TwoCitiesCapital

Long term bull markets are born out of low valuations that lead to multiple expansion - not technological innovation. Technological innovation leads to long-term productivity gains that lead to long-term growth. Growth does not necessarily lead to higher valuations as can be seen in many periods of time throughout the stock market history of the U.S.

Hmm, I'm not sure I understand this. How does switching their stock positions into total return swaps relate to the cash they've been losing on the short index swaps? I apologize if I'm being thick as a post. Total return swaps are legal agreements to exchange cash flows from two items. In Fairfax's case, they are paying the return on the Russel 2000 index (and will receive the return if it's negative) and are receiving payments on the financing leg of the swap (likely to be th 1mL or the 3mL rates plus or minus a spread). I don't know the exact specifics of the swaps, but it's likely that they result in either monthly or quarterly cash outflow for Fairfax as the index appreciates. The financing that Fairfax receives on the opposite side if the swap isn't going to be anywhere near the outflow on the index side so they need regular cash flow coming in for these payments. Fairfax could regularly sell shares to cover this monthly/quarterly outflow, or they could enter into monthly/quarterly swap agreements to receive the return on the underlying stocks. This would result in cash flow coming in every quarter which will partially offset the cash outflow every quarter.

Why hedge 100% of your equity portfolio? Why not 50% ? Why not hold cash instead? Not hedging 100% of the portfolio is making a market directional bet. Had he only hedged 50%, that would still mean he's "betting" in a more bullish favor. He's market neutral...what a proper hedge should be. He could have held cash - to hold enough cash to hedge the downturn in the equity portfolio and to protect ratings, I imagine that would have required him to liquidate a large number of positions which has it's own complications with it. Hedging allows him to have exposure to his alpha - liquidating and holding cash doesn't do that. Now, in hindsight, you can argue that holding cash would have turned out better, but that's a different argument. Everything is clear in hindisght... He built it into what it is. He, and a group of people he hand selected, run the company and control it's directions. He has the majority voting position in the shares. And his investment committee is the reason that we're all in investors. The only thing you do as a shareholder is provide liquidity in the market for share ownership making it easier for them to issue equity in the future. If you feel that is doing enough to deserve being "offended" at my calling it his company, well...I don't know what to tell you.

I think it's wrong to look at it from a point of right or wrong because that suggests that Watsa is making a market directional bet. The equity hedges clearly aren't as he has hedged 100% and has recently rebalanced to maintain 100%. If he were making a directional bet, his net equity exposure would have to be significantly negative and for a decent period of time. The deflation hedges are a little less clear since he seems to be adding exposure over time; however, Watsa has raised points in the past. He jas reminded us that Japan didn't experience deflation until 5 years after that crisis. The slack in the U.S. and European labor forces, the low interest rate environment, and continuation of QE over the last five years all support the argument that deflation is still the biggest danger. Its hard to fault Watsa hedging HIS business from such an economic catastrophe. If you're thinking in terms of "right" and "wrong" you're assuming he's making a market directional bet which isn't currently supported by the evidence. He's simply being cautious and you can't be "right" or "wrong" by being careful.

Would you share your short thesis on AMZN, Zach? Thanks. Probably the same one you've heard from others. I don't believe the revenue growth will justify earnings to support such a lofty valuation. I basically view Amazon as pursuing low-profit to zero-profit ventures that add to revenue growth that support it's stock market price which helps give it access to cheap capital to continue pursuing non-profitable business. I'm sure some of the stuff they're doing will eventually lead to bottom line growth, but their entire history of profitability since being a public company says more than enough for me in determining if they'll ever achieve massive profitability like everyone imagines. They're recent move to do fresh delivery of produce in the tri-state area supports this argument as there are already two very well entrenched companies that work in this already low margin business. It will require a ton of upfront investment for the infrastructure and refrigerated trucks, they'll receive little to no synergies with their current business, and will be competing for a low margin, low profit business in doing so. It just doesn't make any sense to me. All that being said, I rolled my short exposure from Amazon to Netflix when they were both around the $260/share level. I find NFLX to be a more compelling short with the off-balance sheet liabilities and my expectations of their ability to be draw enough customers to justify the costs of custom content. Also roll'd some of the short exposure to TSLA around the $155/share mark on it's way up to $190 because it was a clear that it wouldn't be able to meet the expectations for its shares over the next 5 years.

Not a particular purchase today, but I'm slowly accumulating more DSL, BSBR, with a little SAN overtime through monthly dividend reinvestment. Also, will likely be adding to ATUSF soon.

Somebody forgot to tell Ray Dalio and Bridgewater this....

The Western world can't handle deflation because of the debt burden they have. Deflation is still the real threat in the near term. Inflation might be a longer term worry but being cautious and keeping cash/bonds in your portfolio probably isn't a bad decision. I, for one, am glad that Fairfax is hedged and has derivative exposure. It's a much cheaper way to expose myself to that directional call then to be buying the puts myself.

I bought SB way back in 2010. Let's hope it moves a little quicker for you then it did for me. Recent returns haven't been so bad though since doubling down near the bottom.

Not to take a side, but it's sort of ironic Hussman mentions Bayesian learning. I wonder if he's adjusting his priors for each year that passes without any blow up, despite the Fed's actions. My sense is he's only doubled down on his beliefs. Which means he's not Bayesian at all. Not necessarily. Bayesian learning simply means you adjust the probabilities with each year of new information. Maybe each year that passes increases the probability of a blow up occurring and actually justifies his "doubling down", no? I don't see any reason that this can't go both ways.

Yes. Virtually sold out. Fair value to rich imo. I sold all the shares I bought when they were delisted at $425 but I'm holding onto my core position. I figure that improvements within the insurance industry might be worth waiting around for...especially with the downside protection that comes inherent in a position in Fairfax at this point if the markets go haywire.

I'm about 16% in cash after pushing a bunch of my cash position into fixed income CEFs a few weeks back and recent appreciation in my holdings. I'm also 7% short in Tesla and Netflix combined and will be receiving a large cash payment from the sale of BBRY that will Bump my cash position up to 25%. I'm also letting all dividends go to cash instead of reinvesting, so those bond CEFs yielding 10% will be a large contributor to cash in the next year or two.

I think that generally captures the spirit but isn't descriptive enough. Value investing is the art of not losing money through this concept we call a margin of safety. It's the minimization of the chance for a permanent loss of capital. Buying low can achieve this as risk is a function of price - but you can also achieve this through buying quality companies at reasonable to high prices because it's predictable that they will keep on compounding value. Thus buying KO at 20x earnings can be just as much value investing as buying a cigar butt at 3x. This is mostly what I've been learning over my 6 years of exposure to value investing. It's all about limiting downside. The upside takes care of itself and you'll achieve decent returns. If you want amazing returns, you're most likely going to have a competitive edge and leverage (like Warren) or tweak your style to take more risk than you ordinarily would when the opportunity arrives and nobody else is around to do it.

I think a lot of it depends on how many talented people are in the game. Right now, you have a lot of talented people throwing a lot of resources in figuring things out. This is not a game that you play to win, because you won't. It's a game you play to not lose. It's a game to play to not lose because you are outmatched. I actually think times like this is exactly when value investing works best - you putter along with "subpar returns" when everyone is making big bucks, and then when they all blow up from making mistakes, you are the guy who survives and is able to profit from the wreckage. The time to be concerned about value investing, if ever, is once everything is blown up. At that point in time, the playing field has cleared and you have a little more leeway to be aggressive and to be able to take on more risk and seek higher returns (playing to win). Sure, people made good money buying conservative investments like JnJ or low P/B stocks at great prices in 2008. You probably made more if you bought Amazon, Apple, Google, etc. You know...the sexy, momentum stocks that typically carried a smaller moat, work in ever changing industries, less downside protection, and have spectacular booms and busts. Value investing will likely always work. I view it as a linear progression of generally lower returns during most years, and when shit hits the fan you are in a position to take a little more risk and make the parabolic profits that change the course of your investment portfolio for decades.

I think you've got it backwards. Return of capital by definition flows to shareholders, it's not a reinvestment in the firm. It doesn't flow to shareholders. When a firm produces cash from operations it goes to the firm's equity, if it's used to buyback, it is an outflow that continuing shareholders do not see. I disagree. It's seen be whichever shareholders are directly selling the shares to the company. The remaining shareholders see no cash, but they see an increase in their % ownership of equity and cash flows and (hopefully) and increased stock price based on P/E and P/FCF multiples.

This is my experience as well. Seems like the site has fallen a lot in quality in the 4 years I have been using, but there is no better alternative.

1) my first major mistake was Shengkai Innovations. You can read all of my articles on it on SA. I thought it was ridiculously cheap and did a ton of research on it. I was very comfortable with the position and had spoken with the largest third party distributors in the Middle East and in the United States so I was pretty confident that it wasnt another Chinese fraud. I bought at $5, more at $8.50, more at $7, more at $5, more at $2.50 (trading for less than cash on hand). I sold everything at $1.50ish after e CFO resigned. There had been a few red flags, but I was so confident in my analysis and the price was so compelling I kept buying more. No fraud was ever proven, or even accused, but the shares trade for about $0.25 today after a 2-for-1 reverse split. Lost something like $6,000 on this one and it was 30-40% of my portfolio at one time. That's a huge sum of money to lose when you're 21. 2) I bought garbage all throughout 2008. Instead of entering positions in high quality branded names, I was buying cigar butt stocks that were cheap on an asset basis. I remember very vividly looking at Limited Brands and Harley Davidson given the strong brand profiles and cheap valuations. I bought over-leveraged dry bulk stocks instead. Lost 75% or so subsequently on on EXM but watched in regret as HOG and LTD both returned over 500% in the following years. I still buy cigar butt stocks but recognize if you can get strong brands at a cheap valuation, it's likely going to end better even if the cigar-butts have a more compelling value just per the numbers. This wasn't all bad though - I did get into BofA with an average price of $7 and Google around $375. I did this with GE in 2008/2009. Had been buying BofA and it dropped like a rock once it fell below $5. All the way to $2 something if I recall. I was watching GE at $7 and didn't buy thinking that the same thing would happen and I could pick it up cheaper. It never happened and I never bought and missed out on a pretty great time to enter....

Someone forgot to tell Japan that for the first several years they did stimulus.. People weren't terribly optimistic in 2007 from what I recall. Not pessimistic but I don't think they were optimistic either. Then again, I was just getting into stocks at that point so maybe I missed something.

Recent purchases in the last month: DSL - Doubleline income solutions fund NLY - Annaly BSBR - Banco Santeder Brazil SAN - Banco Santander LCSHF - Lancashire SHLD - Sears holding

I've started a position in BSBR over the past two weeks as opposed to simply adding shares to Santander like I have been for months. Seems like the discount is finally wide enough to attract me to the single name instead of the parent co.

I think you're very wrong here and that is the difference between minority ownership and a majority stake. Taking a majority stake means the cash is yours because you get to decide what to do with it. With a minority stake, there should be a discount for a lack of control since the executives could squander it with or without your input.

I agree. I picked up a small position on Thursday in NLY. I like fixed income investments at this point. You can find a lot that have been pummeled, have decent yields, and trade at discounts to NAV at this point which is great if you do think rates can't go much higher and/or are worried about the stock market. Especially mortgage securities given they have lower durational risk than a comparable bond due to higher yields, small principle return each month, and slowing prepayments. The thing to keep in mind is that these mortgage REITs' price action will likely be highly correlated with that of the market - not really a true hedge like other fixed income assets might be. But at such discounts to NAV with high yields on low leverage, I can't think of a much better time to be buying them. The only thing they're missing is a guarantee of lower rates.

I agree with wknecht. I work with equity swap derivatives every day and have added some clarity below: This is mostly correctly. Also probably includes variation margin to some extent for the P/L that has moved against Fairfax/Counterparty since the last cash settlement. Also correct. It could also be LIBOR minus a spread depending on swap rates. From the looks of it, Fairfax lost 2,220B on the index portion of the swap, but paid a total amount of 2,269B total. This means they're probably losing money on the interest leg too if the subtracting of the spread resulted in a negative figure for a period of time (totally possible, have seen it before). Since these typically settle monthly, or quarterly, it's possible Fairfax was losing money on both sides of the trade for 3 or more months. Chances are they'd receive the whole $1B back and settle the P/L with a separate payment. You don't pay your settlements cash with your collateral unless if you go bankrupt. But for all intents and purposes of the total cash changing hands, this is correct. Also, I agree, the 132M is likely the accrued liability that they had in current losses on the swaps for this reset period.

I looked into doing this once. What I was able to determine was that you could have a self directed IRA that as invested in LPs and LLCs as long you were not the managing member of said LP or LLCs. This would mean you can use it seed the hedge fund of a friend, but not the one you're starting. At least that's what my understanding of the rules as of 3 years ago when I was looking into this.