TwoCitiesCapital

But this is a value forum - shouldn't he be valuation timing it? Shifting away from any equities relative to their expected return? Are your equities indexed or in individual stocks, Eric? If the former, I'd make the switch today (believing the market overvalued and so the expected return not enough greater than bonds to justify the risk). If the latter, you might shift away first those with the least expected return. Yes, but we're discussing asset allocation and not tactical bets on the market. Regardless of market values, if you can't tolerate being 100% equities, you can't tolerate it and market values, or lack there of, shouldn't be what determines that decision. The author has an end state in mind. He just needs to pick a time frame, pick a Target to start with, and systematically move overtime regardless of what markets are doing. He can make tactical allocations within the asset classes, but I wouldn't let it dramatically impact the allocation itself for something as important as the money you're interesting to live off of.

Was it JGBs? I feel like I recall him saying that the pressure wouldn't play out in the bonds because the central bank wouldn't let it. I think he said the pressure relief valve would be found in the currency and that shorting the currency would be the play. Depending on when he said it, he was right.

Set a systematic plan and stick too it. That could be moving a portion each month regardless of what markets do or starting off with a lump sum (10-15%) and reinvesting all cash flows and deposits on the fixed income side until you accomplish the goal. Point is, pick an approach and stick with it as opposed to trying to tactically time it.

It's also a PFIC, which sucks for U.S. investors. Yes, that can be an impediment. 95% of my investable/liquid assets are in tax-free/tax-deferred accounts so I'm less impacted by the PFIC designation.

Sure, but the argument for owning something for me has to be a higher bar than single digits. Particularly something that itself has the potential to be super-volatioe in a downturn simply due to market sentiment. My only point wasn't to say FFH will lose money. It's just hitting their 15% ROE target consistently enough to get a rerating in the stock is seemingly a pipedream with interest rates and equity valuations where they're at. There's probably better opportunities out there at this time/price. I don't have any specific forecasts for Fairfax India other than being generally bullish on EM, generally bullish on EM currencies, taking advantage of a significant pullback in Indian assets, and generally liking the investments they've made in that vehicle. I don't like the fees, which is why I haven't owned it previously, but the high water mark should ensure I have plenty of upside in the near-to-midterm without paying much for it.

Yes, but as has been discussed exhaustively, 15% is no easy feat when interest rates are at 2.5% on the 10-year treasury. So either those equities need to do 15-20% per annum to make up for the dead-weight of the fixed income portfolio at 2.5-3% OR they need interest rates to rise to lock in longer term yields that are much higher than 3%. I know the Prem keeps benchmarking himself to that number, but I haven't really heard anyone make a case for why we should expect 15-20% on the equity side. They haven't done that in the past decade even if you exclude the equity hedges and I don't expect them to suddenly start when valuations are very full and the bull market seemingly slowing after a 10-year expansion. Even if there is a pullback, they're already fully invested on the equity side. It's not as if there are billions in cash, or hedges, that could be rolled into equities at more favorable valuations to help achieve that 15% ROE. Further, any sustained pullback is likely to impact Fairfax's stock as well - particularly since they're unhedged at this time. I just don't see much reason to own this today. Maybe if you think that India or Greece or Blackberry is suddenly going to go gangbusters, it could be worthwhile, but then why not just Eurobank, Fairfax India, or Blackberry directly. Personally, I rolled all of my proceeds out of Fairfax and into Fairfax India earlier this year with the expectation that the India vehicle will dramatically outperform the parent in the near-to-mid term.

So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on). Pete I’m really surprise that you think FFH will probably not achieve 7% investment returns. Long term it’s less than a S&P500 index. I’m more septic about 95% CR when the loss from catastrophes are include That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater. Agreed here. 7% is going to be very difficult in an environment where 10-year Treasuries yield 2.5%. Bradstreet has been amazing in bonds, and the return has been exceptional - but that all occurred primarily in an environment where yields were falling (i.e. bonds purchased gaining value). Starting from yields of 2.5% with the bulk of the portfolio in short-term debt, we don't have that tailwind. Brian may make some very prescient moves (a la selling portfolio following Trump's election), but that primarily results in losses avoided - not gains to the bottom line that count towards that 7%. That will generally be the case if we're in an extended period of rising rates like Prem believes. Until interest rates are significantly higher, and the portfolio deployed into longer-term debt collecting the higher rates, a consistent 7% hurdle/average is going to be very difficult on the investment side.

Gurufocus.com has very generalized high level days

Buffett answers that question here: 1) there's a caveat to what he said which basically is summarized 'if you have the certainty rates will remain low.' Yes, if rates remain at 0%, stocks CAN trade at massive premiums into perpetuity. We don't have that certainty AND it doesn't mean stocks SHOULD trade at massive premiums 2) low rates make financing easier and act a sa grease on financial systems. This makes it EASIER to bid up assets which, in turn, causes financing to become even easier. It's a fortuitous cycle, but it says NOTHING of the intrinsic/fair value of the stock. Only that the environment breeds easier financing/speculation/and potentially higher values 3) using DCF, the value of a stock is the summation of all cash flows discounted into perpetuity. Basically it's CF (1+growth)^n/(1+rates)^n People who say that low rates lead higher values/multiples assume it's because your denominator is shrinking. But if those low rates are due to exceptionally low growth/low inflation, then your numerator is ALSO shrinking. Assuming higher multiples is double counting the benefit of low rates. Example scenario. $1 invested at 6% growth for 30 years when discount rates are 5% has a present value of $34.86. A P/E of ~35x. If you assume the discount rate falls to 4% you get a P/E of 40 and a present value of $40; however, that doesn't consider the impact of the lowered growth. If the 1% drop is primarily due to a 1% drop in inflation or growth, then your numerator also shrinks and your stock's present value is virtually unchanged at $34.91. The same 35x. People who say low rates lead to higher multiples are 1) confusing the meaning of CAN and SHOULD and/or 2) ignoring mathematics and/or 3) ignoring real life cases like Europe and Japan where the same relationship HASN'T held true

Right, which is why I wouldn’t be too surprised if we had a final stage of euphoria before this cycle ends. One thing to note though is that corporate profits as a share of GDP have been unusually elevated over the last 10 years or so, and the CAPE ratio (by only looking at earnings over the last 10 years) effectively assumes that this is the “new normal.” That may be correct, but if it’s not then the market is already just about as expensive as it was in 1999. ;) Margins are at a record and appear to be on the cusp of contracting given wage rates rising 3-4% and rising commodity/input costs - much higher than revenue growth/GDP. Then again, markets didn't care in 2015 when earnings contracted for an entire year so maybe we don't care now.

Isn't this the exact opposite of the logic that determines higher growth companies deserve higher multiples? Why would high growth lead to high multiples at the micro level and low growth lead to them at the macro level? If low GDP is the secret to high multiples, where are they in Germany and Japan 0?

But this is simply not true. Historical data shows little-to-no correlation between interest rates and P/Es. Further, Europe has significantly lower rates and significantly lower P/Es. I don't know where Japanese equities sit today, but they also have had significantly lower interest rates than the U.S. and have been at a discount to U.S. equities for much of the last decade. If interests rates are low because inflation is stable, it tends to be a positive. If interest are low because growth is low, it tends to be a negative. It's inflation that matters. Not rates. And what we're seeing is the first tell-tale signs that wage inflation MIGHT be picking up. Last time I looked, it was trending near 4% for 2019.

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom. Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates. I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy Reflexivity. In this case, there are definitely fundamental issues regardless of expectations. Rising rates would have a serious impact, no matter how they do it, the only question is how bad. The method the Fed uses makes things worse, because, well, they are clueless as the past few months have shown. The big unknown here is not the Fed, it's Trump. He called an emergency on the wall. He just nominated someone to the Fed that no doubt he believes will support his views. What else is he willing to do for us to get a happy dead cat bounce? That's my bet, it's not going straight down from here. We will have fun first. Agreed. It's never straight down. There are always bounces along the way until the buy-the-dip mentality is sufficiently beaten to death. It's why I didn't sell/short on the way down in December, but was selling/shorting/buying bonds after the incredible bounce in January. This was an opportunity to reduce risk after markets have confirmed the bear market. Not an opportunity to buy the dip.

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom. Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates. I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

I've also reduced my shares, but it was basically because my thesis didn't play out. I loaded up on Fairfax expecting two things to happen: 1) Interest/Dividend income would dramatically increase over the following 2-3 year period due to rising rates which would lead to share price appreciation 2) Significant buybacks at prices from $450-550 USD would likely be accretive if income was to rise dramatically I sold most of the shares that I had purchased based on disappointing outcomes in both regards. 10-year rates rose to 3.2% prior to falling back down to 2.6%. With low inflation and limited pressure in the near/mid-term from rising front-end rates, it's hard for me to make a case for rates to rise as significantly as originally anticipated. I'm not saying Fairfax should've played the short-term game, but they did miss an opportunity to lock in longer-term rates and the opportunity set for increasing interest income in the near-term appears challenged. Further, buybacks have been less than I anticipated based on Prem's first comparison to Teledyne...and have been further diluted by compensation and share issuance that were unanticipated at the time of purchase. I still some shares and would be willing to add in the low 400s near book value, but there doesn't appear to the be the catalyst for anything to change with the company or help them achieve the 15% ROE that I initially anticipated.

Yeah.... What you said is totally possible as well. The other possibility is that they want the plans to be leaked out, and share prices slowly ascending, so they don't get any headline risk of their plan helped push the stock up 150% in one day and enriching the evil hedge fund managers like John Paulson. We'll see. It's almost as if... this... is happening already...? Lol +1

BTW, selling assets isn't what I was suggesting, but others have. I was just saying that mentioning one number alone without the other doesn't provide enough context to know much. ie. Mr Henry has 2.5 million dollars of debt. Is he in trouble? ¯\_(ツ)_/¯ Depends if he's a founder-CEO with $125m in t-bills and an annual income of $10m or if he's a Vancouver janitor. I get it. Wasn't picking on you specifically, just saying even considering the "assets" is pointless if you can't/won't sell them to service the debt. Current/future income is what should be considered for debt service at the national level and nothing else IMO.

I agree in principal with the proposal that debt needs to be looked at in relation to assets. I also agree debt needs to be looked at "in context." I just wish you would provided a context. No thanks, I don't care enough about this field to do research. Someone else who likes macro can, if they want, it should all be public info in FRED or whatever. I just thought someone should point out that only giving one side of the "assets & liabilities" columns wasn't very productive. No problem. But I will give you my context - gratis. First the likelihood of the U.S. selling assets is somewhere between slim and none. As to the "royalty through taxation," based on the ever growing pile of debt the U.S. - I'm thinking that's not working out too well. +1 I've heard the asset/liability argument before. Using assets to pay off debt, as opposed to income, is typically a move of desperation and not the best financial decision. Ask someone who defaulted on their mortgage and were foreclosed upon. Do they feel good that their house (asset) offset their liability (mortgage)? Is that still considered a positive scenario just because they remained solvent through the transaction? Secondly, the U S has vast geographical assets that CANT be monetized by selling or leasing to someone else. We don't really want a third border and we benefit greatly by having an oceans between us and most other countries. We could probably sell Hawaii to someone, but Alaska is too important for oil and we'd never sell land in the contiguous U.S. unless it was a state bordering Mexico/Canada and the buyer were Mexico/Canada. Is the U.S. likely to go bankrupt? No, but it's not because of our assets that can't/won't be monetized. It's because we'll print money to take care of it and slowly erode the standard of living for our citizens to cash those checks. In most cases, debt is only responsible if it can be serviced conservatively from current income.

Realistically - we would need to do something like cut spending and/or freeze it at some level below revenue for 5-10 years. It might take something extraordinary like fixing rates on Federal debt too - but we're probably not there yet. Global demographics will keep U.S. treasury rates lower for a bit of time. I'd be down for raising federal taxes on all brackets and pushing more responsibility to the state and local govts that are more easily held accountable, but let's just be honest. Nothing is going to happen. State/Local/Federal govts all run deficits, all spend irresponsibly, and nothing will change that. When it blows it - I'm betting that it will be blamed on capitalism... ironically

I don't disagree, but limiting it only to billionaires is too limited in scope. After all, the guy who has $250 million St his death didn't get by operating the local corner store that now can't be passed onto his kids.... Sure, make the estate cap in excess of 10, 15, or even 25 million - wherever you want to draw the arbitrary line of "disadvantaging the advantaged" or what qualifies as a "small" business - but targeting only billionaires is too limited in scope for an argument intended to support small business. Further, for family members inheriting a successful operation - it wouldn't be too hard to finance to pay the taxes and then use cash flows from the business to pay off the financing. Will you be as rich as your old man when you're done? Probably not - but that's because your old man built it from the bottom up and you inherited a permanent job with a built in consumer. I don't think that's too unfair.

This. As a libertarian, I'm generally against the idea of taxation of wealth. I have no problem with people being billionaires because generally it means they've created billions in value for millions/billions of people. That being said - their kids didn't create that value. Their families didn't create that value. So I don't think that value should just be allowed to transition to the next generation who didn't earn it. They'll be well off enough from having the benefits of a super-welathy family their entire time growing up. In other words, I'm ok with billionaires and don't want to tax them while they're living. But I do generally support an excessively high estate tax with lower limits as to when it kicks in and less loppholes to get around it like various trust structures.

Agreed. My guess is that it won't all be raised at once. It would be nice if any money paid after the 10% moment were returned, but that may not happen without the courts. Seems like the most straightforward action would be: Eliminate the senior preferred. Convert govt warrants Convert higher-yielding juniors into common. Re-issue common equity, preferreds at appropriate yields, and debt. Restart common dividends Follow-on equity offering Those things, along with retained earnings, might get us there in the next 2 years.

Whoa. Am I allowed to say "holy s***" on here? This might be the single most important piece of news, in terms of its specificity and impact, that I have seen in a long time. It's the first time I can remember that an important player even implied a recap. That line about going from $6B to $150-200B has to mean a recap, right? At the same time, there is something in the back of my mind saying that I should sell some of my shares. I cannot explain it, so for now I'm going to ignore it. I will, however, pay very close attention to every detail we hear from Otting and Mnuchin. Same. I actually sold ~7% of my position back around 27% of par just a few days back. Wanted to hold on to most of it now that the developments seems to be moving our direction BUT that's how it's felt every time and was majorly kicking myself for never having taken advantage of prior ramp-ups before the collapse in value. Now that I've scratched that itch and wont' be as mad at myself if this goes sideways again, I decided to take a look at the entirety of my trade history with this saga - goes all the way back to 2014 for me. I may have never been very good at selling at the tops, but my trade history demonstrates I was VERY good at diligently adding to my positions after the sell-offs. While I've felt like I was losing money on this for 99% of the time I've owned it, my actual annualized IRR is 48% if I were to sell today. This perspective of knowing that I didn't actually waste the market opportunity as they were provided to me (was just buying at the lows instead of selling at the highs) gives me greater confidence to continue holding and makes me less eager to sell now that the market is providing an opportunity to do so. I'll probably hold the remaining 93% of my position for significantly higher prices.

I'm not convinced they did. I would love it if Fairfax had locked in Treasury yields at 3.2% or rolled into credit in December, but neither seems REALLY compelling if you're waiting for a fat pitch. 3.2% was the highest rates in 7 years, BUT Fairfax believes we're in a period of unprecedented economic growth and rising rates...which makes 3.2% less compelling especially when compared to historical Treasuries. Did credit spreads widen in December? Yes. But they're still mostly tight by historical standards. I think they'd have waited for higher rates and spreads before making a move given their outlook on valuations and rates. Well, locking in at 3.2% might have been the thing to do in retrospect, but in the short term it probably doesn't make that much difference. My guess is that half the $27B of cash/bonds were rolled during 2018 and if they were rolled into 2-year treasuries, what would be the weighted average rate? Would it have been around 2.7% over the year? So the "penalty" for not having perfectly managed the bond port might be ~50 bps on $27B? It would clearly have been better to have nailed it perfectly, but I don't mind the small-ish penalty that they've taken on the theory that rates are headed north over the next five-ish years. SJ Absolutely agree! That was basically my point - in hindsight, locking in at 3.2% or rolling to credit would have been the right things to do, but wouldn't have made sense if Fairfax is truly waiting for a fat pitch which is what we all believe they're doing. So there was likely 0 benefit to Fairfax from the December tumult or the spike and subsequent fall in rates. If anything, the fall in rates is going to hurt them as they roll the 2-year Treasuries. Was simply rebutting that Fairfax put money to work in December.

I'm not convinced they did. I would love it if Fairfax had locked in Treasury yields at 3.2% or rolled into credit in December, but neither seems REALLY compelling if you're waiting for a fat pitch. 3.2% was the highest rates in 7 years, BUT Fairfax believes we're in a period of unprecedented economic growth and rising rates...which makes 3.2% less compelling especially when compared to historical Treasuries. Did credit spreads widen in December? Yes. But they're still mostly tight by historical standards. I think they'd have waited for higher rates and spreads before making a move given their outlook on valuations and rates.