Is mr market expecting a results disaster????

[obtuse_investor]

Anyhow, I'm not overly concerned about the move. I just thought it bizarre that they'd sell the Treasuries now and not 4-5 months ago.

 

To be frank, the only thing I find bizarre about this sale is the date. It all happened on one day-- yesterday, the day of the Q3 results.

 

This is too much of a coincidence.

 

Something doesn't smell right. That's all.

 

[rb]

Well if they sold cause they're worried about Trump winning the election that risk only came about in the past couple few days. So it's not that wouldn't be so weird. Maybe it's just a coincidence.

[WhoIsWarren]

Here is the full quote.

 

http://www.bloomberg.com/news/articles/2016-11-04/prem-watsa-s-fairfax-sells-90-of-long-bonds-ahead-of-election

 

“We’ve sold 90 percent-plus of our Treasury bonds and we’ve made the point that the uncertainties in the U.S. election are the reason," Watsa, chief executive officer of the Toronto-based company, said on the third quarter conference call Friday. “We don’t know who’s going to win the elections, but you could have significant infrastructure spending, a drop in corporate tax rates, and while we think it might work in the short-term, in the long-term we have questions about that. We wanted to take that risk out."

 

My quote was taken from the earnings call.....where Prem specifically says we "live in a mark-to-market world and we wanted to take risk out".  I've never heard him equate risk and mark-to-market.

 

I dunno, seems like at Fairfax there's way too much focus on the investment side of the business.  Compare and contrast with Markel.....

 

Could you elaborate?

 

 

Petec, I also think that Fairfax has likely made great improvements in its insurance operations in the last 5+ years.  So why isn't it enough for management to let those insurance results shine through and to implement a comparatively simpler investment process (like Markel)?  It just seems to me that they are trying a bit too hard on the investment side.  They have the appearance of naive high-rollers at the casino looking for a couple of long-odds big paydays (the deflation swaps, the equity hedges).  Trading out of long-dated Treasuries looks to me like they are being too clever by half.

 

Don't get me wrong -- I also have concerns about the health of the global macro backdrop.  But how do you judge the probability of the doomsday scenario occurring?  And what's your opportunity cost os sitting in a cave with your tin of beans and an opener?

 

Correct me if I'm wrong, the bread and butter of Fairfax's investment track record is buying underpriced securities.  Singles and doubles.  The CDS bet was something of a departure from that, but it was still based on fundamental analysis of individual securities or a class of securities.  As we know, it paid off big time but this was because of the asymmetry of the payoff.  However the deflation swaps bet seems to be mainly based on 2 historic scenarios (Japan, the Great Depression) that may or may not be relevant to the current situation (check out Modern Monetary Theory for an alternative view of how the system works).

 

[Luckyone77]

From WhoisWarren:

 

"They have the appearance of naive high-rollers at the casino looking for a couple of long-odds big paydays (the deflation swaps, the equity hedges).  Trading out of long-dated Treasuries looks to me like they are being too clever by half.

Correct me if I'm wrong, the bread and butter of Fairfax's investment track record is buying underpriced securities.  Singles and doubles."

 

 

My feelings exactly.

[bsilly]

I’ve followed Fairfax for a long time, like many folks on this board, and I agree that selling the treasuries three days before an election because of “election risk” seems out of character. I think there is a bit more to it.

 

There has been a tremendous expansion of monetary base in the U.S. since 2008, which provides the tinder for massive inflation if the private sector suddenly decides to go on a borrowing and spending binge. This hasn't happened and may not happen (thus the deflationary pressure). But holding long bonds exposes you to large losses should that materialize. And really - how much can long rates go down from 2%? I guess they could go to zero, but it seems unlikely. A flattish period of low but above zero rates seems a little more believable to me.  Long dated U.S. treasuries are starting to look like a one sided bet with lots to lose and little to gain. The opposite of the CPI contracts. You have to be pretty certain that significant  inflation is not going to happen to continue to hold.

 

It is not necessarily inconsistent to believe deflationary pressures are real, and yet still see a risk of inflation. It comes down to a probabilistic view of the world rather than a singular view of how things might turn out.

 

One thing to remember is that for the deflation scenario to pay off Fairfax does not need actual deflation. The only need only for the CPI derivatives market to price in a reasonable chance of deflation over the next 5-6 years, causing the contracts to dramatically increase in value. The downside is limited to the premium paid and the upside significant. I think it was/is a reasonable bet, but it is perhaps a touch less attractive now. Time is working against them.

 

Maybe the uncertainty around the election provides justification, but I take the sale of long bonds as a sign of perhaps a little less certainty about the deflation / zero interest rate scenario developing, but certainly not an indictment of the deflation hedge.

 

https://fred.stlouisfed.org/series/BASE?utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=categories

 

https://www.google.ca/url?sa=t&source=web&rct=j&url=https://thenextrecession.files.wordpress.com/2016/02/richardkoo_2feb2016-1.pdf&ved=0ahUKEwjlr9mDipjQAhUJ0WMKHXpYAQwQFginATAX&usg=AFQjCNE9t7lejzExTnQ83MbOjoXR2O4ZQA&sig2=J7e7VyYuIYc7l2ewQe1FcQ

 

[indirect]

Welcome back, bsilly. We miss your input on Fairfax.

 

 

[bsilly]

Thanks indirect. There's often not much to say about this company that hasn't been said :) That wasn't always the case. It remains one of the most interesting to watch though - there is no other quite like it.

[Cardboard]

"Welcome back, bsilly. We miss your input on Fairfax."

 

On any topic :)

 

Regarding long term U.S. bonds, have you noticed that they did not move up but, did go down yesterday while everything else did move more or less as expected?

 

That seemed a little strange to me considering that Trump is seen as much more negative to U.S. treasuries. I would have expected some relief rally in that market considering that Hillary would likely keep Yellen and her policies.

 

And they are down again today.

 

So it seems that long term U.S. treasuries will face some headwind going forward no matter who is elected (fiscal stimulus?). They probably made the right move to get out but, I am unclear why they didn't lighten up earlier or this Summer when yields approached new lows and the crowd kept talking about negative yields.

 

Cardboard

 

[rb]

There's nothing too weird about treasuries going down today. Classic risk off trade.

[benhacker]

I  second TCC and bsilly.  Seems like an ok move to blow out duration; timing does seem odd.

 

Honestly though, given how long Brian and Prem have run with this lower rate / duration bet, and essentially it has been out of consensus most of the time, I can't really fault them for stepping back.  Maybe just liquidate, breathe for a few days and decide.  Maybe fear of Trump-flation was just a good excuse.

 

Frankly, I used to worry about rates rising, but I'm not so concerned anymore.  The math is so bad on the the wealth destruction to institutions / pensions for a sudden rate rise that I believe it won't be allowed to happen (we could get a late 40's / early 50's style "rate cap" by the FED).  I basically think inflation is now guaranteed sometime and rates will normalize slowly.  Not sure how much and when, but I like that Fairfax is starting to change their stripes a bit... long bonds just scare me so I'm kind of happy to see them change.

 

As to comment above in the thread about Fairfax being a single and double hitter that is now swinging for the fences... I think that [edit] does not jive with history.

 

Fairfax is a company that has done the following:

0) Founded as Prem bought/took over an insurer struggling to survive

1) Bet heavily against Japanese stock market in late 80's

2) early 90's bought back >20% of their shares at a discount to book

3) Issued tremendous amounts of shares way above book to make some terrible acquisitions during the second half of the 90's and into the 2000's

4) Bet heavily against the tech / US equity markets in 2000 (and bought OOM call options as well...)

5) Made a huge rate bet in '04-'05 (?) by buying treasuries.

6) Did a very aggressive tax move with BAC to onboard ORH ownership for tax purposes around the same time.

7) No where in their history did they make money from holding minority stakes in "good" companies for years for years and years.

8) During the last couple decades they have progressively been acquiring many nickel and dime insurance companies in various emerging and frontier markets...

 

This is *not* Berkshire.  Never has been.  Maybe some day it will be... maybe not.

 

Cheers,

 

Ben

 

Bsilly, don't go for too long this time.  I joined this board back in the day right when you were holding court... now I feel old.

[bsilly]

Cardboard, I always have enjoyed your take on things. Benhacker I seem to remember seeing your moniker a few times on other message boards prior to this one. I guess once Sanjeev shut down the old MSN Berkshire board I never made the transition.

 

I'm a reluctant follower of interest rates and inflation, owing in part to having significant investments in insurance companies, particularly ones that take large bets on long bonds and deflation hedges! Ben is right - Fairfax has been bold when they see things lining up in their favour. Don't forget the CDS. They seem like hail Mary's but they are usually right, and they typically protect the downside. I see no reason to expect any different going forward.

 

There have been some mistakes here and there but who here has not made a few of those!? If you haven't then you haven't been investing long enough:) You learn from them and move on. The key is the lifetime batting average.

 

As to timing, well, it's pretty hard to get perfect.

 

I did note the action in the bond market over the last few days - but only because I have been curious about Fairfax latest manouvering. I don't normally and I don't think I really have much insight. Dam* it Cardboard I'm a long term value investor not a psychologist!

 

 

[Jurgis]

Wow, so did Prem do the right thing? News at 11...  8)

[Jurgis]

Depending on price changes today when market opens, I might shit (sic) a lot of positions into FFH. Was thinking cash, but FFH might be more attractive.

[benhacker]

Benhacker I seem to remember seeing your moniker a few times on other message boards prior to this one.

 

Yeah, i think we were on maybe some Motley Fool boards a dozen years back.... maybe.  Fuzzy memory.

 

Don't forget the CDS

 

I figured folks hadn't forgotten that one yet. ;-)

 

Jurgis,

 

TLT down 2+% pre-market.

 

We will see....

[petec]

Benhacker and bsilly - excellent posts - thank you.

 

Or at least, I agree with them so they must be excellent ;)

[TwoCitiesCapital]

Look its pretty straightforward.

 

If you think Trump wins two adverse things will happen that will affect US treasuries : decreased corp tax rate and increased infrastructure spending. Prem says as much. Decreasing corp tax rate to 15% and decreasing highest individual tax rates and lowering number of tax brackets means decreased tax revenue for the gov. I have seen estimate of lost tax revenue of upwards of $9 trillion by 2026.

 

Increased infrastructure spending (military, infrastructure - building of Wall, etc) will be financed by huge bond auctions. When you suddenly triple the size of bond auctions to finance the increased deficit, what do you think happens to IR? Who has the appetite to come for a bid in today's environment (the last time that high a deficit as a % of GDP that needed to be finance was in 2008 ... and everyone participated due to safe heaven status of treasuries during those times)?

 

Avg duration of 30yr treasury is 19 years, so 1% moves results in 19% loss.

 

He wants to take the risk off in-case Trump get elected. Given the depth of US treasury market, he can easily do that and he can always come back in once he has certainty. Trump getting elected may result in other 'un-intended' events which he can capitalize on with his newly acquired $10b+ cash war chest.

 

Makes perfect sense with what he did.

 

It makes sense, but obviously wished they would have sold back in June/July when treasuries were hitting their record lows and offered less value than after one of hte largest bond sell-offs in history. Granted, Trump was guaranteed the presidency then, but "Brexit" and other nationalistic movements around the globe should have suggested probabilities were strong and the value in Treasuries, even relative value to other gov't bonds, had all but disappeared following "Brexit".

 

That would have been the time to sell...not once bonds returned to pre-Brexit levels.

 

Anyhow, I'm not overly concerned about the move. I just thought it bizarre that they'd sell the Treasuries now and not 4-5 months ago.

 

Did you think it was bizarre that they weren't selling at the time, or is this hindsight speaking?  Not getting at you, just interested.  Because while I agree, I wouldn't have got the timing right either so I can't criticise them ;)

 

A little of both. Obviously, I wasn't forecasting a return to pre-Brexit levels or that rates would move up significantly in the worst sell off we've seen in years, but markets almost ALWAYS overreact and correct in the days following shock events like "Brexit". 30-year Treasuries went pretty close to 2% flat and the yield advantage from overseas investors buying Treasuries on a hedged basis disappeared - absolute value was much changed after a 20-25% rally AND Treasuries lost almost all their relative value on a hedged basis removing demand from Japanese and European investors who had been a major source of demand.

 

I put my money where my mouth was. I owned a 25+ year zero coupon bond fund for maximum duration exposure and dumped it in July. I tend to agree with his macro calls, but dont' mind shorter term trading. Given the reasoning above, I didn't want to be greedy after clearing 20% in a bond ETF in fewer than 6-months so I took my profits and held the cash and waitied for better rates to re-enter the position (haven't done that yet).

 

I'm nowhere near as sophisticated as Fairfax is when it comes to bonds - just seems odd they would sell now instead of bakc then given his reasoning. Brexit and other nationalist movements should have been the flag that Trump had a chance AND the bonds had just gone through a major rally to set record lows in terms of U.S. yields! Record lows! Trump threat? Check. Bonds the highest valued in their history? Check.

 

It's just weird that they held then but are selling now. The only thing that's changed is that bonds have become more attractive.

 

Well kudos to Prem! I may not have understood the timing, but he wasn't wrong! 10-year yields up 13 bps to the highest levels since March. That'd be another $100-$150M or so loss in a single day across the $10B in treasuries and we may not be done yet.

[Crip1]

"Welcome back, bsilly. We miss your input on Fairfax."

 

On any topic :)

 

Cardboard

 

 

Agreed...

 

 

-Crip

[Crip1]

Well, now the question is...did Fairfax buy back in to all or part of their US Bond position at a cost 1-2% lower than they sold? My guess is that they may be selectively buying back in but for the most part, they did not.

 

Which brings up the next question...what does a company do with $10B in cash?

 

 

 

-Crip

[StubbleJumper]

Well, now the question is...did Fairfax buy back in to all or part of their US Bond position at a cost 1-2% lower than they sold? My guess is that they may be selectively buying back in but for the most part, they did not.

 

Which brings up the next question...what does a company do with $10B in cash?

 

 

 

-Crip

 

 

They pay out insurance indemnities to their policy holders with the $10b of cash.  The potential uses of that cash are somewhat limited...basically most of it needs to be invested in some form of sovereign debt, state/provincial debt, or munis.  I guess a little bit could be directed to corporate bonds or equities, but I'd be surprised if Prem were to reach for yield in the one case or increase his equity allocation in the other case.

[TwoCitiesCapital]

My guess is they haven't done anything with it yet - Prem doesn't strike me as the kind of guy who was concerned about a 1-2% move nor do I think a 1-2% move is going to be the evidence he wants to see regarding whether he was right/wrong.

 

 

[petec]

Well, now the question is...did Fairfax buy back in to all or part of their US Bond position at a cost 1-2% lower than they sold? My guess is that they may be selectively buying back in but for the most part, they did not.

 

Which brings up the next question...what does a company do with $10B in cash?

 

 

 

-Crip

 

 

They pay out insurance indemnities to their policy holders with the $10b of cash.  The potential uses of that cash are somewhat limited...basically most of it needs to be invested in some form of sovereign debt, state/provincial debt, or munis.  I guess a little bit could be directed to corporate bonds or equities, but I'd be surprised if Prem were to reach for yield in the one case or increase his equity allocation in the other case.

 

 

...depends what value he finds!

[LakesideB]

My guess is they haven't done anything with it yet - Prem doesn't strike me as the kind of guy who was concerned about a 1-2% move nor do I think a 1-2% move is going to be the evidence he wants to see regarding whether he was right/wrong.

 

A 1% to 2% move is non-trivial.

 

On a 30yr it translates to a -19% to -28% return due to its approx 19yr duration. The 30bps to 35bps move in US 10yr and 30yr in the past two days is a huuge move with much higher implications on actual returns.

 

The other issue is for a P&C, the investment leverage is always >1 and in FFH's case, its around 3x, so the implications on ROE for FFH are even more dire due to this.

 

Kudos for him to have had the sense to come out of them.

[TwoCitiesCapital]

My guess is they haven't done anything with it yet - Prem doesn't strike me as the kind of guy who was concerned about a 1-2% move nor do I think a 1-2% move is going to be the evidence he wants to see regarding whether he was right/wrong.

 

A 1% to 2% move is non-trivial.

 

On a 30yr it translates to a -19% to -28% return due to its approx 19yr duration. The 30bps to 35bps move in US 10yr and 30yr in the past two days is a huuge move with much higher implications on actual returns.

 

The other issue is for a P&C, the investment leverage is always >1 and in FFH's case, its around 3x, so the implications on ROE for FFH are even more dire due to this.

 

Kudos for him to have had the sense to come out of them.

 

I'm aware of how duration works - we've seen nowhere near a 1-2% move in rates. I thought the prior comment was referencing the notional value of the bonds since rates have only moved 20-30 bps. Which would have been about a 2% move on 10-year bonds in terms of gain/loss to Prem's portfolio.

 

I agree on your point that this is a big move for 30-year Treasuries, but Prem's duration has generally trended around 10...so I don't think he owned $10B in 30 years to begin with.

 

Who knows what he buys back into, but 20-30 bps doesn't strike me as the type of rate move that is going to drive him back into bonds unless if he immediately reverses his concern about rising rates under Trump and moves back to deflationary considerations.

[LakesideB]

Who knows what he buys back into, but 20-30 bps doesn't strike me as the type of rate move that is going to drive him back into bonds unless if he immediately reverses his concern about rising rates under Trump and moves back to deflationary considerations.

 

My bad, I mistook what you meant. Agreed.

[obtuse_investor]

Interesting development... Now the 50% of the hedges come off.

 

Fairfax Financial Holdings Limited: Reduction in Defensive Equity Hedges

 

TORONTO, ONTARIO--(Marketwired - Nov. 11, 2016) - Fairfax Financial Holdings Limited (TSX:FFH)(TSX:FFH.U) announces that after considering the effect of the recent U.S. elections and the potential for changes that may dramatically impact the U.S. economy and, therefore, the U.S. equity markets, the company determined it was prudent to significantly reduce its hedge of its equity investment exposure immediately. As a result of this action, equity hedges currently represent approximately 50% of the company's equity and equity-related holdings (a reduction from 112.7% at September 30, 2016). Fairfax will continue to evaluate the post-election U.S. economic indicators and may determine to reduce those equity hedges further.

 

"We hedged our equity investments to protect our shareholders' capital from exposure to the impact of deteriorating economic fundamentals," said Prem Watsa, Chairman and CEO of Fairfax. "We constantly monitor these hedge positions relative to economic fundamentals. We believe the U.S. election may result in fundamental changes that may bolster economic growth and business development. As a result, there is the potential for a longer term rally in U.S equity markets that reduces the need for the capital preservation protection of equity hedging."

 

Source: http://www.fairfax.ca/news/press-releases/press-release-details/2016/Fairfax-Financial-Holdings-Limited-Reduction-in-Defensive-Equity-Hedges/default.aspx