Viking

@ValueArb no idea. My read is the risk for housing today is not rising interest rates. It is a slowing economy. The PMI’s today were weak… due to Omicron? Or is the economy rolling over?

Well the S&P is now down 10% from highs so we have officially entered correction territory. Russell is down 20% so that index has entered bear market territory. Everything is getting hit now. Weak PMI numbers are just throwing gasoline in the fire. Netflix is now $365. Netflix was trading at these levels back in May 2018! Forget about pre-pandemic levels… And Tesla is at $890. Down 25%. And was trading at $45 in Nov 2019… Perhaps we need to change the title of this post to: The Bottom is Coming…

It is interesting to compare Fairfax’s current situation to what happened when we had the last big financial market dislocation in March of 2020. In March of 2020 Fairfax: 1.) insurance: losses from pandemic were unknown; lock downs were throttling business activity 2.) equities: many of Fairfax’s holdings were getting crushed (cyclicals, small cap, hospitality, financials, emerging markets). 3.) bonds: more of a mixed picture for Fairfax. Plunge in government yields would increase earnings and BV of holdings. Short spike in higher risk yields of higher risk bonds were an opportunity. Pain from much lower yields would only be felt in future. Bottom line, Fairfax BV and earnings cratered. And the shares cratered. Fast forward to today: 1.) insurance: hard market continues to roll. Economy expected to expand above trend in 2022. Prospects took very good. 2.) equities: we are seeing a bear market in speculative Nasdaq stocks. Fairfax’s top positions (Atlas, Eurobank, FFH TRS) are holding up well (so far) 3.) bonds: with yields across the curve spiking Fairfax should see interest income start to move higher again. There will be a hit to earnings and BV as current bond holdings are re-valued at quarter end (but Fairfax will be hit much less than most other insurance companies who have much more duration in their bond portfolio). If Fairfax is able to re-deploy some of its significant short term cash/holdings into longer dated bonds (yielding higher amounts) that will be a big, big win for shareholders (boosting interest income and locking in higher operating earnings in future years - something that would be highly valued by investment community). Bottom line, Fairfax in a much better situation to withstand the current market turmoil. And that is likely why we are not seeing shares sell off aggressively. At least not yet

For people who have a rational framework and follow it and some experience… lots will be able to get through drawdowns like we are seeing right now. However, for the other 75% of the market (Cathy Wood disciples, momentum crowd, new money retail investor, index investor) it looks to me like there is more pain to come (and maybe lots more). Netflix cracked today; now down 40% from its highs. My guess is we will see all of big tech/Tesla roll over before we can start to talk about actually hitting a market bottom. Tesla is still at $1,000… Seriously? The Nasdaq was trading at 9,800 in Feb of 2020 (pre-covid) and today it closed at 14,100. Do people think it has corrected? It is still up 40% from its pre-pandemic high (when it wasn’t exactly cheap)… doesn’t look like much of a correction to me. This is all happening because the Fed talking about tightening. Liquidity is the key. This has been the driver of financial markets for 10 years. When the Fed pumps money into the system you buy stocks. When the Fed takes money out of the system you better have some cash on hand. Also, the Fed is STILL PUMPING MONEY INTO THE SYSTEM… It hasn’t even started removing liquidity/tightening. Think about that for a minute… Wait until they actually start raising interest rates and running off their balance sheet. What we have seen in financial markets the past 3 weeks is just foreplay… the real action is coming in the months ahead. And that is because the market is used to throwing a tantrum resulting in the Fed IMMEDIATELY reversing course (from tightening to easing). But the market has not figured out that the Fed ‘put’ is gone. When financial markets figure this out that is when things will get ugly/interesting. Like when we were kids and we discovered one one day that Santa Claus was not real (sorry to break the news to those of you who did not know this already…). Inflation data is going to be terrible the next couple of months (look at the price of everything including oil) - like continuing to rip at 7% ugly. The Fed is so screwed - watch Jay Powell squirm in his seat next week trying to keep financial markets and inflation hawks happy at the same time. When i ran a financial literacy club when my kids were in high school i started out the investing unit by showing the kids a picture of a person puking over a toilet… Most people are NOT buy and hold because they are not emotionally able to handle big sell offs in the market (of 20% or more).

KB Homes had their quarterly conference call last week. They were asked about higher rates. The CEO said higher rates will have no impact on their ability to sell new homes. And that is because most people buying are making a ‘needs based’ decision. So they will eat a higher mortgage rate. He said they have thousands of people on lists nationally who want to buy right now. The issue is supply - can’t make houses fast enough due to supply chain constraints/shortage of labour and materials. When you have a shortage of houses - caused by under-building for a decade - and then you have three demand shocks all happening at once: 1.) covid/stay at home 2.) demographics - millennials are just entering prime home buying years 3.) investor demand - single family homes are the hot new investment class with individuals and also institutions (inflation hedge and more) Is anyone surprised prices are rocking? And my guess is it last for a few years. My way to play the housing boom is to own lumber stocks (well just West Fraser today).

@hobbit thanks for posting. Solid overview of Fairfax India (i quickly went through the presentation). I will listen to the audio tomorrow. BIAL is really positioned well when get to the other side of Omicron/pandemic in another couple of months. I think international travel could spike (massive pent up demand). Fairfax India has performed exceptionally well the past year - even with 1/3 of its BV (BIAL) in a holding pattern. Looking forward to BIAL ‘taking off’. Hopefully this is one of the catalysts that finally get Fairfax India shares airborne

obviously not representative. In my old house my ‘new’ neighbour was super nice family from South Korea. Wife was a tv/movie celebrity back home. After they bought the house they completely renovated it (before moving in) right down to heated floors in garage. Completely re-landscaped. Probably spend $150,000 on renovations. This is not an exceptional example of the type of immigrant coming to Canada. Lots of new $ coming in. With lots spent on goods and services providing a boost to economic activity. ————— As an aside, my favourite memory with the new family (they had 2 young kids) was showing them how to build a large igloo in the snow shortly after they moved in. I explained to the family that ideal igloo snow building conditions only happened once every 5 or so years in Vancouver (enough snow and sticky so it can be rolled and used to build a structure). And we had perfect conditions that day. Man were they ever surprised and happy with the final product (they clearly had no previous snow building experience). Took us about 4 hours. Snapped a ton of pictures and played in it every day. Great introduction to Canada. And, of course, the igloo was gone a week later (melted).

@glider3834 thanks for posting. Very humble man; comfortable in his own skin. I found the comments regarding Prem to be interesting (about 28 min mark). The relationship with Kamesh (before Digit was a twinkle in his eye) was built over many years with lots of work from Prem. And now Fairfax has a significant stake in Digit. We like to hammer on Prem. Digit is a great example of Prem at his best. Relationship builder. Trusted. Risk taker.

The current market set up is feeling an awful lot like the late 90’s. A sub sector of the market (dot com and tech names back then) is getting absolutely destroyed today. Meanwhile, the cheap, old economy stuff (like FFH, BRK, banks, commodities etc) that was cheap for years gets its groove back and performs well over the next couple of years.

That is similar to the approach i take with family members who complain about banking fees or the cost of their cell plan… i tell them to buy banks or the cell providers and make $ on the other side (that whole Munger invert thing). But they refuse. And keep complaining…

What to do when energy costs spike? If you are an energy company in the UK you send your customers a pair of socks so they can stay warm. Another suggested customers cuddle a pet or do jumping jacks. Now i know Brits are different ducks… but really? Energy markets are VERY messed up right now. Especially Europe. We are just starting to see the consequences of decisions made the past 6 years or so on the energy front. But energy policy is now religion - no place for logic… it is all about what you believe. Where do energy prices go in 2022? My guess is socks, pets or jumping jacks are not going to solve any of the root problems… ————— E.ON says sorry for sending socks to customers with advice to keep warm - Energy supplier sent pairs to 30,000 households with advice on turning down heating to cut carbon footprint - Many of the new E.ON Next sock owners took to social media to criticise the “pitiful package”, which was delivered to homes in the same week that Ovo Energy was forced to apologise for a customer letter urging households to cuddle a pet or perform star jumps to keep warm. - The apology comes days after Stephen Fitzpatrick, the boss of Ovo Energy, which bought SSE’s supply business two years ago, was forced to apologise for a “ridiculous” email that urged customers to enjoy “hearty bowls of porridge” or a “hula hoop contest” to help stay warm this winter. https://www.theguardian.com/business/2022/jan/14/eon-says-sorry-for-sending-socks-to-customers-with-advice-to-keep-warm

2021YE BV north of US$600 sounds reasonable to me too. Stock hardly looks expensive trading around $515 = 0.85xBV. I think US$700 is a reasonable (low) target for YE 2022 BV (absent a 20% drop in the stock market). At 0.9xBV = YE stock price = $630 which would be a +20% return from where the stock is trading today. Review of a few of the ‘fundamentals’: 1.) hard market driving double digit top line and lower CR 2.) bond portfolio is positioned very well for rising rates 3.) equity portfolio is positioned very well: Atlas, Eurobank, commodity plays (Stelco, RFP, EXCO) 4.) FFH TRS poised to add to earnings 5.) Digit IPO? This would be a big time catalyst given its likely size ($3-4 billion?) 6.) post omicron pick up in international travel will be very good for BIAL; potential IPO of Anchorage? 7.) more share buybacks, with the pace driven by quarterly earnings Another catalyst will be improvement in sentiment with investors. Fairfax has just completed a superb 2021. 2022 is looking solid. Prem’s letter, and rightly so, will lay out all the many wins in 2021 and expand on the many good things going on under the hood at Fairfax. The narrative will improve. Investment advisors will be ok putting a small amount of clients $ into Fairfax. And the PE multiple will likely expand. (Having an in-person annual meeting will also help…)

The US$10 dividend payment coming soon (record date Jan 20) is likely pushing shares a little higher. And then early Feb will be all about earnings for P&C and then Fairfax (as FFH usually reports later than WRB CB etc). Lots to be digested over the next 3-4 weeks.

I was not sure how shares would trade once the dutch auction had completed. I am pleasantly surprised they are trading higher than US$500 (although i was hoping they would drop back to the US$450-$460). Perhaps the period of severe undervaluation of Fairfax shares that we have seen the past 22 months is over. And now we are entering a more normal just ‘undervalued’ phase. If the shares continue to move higher in 2022 the dutch auction may prove to be one of Fairfax’s best decisions in 2021. 2 million shares at US$500; something to file away. Share buybacks should be done when the stock is trading below intrinsic value. Looks like Fairfax nailed this one. Just another of many examples from the past couple of years of much better decision making from Fairfax’s management team. Chug, chug, chug…

As we start 2022 Eurobank will be a Fairfax holding to watch. It is Fairfax’s second largest equity holding so how it performs matters. Financials are getting a lot of love. And we could see a monster year from international travel (as we get to the other side of Omicron) and this would be very bullish for the Greek economy. Real estate prices are also expected to be strong. Lots of tailwinds for Eurobank. Eurobank stock is up 13% in less than 2 weeks to start the year (from € 0.89 to 1.01). This is about a US$150 million increase for Fairfax. I think the stock is trading at a new multiyear high which is nice to see. We should see solid earnings combined with PE multiple expansion in 2022. My guess is the party is just getting started.

@Gregmal “HOW DOES IT HAPPEN” My read is we have seen central banks pump an unprecedented amount of liquidity into the economy starting in 2008. Initially it was done get the economy out of recession and ensure disinflationary/deflationary forces did not become permanent. QE + ever lower interest rates. The liquidity being pumped into the system reached a climax in 2021. 14 years later we have asset bubbles forming in bonds (most now have large negative real yields), stocks (Tesla, Bitcoin, ARC, SPAC are just a few of the poster children today), and real estate (just getting started in US but far along in other countries like Canada). So if unprecedented levels of liquidity drive asset prices into the stratosphere then it makes sense to me that simply turning the tap off will challenge asset valuations. The real problem is when the liquidity REVERSES. That is when the fireworks happen. Maybe not right away (the first rate hike). But when the Fed TRIES to hike rates AND do balance sheet run off at the same time i think the stock market will sell off and steeply = tantrum. THE NEW NEWS is the Fed will likely do nothing in response. At least initially. And that is because it is fighting a new war today called inflation; the playbook to fight inflation says you need to slow economic activity. The key will be where inflation goes from here (no one really knows). IF INFLATION IS CONTINUING TO RIP AT +6% INTO JUNE THEN THE FED WILL HAVE TO IGNORE A STOCK MARKET TANTRUM. And that is perhaps when we enter a brave new world for equity investors. i am not saying this WILL happen. However, I do think the risks are elevated in 2022 especially as the year progresses. Especially if inflation continues to run hot. I am not saying build a bunker, buy some spam and a generator and get ready (like i was when the Covid tsunami was coming in Feb of 2020). While it is always more fun (and usually more rewarding) to play offense, sometimes it pays to focus a little more on defense. (Buffetts first rule: don’t lose what you got. He made it rule #1 for a reason ) Now if i was younger i would likely be fully invested and hoping for a shit storm (so i could invest more $ in cheaper stocks). But i am older and have enough - so capital preservation is near the top of my list (if i really think about it).

We know the Fed will be ending Taper in March. It looks like the first interest rate increase may be as soon as March. We now also know they will be reducing the sizeof their balance sheet in 2022. The issue is everything happening pretty much at the same time in an accelerated way in 2022 driven by the inflation print (and all the people yelling hysterically for someone to do something… the US is in an election year). Over the past 10 years EVERY TIME the Fed tried to get more hawkish the stock market threw a tantrum and the Fed quickly reversed course. The Fed was able to quickly reverse course because DEFLATION was the big, big worry. So i fully expect, as the Fed gets more hawkish, for the stock market to throw another tantrum (like 2018; down 20%). Everyone will expect the Fed to reverse course. Except this time INFLATION will be the Fed’s big, big worry. So my guess is the Fed may not come to the stock markets rescue this time… (at least not as quickly). I expect a shitload of volatility as there will be way, way too many balls flying around at the same time and i fully expect a bunch to hit the ground likely at the same time. My plan will be to build cash in the coming months. i love cash because it allows me to lock in gains. And it makes it easy to ride out any storm. And it provides the opportunity to buy when there is blood in the streets.

Just imagine what $100 oil does to the inflation picture moving forward. Especially if oil stays elevated (as expected) in the $80-$90 range into 2023. Given the shortage of workers - wage increases should stay at elevated levels for some time. Given the shortage of houses - house prices (and rents) increases should continue to elevated levels. When you weave it all together it does suggest higher inflation for longer. The interesting thing is the Fed raising interest rates will do little to solve some of the root problems. Oil going to $100 will be caused primarily by limited supply (thank you ESG). Higher wages are being driven by an acute shortage of workers (thank you pandemic). A shortage of houses (thank you decade of under-building) is a key driver of the spike in housing prices. Don’t get me wrong… Fed policies are blowing up asset bubbles everywhere. If the Fed HAS to get much more aggressive to fight inflation the big obvious loser will be the stock market. The 2H of this year could be ugly.

@Blugolds11 great post. We villify low income earners who game the system. And celebrate high income earners who game the system. Each simply does it in their own way; not surprising human nature being what it is. In terms of labour and the current severe shortage perhaps the real issue is the US simply does not have enough workers. Usually the simplest answer is the best one. I do find it interesting that when all the government covid payments ended earlier in 2021 we did not se a spike in labour participation (all those lazy people collecting free money would be forced back to work). This of course did not happen. Shocker (well, we don’t talk about that failed theory any more in polite company). I am not sure the lack of workers in the US today is due primarily to lazy people who do not want to work. But hey, some people believe in Santa Claus. Maybe he really does exist! I try and stay open minded… Immigration is one easy solution but has become such a political hot potato it is perhaps of limited use for the US.

i don’t see a recession in 2023. Too many tailwinds… housing is a big economic engine and it should continue to roll (even if the Fed raises rates 3 times in 2022). Tech is growing like crazy (and hiring like crazy). Broken global supply chains will see more production shift back to the US (slowly). People (finally) are getting China (adversary) and this will see investment shift back to US. Services part of the economy will boom post Omicron, especially international travel. The US has lowest energy costs in world; this will see production for some energy intensive industries shift back to US. Investment in electric vehicles will be massive. Investment in alternative energy will be massive. Investment in infrastructure will be large. The US has a BIG problem today. It does not have the labour for all the demand today. Demand for labour is exploding.. except.. there is no corresponding increase in labour supply. Can a severe shortage of labour in an otherwise strong economy cause a recession? Economics is really interesting because sometimes stuff happens that ‘the models’ have never seen before… so ‘economists’ (and everyone else… politicians, central banks etc) gets it completely wrong. But of course they actually got it ‘right’ based on their (flawed) models… Its not what you know that gets you in trouble; it’s what you know that ain’t so… ————— Population growth is an interesting thing. Highly correlated with GDP growth. Immigration is one solution…

Glider, rising bond yields will be something to watch with Fairfax and all insurance companies. There will be two impacts: 1.) in the near term the hit to earnings and BV as rising bond yields lower value of bonds held (Fairfax has very low duration so the hit to them should be much less than most insurers). 2.) opportunity to redeploy short term holdings into bonds with higher yield. Again, Fairfax is better positioned than most insurers in this regard.

My read is what the Fed does matters to financial markets. Monetary policy has never been as stimulative as it has been over the past 22 months. We have also had unprecedented fiscal stimulus (government spending/direct transfers to people) over the past 22 months. Asset prices (stocks and real estate) the past 22 months have ripped higher. My guess is the unprecedented monetary and fiscal stimulus was a factor driving asset prices higher. As of today we KNOW the fiscal stimulus is largely done. And the monetary stimulus will be quickly reversed starting Jan 1. End taper first (Q1). Then higher Fed funds rates (starting March?). Then shrink Fed balance sheet (2H 2021?). If all the stimulus (monetary and fiscal) helped spike asset prices higher it makes sense to me that when it is withdrawn that will have a negative impact on asset prices. I just have no idea what the magnitude will be… Or how it will play out…

Well, what a crazy first 3 days of trading to start the new year. The spike in 10 year bond yields. The rotation out of tech. Oil stocks are on fire. Steel stocks are fire. Watching CNBC i am absolutely amazed at how bullish people are on these sectors right now. People are finally talking about how much free cash flow oil, steel, forestry stocks are going to earn in 2022 (like we did not already know that). And how sustainable it is looking. And despite the run up over the past year how crazy cheap many of these stocks remain (even after the current run up). The ‘narrative’ is shifting. From hate to OK. Not like yet. Definitely not love. Simply incredible to me how this process works (the psychology of investing). It will be interesting to see where we go from here…

@StubbleJumper FYI, i found your communication on the tax impact of the dutch auction to be excellent. And bang on. Especially the strategic thinking. It certainly helped me understand a few things i needed to learn more about. And i am VERY happy with how it all played out. Thank you!

RBC just updated all of my accounts to reflect the dutch auction transaction. Wasn’t sure how long it would take. Pleasantly surprised it got done this quickly