Time to buy Fairfax again?

[SharperDingaan]

No one buys a stock & sits on it forever; not even a BRK - as sh1te happens routinely.

If WEB, or HW, had a heart attack tomorrow, the smart thing would be an immediate hedge.

 

FFH is not going to receive a high BV valuation, until it gets the HW black box, & its big investments, out of its structure. The HW black box is opaque, inherently more complex ('finite' risk coverage), hard to explain, & exposes them to short attack (why the FFH raid a few years back had legs). Their hedging & the investments also make them perform like a hedge fund - not an insurance firm (& why despite a sizeable favorable reserve release, & a historically benign payout a year or two back - they lost money - when they should have been making it hand over foot).

 

Even if you hold $1000 of shares trading daily in your subs portfolios, an equity investor will haircut 5-7.5% off that value - simply to recognize the potential costs of liquidation & wind-up if they need to get their money back; take an additional 5-7.5% off the valuation if there is a possibility of mystery wind-up obligations arising from the black box. FFH traded at 85-90% of BV, not that long ago - for a reason.

 

To get a premium, your insurance ops have to be easily comparable to peers - & win the comparison. Comparable CR, & history of being able to successfully acquire & integrate various books - a routine part of industry business. Not great at either, but at least getting better.

 

The HW team does add value, but they need to add 10-15% just to get past the structural drag. Good - but not good enough.

At current pricing at 115% of book, it implies they are currently adding around 25-30%.

 

SD

 

 

[ERICOPOLY]

Much of FFH's BV growth comes from capital gains -- which don't deserve a multiple IMO.

 

I mean... suppose you find a mutual fund or hedge fund that grows "book value" at supernormal clip because the investor behind the scenes is generating a lot of capital gains.  Well, those gains are not priced at a premium -- you invest in that fund for book value, no matter what... it doesn't matter what the past record of the investor is, it's still done at book value.

 

So for what reason would you pay a premium for capital gains if it's a company instead of a mutual fund? There is no such reason.  Thus, you need to strip out the capital gains from FFH's book value growth before you decide on a multiple -- IMO.

 

You are paying a premium for a business -- and capital gains is not a business.  Underwriting profit is a business.  Investment income from float is a business.  Capital gains is not.

 

This argument that capital gains shouldn't impact valuation makes no sense.  The value of a business is the discounted value of its free cash flow.  Suppose you were confident that Fairfax, without insurance operations, was able to reliably compound its book value at 1000% a year through investing.  Saying, "that stock is worth book value" makes no sense because its future free cash flows are worth far more than that.

 

It's irrelevant if you choose to value other companies in the industry on a sum of parts valuation.  Given a choice between buying an index mutual fund at book value, and this "compounding 1000% every year" company at 4 times book value, I would take the latter every time.

 

Richard

 

Me thinks you are putting the cart before the horse.

 

You value equities on FFH's books at a premium to what they trade for on the open market.

You value the bonds on FFH's books at a premium to what they trade for on the open market.

 

You do this because you think they have higher intrinsic value than what the market believes.

 

You say, "Hey, if Fairfax thinks they're worth more... then I'll pay more today... even though the market doesn't yet see that value".

 

Hey, do you want to buy some FAIRX at a premium to it's NAV while you are at it?

 

Listen dude, you are supposed to enjoy the capital gains as they come in -- not pay for them ahead of time.

 

Maybe Pabrai should have priced Dhandho at a premium to the very money that he was raising.  Because, don't you know, they will be invested in undervalued stocks and therefore are worth a premium based on anticipated capital gains in the future.

 

Uh huh... I don't agree.

[hyten1]

so i guess some of you would invest in a hypothetical WEB hedge fund and immediately take a hair cut? meaning if you put $10mil into WEB HF you don't mind that WEB immediately mark what you put in at $8mil!?!?

 

hmm i don't ever see that happen, not even with the best of managers.

 

[Rabbitisrich]

The business and the management aren't so clearly separable. After all, management can divert money from one business line into another. Payouts are another option. In that sense, there isn't really an operation that you can distinguish from management decisions, without assuming a baseline management plugin. If it's trivially easy to replace a management team, then you just have to determine whether your team is superior to available alternatives. So in the case of a low turnover, secondary market investor, like Bruce Berkowitz, degree of portfolio replicability approaches that condition of being trivially easy to "replace" management. In which case, management becomes more valuable when outperformance can only be achieved through less available instruments and methods.

[Rabbitisrich]

so i guess some of you would invest in a hypothetical WEB hedge fund and immediately take a hair cut? meaning if you put $10mil into WEB HF you don't mind that WEB immediately mark what you put in at $8mil!?!?

 

hmm i don't ever see that happen, not even with the best of managers.

 

But it does happen thought fees, lockups, collateral calls, and any other conditions that transfer value from investors to management. It is difficult to match variable fees like performance charges to a flat upfront fee, but that is a modeling challenge rather than a theoretical issue, I think.

[matjone]

If a younger Buffett or Klarman started a CEF with 10 mil in capital I'd happily pay 25% above NAV.

[gurjot]

my holding period is not forever.  i got a day job and i am investing money to send kids to university and retire in the next 10-15

years.. So this idea of lumpy returns where you make money once every ten years dont make sense and market and i will not pay premium for that.  buy brk and i can go to sleep and not worry,  i am not sure if  most of us can say that abt ffh.

[RichardGibbons]

Me thinks you are putting the cart before the horse.

 

You value equities on FFH's books at a premium to what they trade for on the open market.

You value the bonds on FFH's books at a premium to what they trade for on the open market.

 

You do this because you think they have higher intrinsic value than what the market believes.

 

You say, "Hey, if Fairfax thinks they're worth more... then I'll pay more today... even though the market doesn't yet see that value".

 

Hey, do you want to buy some FAIRX at a premium to it's NAV while you are at it?

 

Listen dude, you are supposed to enjoy the capital gains as they come in -- not pay for them ahead of time.

 

Maybe Pabrai should have priced Dhandho at a premium to the very money that he was raising.  Because, don't you know, they will be invested in undervalued stocks and therefore are worth a premium based on anticipated capital gains in the future.

 

Uh huh... I don't agree.

 

I'm not valuing the equities at a premium.  I'm valuing a business which is more than just assets.  The fact that the business involves investing is irrelevant.

 

I think Dhandho, just like every other business, should trade at multiple that is dependent on its discounted future free cash flows.  If you think that Dhandho is going to greatly outperform the returns of the market, then you're saying is the equivalent to saying that Dhandho should trade greatly below the value of its future cash flows.  And if you believe in DCF for other companies, but not for investing companies, you're saying that Dhando should be cheaper than those other companies that you do value using DCF.

 

To me, that's a pretty bad idea.  (This is the funny thing about this discussion.  If you follow through your reasoning to the natural conclusions, you very quickly reach a contradiction that should indicate to you that your premise is faulty.  Well, unless you want to throw out DCF entirely.)

 

That said, if you don't agree that future cash flows are a good way to value a business, that's fine.  Not everyone is a value investor.

 

For what it's worth, the market also doesn't believe you. Closed-end funds generally don't trade at NAV.

 

Richard

[ERICOPOLY]

Me thinks you are putting the cart before the horse.

 

You value equities on FFH's books at a premium to what they trade for on the open market.

You value the bonds on FFH's books at a premium to what they trade for on the open market.

 

You do this because you think they have higher intrinsic value than what the market believes.

 

You say, "Hey, if Fairfax thinks they're worth more... then I'll pay more today... even though the market doesn't yet see that value".

 

Hey, do you want to buy some FAIRX at a premium to it's NAV while you are at it?

 

Listen dude, you are supposed to enjoy the capital gains as they come in -- not pay for them ahead of time.

 

Maybe Pabrai should have priced Dhandho at a premium to the very money that he was raising.  Because, don't you know, they will be invested in undervalued stocks and therefore are worth a premium based on anticipated capital gains in the future.

 

Uh huh... I don't agree.

 

I'm not valuing the equities at a premium.  I'm valuing a business which is more than just assets.  The fact that the business involves investing is irrelevant.

 

I think Dhandho, just like every other business, should trade at multiple that is dependent on its discounted future free cash flows.  If you think that Dhandho is going to greatly outperform the returns of the market, then you're saying is the equivalent to saying that Dhandho should trade greatly below the value of its future cash flows.  And if you believe in DCF for other companies, but not for investing companies, you're saying that Dhando should be cheaper than those other companies that you do value using DCF.

 

To me, that's a pretty bad idea.  (This is the funny thing about this discussion.  If you follow through your reasoning to the natural conclusions, you very quickly reach a contradiction that should indicate to you that your premise is faulty.  Well, unless you want to throw out DCF entirely.)

 

That said, if you don't agree that future cash flows are a good way to value a business, that's fine.  Not everyone is a value investor.

 

For what it's worth, the market also doesn't believe you. Closed-end funds generally don't trade at NAV.

 

Richard

 

Speculation is a business?  Speculation has free cash flow?  Huh, I never saw it that way.

 

I still don't agree.

 

So how much of a multiple can Fairfax sell it's equity portfolio to you for?  Are you saying the equity portfolio is a business with free cash flow?

 

Can you buy my BAC shares for more than their market value?  Please?  I figure it's worth a try if you're willing -- you never know, perhaps you will.

 

[ERICOPOLY]

If you follow through your reasoning to the natural conclusions, you very quickly reach a contradiction that should indicate to you that your premise is faulty.  Well, unless you want to throw out DCF entirely.

 

Equities in their portfolio are marked to market.  The market already values those individual equities using DCF, presumably.

 

You are assigning an additional value on top of that for look-through DCF given that you disagree with the market.

 

That's putting the cart before the horse.  You are trying to pay intrinsic value for them, in other words, yet they aren't yet trading for intrinsic value.

 

The whole point is to buy them for today's price and then sell them in the future after they trade in line with their intrinsic value.

 

Yet you want to rush out and pay the premium already... today... merely because FFH holds them.

 

That's just crazy.  You can reason that FFH is undervalued because of look-through DCF, but it needs to remain that way unless you've fallen off your horse on top of your head.

 

Over time, the market will rise for those shares, and FFH will take the gains.  It's just a process that you need to be patient for... what's the point of buying the shares today at a price that already reflects all those future gains?

 

Why not pick any portfolio manager and say... well that guy is going to crush the market by a huge amount... So let's see about figuring out a way to invest with him that pays for all those future gains upfront, discounted to the present.  That's what you are arguing for.

 

[ERICOPOLY]

Fairfax should always, always, always, always!  Always be trading under intrinsic value.

 

Otherwise, they aren't value investors.

 

This is because the very market that values Fairfax also values their various holdings.

 

And the market is saying their various holdings are only worth X.

 

They are not saying X+some future premium.

 

Just X.

 

Do you really think the very same market that says each stock in their portfoio worth X is going to pay more for it merely because Fairfax owns them?

 

No way.

 

It's the same market!

 

Think about it.  How is that even remotely rational what you are saying?  The market has a firm belief that the portfolio of Fairfax's is only worth X.  The market gets to decide that price.  And on the same day, the market also gets to decide the price that FFH should trade at.

 

You are confusing today's pricing of their portfolio with your expectations that it will appreciate a whole lot in excess of the market's expectations.  The market already priced in the future appreciation when it priced the individual holdings of Fairfax.  So for you to expect the market to then disagree with itself when it looks at those very same holdings in the Fairfax portfolio -- it's just totally illogical to conclude that the market will say "okay, my bad... if Fairfax owns them then they are worth a ton more and thus a big premium for Fairfax is in order".  If the market believed that... well then it would just price the individual holdings in that way to begin with.

 

Yet it doesn't price the individual holdings that way to begin with.  And so it doesn't believe they are worth a premium to their market value.  And therefore it doesn't believe FFH shares should trade at any premium whatsoever above the mark-to-market for those assets.  And therefore the market does not agree with your view on this topic.

 

The market does however value the company at a fairly large premium to tangible book because of the value of the float, it's growth, and the anticipated underwriting profit.  But expectations of above-normal capital gains?  No way, because if the market thought those capital gains were coming down the line... why then the individual holdings would already be trading at levels that reflect it.  But they don't trade at that level, and so there is no expectation from the market for these capital gains, and so therefore there is no such premium in anticipation of them.

 

It's all very logical.

 

It makes sense to just use whatever the standard assumptions are for a portfolio return -- stripping out all expectations for above-market returns.  So even if you think FFH will earn 7%, you only use 4% (or whatever) if that's what this interest rate environment dictates.  They don't have any special investment skill in the opinion of the market -- because the market already priced the individual portfolio holdings efficiently (in the market's view) and the market is the one that prices FFH.  So it's not like it's logical to expect the market to disagree with itself.

[RichardGibbons]

Yeah, you know, this doesn't make any sense.  Your first clue should have been that this is the thesis of your post:

 

Fairfax should always, always, always, always!  Always be trading under intrinsic value.

 

Otherwise, they aren't value investors.

 

This is nuts, and should have clued you in that your logic is flawed.

 

That said, I've made my point as simply as I can make it, so I don't have anything to add.  Good luck.

[ERICOPOLY]

Yeah, you know, this doesn't make any sense.  Your first clue should have been that this is the thesis of your post:

 

Fairfax should always, always, always, always!  Always be trading under intrinsic value.

 

Otherwise, they aren't value investors.

 

This is nuts, and should have clued you in that your logic is flawed.

 

 

It doesn't make sense to someone who can't make sense of it.

 

So I'll lob it in low and slow to see if you can hit it one last time...

 

Example:

Fairfax could liquidate everything and just buy one stock with the proceeds because they believe it trades at 50% of intrinsic value.  Furthermore, let's say that you also agree with Fairfax's assessment of this single holding.

 

You very plainly see now that Fairfax has become a holding company with only one stock in it.

 

Are you still going to argue that it's nuts for Fairfax to trade at 50% of intrinsic value?

 

Or will you continue to maintain that it should trade closer to intrinsic value, where that's DOUBLE the value of what you can readily purchase that asset for on the open market.

 

Okay... so let's skip to the obvious conclusion to that one...

 

Therefore, if they are value investors then they should NEVER trade for intrinsic value.  Never!

 

It's just so easy for me to see this.  Sorry it isn't for you.

 

 

[Rabbitisrich]

Valuing a company according to the market value of its assets is an implicit modelling of management decision making. You are modelling that they will have the same impact as if you simply owned the stocks directly and went passive. Think about a holding company consisting of only SPY shares. Now imagine that the newly hired CEO is:

A. The Dumbest person you know

B. The Smartest person you know

C. A young orangutan

 

If your valuation of the company is the same across all options, then you are implicitly modelling different relationships between assets and CEO decisions. The balance sheet is just a snapshot. Furthermore, how is modeling spelled?

[giofranchi]

Wtf does Buffett's appraisal of Berkshire have to do with Fairfax? They're not even close to comparable.

 

Also, it's not clear why a fair to mediocre insurance operation that has hedged away hundreds of millions (billions?) in investment gains over the last five years should be worth much more than BV.  Certainly not because Buffett thinks Berkshire is.

 

I guess "Wtf" means something not very polite...

 

Anyway, the multiple over BV you should be willing to pay both for FFH and for BRK depends on the rate of BV growth they will achieve during the next 40 years (more or less).

 

What do you think will grow faster:

 

A) an $8 billion company led by a 63 self-made billionaire, who is still very motivated and planning for the very long term... With an equity portfolio hedged for the next 2 or 3 years;

 

B) a $300 billion company led by a genius like Warren Buffett... For the next 10 years.

 

If your answer is B, well then I think you might be right... Unpolite, but right...

 

My answer is A!

 

Gio

 

Ajit Jain, Tad Montross, Tony Nicely et al have been running BRK's insurance biz for over 20 years. They have managed the CR, profitable float etc for that entire time. The next 10 or 30 years is likely no different. So, BRK's insurance business promise over the next 50 years has very little to do with WEB's age.

 

Prem has not run a good insurance operation at all over the comparable timeframe. Yes, Odyssey has brought some insurance wherewithal to FFH and thus it is all conjecture at this point that ORH insurance prowess is readily scalable across FFH. I sold out of FFH waiting to see how they do as an insurance operator. Five years at least for me.

 

The only real comparison between BRK and FFH is what would happen if there are two or 3 years of disasters, like KRW & Earthquakes & floods. The insurance clock will be reset then. The largest Insurers of today, State Farm, Allstate are said to be vulnerable. Will FFH be found with or without clothes when that tide goes out? Berkshire will do fine. Especially in the aftermath. What's the probability of this happening? It is non zero. It has happened in the last 100 years.

 

It seems almost anybody tends to overlook the importance of a leader. In general there seems to be the idea that the larger the organization the less important the quality of its leader.

I don’t agree.

Most people need and even want to be led, either they find themselves in a small or in a large organization. And the quality of their work and their performances is deeply affected by how effectively they are led.

I am not saying Berkshire will come to an end after Buffett is gone… After all, the roman empire didn’t come to an end after emperor Nero succeeded emperor Claudius, right?… Of course, results weren’t very satisfactory either…!! ;)

Seriously: Berkshire might go on growing like it is doing today after Buffett is gone, but it is not something I want to bet on.

 

Gio

 

[gary17]

Eric

i see what the issue is.... may be ... let me guess:

 

i won't pay for your BAC any more than the market value today.  however, some on the board are saying they may be willing to pay a premium in exchange for your decision making on the next purchase after you've sold out of BAC-- that ability to spot value stocks & take advantage of it is the premium some are willing to pay for --  not the holding; but the next decision.

 

G

[giofranchi]

Me thinks you are putting the cart before the horse.

 

You value equities on FFH's books at a premium to what they trade for on the open market.

You value the bonds on FFH's books at a premium to what they trade for on the open market.

 

You do this because you think they have higher intrinsic value than what the market believes.

 

You say, "Hey, if Fairfax thinks they're worth more... then I'll pay more today... even though the market doesn't yet see that value".

 

Hey, do you want to buy some FAIRX at a premium to it's NAV while you are at it?

 

Listen dude, you are supposed to enjoy the capital gains as they come in -- not pay for them ahead of time.

 

Maybe Pabrai should have priced Dhandho at a premium to the very money that he was raising.  Because, don't you know, they will be invested in undervalued stocks and therefore are worth a premium based on anticipated capital gains in the future.

 

Uh huh... I don't agree.

 

I am not saying what you suggest.

 

But I don’t think Buffett started investing in insurance companies because he liked an intensely competitive market… Buffett has said many times the insurance business is a difficult business… And he doesn’t like difficult businesses.

He started investing in insurance companies because of the float and because he thought the securities business is a good business. If I remember well, those are the exact words he used in a letter from the days of his partnership: “the securities business is a good business”.

And float is the stuff the securities business is made of.

When you buy FFH, you are clearly not only paying for the securities on its balance sheet: instead, your are paying for all its balance sheet. You give $447.5 and you get more or less $1,200 in investments working for you.

What’s the difference if Buffett pays for his float and then he uses it himself, or if I pay for my float and then ask Prem Watsa to take care of it?

Of course, you might say Buffett didn’t pay more than BV for the insurance companies he bought… I don’t know how much he paid, cannot reply to that… Anyway, it is clear to me he thinks they are worth much more than BV.

 

Gio

 

[dolce far niente]

Gio, Buffet gets his insurance business at depressed pricing.

 

A recap on Geico:

http://www.gurufocus.com/news/218282/geico--the-growth-company-that-made-the-value-investing-careers-of-both-benjamin-graham-and-warren-buffett-wedgewood-vic-presentation-

 

Buffet's brilliance was actually buying great company, led by great CEO at very low PE or PB. So, all the stars are aligned and it was a very fat pitch.

 

The Company’s shares, which had traded as high as $61 in 1972 and $42 in 1974, were down to just under $5. By the time of the 1976 annual shareholders meeting at the Washington Statler Hilton, panic was in the air and pitchforks were drawn. Within a month, CEO Peck was booted. By then, the stock was little more than $2 per share. (A sad aside: The Goodwin’s had bequeathed their stock to their son Leo, Jr., who had margined the stock to the hilt. Tragically, after the stock crashed, he took his life.)

 

Buffett was so impressed by Byrne that he started buying GEICO stock the very next morning. The first order was for 500,000 shares at $2 1/8. Buffett opened up Berkshire’s thick wallet for even more. He ultimately invested $19 million in a Salomon Brothers led convertible preferred stock issuance of $75 million, plus $4.1 million at an average price of $2.55 per share. Buffett’s fully converted cost-basis was just $1.31 per share.

 

1952: Buffett sells his GEICO stock at $43 5/8 to purchase Western Insurance Securities at 1X earnings.

 

There is nothing wrong with paying up for good companies led by great leader. But it's just a less "fat pitch", return is probably reduced since you have paid up for the premium.

[adesigar]

Sum of the parts valuation, in other words.

 

What sort of a premium will you pay for their fractional ownership in company X, when company X's shares trade on the open market.

 

Zero. 

 

Let's say they invest all of their equity into just one company -- Bank of Ireland shares for example.  Are you going to pay 1.3x book value for FFH (while arguing they are good at stock picking and thus it's a "business") when you could just pay 1.0x for Bank of Ireland shares directly instead?

 

You are comparing how someone would value a mutual fund v/s a company. Isnt that a really dumb way of viewing it?

 

When you buy shares in a company run by an exceptional manager you pay a premium not for the assets of the company but for the manager. There are a limited no of shares of the company it doesn't create shares (like a mutual fund) just because you want to invest some money in. You also cant match future buys and sells at the exact same price as the manager so you can never track the returns exactly. you can only match buys and sells after they are reported and for the best managers with special exemptions like Buffett/Berkowitz/Ackman that could be months after they build their position and the stock has run up. If 2 companies have the same amount of assets say 1 Billion and hold all their assets into just one company - Bank of Ireland shares for example but one is run by someone like Buffett/Berkowitz/Watsa/Pabrai and the other company is run by XYZ would they sell for the same price? Also think about this, would you have avoided buying Berkshire/Leucadia 30 Years ago if it had traded at a premium to book value of assets held?

 

[giofranchi]

There is nothing wrong with paying up for good companies led by great leader. But it's just a less "fat pitch", return is probably reduced since you have paid up for the premium.

 

A premium to BV doesn’t mean you are paying a premium to IV: if you are paying more than BV, but less than IV, chances are your investment will turn out fine.

The point is not really how much Buffett paid for his float (he is among the richest men on earth, isn’t he?!), the point is 1) how much does he think float is worth? 2) Does he think float in the hands of a bad leader is worth as much as float in the hands of a good one? 3) How much does he think underwriting profitability is worth?

My answers:

1) A lot,

2) Not at all,

3) A lot, but much more as a sign of how safe insurance operations are, than for the amount of cash generated.

 

Gio

 

[petec]

Besides the growing insurance empire, don't forget, there are some strong non-insurance companies under the cover as well:  William Ashley, Arbor Memorial, CARA, Keg Restaurants and Thomas Cook India.  These companies have significant growth potential ahead of them. 

 

The problem we all have with Fairfax has been the macro bets, hedging and the significant stake in Blackberry.  I wish Prem and company would admit they made significant mistakes and the team has learned from them and will ensure it does not happen again.  That message would calm shareholders nerves and allow the company to focus on what they do best compounding capital at a 15%+ clip for the next 25 years.  (Blackberry was a huge distraction to the team)

 

tks,

S

 

 

+1. 

 

That is the reason I sold as well.  I am not comfortable investing alongside someone who believes they can consistently make good investments based on the macro.  Also, I see his current bets on a stock market crash as very different from his subprime mortgage bets.  With his CDS bets there was an identifiable irrationality you could point to - lots of money being loaned to people with terms such that they were very unlikely to repay the loans, and with some foresight you could say that "this is going to end badly".  Certainly we should give Prem credit for seeing this.  But his new bets are just macro bets plain and simple, with no irrationality you can really point to, except perhaps for deficit spending, which has been going on for decades.  With Blackberry, I seriously doubt that he would have invested if Blackberry was headquartered in Dallas, TX.  Thus in my mind the Blackberry investment signals a bit of hubris - that he felt he should go in and save the Canadian technology company.  Investing in tech turnarounds is not how Prem made his fortune, and every experienced value investor knows what a dicey proposition it is.  Hopefully Fairfax has learned from its mistakes.  I wish like you that they would fess up to their mistakes, as acknowledging one's mistakes is the best way to avoid future ones.

 

FWIW I disagree fairly profoundly with both these views.

 

Broadly I agree on BBRY - hasn't worked as they have hoped, but then not every investment does and they may still make money so let's wait and see.  I agree that they would not have invested in BBRY if it had been in Dallas, but more because they wouldn't have known it so well.  I don't see it as hubris - there must have been dozens of Canadian bankruptcies that Prem did not try to save, including the last 'Canadian tech company' - but I suspect that because it was so close, he knew a lot of people involved and thought he had an edge.  He may yet be proved right.

 

The bigger issue for everyone seems to be the macro.  They have done two big things here.  The first is protect what is a very levered (with float) balance sheet in the event of an epic crash.  Would you really rather they had left the company exposed?  OK, so there are other ways of doing it such as holding cash, but if they'd done that we'd all still be saying ooh look how wrong they've been.  The second is they have made a macro call.  The CDS bet when they made it was very controversial - it was not obvious to most people that there was an "identifiable irrationality you could point to - lots of money being loaned to people with terms such that they were very unlikely to repay the loans".  It certainly wasn't obvious to me.  However, having lived through that, I think I can identify another one today.  China's banking assets went from $9trn in 2009 to $23bn in 2013, an increase of $14trn vs. a total US commercial banking asset base of $15trn.  In 2011+12 they made as much cement as the US made in the 20th century.  I would suggest that there is a very strong possibility they are borrowing money they can't afford to repay to build things they don't need (and that GDP is unsustainable in absolute terms as a result, with investment at 50% of GDP and quite capable of halving).  If China does go bang - and it is only an if, but a big if - I think that will be reflected in global asset prices, at least for a time.  So here's the thing: why is it more of a macro call to say "I see serious imbalances in the world, and I will both protect myself against them and make a bet to benefit if I am right that they are unsustainable" than it is to say "I see serious imbalances in the world, but I can't predict macro because everyone tells me macro is unpredictable, so I'll just carry on regardless, risk my company, and not make any money if I am right"?

 

Or to put it very simply: I don't want these guys to admit they've made a mistake because I think what they have done is stick to what they believe in.  I invest in them precisely because they stick to what they believe in, and because it has worked over time.  If I saw them wavering because the short term (and yes, I do view 5 years as short term) didn't work in their favour I'd be *very* worried.  I have listened to Prem saying: the world may muddle through, and these investments may not pay off, and that'll be fine; but if they do, we'll do very well when everyone else is on their knees.  He *knows* he might be wrong, but wants the protection because he knows being wrong about holding protection is far less painful than being wrong about not holding it.  And I am delighted that he runs his company that way.

 

Thanks for reading,

 

P

[giofranchi]

That is the reason I sold as well.  I am not comfortable investing alongside someone who believes they can consistently make good investments based on the macro.  Also, I see his current bets on a stock market crash as very different from his subprime mortgage bets.  With his CDS bets there was an identifiable irrationality you could point to - lots of money being loaned to people with terms such that they were very unlikely to repay the loans, and with some foresight you could say that "this is going to end badly".  Certainly we should give Prem credit for seeing this.  But his new bets are just macro bets plain and simple, with no irrationality you can really point to, except perhaps for deficit spending, which has been going on for decades. 

 

Almost all developed economies are plagued by debts that keep rising instead of gradually decreasing. And debt beyond a certain level stifles economic activity, instead of stimulating it.

Meanwhile central banks have flooded the world with cheap money, printing like it has never been done before. As a result all asset prices have gone way up.

Poor economic activity, high asset prices… what other irrationality do you need?!

Fairfax is right about being worried. It’s a $37 billion in assets insurance conglomerate… It must worry about high debts and high asset prices… We might have the luxury to disregard what’s happening around us… Certainly not Fairfax!

Anyway, this sums up pretty well what I think:

The Schiller PE of the S&P500 is around 26.5, either in the next 2 years it gets to 29 – 30, or it stops getting higher and higher. If the Schiller PE gets to 30, there is no doubt in my mind a bubble has finally developed. Otherwise, we will muddle through.

In any case Fairfax’s conservative stance will be finally proven either right or wrong. Not much time left to wait.

 

Gio

 

[petec]

what I should add is that if FFH are proven right, it might well be a case of a broken clock.  They clearly mistimed their bet, so maybe it is luck and not judgement.  But there is some judgement in ensuring that you will be lucky, and have a lot of cash to invest, just when everything is cheap!

[giofranchi]

Or to put it very simply: I don't want these guys to admit they've made a mistake because I think what they have done is stick to what they believe in.  I invest in them precisely because they stick to what they believe in, and because it has worked over time.  If I saw them wavering because the short term (and yes, I do view 5 years as short term) didn't work in their favour I'd be *very* worried.  I have listened to Prem saying: the world may muddle through, and these investments may not pay off, and that'll be fine; but if they do, we'll do very well when everyone else is on their knees.  He *knows* he might be wrong, but wants the protection because he knows being wrong about holding protection is far less painful than being wrong about not holding it.  And I am delighted that he runs his company that way.

 

I agree 100%.

 

I guess probably in Europe we are still feeling a pain that in the US was only briefly experienced in 2009-2010… That’s why rising stock prices don’t make us feel so much comfortable… In Italy, and maybe also in England (at least in part!), we feel first-hand the irrationality of asset prices that go up almost every day with tons of qualified people that remain without a job… The piece of news industrial production in Italy declined again last July is just out, the biggest construction companies in Italy have all practically left the country, our debt is the third largest in the world… and yet the Italian government can borrow at a lower cost than the US!

Isn’t this irrational enough? Believe me, if you live it each day, it surely is!

 

Gio

 

[petec]

Or to put it very simply: I don't want these guys to admit they've made a mistake because I think what they have done is stick to what they believe in.  I invest in them precisely because they stick to what they believe in, and because it has worked over time.  If I saw them wavering because the short term (and yes, I do view 5 years as short term) didn't work in their favour I'd be *very* worried.  I have listened to Prem saying: the world may muddle through, and these investments may not pay off, and that'll be fine; but if they do, we'll do very well when everyone else is on their knees.  He *knows* he might be wrong, but wants the protection because he knows being wrong about holding protection is far less painful than being wrong about not holding it.  And I am delighted that he runs his company that way.

 

I agree 100%.

 

I guess probably in Europe we are still feeling a pain that in the US was only briefly experienced in 2009-2010… That’s why rising stock prices don’t make us feel so much comfortable… In Italy, and maybe also in England (at least in part!), we feel first-hand the irrationality of asset prices that go up almost every day with tons of qualified people that remain without a job… The piece of news industrial production in Italy declined again last July is just out, the biggest construction companies in Italy have all practically left the country, our debt is the third largest in the world… and yet the Italian government can borrow at a lower cost than the US!

Isn’t this irrational enough? Believe me, if you live it each day, it surely is!

 

Gio

 

Absolutely.  The UK is arguably in a better state than Italy - until you consider what you have to spend to buy a house in London.  These prices are not right.  I have been saying so, and been wrong, for several years, but the more they go up the more I think I'm right.  Overall, with the exception of the (admittedly very important) US consumer, the world is still leveraging up, not deleveraging, and in debt cycles the way up tends to be a much smoother ride than the way down.  Protection is just fine by me.