bmichaud

I don't follow the computation because I see something missing. Take WFC for example... only a portion of the cash returned to shareholders comes via the dividends, but you are only capturing the dividends. I'm not sure if my objection matters though -- taken as a whole, how much higher would the dividend yield be if buybacks were totally outlawed and banned? And don't forget the stash that companies keep piling up overseas. They seem unwilling to pay it out as a dividend because they don't want to pay the US tax on that income. Again though, I'm not sure how much that moves the needle on dividend yield if you add that in. I think as a whole, the SPX likely breaks even on buybacks - i.e. just offsets dilution. There is a good chart out there somewhere showing how cyclical corporate buybacks are, which likely explains the lack of value they add over time. Plus you would expect per share dividend growth to be higher than the average long-run nominal growth rate for corporate profits - but pretty much no matter what time period you look at, per share dividend growth for the SPX is between 5 and 6% per annum. On my divy analysis, I'm actually giving the SPX the benefit of the doubt. I'm assuming the "normal" DVPS is 50% of $75 of "Schiller" EPS, or $37.50. The latest SPX divy is actually 31.25 or thereabouts. Hussman has a good comment out this week on the corporate cash argument.... http://hussmanfunds.com/wmc/wmc130204.htm

In the GMO doc I attached, you can see that the long run real return for US large cap stocks is 6.5%.... For stocks to be fairly valued here with a 2.5% yield, one must believe in a 4% real growth world. Long run real GR is 3%, so that means 1% deflation. We are running over 2%.... If in fact real growth is 3%, then US stocks are fairly valued at a 3.5% dividend yield, which would be around 1,100 give or take. Say inflation ticks up to 5 or 6% as some would project - would US stocks be able to pass through all of that 2 or 3% excess inflation via price increases? If so, then fair value remains around 1,100. I would argue stocks would pass through 50% or so of the excess, which means the FV dividend yield would need to rise 1 to 2% to compensate investors for a lower real growth rate.

Al, GMO has a wonderful long term record of forecasting asset class returns using long run mean reversion for margins, growth and PEs (i.e. More comprehensive than just Schiller), and their most recent projections indicate rather severe overvaluation for the aggregate market. However, within that aggregate, their "high quality" subset is closer to fairly valued and appears to be what you point to. Please see attached. Who knows what will ultimately drive the market down to or below fair value - but it appears the good majority of the buyers have been sucked in, as evidenced by very high sentiment readings and multi-year highs in hedge fund net long exposure. Even if a decline is limited to 20%, the opportunities that will be available after such a decline, in aggregate, will dwarf any individual opportunities right now, IMO. GMO_7y_Forecasts_4Q12.pdf

http://theshortsideoflong.blogspot.com/2013/02/equities-in-euphoria.html?m=1

Last year the Euro was going to collapse and there was to be a daisy chain domino effect on global banking. So now if the "Euro is here to stay" it might mean that BAC and AIG will be spared this year. http://www.bloomberg.com/news/2013-01-24/soros-says-euro-is-here-to-stay-with-two-tense-years-ahead-2-.html Very likely - thus why I would love to buy more at 30 and 9 again, versus 25 and 7.

Massively net short. This market is crazy within the context of a secular bear market. Sentiment is at extreme optimism, VXO is at multi-year lows, valuations are at extreme highs and the Citi econ surprise index has rolled over substantially. I can't think of any reason why this market should decline....typically a sign the market is peaking. Can't wait to be able to pick up AIG at $30 and BAC at $9 again...

As always, hat tip to Moore for introducing the board to Zeal LLC... Wonderful essay out today on the extreme complacency currently in the market. This complacency is just being fed, IMO, by Tepper coming out and daring everyone to go max long and Dalio saying all of the cash is going to move into non-cash assets. http://zealllc.com/2013/highcomp.htm Disclosure: getting more net short by the day

Can't get enough Big Bang Theory! My wife cannot understand how I can see the same episode four times in two months and laugh harder every time. Sheldon is just brilliant!

Great analysis by Tim Hayes and Ned Davis himself - but I find the most value in the plethora of charts available, mainly the sentiment charts.

NDR is not free :( Zeal is though ;D By ensemble market analyses I mean Hussman should employ other research outside of his own. With over $2B under management, he should easily be able to afford the $30K or so required for NDR. If not that, Zeal is free, Doug Kass's market thoughts are free, Cullen Roche over at pragcap used to provide relatively regular market risk/reward updates for free (now you can access his research for $500 a year through Orcam)....

Ned Davis Research. Zeal LLC. It boggles the mind why Hussman doesn't employ an "ensemble" of market analyses - clearly his methods have failed during one of the greatest bull markets in market history....

I think a lot of it depends on what it means to forecast correctly. Broken clocks and all that. It's pretty easy to forecast certain things if you aren't held to a time frame. I mean I can tell you with certainty there will be a recession, but when is it? If I just say its coming, well, is that a month from now, a year from now, 3 years from now, or when? That's not to say Hussman will or won't be right, but a lot of these guys have been fighting the last war (the financial crisis) since late 2009. Perhaps they will be right someday, but I don't necessarily give them credit for predicting it. I almost put in parentheses whatever "right" means. He can't claim he was ultimately right if the market doesn't fall well below 1,100, as he was fully hedged coming out of the 2011 bottom. I think if the secular bear finally ends somewhere in the vicinity of 10x Schiller EPS, or 900 or lower in a few years, he can claim he was right. That's the fascinating aspect of investing though - those with different time horizons can all end up being right....think Berkowitz with BAC and JOE, or somebody owning Apple stock through the doldrums.

http://www.hussman.net/wmc/wmc130122.htm I'm starting to feel bad for the guy - he has taken a brutal beating over the past three years. Deep down inside though, I don't want to bet against him long term. Perhaps the time is near for him to finally be right....four years into a cyclical bull within a secular bear, Schiller PE over 20, VIX at extreme lows, margin debt high, hedge funds at four year high net long positions and overall investor sentiment starting to climb into very extreme territory.

It's probably not very scalable for a large fund . I like it in IRA's, because there is no tax on short term gains. We 're all friends and family so it's fun to play around with, but the short term calls are very speculative now because the repurchase limit being five percent below the market price isn't much of a floor with a short term horizon. What's worked extremely well though in absolute gains is the leaps. These are scalable for the size of our accounts. Owning the leaps has given us great leverage compared to merely owning the common. The repurchase limit still being only five percent below the price of the common is quite important for the MOS of owning the leaps because of the long time horizon. Plus, we don't have to pretend we're traders. We can sleep on the leaps. :) Thanks TWA ;D

Twa, If you don't mind me asking, what % of AUM are these near-term option trades? Is this a scalable strategy for say a Bruce Berkowitz with $8B under mgmt or even WEB back in the early BRK days?

Now THIS is hedge fund porn 8)

I haven't seen Cramer in months, but happened to turn it on tonight after the gym - was actually impressed that A) he admitted he was dead wrong this whole time on BAC and B) recommended staying away from Home Depot, one of the best momentum stocks in the market right now!

gundlach has also been saying for the last 3 months to buy stocks... agreed, with stocks up 10% and the 30 year at 3.1% vs 2.7%, this is no longer as good of a trade, but that doesn't make me a bull on the bond market. completely agree - just an interesting trading opportunity perhaps, especially with the buoyancy in the equity markets and Europe.

http://pragcap.com/gundlach-where-to-invest-in-2013 Gundlach saying decent time to wade back into the bond market - sees 190bps on the 10y as a ceiling...

Kraven, congratulations! Fantastic job! I think very few investors on this board can claim to have studied Mr. Graham as extensively as you surely have. Therefore, let me ask you two questions: 1) How do you reconcile Mr. Graham advice that “investing is most intelligent, when it is most businesslike” with the way he actually invested? I really do not know of a single businessman who holds interests in dozens of positions and who sells them as soon as they reach IV… What am I missing here? Was Mr. Graham just advising that investing is no hobby, but serious business? If so, don’t you think that wonderful phrase loses a little bit of its strength and meaning? Isn’t is just obvious that investing is serious business? 2) Is it true that at the end of his career Mr. Graham acknowledged he had made more money investing in Geico, than in all his other positions combined? Or is it just a myth? If it is true, how can this statement be reconciled with the way he invested throughout his whole career? Don’t get me wrong! Your results speak very loudly for themselves! No doubt about it! And congratulations again! You are a much much much better investor than I am! It is just that you wrote your investing idols are Graham and Schloss, so I was curious! Thank you, giofranchi Gio, thanks for the kind words and good questions. Ha ha, I seriously doubt that I am a better investor than you or anyone on this board for that matter. I just do my thing. 1) How do you reconcile Mr. Graham advice that “investing is most intelligent, when it is most businesslike” with the way he actually invested? I really do not know of a single businessman who holds interests in dozens of positions and who sells them as soon as they reach IV… What am I missing here? Was Mr. Graham just advising that investing is no hobby, but serious business? If so, don’t you think that wonderful phrase loses a little bit of its strength and meaning? Isn’t is just obvious that investing is serious business? That line from Graham is one of my favorites. With all due respect, I think you are thinking of being a "businessman" and "businesslike" in too narrow a fashion. It would seem to me that you are equating the terms with running a business. But it's more nuanced than that in my opinion. I think when Graham talked about investing in a businesslike manner he was in the first instance distancing himself from how he saw most people of his day investing. That is, they would buy something on a whim or based on a tip or what their friend or shoeshine guy said. So for Graham, a "businessman" doesn't just jump into an endeavor without analyzing it and making a decision based on the facts. Further, one of Graham's goals was to develop security analysis as a profession. So in that vein he wanted an investment "scheme" to include thoughts about profit and loss and knowledge of own's results. So "businesslike" to me in the broader sense mean being professional about investing. Be serious about it. Treat it in the same manner one would treat any type of work. But you raise an interesting point. I think there are many on the boards who equate "proper" investing with Buffett and Munger. So a focused portfolio that one buys and holds until the earlier of eternity or a reason for the investment thesis changing. That's one way to do it. It's a damn good way if you can do it, but it never made sense to me. I don't want to buy something that's arguably 2% below fair value today and let it compound for years. I can't see the future in that way. I would rather buy something at 50-60 cents on the dollar and let it revert to the mean. Then I sell. Graham also said that he buys his stocks like he buys groceries, not perfume. That was always one of my favorite sayings from him. I have always envisioned myself as running a grocery store or something. My inventory is my stocks. In one aisle you may have the high end filets and lobsters, but in another aisle is the gum and candy and paper plates. To me it's all good. What do I care what someone buys? Come into my store and buy a pack of gum. Sure, I might just make 2 cents on that, but gum sells all day long and it doesn't take a lot of time to determine your gum inventory. You buy it, you stick it on the shelf and someone will buy it from you. It doesn't take long to track it. So for me, businesslike is treating my investing as a business. Our difference, if we actually even have one, is that you are equating each stock you own as if you ran the business while I see it as inventory. While I do fervently believe that each stock I own is an ownership in a business, it is also just a piece of paper. It's both, Graham says that as well. We have the best of both worlds. So I buy thinking of the business, but then put it on the shelf. Everything is for sale! I run things professionally and can't imagine running it in any more businesslike manner. 2) Is it true that at the end of his career Mr. Graham acknowledged he had made more money investing in Geico, than in all his other positions combined? Or is it just a myth? If it is true, how can this statement be reconciled with the way he invested throughout his whole career? I don't recall whether Graham acknowledged it or not, or whether others said that about him after he died. I don't think it's actually true, although someone can correct me if that's wrong. My recollection is that while on paper he did make a ton of money on GEICO, I don't believe he actually sold the stock or all of it anyway and was holding at the time of his death when GEICO was on it's "last legs" and just a buck or 2 a share. Even if we assume for sake of argument that he made most of his money on GEICO (which I don't believe he did as noted above), it wouldn't change my views at all. One, Graham made lots of money by investing in his net nets and so forth. He was a millionaire many times over long before GEICO did anything. Remember that he retired to California in the last 1950s. After that point he taught and dabbled, but didn't really do much. So any profits that came from GEICO were late in life. And whatever he got out of it was really a "mistake". I don't mean a mistake in the sense that he didn't intend to buy it, but he didn't really care about investing all that much after he retired. He held the position but I don't think it was because of the modern "compounding machine" reasons. I think it was in his portfolio, he retired, he kind of forgot about it. So for me, what Graham means to investing has nothing to do with his GEICO investment. His brilliance was out there for the world to see long before GEICO did something or not in his portfolio. Hope I answered your questions. Kraven - this is a wonderfully well-written description of the Graham & Dodd process. Love the grocery store analogy!

You very well know who said that! Let me tell you a story. Gino is the father of Giuditta. And Giuditta is a partner of mine in AMiS. Well, Gino is by any standard a very successful real estate operator in the area of Bergamo, 30 km outside Milano. It happened that in 2007 he possessed a big, still undeveloped, lot of land for residential and commercial construction. And he decided to invest 25 million Euros (at the time they were more or less $37.5 million) to build 80 apartments, a commercial plaza, and many underground parking lots. I still remember that I objected: “Gino, are you sure you want to go “all in” and use the entirety of your cash reserves? Who knows what might happen!”. He answered: “Don’t worry. I possess other 20 buildings, more or less 300 apartments which assure me a continuous stream of cash, via rent payment, each month. Furthermore, also my commercial activity (he is a wholesale dealer in construction materials) provides me with more than enough cash.” Well, you might guess what actually happened: at the end of 2012, five years later, he has sold only half of the 80 new apartments, 2/3 of the apartments he possesses are delinquent and have ceased paying the rents due, his commercial activity is in a slump. The only thing that saved him is the fact he is completely debt free (a sort of protection). But don’t even think of looking for opportunities in the real estate market right now…! His capital is frozen and completely locked in troublesome situations. So now, would you tell me why something like that couldn’t happen to me? Mr. Ray Dalio is famous, among other things, for the following rule: Make sure that the probability of the unacceptable (i.e., the risk of ruin) is nil. Well, I have my own rule, which is even more demanding: Make sure that the probability of not being always able to take advantage of the situation, whatever might happen, is nil. As I have already said, it all comes down to know yourself and your situation. And I know that, if a correction comes, and I had all my firm’s capital already invested, and the stream of new cash dried up, exactly like it happened to Gino, I would torture myself! Instead, having sub par returns for a few years is something that, although not pleasant, I can manage with ease. Moreover, as I hope I have shown you, if my longs start performing well, returns might be not bad at all! ;) Once again: that is me and only me! And if you think about it, in fact I am a little weird… Because most people would feel the exact opposite! They would suffer much underperforming while the market is in rally mode, instead they would bear quite well with a downturn (provided that at least Mr. Dalio’s rule is not broken…), because everybody else is helpless too. Thank you very much, but I have no unique ability. If I had a unique ability, that would be the best protection by far! That’s why I think it is dangerous to try and imitate Mr. Buffett! I simply try to do what any businessman should do: to find great managers. What I have just read on the subject in Mr. Taleb’s “Antifragile” follows: I totally ignored I had some of the venture capitalists genes in me! 8) giofranchi Gio - you make a very good point here. Likely my BRK example is swayed by the diversity of BRK's cash flows....whereas your firm has two key companies where cash flow could dry up in a bad time. Good discussion 8)

Gio you are far too kind - I hardly deserve to be a member of this great board let alone be mentioned in the same breath as some of those on here!! I understand your concern with generalizations - I don't expect a model such as mine or anyone else's to perfectly suit your needs. My primary point was that there are tools available to more effectively gauge market risk than just looking at valuation - it baffles me why Hussman does not employ such methods and puts his shareholders through such pain. My model is by no means a timing model - it can go years on a single signal - but rather an attempt to holistically gauge market risk versus relying upon only valuation. Ned Davis provides such a service if ur willing to pay. A lot of frctional cost an be avoided if one does not hold cash and/or shorts through a three year bull market - think Fairfax short position since late 2009 and Hussman's short since early 2009.... Most importantly though, it would keep you from under owning wonderful companies such as Fairfax and BRK - if those companies compound intrinsic value at 15% per annum and you get them at around or just above book, why under own for three years waiting for a market decline? My point in comparing your company to BRK is this - a portfolio of operating companies spinning off free cash flow paired with a stock portfolio provides a natural hedge. For example you said your FCF return on capital was 16% this year - so at the beginning of this year, had you been fully invested on the equity side, and had the broad market declined taking your equities along with it in lock-step, you still would have outperformed the market on a consolidated basis due to the 16% FCF ROC and had cash to invest in a downturn. Thus it appears redundant for a HoldCo such as yours to hold excess cash when attractive stocks are available, since you generate cash on a continuous basis! Obviously if your operating companies are under pressure and require additional funds, then the discussion is moot - but I'm simply referring to the principle of the enviable position your firm is in to have a continuous stream of FCF available to hedge performance AND provide additional capital to deploy in a downturn. No need to divert your attention from finding wonderful owner operators, OR (perhaps more importantly!) working out - it just seems you have a unique ability to identify wonderful owner operators and could take advantage of that skill by more aggressively deploying capital into them regardless of the broad market. I speak from a position of envy, as I would love to one day be in a situation such as yours (I.E. redirecting FCF from operating COs into stocks) and have put much thought into how I would go about it 8)

Gio, I am of VERY similar mind to you on broad market valuation and holding cash (I actually tend to hedge with an SPY short more than anything due to my inability to pass up attractive individual stocks and special situations), and paid the price for much of this year with extreme underperformance (until recently :)). I came into the year convinced the toxic combo of broad market overvaluation, Euro depression and a slowing China warranted a fully hedged portfolio. Our fellow poster moore capital and I battled it out late last year on whether it was a good time to be fully invested if not leveraged - he certainly bested me, to say the least. However, I learned a tremendous amount as a result of the debates we had as I set out to determine why I was so wrong and how I could improve going forward.... I originally adhered strictly to GMO/Hussman/Schiller long-term valuation methods for determining my exposure to the broad market - as demonstrated by my underperformance through most of this year and Hussman's horrific performance since march 2009, these methods do not work over the medium term, which is driven primarily by A) sentiment and to a lesser extent B) momentum. All that to say, I have attempted to come up with a model that incorporates valuation, short and long term over/under-boughtness and momentum in order to keep myself in the market even in times of overvaluation. It is a very crude model that still needs work...but from what I can tell has worked quite well since the mid-1920s (as far back as I can go right now). I used Adam Hamilton's (of Zeal LLC - h/t moorecapital) method of measuring the market relative to its 200dma as a springboard. EG when the SPX is at 110% of its 200dma it's in overbought territory, and when it's at 80% it's oversold. Using this sole ratio through history does not work, but it works over shorter time frames as a sentiment indicator. So I added a medium-term relative ratio - the SPX's 50dma divided by its 200dma - and multiplied it by the original ratio. The higher the ratio the more at risk the market is - so if spx is overbought at 1.1x the 200dma but medium term oversold with the 50dma at .90x the 200, the "trading ratio) is .99x. Whereas if 1.1x 200 and 1.1 50/200, trading ratio is 1.21x. So I back-tested the "trading ratio" and came up with better results than just using price/200dma, but still not good. Then I added a third component - schiller PE relative to the long-run schiller PE. So right now it's at 19 versus long run avg of 16 or at 1.18x - I call it the "relative PE". I multiply the rPE by the trading ratio to come up with the "Adj. Trading Ratio" (ATR) - so now you have a market indicator that incorporates long-run valuation, short-term over-/under-boughtness and medium-term over-/under-boughtness. Final step is momentum. I add this by dividing the ATR by the absolute value of the 100-day growth rate of the market's 100dma (minimum of 5%). Basically the slope of the 100-day moving average. So by dividing the ATR by the % growth, you give the market the benefit of the doubt for its long-term trend - up or down. Sounds weird but it works. Those are the key pillars of the model - a good amount more goes into it such as buy, sell and hold signals etc...but you get the idea. I've had too much coffee and am up late typing on my phone without access to the model - but off the top of my head, since the early 1950s the model... A) keeps you fully in the market from early 1950s through 1968 B) gets you back in the market part way through the 1973/4 bear - so doesn't do a great job here...but C) keeps you in the market from the mid-1970s through the early 1990s D) has you in and out of the market a couple times in early 90s E) back in the mkt with a buy signal in 1996 and 1998 before.... F) a sell signal in 1999 just before the crash G) back in the market in 2001/2002 and no sell signal until... H) early 2008 I) Back in the market October 2008 J) out of market early 2010 and back in mid-2010 - this was a poor sell signal as the market was largely flat during that time K) out of the market early 2011 and back in.. L) Aug/sept 2011 M) model remained a buy through early 2012 and has been on a hold signal ever since This model does not keep you out of every market correction, but helps avoid the bulk of large-scale declines. Most importantly, IMO, it keeps you from the making the mistake Peter Lynch refers to in his quote, "more money is lost waiting for a decline than in the decline itself". In order to avoid short term 5 to 10% corrections, I believe sentiment indicators are BY FAR the best tools. Sentiment can be measured in various ways - put to call ratios, AAII surveys etc... - but if one has access to Ned Davis Research, the Crowd Sentiment and Daily Trading Sentiment charts are two of the best charts on the planet...again IMO. So Gio, why am I babbling on? A) I love to learn, B) I like sharing what I've learned to help others and/or receive feedback and C) I relate to virtually every post you write about the broad market and holding cash!! I feel your pain of underperformance. From an outside perspective it appears you and your firm are in a Berkshire-type situation where you always have free cash coming in the door...thus I don't see why you ever need to hold an inordinate amount of cash (outside of some type of buffer such as the $10B minimum Buffett imposes on BRK) when you can find the attractive owner-operator opportunities such as Fairfax below BV. What if takes two years for the market to correct down to 10x earnings and in the meantime fairfax's BV climbes 20% per year and its stock price never corrects below where it currently is? Point is, your firm, like BRK, always has a cash buffer in the form of monthly free cash flow, so unless opportunities are scarce, why build cash? Just continue to build your positions every month in dribs and drabs as valuations allow, and if you feel the need to hedge, come up with some type of model (or subscribe to - think Ned Davis Research) that allows you opportunistically hedge your portfolio of owner-operator stalwarts! Thus you won't miss out on the inevitable growth of the underlying businesses by not owning/under owning those stocks. Just one man's thoughts and opinions - probably worth far less than two cents.

Sorry Sanjeev! Gotta disagree on le miz - I didn't run, I sprinted out within half an hour at tonight's showing. Everyone I was with were not far behind.

Django was unbelievable!! Saw it twice in 24 hours. I loved Inglorious Basterds though, and thought Django was in the same realm.