TwoCitiesCapital

Japan announced that inflation was negative for August. Stripping out fresh foods, core inflation was was also negative at -0.1% - the first negative print in core inflation since the beginning of the current QE program started in 2013. Abe-nomics isn't working just like none of the other QE programs in Japan ever worked. Sure, someone will probably have the excuse that China's weakening yuan is wreaking havoc on Japan's export economy. I'd just add that there always seems to be some good excuse for why any individual QE program doesn't work, but I've yet to hear a good excuse that explains why they have all collectively failed without a single instance of success in stimulating "normalized" growth and inflation. We're not there in Japan after nearly 10 rounds of QE. We're not there in the U.S. after 4 rounds of QE. We're not there in Europe during the first round of QE. Hey, I know what we need! MORE QE!!!!

I am not familiar with Stanley Druckenmiller… Is he as good as Tepper seems to be at market timing? Cheers, Gio He was the guy who generated a lot of ideas for Soros' fund back when Soros was killing it. Also managed his own fund that did pretty well. You should look into him. With the amount of leverage he used, I would imagine he'd have to be a somewhat decent market timer to not get killed.

Rates were low for 20+ years after the Great Depression. Rates have been low for 20+ year in Japan. When you have a financial crisis, you generally get low rates for the next 2-3 decades. Doesn't have to happen, but seems like it generally does because the government/Fed lacks the political support to do what's necessary to change that (for better or for worse). Then again, I'm biased. I'm assuming that rates will be low for a long time regardless of Fed action and I believe in Fairfax's deflationary thesis.

Doubled my SPY short today. Also sold FCAU 11/20/15 PUTS @12 for $0.60. Now I've got around a 4-5% outright short, another 7% or so in cash, 10% or so in Fairfax, and have selectively sold calls against positions to generate yield as prices fall. Will continue to add to the short position if my various cash-covered puts are exercised.

You're missing the second side of the equation - too much supply. There's a pretty good argument to be made that 20 years of excess supply in credit inflated people's consumption abilities which leads companies to over-invest in capacity which is a major problem when the credit stops flowing and people have to consumer below their means as they delever. Capacity utilization in the U.S. is still running below it's 40-45 year average. This is 6 years into a supposed recovery where tens of trillions have been spent globally on stimulus, we have "normalized" unemployment rate, and the consumer balance sheet has healed due to a transfer to the public balance sheet. Also, you have to consider that if China/EM is really going down hard, which appears to be the case, that people will flee to safe haven assets denominated in USD, euro, and yen. As the USD appreciates, all imports get cheaper. For an economy that is a net importer, that is deflationary in and of itself. Every 1% tick up in the dollar brings down inflation readings by some fraction of that. A slow, sustained rise in the dollar brings a slow, sustained, deflationary pressure on top of the of the excess capacity which will result in companies cutting prices to get rid of inventories.

It's on the higher-end of this year's trading range, but not terrible all things considered. Also, that's only CAD 85M worth of shares. That's right around 0.5% of shares outstanding so it's not like they gobbled up a ton. It does give us some hope that more share repurchases have/will commence if the price stays weak. I hadn't given that thesis much weight recently given that they didn't repurchase when it was delisted.

Yes! I enjoyed this book so much.

http://www.reuters.com/article/2015/09/22/us-climatechange-energy-divestment-idUSKCN0RM2PZ20150922 Sounds like oil companies might be structurally cheap in the future if this catches on. Not bad for long-term investors who are looking for their "Phillip-Morris" stock to be the long-term, best performer in an index, but also not good for those expecting a quick turnaround and high capital gains.

Sold VALE 11/20/15 PUTS @ 4 for $0.25

Or you increase your compounding power by 10-15% over the long-term life of the investment. This would be much more helpful than a 10-15% one-time boost. well, it's also a levereed bond portfolio of CCC rated MBSs. How do you feel about owning a basket of that at a 15% discount to NAV? I'd feel alright about it. Here's the deal, we all recognize that markets are mostly efficient, but that there are some inefficiencies. But the market has deemed the value of these CCC MBS at one value, and then at the same time said if you buy them as a package you get 15% off. I can't imagine it will work out in every situation, but it doesn't seem hard to beat the market when you're buying everything the market has available at double-digit discounts. My main problem with these things is the active management. You can't look at them and say you're simply buying assets cheaply relative to the market. You have to trust that the active management isn't going to burn through the benefit of that 10-15%. That's a harder question, but my guess is that anyone who carefully selected a handful of CEFs trading at 10+% discounts would have no problem handily beating the market. I haven't looked at the actual numbers to know if has been proven or not, but it's hard to come up with a scenario with the active managers of all of these funds just destroying the 10-15% value year-in and year-out.

Or you increase your compounding power by 10-15% over the long-term life of the investment. This would be much more helpful than a 10-15% one-time boost.

Shorted some SPY shares. Yesterday's failure to close above 2000, along with slipping below long-term moving averages, on the S&P gives me some comfort that the momentum is firmly downwards with prior supports acting as resistance. Options are still expensive so I haven't re-initiated my puts after selling for a sizable gain. To recap: 1) Fundamentally expensive 2) Earnings growth likely to shift negative on stronger dollar 3) If wages pick up (I doubt they will, but is the bull case for the economy), then margins will likely be pressured exacerbating #2 4) Globe seems dangerously close of falling into a global recession. It's not a huge position - just something to give me a little comfort knowing that I'm profiting some if I'm right as opposed to sitting on the sidelines. Will switch to options if I can eventually get back into some LEAPS for a reasonable premium/implied vol.

That sums up the $400B argument. Just saying that I think there are many great reasons to be bullish: violation of 5th amendment, illegal under Delaware law, the dangerous precedent set, the risk of public release of documents. But the lack of capital is not a real problem when you're backed by unlimited funding when needed. Makes for great talking points though. The lack of capital is the political argument that gets them airtime because most tax-payers who bailed out companies once don't look so favorably at the possibility of having to do it again. The networth sweep eliminates any chance that the GSEs could ever recapitalize on their own and leaves taxpayers on the hook for bailout after bailout after bailout every time the economy hits a rough patch...

http://www.agriland.ie/farming-news/fbd-raises-e70m-through-agreement-with-fairfax/ Fairfax to receive EUR 70M of 10 year convertible notes at 7% coupon. Will receive a 12% coupon in the interim from today up through 7 days past shareholder approval of issuing convertible debt. Not going to move the needle much, but 7-12% on convertible debt isn't bad in this environment.

A Colossal Failure of Common Sense is about the collapse of Lehman. Doesn't go into all of the intricate details, but gives you an idea of the culture that existed during the time that it failed.

Sounds like you're having one of those years. I've had them, and it sucks. What you have to wonder is: Are you having bad luck despite a good investing process, or do you need to rethink your approach? Personally, I ended up rethinking my approach. Yea - I've ended up changing something every time this happened in the past. It's years like this that drove me to set position limits for myself and to do my buying/selling activity in multiple steps instead of all at once. I'm not sure that this year will result in that though. I believe the long-term numbers that show currency hedging is a wash in the long-run and I don't fancy the idea of limiting my exposure to a diversified and increasingly idiosyncratic asset class like EM that is offering value just because I already have a lot of exposure. I think this year was largely one where it was more of a coincidence that everything I bought went down and less of a problem with the process. I mean, the things that drove Whole Foods down is different than what is driving Fairfax down which is different than what caused the recent drops in Outerwall which is different than what is driving the value of the euro which is different than what is affecting EM companies. Looking back, I might have reduced my how much I allocated to commodity companies back in March given my exposure to EM which would be correlated, but that might be the only thing I'd do differently. The year isn't over yet and I'm not quite willing to say that EM and commodities were bad choices just because of one year of tough performance. I'm not managing money for anyone else so it's easier for me to stomach a bad year.

I'm having a pretty rough year. Was in EM pretty heavily before this year given the attractive relative valuation to the U.S. Have been double-whammied by currency and equity movements. Have been doubling down on many positions that trade at sizeable discounts to book, single digit P/Es, and attractive dividend yields, but this probably won't help performance this year. Was also in Europe pretty heavily starting in 2013 and been building ever since. The devaluation of the euro relative to the dollar over the last 15 months hasn't been kind to me and most of the positions are down significantly from their highs - mostly due to currency fluctuations as most of the businesses are better than they were 15 months ago. Started building some significant positions in commodity companies (energy and coal related, mostly) back in March when panic was seemingly at its highs. Some of these have held up alright, but many of them have taken considerable unrealized losses. Selling regular options against the positions has helped limit the losses, but this portion of the portfolio is down about 15-20% in just the past 6 months and is significantly off its highs (+20-30% about 6-8 weeks after the positions were initiated). The few stocks U.S. companies I own have been hit by idiosyncratic risks: Fairfax is down significantly from the beginning of the year (and it's highs) and Whole Foods has collapsed a good bit. Was fortunate to be able to sell my U.S. equity puts at a nice gain though given the market action in the last few weeks. Basically, if you want to make a quick buck, you could probably do the opposite of what I've been doing and have some pretty good results. :)

I've been a buyer. Once mid-October comes around I'll have more money as my cash secured puts will expire. Hoping it stays low through December/January when I'll have even more money to allocated to it.

While I hope it's true, has wasn't buying back when we were delisted and sank 20% below the current price. Maybe he had better opportunities back then, but I'd truly be surprised if he bought back here.

Thanks for this - really interesting. In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'. But it doesn't tally with his 'cumulative 14%' deflation claim. However, look at the GDP deflator graph on the same page. That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change). So...this tests my knowledge of these statistics to their limits! Does anyone know why the GDP deflator would differ so much from CPI? I thought through this and it seems that they should be measuring the same thing; however, a quick Google search does suggest there are some differences. The GDP deflator only measures domestic goods consumption and ignores the price differential of imports that are subtracted out of the calculation of GDP. Also, CPI only measures consumer prices (which is why we also have PPI). The deflator will capture both. So the GDP deflator could drop massively and the CPI could remain the prices you had import inflation while the business investment/PPI falls off a cliff. The opposite could also hold true where the GDP deflator remains stable and CPI falls off a cliff if you import deflation via a stronger currency (the current situation of the U.S.). In Japan's case, their currency appreciated massively between 1990 and 1995. Given that it was an export based economy - that is going to blow a whole in your business investment, CapEx for export purposes, etc. but it may not flow directly through to domestic consumer spending because that's not where the massive excess in capacity was targeted. Also, the "bubble" in real estate was largely contained to Tokyo - not a national trend. So the only part of CPI that would have been decelerating massively is the % of the entire index that went to housing further segregated by the % of that figure that is Tokyo. Most other assets, outside of stocks, were untouched by the disaster in 1990.

http://www.ft.com/intl/cms/s/0/18c672e6-5793-11e5-a28b-50226830d644.html#axzz3lFWM9CIY Food Prices Record Largest Monthly Drop in 7 Years So - it's just the drop in energy right? That's all that's driving CPI and inflation expectations? We can ignore the drop in nearly all global commodities and food as coincidence? I think it's more of the canary in the coal mine.

I've struggled with what kind of multiple to apply in the past, but this thought always crossed my mind. It doesn't make sense for me to discount their future earnings streams by some massive percentage unless if I think they'll be equity-hedged with bonds yields at 2% into perpetuity. I have no idea where bonds yields go, but I bet they're higher in 10 years. Also, Fairfax has a history of hedging and then removing the hedges so we cant expect them to hedge into perpetuity. So today they're worth x, but tomorrow they take equity hedges off and they're worth 1.3x because of the increase in earnings power? It'd be hard for me to get behind such a drastic change in valuation for something that is so easily changed and that they have a history of changing. I think it might be better to change your position sizing instead of multiple you buy at. Maybe instead of a 10% position if they were fully unhedged, you do a 3-5% position so the opportunity cost doesn't kill if you they're wrong. If they remove the hedges, or appear to be right, you can rebuild your stake. It seems like this would be an easier way of controlling for the uncertainty than trying to come up with a different multiple of book for every change in interest rates, deflation hedges, and %-equity hedged status. I'm sorry but I'll have to disagree with you here. It's not just that the hedges worked out badly that would hurt the valuation. It's a bit the fact that they did them. The equity hedges were put in place at a time when the market wasn't really overvalued. Maybe some people may have made the argument that it was somewhat overvalued, but I don't think anyone could have made the argument that it is grossly overvalued. So why go so short? If you want to debate what they did 5 years ago, go ahead but you'll be wasting your breathe. I'm not here to argue that what the did in 2010 was correct. I'm suggesting what they're doing now is correct. I could give a damn if they were early/wrong 5 years ago. What's important is that I agree with the thesis NOW which is why I'm doubling my holdings NOW and not 5 years ago. There is a difference between the two, but you've missed it. You owe the dividends when you short a stock too. The main difference is the regular cash settled nature of the TRS which is a boon to the contract winner and to the detriment of the contract loser. Maybe you should. You'll see that there's been several times in history where 3, 5, and 10 years worth of returns have been wiped out in a single year and it's generally been at times when long-term P/E ratios were about where they're at now. If you think that collapeses like 2008 don't happen all that often, you only have to go back 7 years to 2000/2001. There have been mutliple 25, 30, 40, and 50% corrections in equity markets all over the world. The U.S. isn't immune to them. If you hedged in 2003 you looked pretty stupid until 2009 - and then you came out way, way, way on top. I generally agree Fairfax hedged early. I didn't personally start hedging until the European banking crisis in 2011. I've had mostly long exposure since and the most I've been short was 30-40% of my notional going into the most recent correction. That worked pretty well, but now that it seems things are unraveling as expected, I'd rather have more of my portfolio in a position to benefit from potential turmoil. Options are expensive - I sold my puts and am buying Fairfax which has gotten a lot cheaper. I'm glad for that. Most economists, including the "smartest" ones leading central banks missed 2008 and the ramifications of the market collapse. I'm glad that Fairfax hasn't hired such people to tell it how to invest. Show me a single economist that made a billion dollars in 2008. Oh, there's none! But there are a handful of asset managers who managed to do it and Fairfax is one of them. Maybe they are. Maybe they aren't. They've proved somewhat adept at it in the past whether it be through equity hedging, derivative exposure, or betting on rates actions. They've been early at times, but I'd rather they be roughly right then to be precisely wrong like most were in 2008. Also, I don't think it's really up to me, or you, to determine what's in their circle of competence. Lost opportunity cost isn't quite the same thing as actual losses. They could have achieved the same thing by simply selling all of their equities, but then you probably wouldn't be tallying all of the billions "lost." Maybe you would - but it still wouldn't capital loss. Simply opportunity cost. If you tally up every bad investment Warren has made, and compound it at the rate that he's grown book value since, I'm sure his mistakes tally in the tens of billions too. Secondly, of course it affects valuations in hindsight, but the question is going forward. They could remove the hedges tomorrow and then the stock is supposed to fly up a massive percentage on increased earnings power potential? The real value of the company would accommodate for the earnings power at all levels of hedging and probabilities of them occurring. Unfortunately, that requires several assumptions on what the probabilities are and what forward looking equity returns are. I'm pretty sure we're all likely to be wrong on both counts so it's easier to adjust the position size based on a range of multiples to book value than it is to be regularly buying/selling based on your new updated assumptions and the stock price action. I don't think you can compare the two. They have different structures, different leverage to publicly traded equities, and differences in terms of a diverse base of earnings. Fairfax will always need to hedge these risks more than Berkshire until it becomes similarly diversified. Berkshire has the opportunity cost of always holding $20B, or more, in cash. Do you consider that lost money every year the stock market goes up, or is that just business as usual for Warren? Then enlighten us what intrinsic value is today and what multiple you'd pay for it and how that's evolved over the last 3 months and how it's likely to evolve in the future as stocks could go back up 10% or down another 10%. Keep in mind constant changes in inflation expectations and interest rates and make sure you include those in your economic model. I'm simply provided a much simpler framework that serves a similar function without the constant transaction costs, changing value targets, multiples etc. You don't have to like it, but it serves a similar purpose, is much easier to implement, and probably results in far fewer transaction costs for those who are willing to maintain exposure to Fairfax.

Totally agree. These guys are really starting to worry me. SD, Blackberry, RFP. I could have thrown darts at a board and had a great deal more success than this nonsense. They need to get their eyes checked because I just can't figure out what they're seeing. Truly head scratching picks when there's so many more viable companies out there. They've sold class assets to buy what appears to be junk or small potatoes. I'd be a liar if I said they haven't lost me at this point. I keep hoping they prove me wrong and put egg on my face. So far, all they've done is take money out of my wallet. A chef? Really? That's the best they could come up with? This is going from puzzling to goofy. Maybe they should look at something other than a dying or insignificant Canadian business for a change. You mean like the billion dollar fund they launched in India? Or the $300M investment in an Irish bank recapitalization? Or the amount that they've put to work buying real estate companies and banks in Greece? What about the acquisition of Brit or other smaller, diverse, insurance businesses? Their last foray into the food industry worked out pretty well for them, why are we giving them so much hate for this one? The recent investments in Blackberry are far from settled in terms of profit potential - what I do know is that the stock has rarely traded below the price Prem doubled down at years ago prior to the CEO change and burning through billions of dollars in inventory. Seems like he did pretty well with picking a good price to double down at then. Often times, the stock has traded hefty premium to that price. Further, the convertible debt deal looks like a real winner in terms of providing $500M in well covered, high-yield debt in a low rate environment with the upside of equity in the event that software revenue does take off. That also seems pretty great. I can't speak to RFP or SD, but if you put all of the money invested in these "goofy", "puzzling", "insignificant" Canadian businesses together, it still pales in comparison to all of the money they have spent on building and diversifying their insurance business, growing their Indian investment platform, and making actual equity/debt investments statistically cheap areas so I don't understand why you're so caught up on it? It sounds like they're doing exactly what you wanted - spending the majority of their time and money on other endeavors. Cheers!

1) Sold KXM @ CAD 0.61. Mostly a cash holding company for mineral investments. I purchased at $0.48 a few months back and am happy to take 25% off the table to redeploy in other areas of the market. 2) BSBR @ 3.78 - Brazilian banks are cheap.

Ditto. Have been looking to add around here myself. I've doubled my position this year at prices between $450 and $500 USD now that the deflationary thesis is really seeming to heat up and EM markets dive-bombing. The next 1-2 years will be interesting for Fairfax.