TwoCitiesCapital

Something that I meant to include in my original post: your shouldn't be contrarian for contrarianism's sake. There needs to be a fundamental reason. You could argue that the number going back up to where it was should be bullish, but then the converse should hold true of them coming down being bearish. The stock market has risen quite a bit over the past 4 years. Either QE has been enough to overcome deleveraging, a sluggish economy, and this trend or this trend has very little impact. Its not just about the supply and demand of people buying stocks; the price is set by the marginal buyer. This number could fall to as low as 10%, but if the market P/E were 1000 and the next marginal buyer was unwilling to pay that amount, prices are coming down regardless of how underowned stocks were.

I don't think it is necessarily for a near term catalyst. Think of major demographic trends occurring right now: 1) Boomers are retiring. Many can't live off the interest income from their portfolio and will need to sell stocks and bonds if they can't find another way to supplement their income. 2) The current generation of graduates are graduating with the highest debt loads and the lowest real wages in the past decade or two. I know many recent graduates who can't afford to move out of their parents' house, let alone begin investing in a meaningful way. 3) Even if this trend were to reverse, I'm not sure it would be enough to counteract boomers selling increasingly large positions as time goes on. The stock market may go up, but I don't think this will be the reason nor do I think there will be a reversal of this trend anytime soon

Problem with shorting is that you need an active catalyst. Otherwise shares could stay elevated for years. Tesla may be a good option now that it's up over 300% and the recent rally has likely been shorts covering the 45% of float they borrowed. Once theyre done covering, who is going tombuy at these prices???? Now may be a good time to initiate a small position. Have your stop loss set according to the loss you can afford to take though.

1) take anything the CBO says with a very large grain of salt. Their prediction record has been abysmal. 2) housing prices are increasing? Maybe the third time since 2009 will be the charm. Tell me who will buy them when the coming generation is graduating with the largest amounts of student debt and the lowest paying jobs we've seen in a decade? 3) trade balance is improving precisely because individuals can no longer afford many of the imported luxuries they used to buy IMO. Hardly bullish. 4) stock mutual fund flows have consistently been negative up until this year. Not sure if this will last through the next correction or not. 5) deflation takes years to culminate. Even Greece is just now experiencing it. Increased Federal debt has made up nearly every penny of consumer deleveraging. All that's hit the economy has been corporate deleveraging if I recall my numbers correctly. Realize that all interests have to do is go back to the 4-5% they were at before the crash and we're spending more than 30% of current government receipts servicing interest. You don't think that will be a drag on th future economy? Spending will have to be cut somewhere or revenues will have to rise or we can keep interest rates artificially low until we've inflated enough of the debt away where that's not a threat (not bullish for the economy either), 1) industrial production increasing isn't a substantial part of the economy anymore. I'd say this is more of a lagging indicator and is a small part of a much much larger economy. 2) debt service is only at multi-decade lows due to extremely low rates. What happens when rates rise with a recovey? 3) bank capital ratios mean nothing in light of the trillions of derivatives that they hold on their books with global counterparties who aren't as strong (European banks leveraged 30-to-1 who have gone double or nothing in buying European sovereign debt). 4) the level that housing construction is rising from is meaningless without the context of the overbuilding that occurred. There are still empty neighborhoods with vacant houses in places where the most overbuilding occurred. 5) housing may be the most affordable it's been, but only for those who can obtain credit. Not the easiest task nowadays. 6) non-farm jobs are being added but they're typically low wage, part time jobs that are replacing the full time jobs. Not bullish for real wages (which have been declining for a decade) which means its not all that bullish for the long-term economy. Granted, some jobs are better than no jobs. All of this isn't to say that I think Watsa will be right. It's simply saying arguments could very easily be made for the other side. He's been cautious in his approach to protect capital, not necessarily to maximize short term gains. Also, we're seeing unprecedented amounts of global stimulus that aren't sustainable. What happens when trillions in liquidity stops? The velocity of the dollar has continued to slow and has fallen very far from where it began in 2007. This is not the sign of a healthy economy, but is partly why we aren't seeing inflation from printing. I think Watsa made a very smart choice. He looked at the unprecedented rise in global debt over the last 30 years, asked himself what are the consequences if this goes South, and hedged accordingly. This was a way to protect his business. Could we have profited from it? Sure. Was that the intention? Unlikely. Secondly, you focused on all U.S. statistics but the majority of the deflationary derivatives were written on Europe. Europe does appear to be heading towards a deflationary end game and these may still pay off in the next 5 years.

What do you guys think about Russian stocks. You have entire ETFs trading at single digit PEs and below book value. You also have megacap companies like Gazprom trading at .3x it's book value. Obviously there is political risk and corruption, but valuation makes it tempting. I guess my main concern is that I've been burned badly on cheap companies with shady management (Chinese reverse mergers) and etc before and want to make sure I'm thinking through this correctly before taking capital. What are your thoughts?

Sanjeev, I was wondering if you could elucidate your approach to these options. I'm fascinated with options and have tentatively been trying out different strategies as I learn about them over the past 3 years. My two favorites are to go long deep, LEAP call options to get get a delta of 1 to the common stock with less money down or to buy way out of the money calls/puts in a binary outcome type situation. That being said, I have yet to ever make any significant returns using options and have typically ended flat or at a loss. I'm curious to know why you picked the options over common and what your thought process was on the risk/reward of the situation. Thanks for any insight

I'm a little late to this discussion now that the Russian bailout appears to be the way they're going; however, I figured I'd toss in my 2 cents since I didn't have the ability to respond at work and this is a good discussion. Wrong. As mentioned previously, it's not just Russian oligarchs that will be paying. Secondly, it puts in place a precedent that could be abused in the future. Who is to say they won't do this again in the future. Also, maybe they're Russian criminals, maybe they're not. Why is it their responsibility to foot the losses that should be borne by bondholders and equity holders? This totally upsets the precedence of bankruptcy law and etc. Bondholders and equity holders are the ones who accepted this risk. Not the depositors who thought they were insured. Lastly, and the biggest issue IMO, is that this is a tax so they could receive a bailout loan the size of 50% of their GDP. So the depositors are paying 6.7%-10% so that the citizens (many of them depositors) have the privilege of paying back 50% of GDP at interest. This. I too am long certain European securities and am looking to increase my exposure, but I'm mainly picking up European assets that have exposure to the emerging markets or real assets. I disagree. The Cypriotic banking system functions as a massive money laundering system for (mostly) rich Russians. My guess is that the EU made the clawback a requisite for a bailout because they don't want to pay so the 'mobsters' can keep all their money. Cyprus is tiny, can be saved easily, it's just a bit of politics. Basically Europe is saying: "if you stash all your money here, you better help us.". The EU doesn't want to target the local population, they affirmed this today: http://www.forbes.com/sites/afontevecchia/2013/03/18/eu-takes-shot-at-moscow-with-cyprian-haircut-as-russians-own-22-of-deposits/ http://www.eurozone.europa.eu/newsroom/news/2013/03/peg-statement-cyprus-18-03-13/ Small depositors treated differently then large depositors? Maybe the pay a lesser amount upfront but they'll be the ones repaying the loan at interest, and struggling under the debt burden even more. Just look at Greece. The problem is that EU still can't admit that it has a debt problem. They're still viewing this as a liquidity driven epidemic and treating a problem of insolvency with emergency credit and printing money. Neither one of these is directly addressing reducing the debt and it simply increases the debt load, by a massive amount, at the expense of the tax payers. Default. Bite the bullet and get better.

I think you're looking at a very limited time frame. Japan has been printing money with the encouragement of people like Bernanke and Krugman since the 90s. They just recently announced QE8 (or was it QE9). Has the currency "collapsed" over the past 20 years? No. It's down maybe 20% in the last few months, but it's up a significant amount over the past 20 years if I'm not mistaken. The stock market has also rallied by a similar amount, but still remains at less then 1/3 of its peak value even after the recent rally. If a similar situation does happen in the U.S., we could definitely expect another drop in equities of 50-80%. Secondly, the recent occurrences have been in large part predicted by Kyle Bass. He believes Japan is going through a currency collapse given that they are the most indebted nation in the world. The U.S. is a long way from there, but definitely going down that path, IMO. It might be 10-15 years before we experience similar happenings as Japan right now. I tend to agree with Watsa on being concerned about deflation. We haven't seen deflation because there has been no deleveraging. Private households have mainly delivered by defaulting (not paying down credit) and the government picked up the slack by spending with massive deficits. On a net-net basis, no deleveraging has occurred. What has occurred is that wages are down and prices for necessities are higher meaning less disposable/taxable income to service the same amount of debt. the next crisis will be worse because we're in a much worse spot to handle it. Secondly, I don't know if this is a macro "bet" as much as it is a hedge and our attitudes towards the 2 should be different. Watsa spent what was roughly 1 year of earnings (~6.5% of market cap) on deflation hedges to protect the entire company against a very serious outcome that is definitely a possibility. Not only that, he gave himself the ability to profit from it if it does and place him in a fine spot to swoop in with cash at the bottom. I don't care if deflation happens or not. This is a smart way to protect your business. it is prudent to protect assets and capital when they are in danger even if the danger never materializes. Hindsight is always 20/20.

Damage from sandy seems pretty bad in the tri-state area. Fair fax doesn't have much exposure Coming in at 74 on estimated impact. Berkshire may not be so lucky. http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2012/10-2/20121030_sandy2.png

I have a hard time believing that any financial assets (paper assets) do well in a hyper-inflationary environment. I guess it all depends on the rate of the hyper-inflation. The simplified scenario looks like this: 1) You buy an ownership in the business through purchase of stock. 2) The earnings of the business should grow with inflation, but will likely lag a little bit given lower earnings/prices at the beginning of each period. 3) The price of the stock might rise to reflect these gains in earnings However, if we're talking real hyper-inflation like Weimar Republic, then I don't think it works like this. Think about it; it takes a few days for trades to settle and cash to be withdrawn from your account. If there is a danger of that cash losing a significant portion of value of that 3 day period, then that will have to be discounted into the prices. Secondly, in a hyper inflationary environment, investors will be drawn to real assets as a hedge. Third, there are huge risks to companies for holding cash for liquidity/safety/flexibility because it's losing value so fast. This means they have to either continue holding a depreciating asset or accept the risks involved investing it in other less liquid assets. This increases the risk to businesses and exposes you to the risks involved with whatever investments they are making. Stocks may appreciate some, but I do not see how it will keep up with inflation. I think that there could be massive real losses resulting from P/E contraction due to the loss of attractiveness in stocks for the aforementioned reasons. Just my two cents...

I was under the impression that PIMCO was the one who sold them the contracts. Can anybody clear this up? Secondly, it's a very real threat given that derivatives are a legal contract that follow very, very specific rules and guidelines (just like any other legal contract). If something occurs that is outside the bounds of these limits, it's likely in legal limbo. For small deviations, counterparties will generally work out agreements/compromises to maintain their rapport with clients; however, if you're talking about a multibillion dollar payout from institutions who will already be struggling from such harsh economic conditions, then it's a matter of survival and you can be sure they'll fight it.

Low interest rates and low prices make real estate a very attractive play at the moment. My business partner and I have started a LP to collect money from family and friends and we are identifying properties that we would like to own if we can get the right price. We're working on our first acquisition right now. Both residential and commercial real estate offer huge opportunities. For example, it currently costs 30% more to rent a home than own in Atlanta. That means if you can buy the home and find a tenant, you could have 20-30% gains on it in just the first year employing absolutely 0 leverage...that's incredible.

I typically ignore "small bumps" in the macro economy for a more bottom up view. I'm still highly invested in individual equities as well, but just as a rising tide lifts all boats, a receding tide will likely lower them all. I agree with Watsa that this is not like other recessions. If it was, I'd be buying now and all of the way down to the bottom; however, if this really is a one-in-50 year event and if the U.S. does really have 10 years of slow growth and the possibility of deflation ahead, then equities will get slaughtered no matter how cheap they appear to be now. I'm not selling my current holdings but I am diversifying and putting all my money for the next year or two into privately traded investments that will likely perform well no matter what happens in the economy, and I benefit from not having glaring red numbers stare at me everyday. I think if you cherry pick your investments well, you could stand to profit (even in the short term); however, I think more losses are likely to come for most everyone before the gains.

I disagree. If Italy gets to the same point that Greece is at, Europe will have a crisis that causes more global financial loss then did the U.S. mortgage debacle.....and that's just Italy. What happens when Greece, Italy, and Spain topple? Or all of the PIIGS? This European debt crisis is far more serious than the U.S. mortgage debacle both in the severity of loss and the inability of over-indebted governments to be able to do anything to prevent it due to fiscal inflexibility from decades of overspending. Value investing is all about downside protection. Do you really believe that stocks are at reasonable prices assuming a worst-case scenario? U.S. businesses are in a much better shape than they were in 2008, but sovereign entities are not. Thus, if we dip back into a depression (assuming we ever really recovered from the last one) we won't see the same kind of steep 2009 recovery that we saw before that was induced by trillions of government stimulus because the governments will not have any flexibility to spend anymore or borrow anymore. Try to convince companies to spend their cash piles going into such a depressionary environment. I'm no expert about what is occurring in Europe, but it seems that a Greek default is all but inevitable and is likely the best solution in terms of biting the bullet now for a better long-term outcome. Beyond that, I think there is still the possibility for other countries and their banks to be spared; however, there is no guarantee of this. Whatever the outcome, we can be certain it will be painful for the entire Euro area, and thus will be painful for the U.S. and the rest of the global economy. It seems like a decade of flat/declining equity markets may be just what we have ahead of us. Japan lost two decades and had long-term spouts of deflation even though the global economy wasn't in a recession. Can you imagine the global consequences if both the Euro area and the U.S. go into a decade or two of little to no growth and are in deflationary depressions? This to me would suggest that markets are actually UNDERREACTING and that we could certainly go much lower. I'm not a fan of speculating in commodities, and I do not personally own gold, but I think that equities will go much lower and gold will go much higher before this is all over. Market timing is near impossible though and I could always be wrong. I would think that beginning moderate positions in undervalued companies now would be a good idea, and to add to these positions slowly over the next two years. I think going forward is going to be a once in a lifetime opportunity for stock-pickers/value investors; however, it's going to be a very rough ride. If you can't stomach extreme volatility, you may consider other investments outside of stocks, bonds, and commodities over the next two or three years.