Identity Crisis

[Cardboard]

"We've seen 10x that amount in global central bank action over the past 6 years with near 0 impact on inflation thus far."

 

"To the second point, banks are still sitting on tons and tons of excess reserves and most of the money the Fed has printed is not being circulated."

 

The central banks policies combined with stricter regulations such as Dodd-Frank and new Basel rules were mostly intended to recapitalize and fix banks. As you stated, most of that cash never went into consumer hands: banks hold more reserves, banks have increased their lending standards.

 

Trump is proposing a large infrastructure spending plan combined with fiscal stimulus (lower taxes). I think that Clinton would have done the earlier but, raised taxes. This is Helicopter Ben plan at work.

 

The one thing that is not reacting correctly at the moment, I think, is the USD. I understand assets moving away from emerging markets but, once there is realization that the U.S. debt to GDP will skyrocket (at least temporarily), I can't see the currency heading up. Moreover, with the kind of move that we have seen in treasuries, refinancing risk goes up a lot and the share of budget going towards interest payments.

 

At the end of the day, no one knows how this will all play out: not me, not Dalio, not Watsa, not even the ones in charge. I do believe that Fairfax should get back to plain vanilla investing and improving their business on a daily basis. They can also keep a lot of cash on hand for potential deals. That is the best hedge IMO.

 

Cardboard

[DCG]

I see Fairfax as an ok insurance company with a terrible investment team.

[SharperDingaan]

'The one thing that is not reacting correctly at the moment, I think, is the USD. I understand assets moving away from emerging markets but, once there is realization that the U.S. debt to GDP will skyrocket (at least temporarily), I can't see the currency heading up. Moreover, with the kind of move that we have seen in treasuries, refinancing risk goes up a lot and the share of budget going towards interest payments.'

 

 

 

Keep in mind that if he wants those manufacturing jobs back in the US, he's going to have to devalue the USD - and automate the new factories to get around the demographically small number of young Americans. The same thing as is currently occurring in the UK.

 

Then keep in mind that the US is the 'sleeping giant', it has been sleeping for a very long time, & Trump has woken it up.

 

The domestic US infrastructure market is big enough to absorb the vast bulk of the supply from that bigger domestic workforce, he has the domestic resources to do it (oil, steel, etc.), and he can ignore export sales for some time (ie: extended FX devaluation war - & disincentive to stay in the TPP). He can quite easily haul US infrastructure into this century, use the age wave to progressively reduce the workforce as the infrastructure is replaced, and end up with high tech state-of-the-art infrastructure, everywhere - run by high-tech employees, when he's done. An 'us versus them' trade war to promote 'kinship', todays workforce successfully retired, & everyone voting for him because he's secured a long term economic place in the world for their kids. Game changing.

 

WWII woke up the US, and it pushed the US into prominence all around the world - for decades.

The good news is that this time around - it looks like no bullets.

 

It looks like helicopter money, & in the early days would be - but its really the cumulative $ that have been piling up on everyone's financials, & diversion of the existing QE out of the weak sisters in the banking sector. Again, game changing.

 

 

SD

 

 

 

 

 

[Uccmal]

What about deflation hedges? - looks like there is going to be inflation not deflation.  I like PW as well but I think the 15% return goal in the AR is a bit disingenuous.

 

Fairfax has always been enigmatic.

 

I agree it is pretty hard to argue that that the Russell 2000 is cheaper today than 5 years ago. I'd like to see a good honest discussion of the hedging mistakes, and ultimately  get out of the equity "hedging" business altogether.

 

It's funny - Donald Trump gets elected president, rates rise to where they were at the beginning of 2016, and everybody is back on the "runaway" inflation argument even though nothing has really changed on that front. Donald Trump isn't printing trillions more dollars. Donald Trump isn't personally giving everyone in the U.S. a raise. Donald Trump hasn't weakened the dollar to the point where import costs are soaring.

 

I know what rates and currencies have done. I've witnessed and watched it. I also know that global central banks have spent trillions over the last 5 years trying to generate inflation and have collectively failed so why do we think D.T.'s election portends a great impact that tens of trillions of dollars failed to achieve?

 

The way I see it,  there's three possibilities:

 

1) Donald Trump is a REAL game changer and we're going to see inflation that was not achievable under coordinated central bank action OR

2) We were on the cusp of inflation regardless because inflation is a monetary phenomenon OR

3) Nothing has really changed and the rates market will resume they're downward trend once markets figure this out

 

D.T.'s spending package hasn't been approved, and if it is, is for $1T over 10 years. We've seen 10x that amount in global central bank action over the past 6 years with near 0 impact on inflation thus far. Further, the spending demographic shift of retiring boomers cutting back is still a drag on growth and inflation for the next 2-3 years, minimum, as is the lack of corporate investment over the past decade. Dollar strength is also disinflationary for all the goods we import (A LOT) as well as corporate profits.

 

To the second point, banks are still sitting on tons and tons of excess reserves and most of the money the Fed has printed is not being circulated. Any money that is being circulated in financial markets is being pulled back as the Fed is hiking rates, long-end rates have risen to 2015 levels prior to the January/February panic, and the dollar is hitting 13 year highs. The velocity of money is still falling, real economic activity is still contracting, and the inflation we're seeing is off a low base AFTER oil prices hand tanked 40-50%. Of course we'd expect this figure to accelerate some once oil prices steadied/rebounded just because of the slow inflation in other things like rents.

 

So that leaves us with the third option. As we've seen many times in the past (i.e. taper tantrum, the end of each Q.E. cycle, etc) the markets are over-reacting and likely to come back down. I would not be at all surprised if rates make new lows over the next 2-3 years and D.T. fails to prove the panacea that 10s of trillions of dollars in printed money couldn't achieve.

 

Having massive amounts of debt is deflationary and every day the world has more of it than it did the day before. D.T.'s plans call for even more. Deflation is still the threat - especially in the event of a recession.

 

Very good post.  IMO, this whole bull market is built on a house of cards. 

 

To add to this: fuel prices.  These added 400 B per year for the last two years to the US economy and presumably a lesser amount to the EU.  As energy prices rise, which they will, with or without OPECs cooperation, any benefit of stimulus will be counteracted by higher input costs everywhere else. 

 

Call me cynical but at some point in the not too distant future the 'backtracker' is going to be in political hot water, and everyone will be distancing themselves from him.  Sorry, but a 70 yr. old huckster doesn't change.  The markets were highly valued before the recent run up.  So, is deregulation , tax cuts, and stimulus plans, already in the market prices?  If the backtrackers plans dont come out perfectly, the sh*t hits the fan.  He is fighting a demographic storm and the decendance of the USAs economic power all at the same time.  I mean, aside from Canada and Mexico, does the rest of the world really care if the US goes more protectionist?  Trans Asia/EU/Africa trade is huge and self sufficient without America's involvement. 

 

I dont know what this means for Fairfax and their macro bets.  They may still be right on deflation.  I just dont think they are very good at this, because you cant be good at it.  Three or four times lucky in 30 years doesn't make a track record. 

[Crip1]

 

At the end of the day, no one knows how this will all play out: not me, not Dalio, not Watsa, not even the ones in charge. I do believe that Fairfax should get back to plain vanilla investing and improving their business on a daily basis. They can also keep a lot of cash on hand for potential deals. That is the best hedge IMO.

 

Cardboard

 

 

I could not agree more, Cardboard. For years the underwriting at FFW was suspect so capital was a risk, more so than for the “average” insurer. Now, underwriting looks to be fixed...still risky as is insurance inherently, but far more stable than 10-15 years ago. Looking at it now, a great way to mitigate the existing risk inherent in the organization is to buy good businesses at fair prices as opposed to fair businesses at good prices. That’s not to say that macro bets are off the table, but I’d rather have the needle moved, plus or minus, but a more conservative approach than by macro factors. Over time, I feel that this approach would ultimately reward the shareholder.

 

FWIW, I increased my holdings by 15% last week, effectively sticking my toe in the water. Less than 1.1x BV has shown to be attractive.

 

 

-Crip

[shalab]

I have never understood the deflation bet. As far as I can see:

 

1. Canadian economy has not shrunk despite the drop in commodity prices and people don't expect Canadian economy to tank in the next five years

2. Inflation in China/India etc. is high despite the drop in commodity prices

3. Wages/salaries are going up in the U.S

4. If the Euro/pound drops against the USD, there will be inflation pressure in the E.U

5. The U.S is a major economic power still ( > 18 trillion USD in GDP in 2016 and ~20% of world GDP ) - China has 350B trade surplus with the US, Germany has 75B surplus with the US. These economies will be impacted heavily if the US trade is disrupted.