TwoCitiesCapital

I wouldn't call them lottery tickets. That implies the chance of winning is nearly nil - I'd say that Fairfax's has an intelligent reasoning behind the positioning and that they have been supported by economic data over the last 3-4 years. All we have to do is see if them being right on a general economic malaise actually bleeds into CPI figures that determine the payout. You have cratering energy and commodities prices, a slowing China, devaluations of currency happening all over southeast Asia and Europe, and a significantly stronger dollar. All of those point to a lower CPI - if global aggregate demand slows (which it appears to be doing), we could see a sustained drop in CPI. The chances of this happening aren't nil - I can't tell you what they are, but I've felt that they were much more likely than the market ever gave them credit for. The payout is extremely high and the bar for success is relatively low. We just have to make it to that bar.

http://www.bloombergview.com/articles/2015-08-20/optimists-were-wrong-to-predict-oil-prices-would-soon-rise-again I agree with this somewhat, but I have a hard time thinking anyone will let it get that bad - the Middle East needs the money to fund social programs. As the price stays lower, they have to pump more and will still be missing the target for funding those social programs while using up a limited supply of a valuable resource. I can see them holding out like this for a year or so - showing the industry who is boss, pushing companies into bankruptcy, curtailing capital spending, forcing consolidation, etc., but I can't see this being the long-game for the middle east which must know that they need these social programs in order to prevent regime change.

Fairfax has limited exposure to China, commodities, etc. They do have quite a bit of exposure to EM through their investments in India, but even that is only a fraction of the company as a whole which is mostly U.S./Canadian insurance and bonds. There is absolutely no reason you should expect them to trade together and any trading together they do is purely coincidence or a sign of a general equity "risk off" environment in which all equities exhibit much higher correlations to each other than is normal.

Coincidence?

You can find a list of all available in the annual reports of the companies. The differences are mostly around coupon, face value, and liquidity. Some of the preferred have higher stated coupons, some have face values of $25 and some of $50, and lastly, some are almost totally illiquid. The lower coupon, totally illiquid, ones are the cheapest. Highest coupon/most liquid are the most expensive. All trade at fairly sizable discounts to their underlying value if the courts rule in our favor.

Is it just me or does it seem like the odds are extremely high of the former Chief Justice of a state winning in his old stomping grounds? And, if Steele and the plaintiffs were to win, wouldn't that bode very well for FNMAS shareholders? It's hard to imagine the former Chief Justice grossly misinterpreting the law in his own state. Maybe I'm missing something, but in my view, the odds of this working out very well for FNMAS shareholders have increased to materially above 50% and the risk $1/profit $4+ still remains. I don't even want to venture a guess as to the odds as that's impossible to tell, but it is looking better by the day. Am I way off-base with this line of thinking? Thanks in advance for your input! I've been thinking the same thing and have been slowly building up the position I sold after the AIG decision.

Because Abenomics has been SOOOOO effective...

Which oil stocks do you long right now? :) I have some concerns with "the laws of supply and demand", because that assumes that supply and demand tend to go toward equilibrium. However, when oil prices drop, the companies have no choice but to increase production, to keep the Debt/EBITDA not to breach the debt covenant. If you check the recent few months' US Oil output, it is actually increasing instead of decreasing. When oil prices drop, the companies increase production before they are forced to reduce production by bankruptcy. This makes the bottom of oil prices a bit further away than the "the laws of supply and demand" believers expected. Eventually it will form a bottom. I am sure about that. But I am in no rush to bottom fish right now. :) Another note: Oil was less than $20 back in 2002. China had huge economic growth and a lot of the oil price increases likely come from there. Right now China is having problems and all the factory output decreased by over 20% this year. The other countries like India and Brazil will likely rise and replace the oil demand, but that takes years. The cost to produce oil back in 2002 was also likely lower (though I haven't checked). I think you're right to a certain extent that some producers will increase production to maintain debt service levels even if it isn't economic to do so. Those players will likely go bankrupt, but that certainly doesn't describe the sector as a whole. It was my understanding the increase in production was from wells that were already in progress in 2014 when the oil prices started to drop - they're not going to shut down and fire a ton of people on a nearly completed project because oil prices are volatile. What they will do is severely limit spending on new projects until the price catches back up - it could be a year or two before the reductions in CapEx, drilling, and exploration flow through to lower supply.

Agreed. I didn't go into the cost of oil in goods produced by other industries. I know it's a lot, but I also know the CapEx and R&D spent by oil companies is massive and is being cut. I don't have a good approach for being able to compare the two. This might also be more of a matter of timing than of actual amounts as well. A sudden stop in all Oil R&D would be impactful negatively impactful in the near term because it wouldn't be offset by the immediate offsetting rise in activity elsewhere. It'd take time for the increased activity to flow through the other industries to outweigh the impact of the oil cuts. Between uncertain amounts and uncertain timing, I have no idea how that impacts the economy. I do take qualm with your comment about the family of 4, but it's relatively minor so I don't want to get caught up on this. I'll just say that any study that does work on how much the average American spends on gasoline, but includes people who under the driving age, is generally worthless. I'm assuming that the people who developed the study knew this and by "average American" they meant "average American driver." With that being said, anytime someone references a family of four, they're generally talking about two adults and two children - not 4 adults who all drive independently to the dinner. Savings between the two adults would range between $40-$80 depending on if both of them are primary drivers or not. $40 still doesn't buy the family a dinner at a restaurant. Anyways, that's all I'll say on this because it's such a minor argument to get caught up and I'd rather focus on the big picture.

I would generally agree with you, but I could also pose the situation of diffuse cost and concentrated benefit. Let's assume I add a $0.01 tax to all transactions in the economy. Every person is going to pay an additional penny for everything and it all goes me. That would put me in an extremely high tax bracket, my after tax portion would be lower than the rest of the country's, and the benefit would be entirely concentrated on me, my neighborhood, and my local area where I'm blowing all that cash. The cost is diffuse so it doesn't impact other areas much, but the benefit is concentrated on what surrounds me without impacting the surrounding economies that much. Now consider the exact reverse situation. Those flows reverse and everyone in the country get's a penny back on every transaction and all of that money flows out of my community. People who were looking to buy houses no longer do either because income is less secure or because they can't get a loan or because property values are falling. Some people lose their jobs, default on owed debt, and become a drag on the tax system through lower revenue as well as increased expenditures. Eventually, prices will equalize again and the area recovers with a different base to build upon, but it takes years. Also, that additional penny on each transaction doesn't really improve the surrounding economies that much. So my question is this: Does the current situation in reflect more of your premise where the additional money is spent throughout the rest of the American economy OR is it my premise which suggests the amounts saved are small and diffuse where the cost is concentrated and large. Oil prices have cratered - gasoline prices have fallen less so. http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EMM_EPM0U_PTE_NUS_DPG&f=M Gasline prices have fallen about 25%. The average American spends about $2000 a year on gas. That means that the average American is currently putting an extra $40 month in their wallet. That is likely to be the cap as many oil experts agree that current prices are unsustainable and that mid-term equilibrium is around $60-$65/barrel (from the current $40ish). So, the real question is, do American's who have an extra $40 to spend every 30 days really more than make up for concentrated loss of credit availability, stable jobs, consumer purchases, declining home values, etc. etc. etc. I don't know, but I tend to lean towards no. If we were talking $100-$200 extra each month, I think it'd be a big deal. But $40 per month, max, doesn't seem to me to really do much for most people. It's not a car payment, it's not enough to take your family of 4 to the movies, it's barely enough to buy a family of 4 dinner at most restaurants, etc. I just don't see $40 changing consumer spending habits for all but the lowest tier of incomes.

This is my only point. If you followed this strategy, you may never reach a point where you re-enter the position in Google again. If that is the case, it's likely that your returns from whatever you put the funds into likely did far better because it's not a high bar to outperform a 3% earnings yield. If you do get a chance to re-enter Google again, then it's because profits absolutely exploded (possible, but not likely at this point) or because the stock price corrected. The later would be another validation of the strategy. You're either banking on the unlikely explosion in earnings growth or the greater fool theory. I don't like to rely on either which is why I used the strategy of buying around 20x and selling around 30x. I still watch it, but I certainly won't be caught holding it for 5-10 years as the stock price goes nowhere like what happened between 2007 and 2013.

The commoditized companies -- those are the ones who moved their manufacturing to China a long time ago, because they couldn't protect their margins. Chinese manufacturing has been so cheap for so long that we've been through this cycle already. So are there any of them left here in the US to get hurt by this? What I'm looking for here are companies that will be firing their US workers -- if we already went through that phase, then the US workers will not be hurt by this devaluation. Therefore they keep their jobs and their pay, buy cheaper (deflated) commoditized Chinese goods from Walmart, and have extra disposable income left over to spend (stimulative). That's what the Chinese want, right? They want the overseas consumer to have extra money to buy more things from China. But the US consumer will also spend more in restaurants. Or on whatever. Also, if finished goods from China are cheaper, we buy more of them -- doesn't that provide any support for the pricing of the raw materials inputs that go into those goods? I don't think the yuan devaluation in and of itself hurt America in much of any way. I think a strong dollar in general (which a weaker yuan contributes to) hurts America. Corporate profits will be crimped in USD terms as overseas earnings translate to lower USD amounts. That may impact the hoped for rising wage argument if corporations can point to a lower bottom line even before wages have increased. Also, it's hard to sustain elevated multiples on an equity market that has shrinking earnings which has the potential to hit the so "called wealth effect" (if you actually believe that has been working). There would also be certain domestic exporters who could be majorly impacted depending on where the bulk of the currency delta is felt. But what is probably the worst is a strong dollar's impact on oil - shale states have made up the majority of the paltry growth that we've seen over the last 5-7 years. Strong dollar, ceterus paribus, means lower oil prices and probably a negative contribution from areas/industries that have been providing the biggest boost to the U.S. economy. If we couldn't get above 2.5% GDP growth with shale booming - how high can we really go with shale collapsing? Sure it's a few bucks in the pocket of every other working American, but something has kept those working Americans from spending over the last few years and I would be seriously surprised if the answer was as simple as prices at the pump....

You'll notice that the numbers I reported were only for every 6 months. There were definitely period of time where it traded at 20x, or lower, in this period that aren't captured by the individual points. The low point in Nov of 2008 was right around 15x trailing 12 month earnings. I was merely illustrating the range of multiples that it traded in and not trying to capture the absolute highs and lows of the range. Two, it's not cherry picking an example. It's pretty much exactly what I did. I purchased a massive position in January of 2009 @ $308. I would have bought more, but I was buying BofA between $2.50 and $4.00 at the same time. I purchased more through 2010 and considered adding in 2011 but already had a very large position relative to my portfolio. From that point, I simply waited. The stock price was basically range-bound for 2010 through 2013 until it exploded at the end of the year. I started trimming at $900 (around 26x earnings at the time) and had sold the last of the shares when it hit $1200 (around 30x earnings at the time). Then I watched the shares do absolutely nothing from 2013 until the last 3 weeks. Not cherry picking. My experience. Maybe it was just luck - maybe Goog will never trade at a 20x multiple again. I will simply say if that is the case, than it's highly likely the returns you'd get elsewhere are more attractive than what you'll likely get out of Google. Google is only worth owning if you can get it at a signficantly lower multiple. People who did this significantly outperformed the buy/hold mantra over the same period of time (not that buying and holding didn't provide satisfactory results)

http://aswathdamodaran.blogspot.ca/2015/08/narrative-resets-revisiting-tech-trio.html Although I am against buying great companies at any price, I think Damodaran is being naive that you can make great money by darting in and out of a stock in a great company. He may make money on Apple now, but that approach missed most of the gains in Apple or Google or Microsoft for 10-20 years when huge returns were made. To get that you really had to buy and hold. As someone who held Google for years, I respectfully disagree. Google's multiple varied pretty wildly since I started buying it in 2008. And it's a great example that you don't have to "dart in and out" and simply make intelligent purchases and sales every once in awhile. Let's consider a history of Google's prices and trailing 12M EPS multiple from 2006 and on: Q4 2006: EPS $5.00 P/E ~ 48 Q2 2007: EPS $5.94 P/E ~ 43 Q4 2007: EPS $5.91 P/E ~ 44 Q2 2008: EPS $7.69 P/E ~ 33 Q4 2008: EPS $6.71 (or ~$8.20ish w/o AOL write down) P/E ~ 22 Q2 2009: EPS $7.24 (OR ~$8.75ish w/o AOL write down) P/E ~ 26 Q4 2009: EPS $10.17 P/E ~ 26 Q2 2010: EPS $11.53 P/E ~ 21 Q4 2010: EPS $12.87 P/E ~ 24 Q2 2011: EPS $11.63 P/E ~ 24 Q4 2011: EPS $15.37 P/E ~ 20 Q2 2012: EPS $12.62 P/E ~ 25 Q4 2012: EPS $16.48 P/E ~ 24 Q2 2013: EPS $17.11 P/E ~ 25 Q4 2013: EPS $19.97 P/E ~ 30 Q2 2014: EPS $20.59 P/E ~ 28 Q4 2014: EPS $20.36 P/E ~ 26 Q2 2015: EPS $20.50 P/E ~ 33 A simple rule based formula of buying it around 20x and selling it around 30x would have yielded great results. You would have avoided it in 2006 and 2007 (prices around $350-$400) and been buying it at it's lows in late 2008 and early 2009 (prices around $130-185). You would have bought more in late 2011 (prices around $300-320) and you would have held all of the way through late 2013 (prices around $550-550). All in all, you're return would've killed it. Initial purchases compounded somewhere between 22% and 33% per annum depending on starting and ending prices. Purchases at the end of 2011 compounded at 25-50% depending on starting and ending prices. People who purchased at the beginning of 2006 at $200 have only compounded around 10-15% per year. Even if you were fortunate enough to purchase Google at the lowest price ever, right after it's IPO, your compound annual returns are likely less those who purchased/sold thoughtfully with respect to the underlying value. BTW, that compound return would have been about 20-25% per annum. That return would be significantly higher had they sold back in 2004ish/2005ish, and used the cash to repurchased in 2008, 2009, and 2011, and then sold again in 2013. We're not calling tops and bottoms here - simply buying and selling within a range. So, what would've happened if you held in late 2013 instead of selling. When you'd have about an additional 20% --- all of which was delivered in the last month. Returns from 2013-2015 were negative until July and we only got to positive earnings by Google obtaining the loftiest multiple it's had since the 2008 despite growth levels being much lower than they were back then. I think now, more than ever, is the time to be using your simple, multiple-based rule to be selling the position and to pick it back up once prices revert to 20-22x.

macro is hard, right? as for oil, we will see. I'm on this board a lot. On every oily thread there seem to be at least a couple bears or naysayers, even back in the initial $100-$80 move, it seemed like there were a few guys warning of more pain. I don't think there is a very strong pro-oil bias here. +1 x 10000 Also, my entire income and the majority of my savings are in USD. I don't mind diversifying some of my exposure into commodity companies that have fallen 60-90% in currencies that have fallen 30-50%.... A strong USD may be the near to mid-term play, but many emerging markets have better demographics and better balance sheets than the rest of the globe and it certainly doesn't seem like a bad idea to be buying them at decade lows for the long-term.

No, but we might be seeing the start of that with big corporations lifting bottom-end wages and minimum wages rising. If this feeds into other wage levels then we will see how QE+policy=reinflation. Other than that, +1! I'll believe it when the numbers show it. Real median wages haven't sustained upward momentum over the last 15 years despite periods of economic growth and minimum wage hikes. Obviously, nominal wages are the only thing that matters for CPI, but inflation has been tremendously hard to find even before the strong dollar so where is it going to come from after the strong dollar? I think real wages will be a relatively good proxy for nominal wages going in the near-mid term. I don't expect wages to be stagnant forever. I just don't expect the problem to magically fix itself anytime soon due to minimum wage hikes...

The government referenced Nixon vs. Warner Communications. Probably not the only similarity between the two cases that will be discussed in the history books. +1

Yes - housing and assets in general. I find it hard to see a housing hit given that consumer/bank balance sheets are in much better shape. EDIT: unless rates rise. That's the most deflationary thing of all. Which is why I think we might get a deflation: if things go ok, rates rise, and I don't think things stay ok for long; but if they don't (which they never do, for too many years in a row), rates can't fall. Deflation both ways? But then I've been thinking this (and wrong) for years. It's not just about consumer balance sheets - it's about incomes too. Housing prices and rents can't continue to rise without an enduring rise in wages. We're not seeing that yet which will hold housing. If a slowing economic environment causes negative wage gains, even by a small amount, I think you'll see that creep into housing. Also, I'm not talking about a 10-20% decline in housing prices/rents. Even if it simply falls 1% a year for the next 5 years, you're going to get a pretty good deflationary print in the CPI with the falling prices of commodities, energy, and all imported goods. But if housing stays stable, or rises by 1% a year for the next 5 years, that's a pretty hard hurdle to overcome for the remainder of the index to pull down. We get close to $600 million for every 1% of deflation below the strike price in the U.S. We don't need the CPI to collapse by 10% for these to be wonderful investments. If we get just 2% below the strikes, we'll have more than made a great return on these swaps. I can understand everyone's frustration with the equity hedges - I certainly don't understand anyone's frustration with these swaps. It's such a low bar for success with the potential for an extremely high payout simply because everyone has faith that a room full of a dozen people can control the global economy.

I think the dollar strength is a more important going forward than is commodity weakness. Commodities are such a small part of the index - even oil falling by 50% didn't take us much lower in CPI regards despite the fact that it's literally used in just about everything. A strong dollar will affect the purchase of American made goods at home and abroad. It will also naturally lower the amount of international profits that a U.S. company makes. Lower profits + lower domestic economic activity + strengthening currency = deflationary environment...especially with debt loads like we have. The real key for a sustained deflationary trend in the U.S. again is another sustained hit to housing. Housing is nearly half of the CPI index. It would be hard to see any significant, sustainable deflationary trend if half the index isn't moving downward at least somewhat.

TBH - if you're really looking for a bet on deflation, you'd probably want something a little more "pure" then buying equity that is going to be affected by business results, market sentiment, and other idiosyncratic risks that are totally unassociated with deflation. I think in general, you're best bet would be to have a portion of your funds in long-term gov't bond ETF/mutual fund. The reason Fairfax is so attractive for this purpose is the leverage inherent in the bet - 1) $535 per share in high-quality bonds 2) total hedging of equity portfolio 3) CPI derivatives. For every $460 you put into Fairfax, you're getting $535 in bonds PLUS the upside from derivatives plus any alpha generated from equity hedging. The inherent leverage is what makes Fairfax attractive as a deflation hedge and why I am willing to use it as my deflation bet as opposed to a "purer" play. That being said, you won't find very many businesses that have this deflationary bias, let along have it leveraged, so it might be difficult to find something better than Fairfax and/or bonds.

FNMAJ OGZPY

+1.

Any investor that you see quoted in a paper/magazine/book/interview etc. is probably making adjustments to the numbers. If they're investing a large sum, they're not simply going to take GAAP at face value - there are shortcomings with standardized accounting and these investors will make adjustments to those figures based on their estimates to help correct for those shortcomings. You'll probably never back into the same numbers as them.

Agreed. I wonder if we are seeing "It's far better to buy a wonderful company at any price than whatever man". Hasn't gotten into my thick skull yet. The larger positions in my portfolio are "quality" positions - those are the only ones I'm comfortable building up to 10% with, but I would say 60% of my portfolio is invested in "cheap" as opposed to quality.

I've looked into and had a friend who has done it and received some property. The rules are different in every state - generally, southern states have the most favorable rules. Some general info: * Sometimes it's a fee that is automatically owed to you (I think GA does this). Sometimes it's an accrual for every month of non-payment (MS does this). In the later event, you can buy the lien and someone pay within a month and you get a paltry % return for the effort of going to the courthouse, paying the fees to participate in the auction, etc. In the case of the former, it's great for you but it also removes an incentive to pay until the very end of the 12 month period. * Most liens do pay you back. You do not get into this business to receive property. Most states have rules requiring you to buy multiple years worth of liens before you're entitled to the property (in MS I think it's 2 years). So, you could be out two years worth of liens before even getting a chance at the property, but then you'd still have to pay a title lawyer before you could ever sell or develop the land. *Lots of auctions are competitive bid with no cap (i.e. you can pay more than what is owed hoping to make it back on the fat yield). Some places, like Florida, the liens are literally bid up to paltry returns that hardly make it worth the effort. * this is a literally a state-by-state, county-by-county type of thing. It's really attractive in some areas - less so in others. You may have to travel to get somewhere it's worth doing.