Viking

Hawks, here is a summary from Calculated Risk of what he sees coming the next little while (and he simply calls things the way he sees them... i.e. he is no doom and gloom guy although he certainly sounds like it in this post). What makes me nervous regarding the market in general is it is priced currently for good things to happen although it looks more likely that things are flat to getting worse. If things are flat then my read is the stock averages retreat. If things get worse (good chance) then the sell off gets worse. What causes revolution is not poverty or treating people poorly; what causes revolutions are unmet expectations - when people expect something and they don't get it. My guess is this is also part of what causes the market averages to fall... when the economic news is worse than what people are expecting. http://www.calculatedriskblog.com/2010/08/more-negative-news-flow-coming.html But as many have said... if you find something in your sweet spot then back up the truck!

I love the discussion. As per usual, I have a few thoughts: 1.) to state the obvious, we all have a different intellect, psychological makeup and personal situations. We need to remember this when filtering what others post. For a little more insight, my personal situation is most of my investments are held in RRSP so I have no tax considerations when deciding what to buy and when to sell. As well, my account is of sufficient size that I simply pay a (reasonable) quarterly fee and pay nothing to buy and sell individual positions. Capital preservation is paramount to me as I almost have enough (although I did quit my day job 5 years ago). 2.) most of my friends are fully invested and have no idea what they are invested in or why. Complacency is my read of where 'the market' is today. Yes, everyone is very nervous. I do not see blood in the streets. My friends were freaking out in March 2009. 3.) Regarding current markets, the Guru I would probably put at the top of list (FFH) has been reducing their equity exposure the past 6 months and in the past three months began reducing their corporate bond exposure and just increased their equity hedges to 90%. FFH obviously does not like what they see right now. I also enjoy reading John Hussman and he lays out very well why he feels stocks (in general) are not cheap. I would feel a little better about the economic situation if the number of unemployed in the US was doing better than it is (and, yes, I know it is a lagging indicator). 4.) Bottom line, based on our personal situation and risk tolerances we have to do what we think is the right thing because we think it is the right thing (and not because we think that is what Buffett or Watsa or Templeton would do in the same situation).

87% cash; 13% equities (ABT, BAX & GVC).

the fact this was Buffett's only large recent purchase tells me all I need to know about current valuation (as I have said in the past holding this co is perhaps a better option than holding bonds). The fact that it is a large FFH holding further confirms to me that it is a solid long term bet. Having said all this my current favourite big pharma play is ABT. They are similar to J&J, but they are smaller and look to have a much higher growth rate (looking out 3 to 5 years). My guess is J&J will grow earnings 7-8% and ABT will grow earnings 10-12%. Both are trading today at similar PE's (around 12).

myth465, your Buffett quote below rattles around in my head quite a bit. Lynch has some great ones as well about the foolishness of trying to time the markets (I like to re-read One Up On Wall Street about every second year because I like Lynch's stuff so much). What gives me pause is the chance we are entering a 'US in the 30's' or 'Japan in the 90's' type slowdown (not necessarily another great depression; perhaps just a decade long absence of growth that rewards bonds and punishes equities as earnings shrink). I do not want to end up like Ben Graham in the early 30's; I want to keep what I got (as I almost got enough)! If I was younger, with a small base and adding to my capital every year in a big way then I likely would be more fully invested. Today I am 13% equities and 87% cash (having recently sold a chunk of equities); about 25% of my portfolio is US$; 75% is CAN$.

Insurers are currrently reporting pretty decent earnings. Underwriting income is decent (driven by reserve releases) and investment income is decent (driven by interest income and realized gains). Bottom line is capital in insurance is at a very high level. Having said all this, we can all see the storm clouds: 1.) accident year underwriting appears to be over 100; reserve releases should continue to trend lower 2.) interest income continues to fall as bond yields fall 3.) realized gains will likely diminish (given current bond and equity valuations) We look to be in the slow drip phase. My guess is until a meaningful amount of capital disappears the slow drip will continue. Berkley feels we will see a turn the end of this year. He's a pretty smart guy...

alwaysinvert, I agree that holding mostly cash is not ideal. I also am not trying to closely imitate Buffett or the other gods of value investing. I am going with a strategy that works for me (I sleep at night and my long term return has been more than acceptable). I have benefitted a great deal over the past 10 years by being very, very cautious. It's funny because my friends and family think I am an optomist; most on this board likely see me through my comments as being quite a pessimist. Past experience has taught me that there are times to be fully invested and other times when cash is a beautiful thing. Currently, my preferred asset class is cash and I have no problem holding a chunk for a year or two. Yes, stocks are not overvalued like they were in 2000. However, I do not think they are screaming buys like they were in the late 1980's. And it looks to me that a slowing of the economy is the most probable outcome over the next 12 months and stocks are not priced for this scenario; the risk of capital loss is too high and the reward is too low. If I am right I will do well; if I am wrong I forgo some return and I am OK with that.

It certainly looks to me that we are beginning to slip into what appears to be a multi-year deflation. My guess is the government is largely powerless to stop it, although they likely can make things worse with inappropriate policy decisions. The fact that we have not seen something like this in 80 years means most people do not get it (they only get and view as possible stuff they have experienced, and the more recent the better). The fact that Japan has been living it the past 20 years should provide valuable insights and more than a few lessons. I do not expect our current situation to mirror Japan but it perhaps will rhyme. At the end of the day, no one really knows. However, the risks appear to me to be rising to the extent that a possible deflationary period should be entering into rational investors thought process. If Ben Graham understood better the risks that were brewing in the late 1920's what would he have recommended an intelligent investor to do? Would he have said 'do not try and predict what the economy might do'? The first rule is capital preservation. If we have a situation where the probability of a deflationary depression is the highest it has been in 80 years (perhaps still only 20% chance of actually happening) my guess is he would recommend extreme caution. The reward is not worth the risk.

Insurance continues to be one of my favourite sectors. Stock valuations are at multiyear lows and well run companies have been hit hardest. I would like to believe W Berkley's call that we should see the start of a hard market beginning in Q4 of this year. What I cannot reconcile is the large amount of capital that everyone seems to be sitting on and how the profitability of the industry appears to just keep rolling on (largely due to reserve releases). Until a large chunk of this excess capital is destroyed how will we see a hard market? Right now many firms are using excess capital to repurchase shares. Perhaps we will need to see some really ugly catastrophes (hit to reserves) or a second financial crisis (hit to investments). What is apparent to me is the current math is not sustainable. The P&C industry appears to be underwriting at a CR over 100 (on a current year basis). Bond yields are crazy low and long yields could come down further. And equities have had an amazing run. As reserve releases slow, bond yields fall and equities go sideways (reasonable future scenario) we may see sentiment actually get worse as this soft market drags on into 2011. How do we get a hard market with so much excess capital sitting on the books at so many insurance companies?

What I wonder is if we are in the early stages of another Great Depression. On the one hand, Buffett talks about not trying to time things too much and to 'bet on America'. Looking at things from an historical perspective the downside risks (to equities) certainly look real. FFH certainly is once again battening down the hatches and they have been remarkably accurate (and usually early). Weave it all together and it certainly is an interesting time we live in! I will happily forgo some return (i.e. hold lots of cash) and let time clarify things a little more... And, yes, all of the spin we are seeing is certainly making it hard to read the tea leaves.

It is the US operations that I have never been able to get comfortable with. SOP pricing keeps killing them and they appear to NOT be able to get a premium price (vs hardwood) for the finished product... Tough to build a long term winner.

Zero Hedge posted a very interesting August commentary by GMI... looks to me like it summarizes very well the bear case. I also enjoy reading John Hussman very much (I like the logic he presents...) and he is also quite pessimistic about equity valuations. http://www.zerohedge.com/article/gmi-describes-future-recession-ongoing-depression-must-read-report I have a question I am having a hard time answering. Should current treasury yields factor into how one values equities? Today I can buy well run companies with low debt, solid moats and reasonable growth prospects (8 to 10%) at 12 to 14 times current year net earnings. However in the 1980's these kind of companies were trading at 8 times earnings (or less). My question is inflation in the 1980's was running at double digit levels and Treasury yields were also double digit whereas today inflation and Treasury yields are crazy low... If inflation/Treasury yields are a key factor when valuing stocks then perhaps equities are chaper today than people think???

67% cash (CAN$)... Should the CAN$ pass parity with the US$ I will shift some CAN$ cash to US$. Current strategy: should markets fall 15% from current levels I will move to 33% cash and should we get the mother of all sell off again I will move to 0% cash.

Investors have been on a wild roller coaster ride the past 24 months given how low the market fell in March 09 and how fast and far it has rallied since. People are not built to handle this sort of volatility. My guess is there are a lot of ichy fingers out there; should we get another down draft in the market it could morph into something ugly (and here comes Sept/Oct just as the economy looks to be rolling over...). Should this happen then watch investor sentiment towards equities start to hit generational lows... Then this would begin to look to me to be a real bear market!

Cardboard, as I said in an earlier post I was looking to see with great interest what FFH is doing with its investment portfolio. And as you have indicated above they appear to once again be quite bearish on equity markets and more fearful of deflation risks... Something to think about!

gaf63, here is my rough math: "Net gains on investments is the black box. The equities (I think) were down June 30 about $450 million. Yes, 30% of this is hedged. US Treasury yields came way down; most of FFH holdings are munis and corporates which did not see the same movement as Treasuries. FFH also does a large amount of other interesting things every quarter so they may have anticipated the decline in equities and sold some or hedged further. Bottom line, my guess is realized gains + unrealized gains are negative for the quarter (with risk to the downside)." I do not have a very precise view on the bond changes. It looks to me that muni bond yields were flat for the quarter. My guess is corporates were slightly postivie. Yes, gov't bonds moved a fair bit. Total bond portfolio increased in value but not by a great deal (unless FFH has some leveraged positions to long Treasuries which very well may be the case). Equities = -$450 Bonds/Hedges = +$250 Net = $-200

At the end of the day I expect book value to fall at FFH (around $378) when they report Q2 results. My guess is they also have been buying back some stock (although this may have happened in July and we may not know for another 3 months). I will be watching to see if they have sold another chunk of equity holdings in Q2... Here is my very rough calculation of what FFH should earn in Q2: 1.) Underwriting income (CR = 102) = - $25 mill 2.) Int / Div Income (Q4 $172.4) = $175 Operating Income = $150 3.) Net Gains on Invest = -$200 (incl unrealized gains) 4.) Interest Exp = -$50 5.) Corporate Overhead = -$25 Pre Tax Income = -$125 6.) Inc Taxes (28%) = $35 Increase in BV = -$90 = -$5/share Q1 BV = $383 BV Growth = -1.5% Net gains on investments is the black box. The equities (I think) were down June 30 about $450 million. Yes, 30% of this is hedged. US Treasury yields came way down; most of FFH holdings are munis and corporates which did not see the same movement as Treasuries. FFH also does a large amount of other interesting things every quarter so they may have anticipated the decline in equities and sold some or hedged further. Bottom line, my guess is realized gains + unrealized gains are negative for the quarter (with risk to the downside).

Interesting discussion... For the past 12 years I have had a strategy of buying cheap stuff and then selling when it has gone up. My holding period for any one stock has rarely been more than 2 years. I also have been able to successfully 'time' sectors and the general market (not in tech in 2000, other than FFH no investments during the late 2008/ early 09 crash). I have also been VERY concentrated at times (80% in FFH a couple of times). Today I see an overall market that is not crazy expensive (compared to what the PE was in 2000 or 2008). Interest rates are also VERY low. The CAN$ has appreciated significantly versus the US$. A key macro risk is where the US goes from here (recession or bumpy slow growth). Given the current environment (and my changed situation) I wonder if I need to evolve my strategy a little and become more of a buy and hold investor. Rather than hold bonds, I have decided to over time build a portfolio of reasonably valued large cap stocks (ABT, JNJ, BAX, XOM, MSFT). These co's have good long term track records, have decent management teams, low debt, pay a dividend and should be able to grow earnings at 8 to 10% per year (in aggregate). BDX has sold off recently and I may add to the above list. I also hold 2 small caps (GVC and SFK); GVC I like as a long term hold and I bought SFK recently (a moment of weakness?) purely as a short term speculation (their fiber issue and US operations stop me from wanting to hold long term). I have decided that if I can find companies I really like and good to great valuations I will purchase a small amount (2% of portfolio). Should market sell off I will have cash to buy more (I am currently 30% invested and 70% cash). Should markets go sideways or up I will be sitting on a nice portfolio of companies purchased at attractive prices. For me macro matters; however, valuations are not so high that I want be out of the market completely.

The trick is what is everyone doing with their money. Currently, I am still 30% invested (largely US large cap) and 70% cash. So I am being very cautious right now. Yes, well run companies look cheap but that does not mean they will not get cheaper. Regarding earnings, if you looked simply at NET EARNINGS I am not so sure that the overall market is as cheap as it looks. And with unemployment as high as it is I am not sure where future net earnings are going to come from. I do like to look at the macro. I also have learned to stay focussed on being disciplined: buy well run companies trading at a great price. That continues to be my focus now.... read, read, read and wait for price to cooperate...

I find Hoisington's argument appealing simply because most people do not agree with it. The market rarely does what everyone is expecting. The chance that the US enters a Japanese type deflation are larger than 'the market' thinks. Having said this, I WILL NOT be buying long dated US treasuries; cash will be good enough for me (until Buying Opportunity Of A Lifetime The Sequel comes to a theatre near me! :-)

David Rosenberg has mentioned many times that government bond bears focus only on supply. David's view is demand for all bonds is outstripping supply as Boomers are beginning to rebalance portfolios shifting holdings from stocks to bonds. I also see this on a personal level as many of the Boomers I know have been told by their advisers to increase bonds holdings and they are doing so (with gov't bonds getting their fair share). Should equities sell off again (reasonable chance this will happen) the appeal of bonds will only increase (and yields will continue lower to levels we never thought possible). This is also the trade no one is expecting....

Stubble, I am looking forward to seeing what changes Fairfax has made to their portfolios in Q2. They have been very good at being in the right asset class the past few years. In Q4 and Q1 they were net sellers of stocks; the correct move should the current sell off get more aggressive.

I do not think the overall market is anywhere as expensive as it was in 2000 or 2007. I also do not think it is cheap as it was in March of 2009. Cetain sectors have been pretty beat up at look to me to offer pretty good value (big pharma, big oil etc). As a result, I am now 33% invested in equities with the remainder in cash. Should markets go sideways I am happy with what I have. Should markets correct in the coming months I will get more aggressive (i.e. should the general market fall 15% from current levels perhaps I will move to 60% invested and should markets fall 30% from current levels I will look to go to 80% equities).

After reviewing the sector my top pick is Abbott Labs (ABT): well respected, good management, excellent long term track record, good capital allocators, very profitable (should earn over $4.00 in 2010 and over $4.50 in 2011), cheap (trading at a 2010 PE=11). What really separates them from the pack is their growth prospects (low double digit). Their business is also fairly diversified and they do not appear to be facing the patent cliff that others are, such as Pfizer. My second pick is JNJ. I could say much of the same as ABT. The big difference is JNJ will likely grow mid to high single digits (due to its size). My more speculative purchases are BAX, Pfizer and GILD. Bax has had some recent issues but I like its growth prospects looking out. Pfizer is cheap, facing a patent cliff and I am hoping it has something in its pipeline (stock price is saying no). Gilead is cheap, has no patent cliff issues and looks to be buying back lots of stock at current prices. ABT, JNJ, BAX & GILD all have lots of cash and low debt. Should the markets continue to sell off I will look to grow my position in ABT.

Sanj, I hope you are right. My guess is once FFH proves to investors that its reserving practices are in the same league as the industry leaders we will see multiple expansion. BV growth + multiple expansion = investing nirvanna