Viking

S&P500 is trading today 20% HIGHER than it was trading in Feb 2020 - hardly sounds like a bear market to me. Looking under the hood and many sectors - lots of tech - have been shot and left for dead down more than 65%. Lots of other sectors/stocks are down more than 35% - big banks, DIS etc. And you have Apple trading at a 27 PE multiple and Buffett buying more. Tesla, with a $940 million market cap continues to be a head scratcher for me. And sentiment is wickedly bearish. So many significant cross currents. Probably, the best course of action is to do the obvious - buy great companies when they go on sale. But to not be in a hurry, as it may take 6 or more months for the bear to finish its mauling of bond and stock markets. Bottom line, if the Fed continues to aggressively talk down inflation - and hikes and reverses QE as fast as anticipated - and this causes interest rates to CONTINUE TO RISE then my guess is stock market averages will continue to go lower (likely driven by big tech). i am happy to trade the volatility with a chunk of my portfolio. Josh Brown has an interesting theory of how to play the market right now: buy when vix spikes to 30 (when everyone is panicking) and sell when vix gets close to 20. Rinse and repeat.

Nice overview of the economic linkages of housing to the rest of the economy. I found interesting his explanation of why treasury yields might actually fall as the Fed gets further along the tightening cycle (he called it second order effects). It is super interesting how divergent the forecasts are today of many smart commentators… likely means volatility will stay high, until a more consensus view emerges.

We really do not have very good information in Canada on what is really going on with housing. I think it is pretty clear that lots of first time buyers are getting the down payment from parents/family members. Where are these people getting the $ from? Perhaps a home equity line of credit? Is this kind of borrowing increasing? How do rising interest rates affect those borrowers? Would this debt show up in mortgage numbers? MOST IMPORTANTLY, with mortgage rates spiking, will parents be as willing to pull $100,000 or $200,000 out of their HELOC today to help their kid out? Will the big banks start to crack down on this type of borrowing (get a little more stringent)? My guess is the first time home buyer is the key to any housing market… when this group pulls back then it will significantly impact the rest of the housing food chain. As we get the April housing data for Canada it is becoming clear that: 1.) Feb was peak pricing 2.) prices were lower in March (@4% from Feb) 3.) prices were lower again in April (@8% from Feb) 4.) housing inventory is starting to grow (still historically low) 5.) affordability is still at historic lows (given spike in interest/mortgage rates) Bottom line, looks like rising borrowing costs are having the desired impact of slowing the housing market in Canada: rising inventory and declining prices - from Feb peak. Not a panic. But the speed of the turn is surprising given housing trends usually move, and change, at a very slow speed.

Is ‘macro call’ (with attached probability) and ‘risk mitigation’ not largely different sides of the same coin? ————— In terms of re-deploying the cash and short term holdings… it appears Fairfax is redeploying to max 1 to 2 year duration for now. Why not longer duration? Prem talked about ‘70’s inflation and long interest rates that went to 16%… so Fairfax is going to be ‘very careful’… ‘protection’ is the priority. i do wonder what happens to other insurers and capital levels if interest rates do the unthinkable and keep moving higher (like even 4 to 5% across the curve). I can’t see how rates could go much higher due to international capital flows… If rates in the US spike another leg higher then would we not see historic devaluation of Yen and Euro versus US$? ————— From Q1 Conference Call Tom MacKinnon: Okay, that’s great. And then, in terms of deploying some more cash into bonds, are you kind of finished with that now or would you look at putting more of your substantial cash position in the bonds going forward? Prem Watsa: Yeah, so, Tom, we think the big risk today is the fact that people have not -- for 40 years, interest rates have gone down and you have to be in the business for a long time, like in the ‘70s, to have seen how interest rates went up, inflation went up, interest rates went up. So the big risk today, as I said, is interest rates going up, and we don’t know how high it is going to go. So what we’ve done is just one or two year bonds -- we are limiting our investments to one and two years, which by the way significant increase in interest rates have taken place in that term one to two years. And Brian Bradstreet, that’s what he’s limiting it to, two years max, and just rolling it over, as Peter told you in his presentation. Tom MacKinnon: If rates continued to rise, would you look at deploying more or what would be your thinking in terms of what you would want to see before? Prem Watsa: Tom. Yeah, if you were in the ‘70s, you’d have thought the rates were much higher than of course, what 5%, 6%, 7%, would have been good rates, 8% would have been good rates. 10%, 11%, 12% would have been good. It went to 21%. Long Canadas, that’s 30 year Canadas went to an unbelievable 16%. On the other side, in the pandemic treasury bonds went – 10-year treasuries went to 0.5%, never in the history of -- at least the modern history, including depression of the ‘30s, 10-year treasuries go to 0.5%, they did and they stayed for some time. So, you have to be just very, very careful. You can’t have preconceived ideas as to what can happen and we’re just being very, very careful. We’ve protected our company for 36 years, we want to last 100 years, we’re going to be very careful.

Fairfax has a long history of making big macro calls. Sometimes they work out spectacularly well like the CDS bet in 2008. Fairfax could have been added as another big winner in Michael Lewis’ book The Big Short. And sometimes the macro call works out spectacularly badly like the short positioning from 2013-2020. Another big macro call was moving the massive bond portfolio to a duration of 1.2 years at the end of 2021. Given the spike in bond yields that we have seen in the past 4 months Fairfax is the best positioned of all large P&C insurers - and by far. Fairfax’s bond portfolio has an average duration of 1.2 years. WR Berkley is next at 2.4 years. Most P&C insurers are closer to 4 years. So how much money will this bet make for shareholders in the coming year? Could it be as much as $1 billion? More? (IE. What if both short and long term treasury interest rates get to 3.5% by year end?) i would love to hear how other board members are thinking about this macro bet and, importantly, what will be the financial impact and rough $ benefit to Fairfax and shareholders?

I was wondering how Mr Market would react to earnings today. - Fairfax finished +1.1% - S&P500 finished -3.6% Perhaps Mr Market is starting to understand that Fairfax will be a BIG winner in a rising interest rate environment. Perhaps record and growing operating earnings will lead to a re-rating of the stock to something closer to 1XBV. RBC just raised price target from US$675 to $750. They call Fairfax ‘best-in-class value opportunity at about 0.85x book value’ ————— From the RBC Report: Underwriting results continue to improve, a shift towards more yield in investment portfolio Our view: The hard market continues to drive strong top-line growth and improved underwriting margins and management did an excellent job of protecting book value as interest rates rose, positioning them for improved investment results going forward. While the portfolio remains complex, the value positioning seems well suited to current market conditions. With underwriting contributions improving and the balance sheet as well positioned as we've seen it in some time, we see significant room for multiple expansion and continue to view FFH shares as a best-in-class value opportunity at about 0.85x book value. Estimates: We are lowering our 2022 net income estimate to $54.95 from $67.50, which primarily reflects the results in the quarter partly offset by improving investment income. Our 2023 estimate rises to $75.00 from $73.75, also reflecting higher investment income partly offset by more conservative margin assumptions. On an operating basis, we are revising our estimate to $55.19 from $55.78 for 2022 and to $63.29 from $62.05 for 2023. Price target: We are increasing our price target to $750 from $675 (about C$950, up from C$875 at a 1.27:1 exchange rate). Our target remains based on 1.0x book value, which we now apply to ending 2023 book versus 2022 book previously. With good visibility to further book value growth together with a company generating underwriting profits in the middle of a hard market, we think 1.0x book value is a very attractive multiple.

GOOG, AMZN, added to BAC, CRM, DIS, NFLX

Some initial thoughts from Q1 earnings: 1.) CR = 93.1 (Q4 was 88.1 - suggests we might see CR below 94 for the year) 2.) interest and dividend income has clearly bottomed and is now growing again (year over year). Growth should accelerate as the year progresses. Average duration in Q1 was increased from 1.2 to 1.4 years. Given the continued spike in bond yields since March 31 it is GREAT NEWS that Fairfax is being patient to redeploy into higher yielding assets. 3.) Fairfax is on track to deliver $2 billion in operating income (underwriting + interest and dividend income) in 2022. Not sure how run-off affects this right now (subtract $100-$150 million?). 4.) top line growth was +20%. Chubb CEO said we are still in a hard market and it is still going strong. 5.) hard market (20% top line growth) + sub 94CR (and falling due to hard market) + rapidly increasing interest income (due to spiking bond yields and extremely low avg duration) = 2023 operating income of +$2.4 billion. Not sure how run off affects this ( subtract $100-$150 million?). 6.) an investor today is almost getting all of the upside from the equity investments/Digit pretty much for free. That just cracks me up. Crazy times!

@hobbit i was going over some old posts… What do you see as the trigger for Fairfax India to increase the valuation of the airport? Is it perhaps the sale of another sliver of Anchorage - at a higher price than OMERS paid? Would opening the second terminal later this year be sufficient? Or something else? The airport really is the key building block to value Fairfax India as it is the largest asset by far. If we get further confirmation that the current valuation for BIAL is indeed accurate (or even low) then that would scream that the $20 BV is real and the shares are, indeed, wicked cheap at $12.20. Regardless i bought another big slug today. Looking forward to reading the earnings report tomorrow.

My read is there has been a lot of speculating going on with the real estate market in Canada. The stats available for housing are pretty pathetic so it is kind of a big black box. My guess is an investor buying today will rent and be cash flow negative. The investment thesis is built around continuing capital appreciation - ever higher prices. My guess is if we ever see a 10 or 20% decline in nominal prices that persists for +12 months then we might see some distress. Especially if we see higher interest rates. We know property taxes will be going up dramatically (likely at inflation). Here in Vancouver we have rent controls - the allowed increase for 2022 was 1.5%. Revenue not keeping up with expenses + falling asset price = trouble for speculators.

Peter Lynch in one of my favourite investment books (One Up On Wall Street) says the first thing a person/couple should do is buy a house - not stocks. Great advice. ————— One of my buddies bought a house when we were both still young (a few years out of university). i asked why a house? He said he and his wife were terrible with money. But they would pay their mortgage. So he knew his financial future would be secure. Smart like a fox.

The new class divide in Canada is ‘do you own assets or not’? It is no longer worker / owner. Do you own: House? average house is likely worth +$800,000. Stocks? Pension? All 3? You are rich. Rent? Don’t own stocks? No pension? None of the 3? You have just missed out on the greatest financial windfall in Canadian history - over the past 10 years. Everyone that has owned a house for the past 8-10 years in greater Vancouver or Toronto is now a millionaire (at least). Population of greater Vancouver and Toronto is what… 12 million or so? That is a lot of wealth creation. Actually, owning a house for the past 5 years was probably enough. Many people own multiple properties. Gains are tax free (principal residence). Anyone who has been renting the past 5 to 10 years has completely missed the party. That is crazy.

It looks to me like there has been a massive wealth transfer the past few years (with negative real interest rates) from savers AND debt holders to those who borrow. And the more leverage the better. Central banks normalizing interest rates will: 1.) start to pay savers and debt holders a better rate of return 2.) likely end the party for borrowers, especially those with/needing lots of leverage

High real estate prices in the US? Nope. At least not compared to Canada. As has been discussed extensively on this board, the real estate market in Canada has been a runaway train since 2000. A family member just sold a 1,400 sq foot house in a very small forestry community (with forestry shrinking) for C$500,000 (it was only a couple of years old). Community is remote and 8 hour drive from Vancouver. Nuts. The next 24 should be very interesting… ————— Double trouble: A house in Canada now costs nearly twice what it does in the US - https://nypost.com/2022/04/25/the-average-canadian-home-price-is-now-double-that-of-us/ American homebuyers can take small comfort: It’s far worse up north. The Canadian housing market is even more ludicrously expensive than the US’s, with the nation’s home prices recently reaching a new record high, which puts the average housing cost at almost double that of America’s. Since early 2020, Canadian home prices have surged 30%, an increase which is “nothing short of stunning,” economist Robert Hogue wrote for a recent Royal Bank of Canada report (via Fortune). As of February, the Canadian Real Estate Association reported that the average price of a Canadian home stood at 816,720 Canadian dollars, or $646,809 — over nine times the average household income. In contrast, the US has seen slightly lower price increases, with home prices rising 27% over the same period, Fortune previously reported. In America, the median home price last month stood at $375,000, an all-time high and a 15% rise from a year prior.

My comment was they were insanely valued. Now ‘just’ super high. I was talking about the 4 collectively (and forgot to included Tesla). Looking at Google finance, Microsoft currently has a PE of 29. Stock was up 500% in past 5 years (at its peak). Stock is still up 400% after the recent sell off. Yes, earnings is up significantly. But the biggest driver of the stock prices of all the FAANG (+ Tesla) stocks the past 5 years was multiple expansion. Especially Apple. This is sentiment. And in bear markets, sentiment can quickly turn the other way. And that is what we are seeing. FYI, if Alphabet opens lower tomorrow (it is down 6% after hours) i will be buying. Facebook as well (although i will be holding my nose with that stock). Apple and Microsoft i am going to sit tight a little longer. And Tesla i would not touch with a 10 foot pole

BAC (add), JPM, MS, VZ, SHOP, NFLX (small add), FIH (add), LNR, RECP Sold a little more Fairfax

i would add Apple, Microsoft, Alphabet and Amazon. Just like the Nifty 50. Best companies. Super bright prospects. Were insanely valued. Still super high valuation. Works for many years… until it doesn’t.

The Feds well communicated goal to slow inflation is is to tighten financial conditions. One component of financial conditions is the stock market via the wealth effect. Your stock portfolio goes up 50% you ARE MORE WEALTHY. And you spend more than you otherwise would have. Stock averages (S&P500) were up +100% from their pandemic lows and up 40% from BEFORE THE PANDEMIC - TO THE START OF THIS YEAR. That was an absolute shitload of wealth creation. So the Fed wants stocks to fall. Guess what? It looks like the Fed is getting its wish. The S&P500 is down 12% from its highs. Not terrible… but getting there. This could be the key week. Apple, Microsoft, Alphabet, Amazon and Tesla are the key stocks. Looks like Tesla may have cracked today (despite reporting earnings that beat expectations). The other 4 companies report tonight and Thursday… if we get any negative surprises look out below. But even good might not matter. I am starting to wonder if FAANG is going to experience the same fate that the Nifty 50 did back in the early 1970’s… crazy times.

WRB had a very good quarter. Despite the spike in bond yields they grew book value (thanks in part to realizing a big real estate gain). The average duration on their bond portfolio was 2.4 Dec 31 and was still 2.4 at March 31. Their average liability is 4 years. When asked when they will stretch duration they said they feel they are not yet getting paid enough on 5 and 10 year bonds… and they want to see where inflation goes before making a big move to stretch duration. They also discussed the value of having a bond portfolio with duration of 2.4 years (in a rising interest rate environment). It has hurt interest income in short term. With interest rising spiking the hit to BV is MUCH LESS than peers. And as they redeploy, interest income will be higher in future years. Importantly, WRB gave a VERY BULLISH outlook for the rest of 2022, 2023 and 2024. Why? Continied top line growth. Benefit of lag as written premiums become earned. Higher interest income (as duration of bond portfolio is extended). Benefit of hard market pricing (on improving underwriting results) will play out over many years (as they are being very conservative with loss picks). It appears the turn in workers comp (from soft to hard market) is likely 12-36 months away.

@crazyjsj Super interesting post… thanks for taking the time to share your thoughts.

Can anyone please explain to me what China is thinking with its zero covid policy? Is it not pretty much a scientific certainty that it is doomed to fail? This was predicted back when Omicron got rolling, and picked up steam with variant 2 (that China’s zero covid policy would fail). Omicron-variant 2 is simply too contagious to stop. Most importantly, what will the impact of this policy have on the Chinese economy in 2022. Shanghai has been in lock down for close to 5 weeks. Are we witnessing a slow moving train wreck in China that will just keep playing out for the rest of 2022 and after? As long as the zero covid policy stays in place? Clearly, the zero covid policy will result in lower economic growth in 2022. If Omicron continues to spread, and what we are seeing in Shanghai plays out in other large cities in China, how low will economic growth in China be? Lower economic growth will result in less demand for commodities - and this will affect the current bull case. We will also see significant supply chain disruptions - and this will affect inflation in the rest of the world. Or do investors view what is going on in China as being a big nothingburger? ————— I also wonder if this policy, if it continues, will not do significant damage to the credibility of the Chinese Communist Party? They clearly feel they will lose credibility if they now reverse the zero covid policy. But is the alternative better? What am i missing?

I do play this game with some stocks i own (sell a portion on a nice run up; lock in a nice gain; anticipating i will likely be able to re-buy on the next 10-20% decline). And usually in my tax free accounts. Real estate? No. Now i have only ever owned a primary home - no vacation or investment property. So for me real estate has been primarily for living; the investing component has been secondary. Why not own real estate as an investment? A big reason is liquidity. Another is complexity. Another is fit. - Real estate is hard to sell. Transactions costs are significant. There are tax considerations. There are the maintenance costs. And the tenant issues. - the leverage provided from a mortgage can make gains from real estate a life changer ————— Now a year ago i did cash out of the Vancouver real estate market - we sold our primary residence. The decision was driven by quality of life decisions - not financial. However, financially, selling the house was an absolute home run. We sold our house for more than twice what we paid for it 11 years before. Because we had a mortgage (avg interest rate over 11 years was about 3.25%!), by selling we locked in a 3x tax free gain on our initial investment (gains on sale of primary residence are not taxed in Canada). Middle of last year proceeds from our house sale (closed in of June) were then flipped into stocks. Today, proceeds from our house have grown by a little over 30% in 10 months (1/3 of initial proceeds from house sale were flipped into tax free accounts and 2/3 are in taxable accounts). And these proceeds will now keep compounding… irrespective of what happens to the real estate market in Vancouver. Love it. Today we rent a 4 bedroom 2,300 square foot house in one of the nicest parts of Vancouver (walking distance to multiple beaches and some of the best restaurants in town). Rent is $5,075/month… was $5,000 and just increased 1.5% (rent increases are controlled in Vancouver :-). House is likely worth close to $3 million. 2 of our 3 kids will be moving back home for the summer. I am already starting to think about where i want to live next… Would be pretty cool to live in Europe for 3 or 6 months… We will see. ————— Some of the proceeds from our house sale that are in taxable accounts will be used this summer to provide the seed money to kick start savings plans (tax free plans) for each of our three kids. My guess is by the time they graduate from university each of them will have about $50,000 in a Tax Free Savings Account. So they will graduate from university with no debt and have a nice head start in terms of savings (and a vehicle - and skin in the game - for me to teach them more about investing). Another unanticipated financial benefit of selling our principal residence (we did not have the cash - in taxable accounts - to do this before selling our house) that could really pay off in the coming years as compound interest works its magic. ————— Will i own real estate in the future? Probably. If we saw a correction in real estate prices in Vancouver in the next couple of years i would likely seriously consider buying a 2 bedroom unit. We have 3 kids - at least one or two who will likely be long term residents of Vancouver. A one bedroom rents for about $1,500; 2 bedroom close to $2,800. One of my kids staying there solves the renter problem. They can rent the second bedroom out to a buddy and that will help cover some of the cost problem. Most importantly it would provide a stepping stone for one of my kids to be able to live/own long term in one of the most expensive cities in the world. So a blend of quality of life/financial decision criteria. Something i am just starting to think about (my wife thinks i am a little nuts)…

7 years in, Fairfax India has started to more aggressively monetize some of its holdings. This does a couple of important things. 1.) it provides investors with another scorecard for management. What was paid originally? What was the asset sold for? What did Fairfax India management do in the interim (if anything) to add value? And ultimately, what did the investment return for shareholders? 2.) it also provides investors with some clarity on just how accurate reported BV for Fairfax India actually is. Where positions sold at a valuation close to BV? 3.) it also provides Fairfax India with an influx of cash. ————— So what did we learn from sales announced over past 12 months? Proceeds will be about $530 million. Cost was about $240 million. Gain will be about $290 million. Financial return for investors is impressive. And what did management at Fairfax India do to unlock value? Lots. 1.) substantial work was done with Privii and Fairchem over the years culminating in the split of the two companies into their current form. And the returns for Fairfax shareholders so far have been spectacular. 2.) substantial work was done with IIFL over the years - most importantly, the split of IIFL into 4 separate companies, each of which are thriving. 3.) substantial work has been done at BIAL over the years - BIAL has been developed into an incredible asset. Fairfax India has also created a new platform - Anchorage - to participate in what is looking like an infrastructure boom in India. Bottom line, over the years management at Fairfax India has provided enormous value to the companies it has invested in (i would argue Fairfax India has a competency in this regard that is far superior to that of Fairfax - the mother company). Were the companies sold at valuations close to BV? Yes. (Prem provided a great deal of clarity as to the actual selling prices received during the Q&A at the Fairfax India annual meeting). Bottom line, BV is supported by actual sales. What is Fairfax India doing with the cash? That will be the subject of a future post. More good news… ————- Fairfax India sales the past 12 months 1.) April 2021: Privii: proceeds of $163 million gain was $127 million; 27% compound annual return 2.) Sept 2021: Anchorage (10% of BIAL): proceeds of $129 million - transaction values all of BIAL at $2.6 billion; Fairfax India’s cost was $1.2 billion (100% basis). Sale provides return of about 115% over cost. 3.) Nov 2021: Fairchem: sold 13.9% for $46 million realized gain = $34 million - Still own 52.8% with value of $155 million (Dec 31) 4.) March 2022 (to close Q3): 9.8% of IIFL Wealth: proceeds of $191 million - locks in realized gain of $65 million = +20% per year from original purchase - Still own 3.8% with value of $74 million

Fairfax India’s initial IPO was done in Jan 2015 at $9.50 (net of taxes). They did a second large capital raise in Jan 2017 at $11.75. Shares are trading today at $12.60. What has the company done over the past 7 years? They have assembled a wonderful collection of assets/companies. Each is well run, well positioned and growing nicely. Book value of Fairfax India today is about $20. Is book value accurate? Roughly speaking i think it is. ————- Investors buy companies HOPING management grows the business and builds value for shareholders over time. The interesting thing is investors are able to buy Fairfax India TODAY at a price not far off the IPO price of 7 years ago… and get 7 years of outstanding performance ALMOST FOR FREE. And, given the outstanding track record of current management, INVESTORS BUYING FAIRFAX INDIA TODAY WILL ALSO FULLY PARTICIPATE IN ALL FUTURE GROWTH. It really is a completely bizarre set up. Put simply, the current valuation of Fairfax India ($12.60) is completely NUTS. It is worth much more than that today. And, given managements stellar track record, it will be worth much more in the future. THE ONLY QUESTION IS WHEN WILL MR MARKET FIGURE IT OUT? It is a question SOLELY of timing. For an investor with a long term focus (where timing does not matter) then Fairfax India priced at $12.60 is called wonderful opportunity. With shares priced at $12.60 investors are getting a very high margin of safety.

The real kick in the nuts is if you bought at the peak in Feb and prices correct 10-15% over the next 12-18 months. Your monthly cost to own went up $1,000 (your example). And the value of your shiny new asset just dropped n value by $100,000 (from $800,000 to $700,000). Leverage is a beautiful thing but only as long as home prices to up.