txitxo

Wellmont, I was slowly selling my FFH position (bought at an average of ~370$) because I want to buy European stocks, which are incredibly cheap. So I don't plan to be a FFH long-term holder. All this business with BBRY is a short-term bummer, but it doesn't change at all my opinion about Prem Watsa. Like I said in a previous message, if you do cigar-butt investing, a significant fraction of the companies will tank. It is unavoidable, and the focus should be about having good average returns over the long term. And he has amazing numbers in the long term. Regarding PM macro bets, and statistical indicators, we have talked here many times about the Shiller CAPE, which stands at 24.4 now, almost 50% higher than the historical average, and a total market cap /GDP, which at 113% is at the same level it was in 2007. You could also have a look at the margin debt levels, almost at historical maxima, or the Q-ratio of Spitznagel. Fed or no Fed, there is going to be a very nasty crash in the US, probably similar or perhaps worse than the last one. But we don't know when it is going to happen, whether this year, or the next, or the one after that. And therefore people who warn about it may still look like idiots for some time.

And there may be more to come...One of the reasons why Prem Watsa may want to raise cash now is because he sees something very bad coming down the road...remember that practically all the statistical indicators for the US stock market say that there is a high risk of crash.

I started liquidating my FFH position about a month ago (most of it bought during the drop last year), not because of any tactical reasons, but because of better opportunities available elsewhere. And this sudden drop has caught me still with a 10% position. I intended to sell it anyway, but if I keep reading messages about people getting rid of all their FFH, etc. I may hold to mine or even add to it...Prem Watsa hasn't suddenly turned stupid. Yes, if BBRY were based in Chattanooga he probably wouldn't be invested in it. But the pattern of his results is typical of cigar butt investing. A fraction of the stocks tank, most of them go nowhere and a few soar. When you are this big, the failures become very prominent, but to judge his performance you have to look at the average over all the stocks he holds, over a long enough period of time.

The colourful Justin Mamis quote illustrates nicely how it feels now in the US stockmarket. Lots of danger indicators are flashing, but people say Bernanke this, liquidity tsunami that. And hey, US stocks keep going up. The farmer dutifully feeds the turkey every day. I got out of US stocks around last November, and since them I'm up by 20% with my EU stocks. Bestinver International is also up by 20%, and the only laggard is FFH, which has gone up "only" by 10% since then. Perhaps I could have done much better in the US market. Or not. Predicting the behaviour of the stock market is as impossible as predicting the weather. But you can get a reasonable estimate of the odds for different outcomes. The US market has a Shiller PE ~24, whereas EU stocks hover around 13 and for instance, a country like Brazil, with lots of growth ahead, has reached a Shiller PE of 10. Place your bets, ladies and gentlemen...

Well, this is certainly the only place, in this particular Universe, where you can find a discussion of IV which touches on cosmology...:) In principle each investor has a mathematical function which says IV = f(future cash flows, Assets,etc.). The big assumption on which all of value investing rests is that intrinsic value will tend to the average market price. Now, most of those inputs are known imprecisely. Some of them are intrinsically unknowable, in the sense that weather is unknowable a month from now even if you get the positions of all particles on earth and a computer big enough to calculate their interactions. Quantum fluctuations coupled with mathematical chaos will conspire to make the behaviour of the system impossible to predict. Even if you had that kind of information on all the possible multiverses and enough CPUs to crunch it, you would still be unable to exactly calculate the future. The very act of calculating it would spawn a much larger number of multiverses. What you can do is calculate quite accurately the probabilities of different outcomes. You can know that that there is a 66% probability of the temperature being between T1 and T2, the humidity being between H1 and H2, etc. So a good, rational investor should first use an accurate version of the IV formula, then estimate the probability distribution for each of the inputs, and transfer that uncertainty into the value of IV. So you do not have a IV "value", what you actually have is a probability distribution, P(IV). That P(IV) won't be a nice Gaussian, more likely an ugly looking beast, with asymmetrical tails. That's where the "margin of safety" enters. It is basically a rule of thumb to make sure that, for the typical width of a P(IV), your IV (and thus the expected average price of the share) is well enough above your purchase price. Now, great investors as Buffett (and you Eric, too) do all those calculations quite accurately, without the need to make them explicit, using shortcuts and heuristics. The same as when a basketball player throws the ball, he is not integrating differential equations in his head. There are some simple cases, specially with small caps, in which you can design simple rules and algorithms to detect when IV is below market price and apply that as a mechanical investing system. For large companies things are much more complex, nobody knows how to code all the relevant factors explicitly, and people born with natural IV calculators in their brains have an advantage.

Well, I don't even qualify as a macro tourist, but some of Kyle Bass arguments sounds quite convincing to me when I look at the stock market statistics. The "expensive-junk" indicator is still very low for Japan (it was incredibly low 9 months ago) whereas the CAPE is extremely high > 40. It hasn't really come down to bear market bottom valuations since the late 80's. So how do you reconcile a prediction of a bull market in stocks with a strong contraction in the CAPE? With a huge nominal earnings increase, and given the state of the Japanese economy the only reasonable way I see for that is through very strong inflation. So even if Japan has to inflate away its debt, it does not necessarily mean it will implode. They may still pull off a "beautiful" deleveraging, combining structural reform (look at what they achieved in the Meiji era), taxing (they certainly have plenty of wealth to tax) and printing (after all, they don't have to buy all those JGBs at once). Although at this stage, it will probably be as hard as landing a freight train on an aircraft carrier.

Interesting paper, but in my experience what kills this kind of strategies are the spreads. You never buy at the price the stock appears in the screen and you never sell at the price it has when it leaves it. When I do backtesting, I always assume at least a 2% loss+ commission in each roundtrip transaction (sometimes is better than that, but I'd rather be conservative). Which means that trading each month is absolutely crazy, you'll never make any money. In addition, most of those stocks are thinly traded, so whenever the screens come out, everybody and his dog are trying to buy the ones featured in the best screens. For some time that was obvious with the Piotroski-9 screen, which was shooting up like a rocket. So what I would do is try to use something similar in spirit to the Piotroski, Neff and Graham Enterprising Investor screens (look for statistically solid, cheap stocks), but not exactly the same, so that you limit somewhat the "crowding" I mentioned, and then trade every 12 months, (that way you can take advantage of the different tax rates by selling losers one day before and winners one day after the short-term/long-term gains deadline).

My recommendations: 1. As somebody has mentioned before, net-nets are a good example of a "rockets" screen. Some companies will tank, most will stay put, and all the returns come from a few stocks. The problem is, they often are the ugliest girls in the ballroom, and no self-respecting classical value investor would get near them. So by all means make sure you avoid funny accounting and robber managers, but if you are investing with screens, you'll have to eat the whole animal from nose to tail. That pretty much applies to any mechanical strategy. 2. Therefore you have to spread yourself thin, avoid worrying too much about individual companies, and let the law of large numbers do its work. You'll have to use more than one screen, net-nets will not provide you with enough companies to do that except at market bottoms. 3. Create your own screens, by introducing small variations on established ones. You don't want to be competing with Renaissance Technologies, but with other individuals who are not as rational as you are. 4. The Quantitative Value book does a good job at presenting the backbone of any good screen: financial soundness and cheapness. Avoid suspicious companies and buy a few dozen stocks, spred across the year (I do one every week) in the bottom 10-20% by EV/EBITDA, P/B, or whichever cheapness indicator you like. Keep them for >1 year and you'll beat the index. Tinker with that procedure, and you almost certainly won't. 5. Adding momentum is a bit more controversial. It seems to increase returns, but it may amplify volatility (e.g. see the drop in the Tiny Titans screen during 2008-2009). 6. Be realistic about slippage, commissions and taxes. They wil eat you alive if you are not careful. Trade as little as possible, and watch out for those stocks who are truly illiquid. 7. Mechanical screens will always tend to be more volatile than the market, after all you are investing in a small sample of micro caps, so to protect my stomach lining I complement them with some timing indicators to avoid statistically "dangerous" markets (like the US currently). 8. Spend a few hours during the weekend selecting the stock you want to buy and then do something fun during the rest of the week, write poetry, read the Classics, or try to convince governmental agencies that it is essential to understand Dark Energy...

Kraven, if any prediction about the stock market with attached timing is right, it has to be luck. Markets are intrinsically unpredictable, as the weather, in a chaos-like fashion. So nobody can really predict anything, stricto sensu. But you can look at numerical estimators and calculate probabilities. If the CAPE is 10, you know that it is more likely that stocks will go up than down. But nothing precludes them going to CAPE=7. If the CAPE is 24, you know that it is more likely that stocks will go down than up. But they can still keep rising, as they have been doing for quite a while already. That's why I talk about Goddess Fortuna. Everything is probabilistic. I have my own timing indicator, but it has only flared like this 3 times. So how can I know whether it is right? Thrice is not a broad enough sample. But it adds to the probabilities. And an elemental rule is that, the higher the probability, the closer in time the event will be.

Great plots, bmichaud. However, things never fall to their average and stay there. If the cap/gdp ratio falls to levels close to the last bottom, ~40%, the market needs to fall by 66%. This is similar to what you get from Tobin's Q, and from the Shiller P/E (current CAPE~24 vs CAPE~8 at bottoms). Therefore, if markets keep behaving in the same way as they have done during the last century (which is the only real dataset we have to study), stocks have to go down by ~2/3 from the current levels. I really don't have a narrative to explain how that will happen. I can speculate that once QE-infinity is baked in, and the economic numbers disappoint, the Fed will run out of rabbits to pull out of the hat. Or that Japan, or China will implode and drag the rest of the world down with them or that yadda, yadda, yadda. But the numbers are crystal clear, unless, of course, this is time is different...

If you stay fully invested at all times, and have enough stocks in your portfolio to smooth out fluctuations, it is really hard to underperform the market. You can buy stocks which start with an A, stocks which finish with an Z, tell you cat to chew the newspaper to select them, throw darts on the WSJ, etc. As long as you pick your stocks more or less randomly, and allocate the same amount of money to them, you will certainly beat a capitalization-based index (before comissions). But there is an absolutely guaranteed way to underperform: switching between stocks and cash/bonds, trying to time the market. I remember that Peter Lynch said that most investors in Magellan managed to lose money because of that.

I am a bit reluctant to own Italian companies, too, not because of Mafia links but because backtesting indicates that mechanical investing does not seem to work too well there, a bit like in Japan. About French companies, in the past I've owned Gevelot, which I see is dirt cheap right now, based on recent numbers, and Tonnellerie Frere Paris. One company I've bought recently is Constructions Industrielles de la Méditerranée Société Anonyme. I also have U10, Signaux Girod in my portfolio. Quite a few Belgian companies showing up too, Miko, Picanol, Jensen-Group.

Kraven, I don't how other people do, but I always see these things probabilistically. There are lots of evidence which tell me that, based on the previous behaviour of the markets, a crash in the US is very likely. They also tell me that if there is a crash, the drawdown may be devastating. Am I 100% certain that there will be a crash? Not at all. Nobody knows that because it is intrinsically unknowable. So I just try to estimate odds and place my bets accordingly. Timing the market is impossible but knowing whether a market is expensive or not is straightforward. If there is a major world crash, everything will go down, but the odds are that both Europe and FFH will go down by less than the US market (I don't know about BRK). So if there is a crash, I get to buy companies which are even cheaper than the ones I have (you sell the P/E=7 stocks to buy the P/E=3 stocks, as Buffett says) and therefore I win. And if there is no crash, and the market keeps going up like crazy for another two years, I win too, because I am fully invested. What do I lose? The only thing you can do is estimate probabilities as accurately as possible (sometimes you can't even do that) and then position yourself accordingly. The rest is up to Goddess Fortuna: O Fortuna velut luna statu variabilis, semper crescis aut decrescis; vita detestabilis nunc obdurat et tunc curat ludo mentis aciem, egestatem, potestatem dissolvit ut glaciem...

The Euro break up is certainly an scenario which is not fully excluded yet. But the probabilities are now much lower than 2 years ago. Everybody has done the numbers, and they know the costs. It is cheaper for Germany to let the BCE handle the debt problem by helping with a debt restructuring, than to allow a disorderly euro dissolution. I don't think that a long period of Japanese style stagnation is in the cards. Japan had an enormous asset bubble, there are countries like Spain or Italy which had something similar, but not the eurozone as a whole. The EU Public Debt/GDP is 85%, vs 105% in the US. Most of the Eurozone economic woes are self-inflicted, because of internal political issues in Germany (which is afraid of inflation) and France (which does not want to relinquish budgetary control). The most likely scenario by far is that eventually things will get solved, as Warren Buffett said a few days ago. And then stocks should take off.

Sure, the Shiller P/E has been on average 20% higher in the US than in Europe since 1990 (although it was lower before). But now it is about >70% higher. If the Euro doesn't blow up soon (and it doesn't look like it will), EU stocks should outperform significantly.

Japan Shiller PE was 100 in 1989...now it is starting to get below 20: http://av.r.ftdata.co.uk/files/2011/03/Schiller-PE-for-Topix.jpg

Oh yes. I am pretty sure of that. No doubt that both markets will move in tandem. But certainly not by the same amount. If Euro stocks go down by 50%, we would be at a secular, once-in-a-generation, Shiller P/E =7 bottom. After that you can put all you own in stocks and sleep tight for the next 15-18 years. But if the US market goes down by 50%, you are only at a Shiller P/E of ~12...and you may get another 40% drop to a secular bottom. To put it in a nutshell: if US stocks keep rising, the odds are that EU stocks will rise much faster, and if US stocks crash, EU stocks will drop by much less.

I am buying lot of little companies, selected using mechanical investing. But probably most people here will find more interesting to peruse the holdings of the Bestinver funds, who are classical, Buffett-style investors. Their top euro holdings (>5%) are Exor, Wolters Kluwer, BMW, Thales. Their top iberian holdings (>5%) are Semapa, Sonae, Portugal Telecom, Corporación Financiera Alba, Acerinox.

Like I've been saying since last year, I'm out of NA markets except for ~20% of my portfolio in FFH. The numbers show a huge amount of optimism, the Shiller P/E is over 23, etc. Any major piece of bad news can easily provoke a 40-50% crash. Europe has a Shiller P/E below 14, and you can read everyday articles in FT and other serious publications warning of an impending eurozone break up, half of Europe is in deflation, etc. We haven't had any QE yet, only austerity and more austerity. The indicators show that all that pessimism is baked into stock prices. Which market do you think has more upside?

Not at all! Imo, speculation is something yet different. Speculation is the belief that someone will buy me out at an higher price… because of a trend, because of a fad, because of momentum, etc., but NOT because I have recognized a mistake and I am correcting it! The way I see speculation: somone will buy me out at a higher price, irrespective of "valuation" or "business judgment". The way I see trading, a “valuation” mistake is being addressed. The way I see investing, a “business judgment” mistake is being addressed. All value investing is, by definition, about valuation mistakes. Mr Market can be wrong about the assets (deep value, cigar butts, etc.), about the growth prospects (moats, quality, etc.) or about both. When that happens, there is a higher than average probability (not a certainty) that the price of the stock will go up. You can identify cheap companies by "human" inspection, or by using statistical indicators, which tend to work better in many areas. And that's all there is to it. Of course, sometimes people need to add some narrative, even mystic, to increase conviction, fight biases, etc. That's OK if it works. But that doesn't change the essence of the process.

Gio, you seem to equate trading with speculation. Since this is becoming a discussion about morals, I am going to quote The Book: "Investing as an operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative". Written by the same guy who, after a lifetime of investing, decided to invent mechanical investing and abandon G&D investing. I really don't know who contributes more to the economy...the person who allocates capital to an obscure, struggling but deserving small cap...or the person holding the coattails of great investors? It is outside of my circle of competence...

Thanks. As most people here, I've learned a lot from this board, so I'm glad if somebody finds useful how we see things from the ground...

The higher the unemployment rate, the bigger the share of the shadow economy. Nobody knows which is the real rate, but I doubt that the average is much higher than 20%, which is already bad enough. This is certainly the worst unemployment situation in Spain's recent history. But many older folks have decent pensions, so they help out with the mortgages, expenses. Without family solidarity this would have been much worse. In general, anything related to housing is indeed going through a 30's Depression, from former workers to owners underwater. People went from owning a new house and a BMW (or a Porsche Cayenne) to asking for food handouts at the local charity. But the rest of the economy is not doing so badly, and in fact, due to the reforms, some parts of it are actually improving or at least accumulating lots of growth potential once the tide changes.

Well, I just think, as Templeton said, that you should try to buy "at the point of maximum pessimism", at at least as close to it as you dare to get...

Well, we have almost perpendicular bets...Basically all my stocks are in Europe, precisely because of the pessimism, which produces very low valuations and I only own FFH in NA, because I see too much optimism there. Of course I don't invest based on a narrative...I use cold statistical analysis, and my screens are systematically spitting out Spanish and Portuguese companies, something which didn't happen a few years ago. But I try to make sense intuitively of what the numbers tell me. And talking about the "new" economy eating the "old", soon you'll see Mercadona stores in Northern Italy, this a grocery chain which has been growing steadily in Spain since the crisis started, they've become are the largest operator in Spain and are now expanding overseas...whereas behemoths like El Corte Inglés and others are suffering terribly with the crisis. Vueling, a low-cost air company, ate a big chunk of Iberia's business away. And you are starting to see that in other areas too, with "low-cost" bar chains, etc. We are not there yet, not by any stretch. But at least you can see the outline of a path...