TwoCitiesCapital

http://www.valuewalk.com/2016/03/corporate-profit-margins-trends/ S&P margins have been in decline for the last 12 months. NIPA margins have been in decline for much longer. Can we maintain high equity multiples if profits begin to fall?

+1. We need to waterboard Dalio to get him to tell us how he really feels. My statement was trying to explain how both could be true - Dalio isn't bearish because he doesn't see the immediate catalyst for what will drive equity returns down, but could very well realize that the most likely path forward is for a large drop at some point in the future. If you can't time that drop though, and you're not entirely certain it's going to occur, then it's possible to be "neutral" even while recognizing that there is a very real threat. My only point is that Dalio probably isn't going on record that he's bearish unless if he has immediately recognizable catalysts to drive it. By "pressed" I didn't necessarily mean simply ask him the question and then re-iterate it. I mean if you could force him to allocate money for the 7 years without the ability to touch it, you may find that his allocation to U.S. equities would be lower than otherwise thought for someone who wasn't particularly bearish on it. Then again, the bulk of Dalio's wealth is managed by the All Weather Fund so it may be that he wouldn't change the allocation no matter what the outlook.... In general though, I do agree with you that people tend to ignore disconfirming evidence. I appreciate you pointing all of this out and I was simply trying to do what you were asking by explaining how both statements could be true.

I'll only just add that the caveat that I normally get to when I see this 4% return figure - Dalio didn't predict an equity market crash and doesn't appear to be bullish or bearish at first glance. However, typically, when the stock market has delivered returns like that over the course of the decade, it wasn't a smooth 3-5% per year. Prior examples of low single digit equity returns have resulted from a stock market that went up to extreme levels and crashed back-down. Obviously there is nothing to say that ALWAYS has to be the case for you to get low, single-digit equity returns - but historically, that is how you got them. Dalio may not be bearish on equities simply because he can't yet foresee what causes that crash, but he has to know that it's more likely it will be a large decline in equities and subsequent recovery that brings about that level of return and not a stable 3-5% per year. He even said himself that the falling risk premia lends itself to increased volatility which supports the crash/subsequent recovery theme more than it does the stable returns theme. So even though Dalio may not be bearish on equities, the very fact that he forecasts a 4% nominal returns tells me that he'd probably lean bearish if pressed. He probably is just uncomfortable making that forecast without having a set of evidence supporting outside of simply relying on historical performance.

Why would anyone quote disconfirming evidence? :P What exactly is this quote "disconfirming"? Here is the full Bloomberg interview btw. Thanks for sharing the link.

I don't agree. You take what the market gives you, and I think there is plenty (for me) that is cheap outside of the energy, metals, and mining sectors. Keep in mind that, for the most part, I also don't attempt to play with the big boys...I am mostly looking at sub-$250 million market cap stuff that fits into a couple of broad themes that I think will play out over the next decade. On a more general level, the world seems pretty screwed up right now ....Europe is messed up economically and politically, the Middle East is messed up economically and politically, China is busy building new sandboxes in the South China sea that are armed to the brim with missiles, radar, and planes, we have a bunch of clowns running for the Republican nomination, energy prices are in the toilet (good and bad), we have central banks blindly wandering into uncharted waters with ZIRP/NIRP, the list goes on. To be quite honest, all of the above makes me happy, because absent World War III, it would seem that things can only get better. And in the meantime, I am sure I will keep uncovering individual companies that are cheap with a bright future. I agree with you globally which is why I'm heavily invested in Europe, minerals/metals, emerging markets, oil, etc. I just struggle with the idea that markets are currently "pessimistic" for the U.S. when we're still at elevated multiples on elevated margins at record low interest rates with incredibly low inflation. Especially when you compare these valuations, profitability, and inflation to elsewhere in the world. Now you have the Federal Reserve working to tighten liquidity, eliminate the record low interest rates, spur higher inflation, and drive wage growth through tightening the labor market, it seems like you have a few of those items that are going to create headwinds going forward. To me, it seems like this was a Goldilocks market for the U.S. where everything was just right and things can only really get worse...

I'm also planning to reduce my oversized (relative) position but waiting for a little higher prices (~15%) I tactically increased my position by 20-25% when prices absolutely cratered, but already had a full position. I promised myself I'd reduce the load if we got the relief rally I was expecting after such brutal selling. The price I sold at was just shy of a 35% gain from lowest prices. I'll sell the rest at a 30-35% gain from those prices if we get there, but I was cautious about keeping the exposure too long. The position was already my largest before the adds and became significantly so after them. I'm happy to take my gains and roll into positions that haven't experienced a similar rally. Bought PDER @ 149.50 Covered some SPY shorts and rolled them into IWM instead.

Sold about 10% of my ATUSF position today (after tactically adding 20-25% at prices below $6).

Truly respectable, but 20% in the first two months of 2016!?!?? What the hell do these guys own? I'm hugely focused in emerging markets, European financials, and commodities/oil and my performance hasn't even been that bad...and I'm at the epicenter of basically every crisis occurring right now...

Agreed with this. There are two mindsets - be cheap or maximize your income. Sometimes adding to your income is incredibly difficult. Sometimes being cheap is. The point is both options are available to you and you get to choose the easiest/best for you. I like Ramit Sethi too, as he looks towards the maximizing income route. Working on getting that 10% raise at work is going to do far more for your bottom line, especially considering the compounding over time, than does cutting out Starbucks coffee. his website is www.iwillteachyoutoberich.com

http://www.bloomberg.com/news/articles/2016-03-01/euro-area-factories-cut-prices-at-fastest-pace-since-2013 Producer prices falling at the fastest rate in 3 years.

http://www.bloomberg.com/news/articles/2016-02-29/euro-area-consumer-prices-fall-most-in-year-as-ecb-mulls-easing Deflation still a very real threat in Europe.

If they had a good place to deploy an extra $500M, then there's 6.8B on the balance sheet ready to be deployed. I understand that a good part of book value growth has been savvy financing by issuing equity when it was expensive and by repurchasing equity/subsidiaries when they were cheap, but that figure was based on reported BV. Currently, reported BV was 12B or $540 per share - making the above adjustments for current quarter unrealized gains and investments in associates gets you to $13B which is $585 per share. So, on a reported book value basis (which is what we calculate the compounded return in BV from) he is issuing equity as 0.9x-1.0x BV which isn't accretive to shareholders automatically on a per share basis like it would be if it were at higher multiples. If there were really opportunities to put cash to work, then why not use the $6.8B on the balance sheet or sell a handful of your $12B in bonds? I know I don't have full information yet, but it just doesn't make much sense given what we've been told.

Yea - it really doesn't matter when we're talking high-level though. The inclusion, exclusion, or scaling of $1-2B in the P/B multiple doesn't change much when we're talking about whether or not it was a high value or low value. Especially considering the investment portfolio could return that amount in a single year and make up for any "mistake". I'm just trying to keep things very high level using round numbers. I just can't for the life of me figure out why they needed an extra $500M and certainly don't think it was because the stock was expensive or they think they'll need more cash when the market drops. I just hope we're 2-3 days away from announcing a large acquisition where they'd need the extra $500M to complete it, but I'm skeptical after having read the press release.

I don't adjust the figure for the spread, but know that the coupon the preferred is a low bar and so I give Fairfax credit for the entire preferred equity along with non-controlling interests (we can debate the later point, don't know what to do with it really). Basically I did the following (though not on a per share basis) 12B reported equity 450M unrealized gain in associates 300M expected gain on fixed income 150M expected gain on net equity exposure 100M expected insurance addition barring catastrophe (-3.2B) intangibles Total: 9.8B across 22.2M shares is $441.

I didn't say it was. The original poster asked why it was required. And the only answer I can think of is: given that they anticipate a market collapse, perhaps they see selling at the current reasonable price to invest at seriously cheap levels in the future as an attractive relative value trade. I'm not arguing about the current FFH valuation. It's a third of my net worth so you can be fairly confident I don't think it's overvalued (although I always use historic BV hence our multiple discrepancy). As to why TBV, I tend to watch both. TBV is clearly extremely cautious. I'm sceptical about putting a multiple above 1 on goodwill (it can be justified, but I prefer not to do it usually) so I tend to value it using a >1 multiple of TBV plus 1x GW. If the newly outstanding underwriting results survive the next few cats, I will allow myself to put the GW on >1x. I'm ok with the 1x multiple on goodwill - I think you'll see from my post that I excluded it completely to make my figures more conservative and to get them closer to yours and still only end up at 1.2x. I wouldn't be so disappointed if this were for an acquisition but the way I see it is this: Fairfax has $6B in negative equity exposure Fairfax has $6.8B in cash Fairfax has $12B in bonds Fairfax has hundreds of millions in exposure to deflation (whatever the delta is on the contracts x 110B in exposure) In the event of a market crash, it is likely that they'll make billions on their bonds and equity hedges. That will be on top of 6.8B in cash already held plus whatever cash their insurance operations throw off. Lastly, there is the potential for hundreds of millions in upside from the deflation hedges if sold into a recession. So we're literally talking about a Fairfax that could reasonably have $10B in powder at the bottom of a market - what is this extra $500M going to do?

I can't understand why having billions on the books in cash with hedged downside isn't enough. I don't buy that they taking advantage of the current valuation - it doesn't trade at an excessive multiple to book (not even anywhere close to the high end of it's historical range) and it trades at around a 10x P/E of the average of the last two years earnings which have been reduced by a non-contribution from equities and losses on the hedges. Yep - am long and wasn't suggesting it is excessive in absolute terms. My point is that at >2x tbv they may feel they will do well selling FFH now to buy stupidly discounted stuff in the next year or so. Why are we using TBV? Do they not earn a return on the preferred equity that is invested in excess of the coupon paid? Do they not have $450M in unrealized gains from their investments in associates that should be added? Are we not 2/3 the way through a quarter that currently has them earning something to the tune of $100-200M on net equity exposure and probably close to ~300M on bond exposure? Has the insurance business changed so much over the last 2 quarters that we can't expect another $100-150M in earnings contribution from that for the quarter barring a catastrophe? TBV would understate the value of the companies assets. I think the full equity measure is better for the purposes of valuing them while giving some credit to the earnings capacity of their equity funding. If we include the adjustments I did above and then subtract out the 3.2B in intangibles, then your tangible book value was actually $441 per share and the offering is being done at about 1.2x... not a steep multiple by any measure. Especially since it only represents a multiple of about 10x their depressed earnings over the last two years. Keep in mind that every share of common stock has $553 of bond exposure, $306 of cash, $241 in equity exposure, and $98 in investments in associates. That exposure was just sold for about $560-$570 a share. Obviously there's debt and insurance business and etc. that this calculation doesn't include, but just let that sink in for moment and tell me that you think it's a good multiple to raise equity at. This transaction will not be accretive on a per share basis for anything other than the absolute slightest boost to BV/share. It would be more understandable if this was raising cash for some unmentioned acquisition, but the press release was very clear that this was being used to complete acquisitions already mentioned despite the $6.8B billion on the balance sheet. Something else to keep in mind - this offering only raised $536M with this offering. They could have literally used less than 10% of cash on hand to fund these acquisitions but instead chose to offer equity at a relatively low multiple. It's just moderately disappointing. Not the end of the world but it certainly has me confused.

I can't understand why having billions on the books in cash with hedged downside isn't enough. I don't buy that they taking advantage of the current valuation - it doesn't trade at an excessive multiple to book (not even anywhere close to the high end of it's historical range) and it trades at around a 10x P/E of the average of the last two years earnings which have been reduced by a non-contribution from equities and losses on the hedges.

Actually, given Bridgewater's Pure Alpha performance in 2008 was near +10% while global equities were significantly negative (S&P at -38.5%), I think it's fair to say Dalio's model did predict the crisis and profited from it... I'm also not sure whether White and Dalio are using the same analogy here. Does Dalio really say that the machine "can be closely controlled"? – I always pictured this more as an autonomous machine, though he definitely does say that it can be understood. I think Dalio definitely ascribes to a belief that a certain action that occurs with an economy will have certain predictable outcomes. That doesn't mean he gets those outcomes correct 100% of the time, but what that does mean is that simple higher level truths can be found based on history and logical reasoning. Things like if a country is devaluing their currency, exporters should benefit. Bridgewater's analysis is obviously much deeper than that, BUT that's what he means when he says the economy is like a machine. A general framework would be something like: when some action occurs it has led to some outcome because of a, b, c, and d. Further, a, b, c, and d all still hold true today, therefore we expect a similar outcome. Then Bridgewater bets a small amount on that outcome, either directly or indirectly, in the securities markets. Now, he obviously allows for the option to be wrong because he is very, very heavily diversified in the Pure Alpha funds. If he thought he could predict with 100% accuracy, he'd have the heaviest concentrations in the highest payoff ideas, but that's not really how the fund operates. But he has to be right far more than he is wrong to achieve the results he's achieved.

Actually, given Bridgewater's Pure Alpha performance in 2008 was near +10% while global equities were significantly negative (S&P at -38.5%), I think it's fair to say Dalio's model did predict the crisis and profited from it...

Is this all there is to know about his positions today? Is he 50% cash of the hundreds of billions he runs? Any idea at all? Have you read it? "50% cash" is meaningless for futures trading. And in which currencies, anyway? This is not a value hedge fund. I haven't even bothered to look whether there are 13Fs because they'd be almost completely meaningless. I haven't, and that's why I was asking. Honestly, most of this 80-year debt cycle talk is just over my head. But I am open minded and willing to listen. Generally, I much prefer to look at what fund managers do instead of what they say. I think many of us would have a much better idea of what Dailo is preaching, if we knew what his current positions are. You wont' know what his positions are. A large majority of the macro bets are done via futures, currencies, and swaps. He doesn't have to disclose any of those.

I've got two possibilities: 1) The bulls already bought the heck out of them before individual names fell 20, 30, or even 40% or 2) The bears don't think that a 10% decline in the overall market signals a screaming buying opportunity I covered some of my higher beta shorts. I added a small amount to FCAU, SAN, and ATUSF. Other than that, I've remained about the same because a 10% move either way in the SPY really doesn't mean much to me in terms of trying to take advantage of the swing of fear/exuberance. It's the 25+% swings I try to take advantage of.

I think the goal is to always remain at 100%, but given the mismatch in performance and TRS maturities, there are probably times when it's not. My guess is they had TRS contracts that expired on 12/31 and they probably reinitiated early in Jan.

Wow! Those insurance units are really banging it out even in a softer pricing environment. I understand there have been limited catstrophes in recent years, but Fairfax has pulled in over $2B even while being hedged in equities and losing a pretty sum in Greece.

, he's being much more honest than when he and a bunch of others predict that this will end in 50+% crash, recession/depression, endless deflation (or is it hyperinflation?), etc. I'm going to go with "don't know" too. But I am not going to take macro bets of shorting, currency bets, etc. to attempt to predict the outcome. If that makes me crazy bull, then so be it. I can't remember anybody "predicting" a 50% crash or calling you a "crazy bull" or anything along those lines. You started calling some of us "perma-bears". I don't find that reasonable but I don't mind. Personally, I find these threads quite helpful in trying to find out what's most likely going to happen. I try not to think in categories of "knowing" and "not knowing" because you never know, you know? So, that's hardly helpful. Instead, I try to think in probabilities. What do I think is more probable and what's less probable. Based on that, I make macro bets but that's also the way I invest in single stocks. As a value investor, you can't know things either. In his defense, I've been quote vocal about my concerns that a crash is likely - but I think poor equity returns are to be had regardless of what happens in the economy. I just don't buy that we've reached fairy land with high margins and high multiples forever, which is what is needed for this level of the market to persists. Especially given the relative value offered by Europe and EM at the moment. Obviously we need a catalyst - I don't know if it's going to be negative interest rates, a policy mistake, the devaluation of yuan/the implosion of China, etc. etc. etc. but in a world where so much seems absolutely absurd, debt levels seemed stretch, growth is marginal at best, and inflation has been in a downward pattern for years, something seems likely to happen to be that catalyst and I do think the impact of that will be a significant decline in equity markets as forward looking growth/profits/margins are re-evaluated.

It is normal for a very large percentage of the world’s investors to be paying borrowers to take their money? Is it normal for a major economy to be creating almost 10% of GDP in credit in a single month when their current credits are deteriorating rapidly? Not saying you can’t find good investments but why be so quick to dismiss people who bring up these (and other) important issues as crazy perma-bears (especially Dalio, who isn’t even making a long or short case, just stating the facts)? I'm certainly not a perma-bear, but I'm also not willing to just stick my head in the sand either. The very fact that people are actually looking at negative interest rates in much of Europe and determining that things are "ok" and that maybe the policy should be parroted in the U.S. just seems absolutely absurd to me. I f someone had told you 15 years ago that we would live in a day and age where borrowers would get paid to borrow, you'd feel like you were talking to a crazy person. But today, it apparently makes absolute sense. I don't know what will happen, but I do sometimes feel like a crazy person for worrying about these sorts of things while everyone else seems to think it's all fine.