original mungerville

The main issue for me is that being hedged means that your returns basically come only from your securities picking skill. I know that for me at least, I'm unskilled enough that I want to take advantage of equity returns in general which are positive over long time frames, and also unskilled enough that I cannot accurately predict the times when these returns for stocks as a whole are negative going forward. Understood, this is why I mention being partially hedged - and always asymetrically (so your short can't kill you). Although an asymetric hedge (ie put) costs even more than a symmetric one (short). In any case, maybe be 80% long equities, 20% cash or bonds, and have a put covering 20% of your portfolio. So you would still be long 60% equities and benefit from that, and your hedging costs are minimized at 20% of notional. I am just making the case that, as value investors, we should use our Alpha pretty much at full throttle all the time (to Liberty's and Petec's point), but in certain cases we should take the foot off just a bit and hedge just a bit. After a 6 year bull market, sometime in the next 2 years may be the time that that positioning will be very beneficial.

My timing is piss poor, but my point is its silly to totally dismiss the macro - especially after the market has more than tripled off its bottom, 5-6 years later. As time marches on and the market continues to rise and get more and more frothy, the more you want to start at least partially hedging. And let me be clear, I think we ultimately move to a new monetary system. By Dalio's remarks, it seems he is thinking 2 years out its going to get really really rough. So a fully hedged portfolio for me would be 100% long deployed into value stocks, put options on the market for 100% of notional, and then minimum 10% into precious metals (I like gold miners and silver). So my neutral position is not $100 cash, its $90 cash (or less) and $10 (or more) precious metals - as I believe we ultimately get a huge debt deflation or a new monetary system (and the later seems more probable to me).

Oh, and if Liberty and Petec want to dismiss this macro stuff because they can't predict it, go right ahead. But not being able to predict it means you should be hedged or partially hedged, and not 100% long equity exposures in general because that would be speculative in my view. You can still be a value investor and be somewhat hedged. Just look at Ericopoly, he pretty much only hedges. And by the way Eric has gone short the Russell and S&P in December as well - so lets add him to this list: Gundlach, Gross, Dalio to a degree later this year, Tepper to a degree later this year, and Ericopoly!! I don't know, my best guess is that we may be OK for another few months - but hey, I've been so wrong on my timing so many times and for so long, I just kinda stay semi-hedged. I don't like poor financial management, excessively leveraged economies with continuously growing debts and widening deficits, or central banks which print gobs of money - call me crazy.

Gundlach's reasoning makes sense to me. He lays out a case for a risk which should not be neglected. Its a risk, he is not calling it a certainty. Bill Gross is negative. Ray Dalio said in December 2014, the equity environment is good for another 1-2 years - after that, he says the global economy WILL MATERIALLY CHANGE. He says European and Japanese monetary policy is effectively tapped out right now (as the short-end is at zero and the yield curve pretty flat already) and interest levels and the spread is what drives this financially driven capitalistic system. In the US, they may have another 1-2 years and then he believes they will also be tapped out. This will come at a time when asset prices are already very elevated and secular deflationary forces may cause a recession where the Fed has no ammo left. I dunno, but the bond / macro guys do not seem too optimistic going forward. Dalio however seems quite content to hold equities this year - at least early in the year. Even Tepper the bull said its going to be a good year but like 1999, you may have to know when to get out. Hopefully you are all smart enough to know when to take some risk off as I agree with a previous poster's very well expressed comments: there are two ways stock yields can go down - either stocks go higher (seems like they will in the first bit of this year) or earnings shrink.

OK, that's interesting. Not sure if you are following Valeant, but that company is effectively a LBO company borrowing at low rates, locking-in a customer base, and increasing productivity of the acquiree. But I would think you would want to finance very long-term in this environment otherwise if there is a change to inflation/hyper-inflation, you are in trouble when you attempt to roll-over.

Also 1. purchase stocks at lower p/e ratios and thus rely less on growth in earnings and more on the initial earnings yield (this is similar to buying high dividend payers); 2. buy companies that have pricing power via brand and that make stuff that is very cheap for the customer relative the customer's overall budget (eg, Coke, or a manufacturer of small parts that are required for expensive machines but where that manufacturer monopolizes the market) - these companies should be able to better maintain their margins in the face of deflation; 3. make sure the company has low debt (ie has not mortgaged its future by incurring higher yielding long-term debt in the past);

I don't think there is such a thing as real deflation because deflation relates to prices and so the context is always nominal. Maybe your question could be rephrased as: "Do you mean negative real economic growth? I definitely see negative real economic growth, but deflation not so much with QE and all." To further clarify, you can have price A) inflation or B) deflation, and economically, you can have 1) positive real growth or 2) low/negative real growth. The combinations are: A1: stocks do well; A2: (stagflation) gold does well; B1: probably a mix of stocks and bonds do well; B2: government bonds should do well (unless the markets decide the government just has too much debt and will never repay).

Maybe the following if you are into LEAPs (and don't want to risk your principle on deflationary bets when the opposite might occur): - Call LEAPs on iShares 20+ Year Treasury Bond (TLT) - Speculate short term on the US dollar increasing further (given Fed is saying it will raise in the face of global deflation while Europe, Japan, etc are loosening - this could drive up the US dollar further) by buying Call LEAPs on PowerShares DB US Dollar Bullish ETF (UUP)

I don't think there is such a thing as real deflation because deflation relates to prices and so the context is always nominal. Maybe your question could be rephrased as: "Do you mean negative real economic growth? I definitely see negative real economic growth, but deflation not so much with QE and all."

In my 20s I would have loved to have a clue that investing was for me. I didn't though - started in engineering, then business, then I figured out close to my 30s that I loved investing.

My guess is that this downdraft continues... but who knows. I am pretty bearish, all I hold is IWM puts, some calls on gold miners, and out of the money calls on silver. I've been wrong for as long as Watsa has though...

Sanjeev, Is there a crazy possibility Fairfax provides board members with an opportunity to invest at the offering price? We go back a long way after all - into the 1999 to 2005 period! Is it worth a shot or too crazy a suggestion?

The dislocation is nothing. You just pop those back by yanking on them. Its the tearing the ligament off the bone thing that is a little problem! I dislocated a finger in a pick-up bball game - it was like 90 degrees. Asked the guys to pull it back to straighten it out. They couldn't do it, so I drove to the hospital. Had a nurse and doctor trying to pull it straight, they couldn't do it. So I looked at them and said that there wasn't one single ligament in my body that would move at all with them pulling like that (ie like pussies). They kinda' looked at me a little pissed off and then gave it a good go and popped it back. Ligament ripped off though is a little different, would need surgery for sure...

Keep up the half piping and surfing - don't let these desk strapped CBFM boarders talk you out of some fun just because you are over 40! Last year at 42 I was jumping Swiss chalets on the hills with my skis in the winter and then surfing in Northern Spain in the summer. What's a few bruises here or there - you are either growing or withering away in life, there isn't much in between.

Hussman not only prints graphs about stock market predictions and subsequent actual returns, he also give a numerical correlation. Does the blog point that out? If it doesn’t, I am already suspicious… ;) Gio Why not just read a few of his articles and find out? The primary source is easily available. I think you'll be pleasantly surprised. Here's a few to get you started: http://www.philosophicaleconomics.com/2014/06/critique/ http://www.philosophicaleconomics.com/2013/12/shiller/ http://www.philosophicaleconomics.com/2014/01/cape/ http://www.philosophicaleconomics.com/2014/05/profit-margins-dont-matter/ Gio, its worth your time to read these articles. All they will do is help you better interpret Hussman's stuff and CAPE - I don't think they change the fact the market is overvalued right now but it may change your outlook on 1) how long it could take to mean revert on the "E" in the P/E (ie longer than in the past potentially), and also 2) some slight adjustments to interpreting CAPE/Shiller p/e. Its just helpful - one level more detailed - stuff to interpret Hussman etc, and (maybe?) understand why Marks, Buffett and Munger are not quite at the point where they want to call this a bubble (whereas Hussman is, and Grantham with another 10% rise in the S&P from here will be).

Further Gio, I just stated earlier that I agree with a very conservative allocation to stocks at this point like 10% precious metals, 20% stocks, 70% cash/bonds. With the latter too high and the fact we could wait forever for a market crash, combined with my view that FFH can be viewed somewhat as cash-like for portfolio allocation purposes, I fully agree with your 30% cash, 35% FFH position for a total of 65% which is pretty damn close to where I am. The only reason I would agree with 65-70% in cash-like investments is because I think the market is very very high on a long-term basis. The FFH piece is important because it gives you staying power with high single digit maybe double digit returns as you wait this out. We are in total agreement but I do urge you to read that guys blog and other articles because they are just great - and very relevant, you will enjoy them and they may change some of your views to a minor degree which can be helpful.

original mungerville, This is what Hussman had to say in his latest weekly commentary: Which is basically what the Shiller PE of the S&P500 is telling us right now. Of course you might answer Hussman is not a good investor, he has not made any money for his shareholders in a while, etc. … And I might even agree with you … This doesn’t change the fact than when it comes to general market valuation no one that I know of, and I repeat: no one!, has done a more accurate, thoroughly researched, and convincing work than Hussman. Period. Anyone who doesn’t read his weekly commentary should start doing so. If the Shiller PE of the S&P500 truly gets to 30, valuations will be even more stretched! Furthermore, just look at the ups and downs of the markets in the 20s’ and 30s’: those were two decades of unbelievable booms and busts! And, although the Shiller PE might not have been very useful in the midst of those booms and busts, surely it acquired meaningfulness at the extremes! It never got lower than 6… and it never got higher than 30! If it approaches 30 again, I strongly believe you should take notice. I simply repeat this: In 1929 the Shiller PE of the S&P500 reached 30… a market crash of more than 80% followed… If the Shiller PE of the S&P500 gets to 30 again, and you don’t become defensive… you will never be. Gio Gio, Look, I agree with you completely. The market is high on multiple measures - not just the CAPE. Hussman uses about 5 measures and all of them are at records including the CAPE. My point was not to disagree with you but to point out that that guy on that blog has some really important points and other articles, that's all. Actually the article I was referring to might even imply that the US CAPE of 30, when adjusted appropriately, may be 33 or 35 or something. So actually the article I was pointing out only supports your view. What the article was saying is that Greece has a low single digit CAPE and the Irish CAPE is 8 or something which implies both are cheap, but he clearly argues that the Irish stock market is in no way cheap. So, let me make my final quote more specific (after reading that article): "If the CAPE is low for a country index, do not use only the low CAPE as a justification for investing in the index as that CAPE, in a period following a long-tail dislocation like we had in 2008/9, may not be representative due to the fact that the earnings pre-dislocation are not from the same companies whose prices we are using post-dislocation (think banks which failed whose earnings are still in the CAPE calculation from 2004 to 2008, but then those banks are no longer in the index in 2014 and have been replaced by other manufacturing or services businesses). The CAPE works best to smooth the regular business cycle over a 10-year period, and does not work as well in a post 1932 period or post 2009 period - as it may underestimate valuations due to the above dynamic."

I absolutely agree - this is a fabulous article critiquing the CAPE which has major issues when applied to a discontinuous boom/bust scenario as we have had over the last 10 years. The CAPE works, however, to smooth the normal business cycles over a decade. Just excellent, I recommend everyone read it - the shortcomings are clear and obvious once you read it. This is really important for international investing and deciding what country to focus on at this point - essentially the take-away is don't use it. I'm an avid reader of philosophicaleconomics.com, one of the most thoughtful blogs around. (Psst . . . Anyone know who's behind the pseudonym Jesse Livermore?) To be fair to Gio (the OP), he wasn't citing the Shiller CAPE as a rationale to diversify into lower-Shiller-CAPE countries, and his portfolio construction and cash position is arguably sensible under any market scenario. The US market is high, and the more relevant philosophicaleconomics.com blogpost was in August, in which Jesse deconstructs the Shiller CAPE for the U.S., pointing out the drivers that might account for why it is higher than TTM PE. http://www.philosophicaleconomics.com/2014/08/capehigh/ Interestingly, at that time, he ended that blogpost with this: "An investor’s best bet, in my view, would be to underweight U.S. equity markets in favor of more attractively priced alternatives in Europe, Japan, and the Emerging Markets." He also had another great one on the possible problems with using Buffett's 1999/2000 favorite yardstick for valuations of US equities - ie corporate earnings relative to GDP. Recently, Buffett maybe, but at least Munger, seemed to note that that old yardstick may not fully apply right now. Munger said something like: just because Warren put up a chart 15 years ago doesn't mean...I forget, but basically Munger was kind of dismissing that. Buffett then said they would talk about that over lunch. Don't know where they ended up on that one! I think the blog did not mention Buffett...but the focus was on how QE and government deficits meant that the "E" in the market's P/E may stay high for a long time relative to GDP...

- I like silver (SLV) out of the money 2017 options; and - Gold miners (Sprott Gold miner ETF, GDX, GDXJ - probably in this order) You guys are going to think I am nuts but I think the Western central banks have pushed paper gold prices down so much, and there is so much physical demand right now for gold and silver that the jig may very soon be up (ie default on Comex due to inability to deliver physical - contracts could cash settle). Even without such an event, with backwardation currently at 6 months for gold futures, the physical price mechanism should assert itself soon. This feels to me like Fairfax in 2003/04 with the hedge funds naked shorting. In this case, its coordinated central bank intervention pushing the paper market lower combined with similar banking manipulation of the precious metals markets. As bad as Fairfax was then, this seems worse in terms of what I am up against. Then, I lost a ton of money before making it all back and more. Same thing now: I have lost a ton of money. I am holding firm though - it may be a big mistake. I think miners could double in a year and go up 10x from these levels over the next 5 years. As for the SLV out of the money options, 20-50x depending how out of the money you are. The people on this board were viewed as crazy with regard to their positive outlook on Fairfax circa 2003/04. So call me crazy but this is what I am doing.

I absolutely agree - this is a fabulous article critiquing the CAPE which has major issues when applied to a discontinuous boom/bust scenario as we have had over the last 10 years. The CAPE works, however, to smooth the normal business cycles over a decade. Just excellent, I recommend everyone read it - the shortcomings are clear and obvious once you read it. This is really important for international investing and deciding what country to focus on at this point - essentially the take-away is don't use it.

I agree strictly speaking FFH is of course not cash! However, given the choice of holding 70% cash at this point vs half of that in cash and half in FFH while waiting for a drop, Gio has chosen the latter which makes sense because he doesn't know if/when a market fall is coming. So while waiting he can make combined returns on his "cash / cash-like FFH" of maybe mid to high single digits annually. So he is trading off a bit of flexibility in a crash for higher returns on his "cash" now - this makes a lot of sense to me. In a market fall, its not like he is going to want to go all in all at once anyway - he may want to average into a full equity position, he can start by using his actual cash first, then once FFH stabilizes start selling that for more undervalued stocks. So the flexibility trade-off is not that much of a loss compared to what he gets now in terms of higher yield on his cash/cash-like FFH. That's my point.

I would not consider FFH cash. To me, one of the benefits of having cash is to be able to pick up bargains as they occur in a downturn. In a market crash, FFH will probably go down as well. Ya, but Gio could part with his cash in a crash before he parts with his FFH. This will give time for FFH to stabilize, and differentiate its stock price movement relative to the falling market - like I said, after a year or two in a crash, FFH will be like cash. (You need to read my post - I did acknowledge FFH would fall with the market initially - the difference though is it won't stay down 50% for long when its earnings are rising. Over a couple years the market will differentiate)

You could make the argument that in order to develer, Japan and Europe actually need to print money. Ray Dalio makes this exact argument. print enough money to get GDP to grow at a good rate, and keep interest rates below that GDP growth rate...and over a 10 year period or so, if you're lucky, you will have a "beautiful deleverging". That being said, i'm not guaranteeing this will happen. Plenty opportunities for road bumps going forward. If Japan can beautifully delever (ie no precipitous fall in its currency or bonds) at 260% debt to GDP, taking in only something like 12% of GDP in taxes and spending double that currently - I'll shit myself. Beautifully delevering would seem to work better if the other major economies did not also have to do the same. Its like a druggy going to a rehab clinic when the nurses there are also druggies trying to detox and the doctor is a pusher...its probably not going to work as well as a clean rehab clinic is it? And in the case of Japan, its going to be trying to do that in a drug infested rehab clinic for a few decades. Anything is possible, sure - but the odds of a successful exit seem so minute to me that they are not worth considering. So not that I am an expert, but with those numbers, its over for Japan - they are going to default on their bonds (direct default) or on their currency (indirect default).

Hi original mungerville, well... "cash" that has appreciated more than 30% this year and which pays dividends! Not bad, right? ;) Gio Exactly, its good cash. As other stock prices fall, intrinsic value at FFH would remain stable and maybe even go up a bit. So in that sense, its like cash but with a better return. (Of course FFH stock will temporarily drop a bit along with other stocks in a crash, but that should only last a year or two or three because intrinsic value would stay stable).

I agree Gio. If we are not in a bubble, we are very close. When it bursts, who knows... maybe the central bankers will start buying stocks (like they have in Japan). The "E" in the P/E is at an all time record high as a percentage of GDP, however this may be due to government deficit spending which may persist for some time yet...so we may not get reversion to the mean, or partial reversion, in terms of earnings-to-GDP for some time which keep us at these high valuations for a few more years, who knows... A portfolio of 20% stocks, 70% short-term bonds/cash and 10% precious metals (silver and gold miners at this point for me rather than gold) makes sense to me. Of course if I see a deal on a stock, I would buy (reducing the cash position) but hedge that buy with market puts. I would consider FFH cash, so your portfolio is something like 34% stock and 66% cash which is very close to the above (main difference is you no longer are exposed to precious metals whereas a while back I remember you having some silver).