been closer to 80% if i had not sold and instead drank the Kool Aid Blackberry management was serving). Not only did FFH not sell, they then kept doubling down when it was clear management was terrible. My point is if I was able to identify that Blackberry was being run by a ding dong after 3 conference calls why was FFH not able to come to the same conclusion? It was not difficult. A year or so later Apple was selling for $60 a share. With what FFH had learned a out the cell phone business (after owning a big chunk of Blackberry for a year) why were they not able to capitalize on Apple trading at $60? If they have a choice of doubling their money with a quality name like Apple or tripling it with a dog like Blackberry something in their DNA makes them want to pick the dog (just to prove how smart they are because even a dummy could make the Apple pick and they need to show how smart they are). I think what i am finally understanding is i have evolved over the past 10 years as an investor. I am more in Buffett’s camp in terms of buying quality. Whereas FFH has remained in the Graham camp of buying statistically cheap companies regardless of how stinky the business is. So when i look at buying FFH i am quite often disappointed with the decisions they are making on the investment side of the business (which stops me from buying the shares). There is a simple answer. Fairfax is not going to change :-) So i need to move on and stop being disappointed in what they are doing. They obviously feel the Graham approach is best and i hope it works out for the company and shareholders.

Seaspan is a good example... listen to Prem talk about the aquisition and all he does is talk about how wonderful David Sokol is and what a great track recod he had at mid-American and BRK (it is all about the jockey). This is the same guy that BUffett had to fire for lack of ethical behavior. Now FFH has $1 billion tied up. My point is Sokol has his warts and Prem is all promotion when he talks about him. How about talking about Seaspan’s business (moat), what it is specifically that FFH loves about the company that warrants a $1 billion investment for FFH shaareholders. Yes, the jockey is i portant but surely there are 3 or 4 other things that FFH loves about Seaspan. FFH is not a private company; shareholders should get the straight goods with a minimum of hyperbole or promotion.

Obtuse, the big risk I see is FFH loads up with GE type value plays right before the US enters a recession and a big stock market correction. A second risk is they use all their freecashflow to buy out minority shareholders in companies like Brit which are underperforming. Thanks nstead of using free cash flow to buy back shares that look undervalued. From a corporate governance perspective Prem seems more focused on his kids and keeping control than driving shareholder value.

FFH is now trading at a 52 week low CAN$603 and US$458. What is stopping Mr. Market from purchasing FFH? What is stopping me from buying shares is i have little confidence in how FFH evaluates equities. I am waiting to hear that FFH loaded up on GE when it was trading over $20 and Prem explain what a great business it is and how they think management is great (or some similar company). Yes, the stock looks cheap and the bond portfolio is positioned very well. However, it appears FFH is focussed on using excess cash to buy out minority partners in Brit, Allied and Gravalia. The stock is trading where it was trading in Janaury 2015. My fear is FFH will still be trading at CAN$600 in a couple of years in the future. Hard to see a catalyst. Other than ‘the stock is cheap’ can someone explain to me why FFH should trade higher than CAN$600 over the next year? What is going to happen with the underlying business that is going to warrant a higher share price?

With the current rate at 1.75% and a neutral rate of between 2.5 and 3.5% it looks like the BOC may increase rates 3 times in 2019 starting in January. Given the amount of debt held in Canada one has to wonder when higher rates will start to slow economic activity, particularly in the housing market. It looks like higher rates hit the economy with a multi-year lag as it takes years for mortgage rates to reset at the higher rates (given most mortgages are 5 year fixed). Perhaps we are another 12-18 months from more fully understanding the impact of higher rates on the economy here in Canada (not just slower housing sales but also reduced consumer and business spending as more money is shifted to servicing debts). Bank of Canada will keep raising interest rates, Stephen Poloz says - https://business.financialpost.com/news/economy/bank-of-canada-will-keep-raising-interest-rates-stephen-poloz-says Rate hikes to cost Canadian households $2,500 each year — but it isn't uncharted territory https://business.financialpost.com/news/economy/rate-hikes-to-cost-canadian-households-2500-each-year-but-it-isnt-unchartered-territory-report#comments-area

I think raising cash on strength (stock market run ups) will be a very effective strategy moving forward (the remainder of this year and next year). Being very patient on reinvesting the cash will also be important.

“Of course this is not the reality and there is uncertainty tied to this, but essentially the 10yr treasury trades on whatever the market thinks inflation is going to be for the next 10 years+some compensation for growth+some compensation for uncertainty (aka term premium, right now this is negative - prob because of QE - and a whole other subject).” Chesko, i am trying to understand QE and now that it is being unwound what that means for financial markets. Given it appears to have stoked financial markets when it was implemented it makes sense it will be a headwind moving forward. Any thought you or others have would be appreciated :-)

On curve inversion and a job well done. I’ve been critical and will continue to be, concerning various distortions and unintended consequences introduced in the market by the Federal Reserve and think that the interest rate “conundrum” has not been resolved. However, if animal spirits do lift growth and interest rates going forward in sustainable manner, such as suggested by the Fairfax team for instance, I take the pledge to openly recognize that I’m wrong. If that’s the case, I will also dissociate from the morbid fascination about what happened in Japan. First, some would say that flattening or inverted curves don’t matter and there was some interesting work that came out in 2006 suggesting that curve inversion no longer really mattered and, using Fisherian and Wicksellian concepts, that the curve was not inverted even if it was!? At this point, if long term rates don’t increase, the inverting curve will become inverted with the next short term hikes. Maybe, in a way, not that relevant for most investments, but useful concept when looking at something like the Bank of the Ozarks. Even if the underwriting culture at that bank was very strong, IMO the distorted interest rate market may have very well insidiously introduced a bias to underestimate the risk premiums and decisions to enter certain markets to an extent that credit mistakes have been made. When purely looking at reported numbers, this bank would constitute a good opportunity but, given the historical perspective and the tightening of the term spread which, if it continues, will invariably manifest the stress between borrowing short and lending long, the recent negative developments represent a leading indicator of things to come. Possibly cherry picking to some degree here but, when you look back at actual comments made by Mr. Greenspan (before the 1990, 2001 and 2007 recessions) and Mr. Bernanke, concerns about an inverting or inverted yield curve were put aside. Example (forecast vs foresight?): https://www.marketwatch.com/story/greenspan-discounts-flatter-yield-curve-as-warning-sign FWIW, here’s a recent, interesting and balanced study by the none other than the San Francisco Fed: https://www.frbsf.org/economic-research/files/el2018-20.pdf So what? When I was a young kid, my parents, sometimes tired of never ending questions, would send me to my grandfather who had been born before the 1913 Federal Reserve Act and who had no formal education. But he was one of the wisest man I’ve come to know and never answered questions in a conventional way. One day, looking at the sky, watching the V-shaped flocks of birds convincingly moving in a southern direction, after a typical run of questions, my grandfather explained some “principles”. First he said, “One swallow does not a summer make, nor one fine day; similarly one day or brief time of happiness does not make a person entirely happy" from which I understood that he meant that complex systems are complex, exact timing is difficult and false signals could lead one astray. Then he explained that Canadian geese, some time during the fall, migrate south. But why? My grandfather said I was lucky because, in the new era of Great Moderation (he may have said era of great abundance), I could get educated and hear from the masters as to why birds migrate but he also said that for him, winter coming meant that he had to prepare for survival (food supply reserved and preparation for the next year’s sowing) and that he did not need to understand why the birds were migrating. He just needed to know that no seasons were exactly the same, that occasionally birds, especially the younger ones, did not fly exactly in the right direction and that there were natural and deep-ingrained forces “telling” the birds when and where to go. The future is indeed unknowable and to each our own as we have to decide how to balance profits and protection but I wonder what my grandfather would say today. He always seemed to focus on the real and the enduring. It’s hard to be a contrarian when one “sees” a certain amount of collective foolishness but today, I look at the sky and I see tightening in a late cycle. I assume John has finished his book on cycles and wonder if I’m off-base here. Speaking of tightening and of a job well done and linking to what Cardboard opened with, and basically asking the question: Why suffer if we don’t have to? I read some interesting stuff today and will finish with a question. It’s from Horizon Kinetics Q3 2018. “The U.S. has $71.3 trillion of total debt, including everything from a car loan and credit cards to a U.S. Treasury Bond. If rates were to increase, across all instruments, by 1%, the additional debt service would be $713 billion. The U.S. consumes about 20 million barrels of oil a day. At roughly $70 a barrel, it costs $1.4 billion a day to pay for the oil, or $511 billion a year. So imagine, using the 1% increase in debt service as a reference point, if the country had to pay another $713 billion for its oil. That would be a 140% increase over what it is right now. That works out to an oil price of $168 a barrel.” Yields have been increasing across the board and there’s more in store. If gas prices at the pump would have gone to 5 bucks a gallon and were moving to about 8 bucks a gallon and more in such a short time, the 70’s oil shock induced consumer suffering would pale in comparison. Yet, in the context of a job well done, deleveraging, in the main, has not occurred and fiscal deficits are heading up without any sign of suffering. Why is that? There is a rare disease where some people don’t ever feel pain (those familiar with the Millenium movies will understand). Despite what first level thinking would suggest, people who never feel pain don’t do well. Unnecessary suffering is unnecessary but pain has to be felt. It’s unfortunate but it’s evolutionary. Cigar, one of my favourite posts of the year. Thank you for taking the time to write it!

Cardboard, my read is the 2008 financial crisis caused unprecidented easing by the Fed. Calitalism alsmost ended as we know it (there is some truth to it :-) Interest rates and QE went to extreme levels and this has created asset bubbles in Canada (not sure about Europe). Interest rates need to normalize. There is a huge debate in Canada about affordable housing and nobody wants to discuss the core issue which is crazy low interest rates. As interest rates normalize we are going to have a housing price correction and this will be a good thing for Canada long term (not in the short term). There will be winners and losers (just like there has been in the past 10 years). When asked if the stock market was overvalued Buffett has said repeatedly it was not with the yield on 10 year treasuries of 2% (where they were not too long ago). It makes sense that as rates normalize that the stock market averages will come under pressure. This is healthy. Will the Fed tighten too much too fast? Perhaps. But 18 months ago nobody would have thought they would have been able to raise rates 7 times and for the economy to be running at 3.5% GDP growth. What the Fed has been able to accomplish against the advice of pretty mich everyone else is pretty amazing (and pretty ballsy). The non-consensus view is that the 10 years rate continues higher in 2019 (to 3.5 or higher). If that happens i think the Fed will continue to tighten. (The key to both of these is US economic growth...) My question is why is Europe and Japan not taking the hard medicine to get their houses in order. Both look sick and in denial. What are they going to do when the next down turn hits, especially if it is bad?

It is exceptionally difficult to time the market. As of today, the US economy is performing exceptionally well. None of the leading indicators are flashing even yellow. Yes, there are issues but there always are issues. The current concern is rising rates, on both ends of the curve. And there is a trade spat with China. Is a big sell off coming? Perhaps. I really have no idea. The key is can you sleep at night? If not, something is likely wrong with your portfolio. As long as the US economy continies to chug along I am going to be patient with my holdings. All of the negativity actually makes me more positive on stocks. And we also will be having an election in the US in 4 weeks and a bear market is stocks will not be good for Trump so i expect he will not let it happen :-)