TwoCitiesCapital

Deflation hedges pulled in 116.4M gain in the 4th quarter for a total of +17.7M for the year. This means that the swaps were literally up some 95% in fair market value just in the fourth quarter alone on the decline in oil. Many are expecting headline deflation in 2015 due to the slowing of economies and cheaper oil working it's way through the supply system - we don't need much to get us to breakeven on these swaps. 1-2 years of negative headline inflation in the CPI could result in a nice payday of a few hundred million. As a reminder, every 1% beyond the 2.45% needed to breakeven in the US would result in a net gain of 527M. I wouldn't be surprised to see them continue building these positions though - they've expanded them aggressively over the past few years at prices more attractive than the original position was purchased at. 2010 - 34.2B in notional (cost 302M) 2011 - 46.5B in notional (cost 421M) 2012 - 48.4B in notional (cost 454M) 2013 - 82.9B in notional (cost 546M) 2014 - 111.8B in notional (cost 655.4M) From the original position in 2010, Watsa has committed 116% more capital to increase the exposure by 226% AND adjust the strike price upwards. Averaging down seems to have worked out well. I'm thinking these might actually pay in the next year or two.

Their bond portfolio would have done very well in the 4th quarter. We might even see a reversal of some prior losses on the deflation hedges with the collapse in oil and the drop in global rates. BBRY was up some 10% too which isn't trivial across the ~1B invested in it though it's given it all back so probably won't count for much outside of making the earnings appear better. I think it will be a good quarter, but not a spectacular one.

http://www.bloomberg.com/news/articles/2015-01-30/euro-area-prices-extend-slide-in-sign-ecb-late-to-deflation-game Even the U.S. is expected to see nominal, headline CPI deflation in 2015 - largely due to lower energy costs and how that flows through to most goods produced. Just as a quick summary of what we need to see for these to be profitable. As of 9/30/2014 U.S. EUR UK FRANCE Weighted Strike price 232.19 111.24 243.82 123.85 Nominal (in billions 52.75 36.775 3.3 2.75 Current CPI 238.03 117.43 257.6 124.85 Delta to breakeven -2.45% -5.27% -5.35% -0.80%

Interesting. The velocity of money is still multidecade lows. Down from 2.2 to 1.5. That means dollars are being "recycled" through the economy less frequently and now the supply of money is reducing as well. Fewer dollars being recycled through less often sounds like a recipe for slower growth than even the dismal numbers that have been put up. I do wonderif this is the beginning with all geopolitical risks, the deflation in commodities, and now this. Might be time for me to deleveraging the portfolio some.

It just feels like a great depression for those who own oil stocks. And coal stocks, and copper, and iron, and timber, and corn, and etc. This isn't limited to a single commodity - almost seems like a majority of them are well within correction territory. My guess there is a problem with aggregate demand...and it won't end soon. If im wrong, I have heavy exposure to commodities through Altius. If I'm right, I have heavy deflation protection through Fairfax.

I sold out of my small holdings in Russia earlier this year to add to Altius and FNMA as they tanked. I'm looking to get back in when I roll my 401k over into my Roth IRA. I do have a concern though that I wwas hoping the board could help me with: 1) what would happen to ADR holders in the US if there were some sort of financial sanctions that prevented foreign ownership OR the US simply makes it illegal to transact in Russian investments. Would that simply mean no more buying/selling or would I be forced out of the position and liquidated? Any supporting documentation for similar occurences? 2) I saw commenters on seekingalpha.com claiming they could no longer purchase the shares through fidelity and other US brokers as recently as November. Any of you having issues purchasing/selling shares.

I'd argue that the failure is a bit of both material and candidates - more people taking it who are less prepared due to the popularity of the program and having companies pay it for you and because the complexity of material has increased. I know a CFA grader with a PhD in Finance and the CFA designation who has commented that the course work and materially is substantially more difficult then it was when he took it. Harder material + a much larger audience of candidates = increasing failure rate Certainly glad the CFA has improved so much with their materials though. Even the last four years I've seen pretty large improvements.

I wish you the best of luck but would caution against confidence. The 1 exam that I felt confident about prior to exam day is the 1 that I failed due to lack of preperation. Howard Marks expounds investing scared. I would encourage you to test scared when it comes to these exams. There's a reason only 30ish% pass.

It's not just oil - many commodities are significantly off too. Unfortunately, unless if it affects housing/rents then I have a hard time seeing how it will significantly impact the index. Fuel is a low % of spending for most so it will be a low weight in the index. I do believe that the weakness that were seeing across most industrial commodities/services is supportive of deflationary pressures - this isn't limited to oil production shifts. Iron, copper, shipping, oil, lumber, natural gas, etc are all down significantly year over year.

I had thought I read an interview or earnings call commentary with Watsa where he said they had $1 bilion earmarked for India. If this fund is only 500M, then I imagine we'll be seeing an acquisition announced soon.

Lol. Fingers crossed. How could he miss such an opportunity?

I really HATE articles like that one! I have spent the time needed to read 20 pages of statistical reasonings, trying to convince me of what?... That the very same valuation metrics we use to gauge if our investments are undervalued, fairly valued, or overvalued: - Price / adjusted earnings - Price / sales - Price / replacement cost cannot be applied to a portfolio of 500 companies… And why? Because they inevitably entail some errors and show some lack of precision! Well, thank you very much, but I already knew that valuation is an imprecise art! And I don’t need anyone to write such a complicated article to remind me of how much future returns calculated on the basis of valuation metrics could deviate from the actual truth! But I also know that (Price / adjusted earnings), (Price / sales), and (Price / replacement cost) are the best metrics we have at our disposal to at least try assigning a valuation to our portfolio of businesses. In fact, do the author of the article suggest something better? Absolutely not! And you know why? Because there is nothing which is better! So, do you want to have an idea where the pendulum is at any given time? Do you think valuations might be useful in that regard? If the answer to both questions is yes, then (Price / adjusted earnings), (Price / sales), and (Price / replacement cost) is what you should use… And to the results you get you should apply whichever margin of safety you deem appropriate! To finally draw one of these conclusions: undervalued, fairly valued, or overvalued. In other words, value investing applied to a portfolio of 500 companies! I like Hussman because his analysis makes a lot of sense… surely not because I think his numbers are 100% correct! ;) Gio I actually enjoy these well thought out arguments. Much of what he says is well reasoned, and often contrary to what I have generally accepted. That being said, it seems most of the anays IS more complicated and time consuming and it generally doesn't suggest much different. For example the CAPE article suggests that with the proper adjustment we're only 20-25% above long term averages instead of 60% as reported by the CAPE. I understand that there is a difference but I'm ok with being "approximately right" without having to spend all of my time making these adjustments. I'm doing this kind of stuff after work and don't have the time to spend doing all of these adjustments and comparisons - I'd rather just have a quick and dirty analysis with the knowedge that it's slightly flawed.

Just disappointed it happened so quickly....was planning on tripling my position when I roll my 401k over in January.will probably still add, but not as significantly now that it's up over 15% in just a few weeks.

Maybe I'm a bit more optimistic (or pessimistic) than most. I see deflation being a very real possibility. Debt is deflationary and we have unprecedented levels of debt. Eventually, some of this principal will have to be reduced - the world can't just continue to roll higher and higher debt balances. The only ways to reduce it is to print a lot (massively inflationary long term) or to pay it back/default (deflationary). I think we'll see a mix of both and that deflation will come before the inflation. We've seen a global expansion of massive amounts of credit. Any reduction of these levels will be massively deflationary (given that printing/increasing debt by trillions is barely keeping us even). I can't place % on the probability, but I do think that prolonged deflation is a lot more likely than most give it credit for. I also think that Central banks are given too much credit in their knowledge and ability to avert crisis - keep in mind the Fed missed the massive implications in early 2008 and the ECB and Japan don't seem to be getting the results they're hoping for.

Agreed. Markel has been the better performer in the last few years, but it is Fairfax's international exposure (especially India) and their conservative positioning that has had me really excited to be an owner. The Asian side of the business has been very profitable and growing at a nice rate. Only a matter of time before is contributing meaningfully to earnings. If the Indian market blows up we'll have a lot of exposure there too. Things could be really exciting for Fairfax over the next 5 years.

Maybe it's a bit premature, but I'm trying to think of ways we could lose while still winning th court case. Is it feasible that the government would convert the preferred to common at some price other than the $25 or $50 face value? Is there precedent for a preferred to common conversion at some value other than face? How likely do you think it is for the government to simply release the GSEs from conservatorship and issue a ton of equity at current prices to make up for the capital shortfall (as opposed to retaining earnings and selling fixed income assets) to dilute the benefit of a legal victory? What would occur if another recession occurred prior to release resulting in GSEs seeking more capital since the govt has allowed for them to retain any? I'm getting more and mor comfortable with the legal aspects of this. I'm trying to wrap my head around other ways we could still lose this.

No, no, no uccmal. You will die! ::force lightning::

A. Gary Shilling believes that in 4 years we'll be back to our normal long-term rate of GDP growth. He is aware of all the issues you've raised. So even though they sound convincing, there are other things to think about as well that are also important. For one thing, I doubt the debt has to be repaid as you suggest (one form of repayment is to issue more debt as the old bonds mature). You just need to grow it slower than GDP and you're golden long-term. So you can run deficits in perpetuity and yet still be deleveraging at the same time. There was also a boatload of malinvestment over those 19 years. Did that contribute to the slow growth (and relatively poor market returns) that we've seen? I imagine it didn't help. Could the next 19 years not have this drag? Shiller is certainly smarter than me so I would probably go with his analysis if I were you. I'm just too skeptical to get there myself. Its hard for me to reconcile that there hasn't been massive malinvestments over the last 5 years and that it wont continue until a market correcting event. Its hard for me to believe that politicians will suddenly get fiscally responsible after decades of overspending or that the American voter will actually demand real change. I think we'll get back to a good place eventually....after exhausting every alternative and being forced to by things events outside of our control (debt crisis, inflation threat, two decades of 0 growth, war, etc). It's a very cynical view, but it has thus far been supported year after year of continuous massive deficits, constant manipulations of market participants (malinvestment), constant war, and politicians who regularly prove how inept they are on both sides of the aisle, etc.

I agree with this sentiment mostly regarding prior returns seeming reasonable when compared historically. My only problem is considering the big picture - we have had 2 decades of below average returns despite being fueled by an unprecedented expansion of debt and historically high margins. Debt has to be paid back in the futureand margins generally compress. This suggests that growth will be even slower, and earnings possibly lower, going forward. Future market returns are a function of current value (reasonable to high, depending on what metrics you consider) and future growth (doesn't look good if debts are to actually be paid). Its not unprecedented to have a market have negative returns over a 20 year period - negative is a long way down from 6.7% annualized. That being said, ZH used to actually have decent articles that covered topics more in depth, and far in advanced, relative to the mainstream media. They were talking about the London Whale long before the trade blew up and lost JPM billions. Now it seems to be mostly fear mongering.

I think it depends on your strategy. If you're in quality stocks that are clearly creating value at an acceptable rate, hold it regardless of the lack of market action. Each day it builds value internally but stays flat, or down, in the stock is a day that your margin of safety increases and you're expected future returns increase. If you're doing a basket approach with little knowledge of individuals names, then you need a disciplined rule to to remain consistent. Most choose 1-3 years.

Education, like other things, is reliant on finite resources. Making statements on the benefits of education without consideration of the costs is a one sided decision with incomplete information. This is exactly what Americans have been pressured to do. Encouraging the mentality of receiving an education at all costs paired with easy credit availability and a social stigma for those without has long allowed colleges to operate with no price accountability. I went to school in Mississippi. I work in New York City. I know people who make 2-3x as much as I do because they were able to obtain better educations from better schools. Their discretionary income is less than mine after taxes and student loans and will continue to be for the next several years. Some for a decade or more. Furthermore, they're three years behind me in acquiring work experience and savings. Some of them will certainly come out ahead of me financially, but many others won't. It certainly begs the question if an Ivy League school, or private university, is worth the cost if some kid from the worst state in the country for education can have more discretionary income with a lower paying job. Summary: Education is great. There's a cost associated that can make it not so great. School isn't the only place for education. I've learned more from this board and books then I did by getting my degree in economics.

Because I am getting nervous… During the last few weeks we have witnessed a short market correction… Which nonetheless was painful enough to prompt the FED into saying it is ready to stop the slow unwinding of QE and therefore to resume its stimulus… And the market promptly recovered… I like it less and less… And I demand more and more protection, meaning insulation from the general market. Gio Saw that too. Planning on a substantial increase in my FFH position come the new year when I roll my Roth 401k into my regular Roth IRA. Things haven't felt right to me for awhile - but seeing the reaction of general markets to a small correction was certainly disturbing and suggests that we are in fact addicted to the sugar high. Further, deflation in Europe appears even more likely than previously thought and small caps are better positioned for a fall than they've been previously and their bonds are killing it. What's not to like at roughly 1x book? Hey Zach, Did you buy the pinky? What custodian are you using, if you don't mind me asking? I wonder if they exempting the shares from the withholding tax (as they properly should) in your Roth? Thanks. I own the sheets a Roth at Scottrade. Withholding taxes are taken out of my dividends on foreign shares. I don't know enough about taxes to know if this is appropriate or not. Scottrade told me awhile ago there was nothing they could do about it an I didn't have enough foreign holdings to care until recently. Will be looking into this again as I consider where to move my accounts now that Scottrade doesn't ready quite cut it for me anymore

Totally understand the long short dilemma - just frustrated to put up with so many foregone gains to not fully capitalize in a drop that looks more likely from here than in previous years. I've done long/short bets that lost me money on both legs - didn't add to either side, simply closed out the trade and haven't attempted it again. I'm too familiar with how difficult it is and how to manage the sizing of each side.

Certainly great results 1) anybody follow insurance well enough to know if we're seeing a slow hardening of rates or are the results just a lack of catastrophes? 2) interesting to see hedges down further to 79%. Wonder if they'll talk about a change in strategy here. I have mixed feelings about this. Glad to see equity exposure that begins to have meaningful impacts on earnings but....kind of frustrated that we're only 79% hedged now that they seem to be ripe for paying off. I'm just waiting for deflation hedges to begin paying

Have you factored in the losses in SD and XCO? Nope. But also not factoring in gains from other investments or bonds either so I think it is going to be a wash - especially if you dont consider those losses permanent (dunno enough about the co. zachmansell, I don't understand the point you are getting at with the small caps. Are you talking about small cap indexes in general or small cap investments of fairfax? Could you elaborate? s to determine) Fairfax is short the Russel 2000 and has been bleeding money in it for years. At this point, small caps are close to being the richest value they've ever seen in decades and we're still in a precarious economic position - if there is a sell off, they should sell off much harder than the general market and finally make money.