TwoCitiesCapital

I absolutely think it's cheap relative to POTENTIAL earnings power. Now, when that earnings materializes is anyone's guess. It could take a year or two or three, but let's just think about this. As of 12/31/2016, Fairfax had $1231/share working for you ($722 in no-cost float, $367 in book value, and $142 in net debt). I haven't run the figures to know how the acquisition of allied world impacts this, but it was my initial understanding that it was accretive to these metrics so it is likely higher now. You're buying the earnings power of $1231 for $476 today (and as low as $420 at its recent lows). Obviously, the return on much of that $1,231 is constrained by regulations, but you only need a 4.4% net return on those assets to drive a 15% ROE and a 5.8% net return to get 15% from the current price. With an investment team that has traditionally beaten those returns metrics just in bonds, let alone their long-term returns from equities, I'd expect that these are low hurdles for a 15% return form here on out. Of course it won't happen over night - much of that $1,231 is sitting in cash and is uninvested. You can wait until it is invested for you to get the confidence that they'll return 10-15% a year from those investments, but my guess is the share price will be much higher once that uncertainty is removed.

I find it interesting that Bloomberg has not published a single article on this. If I wasn't a member of this forum, I probably wouldn't even be aware of this news :/

I've been saying it for awhile, and have been wrong, but - corporate earnings are still at their lowest since 2014 and margins have fallen. If this trend continues, eventually equity investors will wise up. Multiple catalysts for lower EPS even outside a recession.

Net-nets generally aren't over-levered. And the table includes the worst drawdown. The last line in the table is 2007. What this means is that they bought the net-net portfolio on Dec 31, 2007 and held it to Dec 31, 2010. So it does include the worst drawdown of the period and doesn't end before it. In that drawdown your initial $10000 investment goes down to $3470 if you invest in the net-net portfolio and goes down to $3251 if you invest in the market. I believe you are applying what you know about low P/B stocks to net-nets. Then your comments about 90% drawdowns and over-levered companies makes sense. Yes, my apoligies. I caught the subtle difference in my comment to Frommi, but not prior to that to know we were talking about two different things. All of my comments, including those about 90% drawdowns, were about low P/B strategies as mentioned in my first comment. The studies have actually shown that it IS the worst of the worst that provide the best returns. Narrowing the focus of low P/B stocks by selecting favorable metrics like positive cash flows, positive earnings, and etc has only ever impaired the long-term results of the strategy. You actually get better returns by focusing only on companies that are LOSING money. You truly have to buy the nonsensical/hated over-levered equity stubs where a handful will surprise and return 50-250% while everything else languishes for 12 months. The drawdowns for this type of strategy are as high as 90% in a given year. That is why few people have a stomach for this - you can't justify why you hold them and the volatility/drawdowns are insane when a bad year hits. This is exactly why the opportunity exists as well. As simple as it is to implement, it's not easy to do so.

Based on what i have seen in the past 3 years of international netnet investing is that drawdowns/volatility are smaller than the overall market. Especially if you have a lot of dividend paying japanese stocks with low betas in the portfolio. And hopefully not every netnet is losing money. I also have netnets with P/E`s of 3-10 in the portfolio. Its just that those are not available in the US. I can absolutely confirm drawdowns can be significantly larger. When I started my passive portfolio back in 2015, 75% of it was international energy companies - some in the U.S., some in Australia, some in Europe, etc. And when oil prices were at $27, the portfolio was down over 40+% while the general market was up. Also, as a subtle difference, there is a difference between net/nets and a low P/B portfolio. The low P/B portfolio, from what I have seen, outperforms all other approaches. So my portfolio of energy companies were typically companies trading at 0.2-0.3x stated book value.

I'm not sure where you are getting drawdowns that large. I'm assuming your talking about drawdowns at the portfolio level. Generally my observation is that the only way you can get drawdowns like 90% is by using a fairly small number of stocks. Tobias Carlisle's study has a table of 3 year returns from 1983 to 2007 (see Exhibit III) http://www.valuewalk.com/wp-content/uploads/2014/07/benjamin-grahams-net-nets-seventy-five-years-old-and-outperforming-full-tables1.pdf Basically net-nets beat the market every single year except for the 3 year period starting in 1988 where your terminal wealth is $9279 (from $10000 initial) vs the markets $14496. There is one big drawdown and that is in the 3-year period starting in 2007 where your $10000 initial investment drops to $3470...however in this scenario the market does slightly worse. Yes, let's limit or historical data-set to the largest equity bull market ever, end it right before that 50+% correction for general stocks the following year, and use that data to determine what a reasonable drawdown for a strategy that invests in over-levered companies that are losing money to determine what a reasonable drawdown is... ::) If you expand the data set to actually include periods of stress (outside the moderate bear market in 2000 that hardly impacted value stocks as a whole), you get drawdowns of 80-90% on a handful of occasions. That's at the portfolio level. The strategy still performs over the long-term though because it consistently produces signficantly higher returns than the market. Say portfolio goes down 80% versus the S&P at 50% in a bad equity bear market. The first year the portfolio rebounds by 70% while the S&P rebounds by 30%. After that, you get 17% per year in low P/B strategy and 7% in S&P. In year 16 you're tied and by year 20 you're 100% ahead of the S&P for the 20 year period (outperformance of ~3.5% per year). Making an extra 10% per year covers a multitude of sins if you stick with it.

Seems plausible, but could argue he's had enough info for a while and has stayed silent I don't feel too strongly about this one way or another, but there is a very LARGE difference in the motivation to do so once the information is public. Did Trump have this all along and stayed silent? Maybe. Will he continue to remain silent on it now that the information is public? I do not know, but the prior silence is not a guide since the playing field is changed with the public dissemination of the info.

You're disagreeing strongly with Buffett (among many others here). Of course, interest rates are not the *only* factor, but they're a big one. Lower P/E's elsewhere also have to do with other kind of risks (ie. political, demographic, or just the opportunity cost between markets with different prospects), so that worse markets need higher equity-risk premiums over the risk-free rates (or if the local interest rates are even risk free -- don't trust Venezuela's central bank!), but there's not doubt in my mind that all else equal, as Buffett says, interest rates "act like gravity" on stocks. Anyone here who is an active manager tends to disagree with Buffett. Buffet doesn't take his own advice, so why should I? Do as Buffett does - not as Buffett says. His comments on interest rates is an over-generalization. There have been times where lower interest rates were good for stocks. There have also been times where higher interest rates were good. These things occur in long cycles - the last cycle started in the 80s when both stocks and bonds were at secular lows in valuations. Of course you're going to get positive correlation between bond and stock returns when both are starting at secular low valuations! But, the 20 years before that was the opposite story. And the 20 years before that it flip flopped again. This "law" has NEVER held true for the long-term. It holds true for two or three decades and then gets turned on its head and is the opposite for two or three decades. To use it as justification for the the second highest equity valuations ever, as if the relationship can never changes, seems absolutely insane. We've seen it change! We know it changes! Think of a moderate recessionary scenario where we get regular deflation of 1-2% a year for a handful of years. With a negative inflation premium, long-term bond yields could reasonably go to 0% and still provide a positive real return, but do you REALLY believe that would type of environment would be supportive of equities? What about an environment where long-end rates rise to 4% because the economy is banging on all cylinders and inflationary pressures are picking up slightly because consumers are spending - do you think that would be BAD for equities? Further, this entire "law" is based on the pre-supposition that bonds are a reasonable alternative to equities. This is simply NOT true for a large number of investors out there. They are entirely different from a risk exposure perspective. If U.S. equities get expensive, I don't tend to flip to bonds. I tend to move to international equities that appear cheaper. If bonds are expensive, pensions don't go all in on equities - they trade interest rate risk for spread risk by moving further out on the risk spectrum within fixed income. Equities and bonds are NOT very good alternatives to one another for MOST investors. To base the valuation of one on the other as a relative value statement to justify extremely high valuations just seems unreasonable. Sure you can use it to make tactical changes to YOUR asset allocations, but the market isn't going to use that relative valuation to provide a floor on another asset class when something goes wrong.

If you don't think equities would be worth more in a world with interest rates permanently at 3% than they would be in a world with interest rates permanently at 6%, you shouldn't be investing. But there is no such thing as a world with interest rates that are permanently at 3% with no fluctuation. Just like equities, interest rates fluctuate. Even when specific yields are targeted by central banks, like the BoJ, bond prices and equity prices still fluctuate. Given a market where interest rates fluctuate, and the risk profiles of debt and equity are NOT interchangeable for a large number of investors, and there has been no historical correlation to support equities being priced off of interest rates, it's even more absurd to use it as an argument to justify some of the highest equity valuations EVER witnessed even while it doesn't hold true across other equity markets.

There is zero correlation between equity values and interest rates over the long-term. While the "yield" relative valuation argument makes sense theoretically, it has never held true and continues to not hold true today. Plenty of places of have lower yields than the U.S. AND lower P/Es. Support for a bubble: 1) Corporate profits are at 2014 levels while U.S. equities ~40% higher from there. Contraction in profits can continue if margins trend towards average or below. 2) On a trailing P/B and P/E multiples, we're in the very top percentile of historical market valuations ever. 3) On longer term metrics like CAPE ratio and Tobin's Q, we're ridiculously over valued requiring a 40-60% drop to get back to average 4) In the middle of 2016, we had never been more expensive RELATIVE to Europe (who has lower interest rates!!!!) 5) Real assets have never been cheaper relative to financial assets as measured by the GSCI/SPY ratio And, for all those pinning their hopes on low rates supporting valuations, the long-end is currently pricing in a negative term premium and inflation expectations significantly below the long-term average for the next 10+ years. If the economy is actually healthy, continues to grow, and term premiums and inflation expectations normalize to reflect that, you'd see long-end rates more than double decimating any relative valuation to equities and the cost to roll any debt that corporations have issued to support share repurchases and dividends over the past 5 years. U.S. equities require a Goldilocks scenario of "just right" when it comes to inflation, interest rates, and corporate profits or the entire story implodes and a 40-60% decline doesn't seem unreasonable. I am skeptical that "just right" can be held for any considerable period of time - particularly considering this is already the third longest economic expansion in U.S. history. In hindsight, everything you needed to identify this equity bubble will have been obvious. The million dollar question is where is the top?

The studies have actually shown that it IS the worst of the worst that provide the best returns. Narrowing the focus of low P/B stocks by selecting favorable metrics like positive cash flows, positive earnings, and etc has only ever impaired the long-term results of the strategy. You actually get better returns by focusing only on companies that are LOSING money. You truly have to buy the nonsensical/hated over-levered equity stubs where a handful will surprise and return 50-250% while everything else languishes for 12 months. The drawdowns for this type of strategy are as high as 90% in a given year. That is why few people have a stomach for this - you can't justify why you hold them and the volatility/drawdowns are insane when a bad year hits. This is exactly why the opportunity exists as well. As simple as it is to implement, it's not easy to do so.

I put a small portion of my money into a "passive" P/B portfolio. While I agreed with all the research surrounding the topic, I started thinking that an annual re-balance may not make sense. Looking at the data, low P/B, P/S, and P/E portfolio's tended to outperform over a 12 month horizon, but if held static, tended to under perform over 2- and 3- year horizons (and longer). This makes intuitive sense in that you're getting the "last puff" out of cigar butt. So, in my hypothesis, I figured you have to constantly turn cigar butts to get the equivalent of a cigar. A portfolio that turned modestly more frequently should have a good chance of outperforming if you're getting rid of the new "dead weight" from recent out performers and turning those into more potential puffs more frequently. I started turning my portfolio anytime a stock hard a large run-up that put it within 10-20% of its book value. If it ran up - I sold regardless of the time frame held (tax deferred account so tax implications do not matter). Some stocks were sold tremendously early and I missed out on a good run. Other stocks were sold after a 50-60% bounce which proved just that - a bounce - before returning to the the prices I had paid and lower. I wasn't immediately re-investing the proceeds, as I did not have the time to run the screen, nor have I accounted for what the actual results would have been had I held, but based on what I know of the names bought/sold and their performance, it seems that I likely that I have done better than a buy/hold strategy in the same names over the past 2-years.

I use LEAPS regularly - but not because of my views on volatility, but because of my views on the underlying. All the volatility premium plays into is the cost of financing - does it make more sense to leverage using LEAPS, margin, a mortgage, etc? It does not provide a reason to enter the position/leverage to begin with simply because movements in the underlying will dominate movements in vol. That was my only point because it sounded like your interest in LEAPS was due to the low volatility premium and not necessarily a view on the near-term prospects for the name. Was just adding my 2 cents.

If you're buying because vol is low instead of the stock being cheap, it's probably best to consider purchasing the volatility aspect while keeping exposure to the stock neutral. The vol component of the option is dominated by the movements of the underlying stock. Even if vol goes up, you could lose just because the stock goes down to 1.3 - 1.35x book (depending on your strike price). If you're making a bet that volatility is likely to rise over that time, buy a put and a call at the same strike for a year out. Doesn't matter what the stock does - if realized vol is higher than the combination of implied vol and the to-date time decay, you'll make money. This trade might have made sense without hedging the vol because the underlying stock moves were likely to dominate that aspect of the trade. It doesn't necessarily work as well in reverse.

Yea, the PIMCO StocksPlus and StocksPlus Long Duration funds are two of the best performing "active" equity funds in the mutual fund universe since their inceptions. The standard StocksPlus fund goes back to the 80s so it's a LONG track record of implementing the strategy successfully without blowing up in the U.S. markets. There's definitely increased risk with the use of economic leverage and EM is far more volatile, but I'm relatively confident in their ability to manage it responsibly given their long-term success in the U.S. Plus, they're not swinging for the fences with the collateral - current duration is less than a year it's diversified across U.S. treasuries, mortgages, and corporate exposures. They simply have to beat the funding cost of the swaps used (LIBOR plus a spread) with the fixed income portfolio so it doesn't have to be anything TOO crazy to get the additional 2-3% a year.

Generally over the past few weeks: 1) EM: Significantly increased my stake in PEFIX as re-balancing has led the portfolio of companies to be even cheaper on P/B, P/E, and P/S basis than it had before it's 50+% rally in 2016. Reduced European equity exposure to do so. 2) U.S. retail: Sold puts on LB and SHLD and re-investing dividends into RL and UA. Looking at other names as they get cheaper and may add SRG to the mix. Closed my position in the 25+ year zero coupon bond fund with gains of ~10% to fund put sales. I am not confident that we'll hit new lows outside of a recession, but think there will be other opportunities to re-enter of the next 1-3 years. 3) Resources: Adding to ALS and PDER. Looking to add to Lukoil if prices remain weak.

Agreed. Any reference to Dietrich Bonhoeffer?

I have a friend that does that. I was amaze at the spread. Wouldn't that mean Amazon is being out priced? Yes....but no one seems to care...at least not yet. I pointed out in the AMZN thread a bit ago that I was surprised at how much cheaper some items from Walmart.com were. Was shocked because that didn't use to be the case, but Walmart was dramatically less expensive on a number of items. Have been considering getting rid of my prime account in response, but have not done so yet.

And marital status since we're talking about household income.

I've been at IB for almost 3 years now with two of my personal accounts. No issues.

Also, expected returns don't get close to 10% annually until the $10B sitting in cash gets invested - particularly after considering the share issued for Allied. Maybe you get 10-12% nominally from insurance in a good year...but that's not counting years of loss/under-performance when a catastrophic event occurs. To get consistent performance in the double-digits at today's price, you need the cash deployed. This requires two assumptions: 1) The cash will be deployed quickly 2) Those opportunities will be value additive I don't know about 1) and 2) is sketchy given that they removed hedges when asset prices were extremely expensive. The hope for many of us is actually that 1) doesn't happen which may increase the likelihood of 2). I am increasing my position myself just because I have faith in the long-term prospects of the company, but on a short-to-mid term basis, I understand why people aren't buying this and that it may get cheaper.

I'm kind of confused or did i misunderstand what you meant by the below statement in the SBLK thread?

Seems like the difference is that I weighted the different conversion ratios and you don't. Now that I think about it, I'm not sure weighting them is appropriate approach so your figures are probably right.

Was trying to determine we might get a better deal buying Allied to get Fairfax given the variable rate or share conversion and the decline in Fairfax stock since announced. Turns out, Allied trades rich relative to Fairfax and not cheap (hasn't been dropping like the currency of its acquirer has devalued). Original deal terms: $10 in cash $14 in shares at fixed rate of 0.030392 Fairfax/ 1 Allied $30 in shares at variable rate based on price (currently at 0.068862 Fairfax/ 1 Allied) Amended deal terms: $28 in cash $14 in shares at fixed rate of 0.030392 Fairfax/ 1 Allied $12 in shares at variable rate based on price (currently at 0.068862 Fairfax/ 1 Allied) 28 + (14/26)*(0.030392)(Fairfax Share Price)+(12/26)*(0.068862)(Fairfax Share Price) = 1 Allied Share Doing the math with Fairfax shares at $420 USD = $48 per Allied share. Allied currently trades ~ $52.00. Allied shareholders who were planning on holding on through the deal anyways should be dumping the position now and buying shares of Fairfax direct to capitalize on the dislocation between the two and capture 8% more Fairfax shares.

I suspect that they're under pressure as rates are falling again - U.S. rates are at 2017 lows. While Fairfax itself doesn't own any bonds to book losses from, it does limit the income generation outlook for them. When Fairfax exited it's hedges and fixed income investments, it moved itself from being a hedging bet on the global economy to a pure investment/insurance exposure. While the insurance side is firing on all cylinders, the investment side is largely in cash. With investment income/gains impaired by low rates (can't have BBRY/Eurobank/Tembec going up 60% every quarter...), the current earnings outlook is limited beyond the first two quarters. While income potential relative to share price does seem high - particularly after accounting for a blowout quarter in gains - it isn't going to be continuously high without hitting homeruns in equities every quarter OR higher rates. I might be content to buy the shares now and wait, but I can understand why others aren't.