Fairfax 2023

[MMM20]

57 minutes ago, Candyman1 said:

Wow, prem referred to making $100 a share for a number of years.

I was glad to see him lay out this math in a straightforward way. And mentioning that the stock still trades at 6.5x P/E as a sustainable base and so they will strongly consider large ongoing buybacks if we don’t see a reacceleration in insurance pricing.

 

^from Trevor Scott on Twitter. I will be surprised if this persists.

 

Edited February 17, 2023 by MMM20

[Santayana]

Well the market seems to like to the results, and didn't even give the customary 3 day waiting period we're used to.

 

On duration, it seems like they are taking Powell at his word that rates will stay higher longer, and don't think he's just jawboning.

[newtovalue]

That was a great call - Prem laid out the case very clearly.

 

I also appreciated their conservative approach to IFRS 17 - they’re not changing the reserve process as a result.

[Dudley]

After that earnings result and call, it's amazing that the stock is trading at ~1.04x P/B. My guess is that it's probably fighting the market's fear today of another 50bps rate hike, which ironically is positive for Fairfax.

 

I agree with the take that the thoughtful deployment into bonds as it relates to rate and duration are more important than taking excessive risk in an effort to optimize bond interest income.

[TwoCitiesCapital]

46 minutes ago, StubbleJumper said:

I was a little surprised about that too.  But, one the other hand, with the curve inverting, any of the Tbills or short term treasuries that they roll over the next 6 or 12 months will likely be rolled into much higher interest rates.  The run-rate for interest and dividend income has grown considerably, and strangely, there is still a bit of runway on that.  I get your point about potentially being subject limited interest income, but that is unlikely to occur in 2024 although it does become a risk in 2025 and 2026.

 

In a more general sense, I would observe that it is unreasonable for shareholders to expect that FFH will nail the evolution of the yield curve perfectly, by going long at the perfect moment to get a peak rate for a cycle.  What we need is not perfection, but thoughtful competence.  And, I would say that so far in 2022 and 2023 Bradstreet has given us exactly that.  FFH has done very well due to the thoughtful positioning of its fixed income port.

 

I never particularly like the release of the Q4 financials because it isn't immediately accompanied by a detailed and verbose report.  I guess we'll see in a month exactly what has been done with the maturity profile and the extent to which FFH has (or hasn't) reached for yield by buying bonds from sub-national governments or corporate bonds.

 

 

SJ

 

 

If the Fed cuts rate back to zero in Q4 of this year, you'll have run off and reduction in rates every quarter of 2024 until the end. 2025 will be the year of near 0 income, but 2024 would be declining every quarter. 

 

I don't care so much about Fairfax maximizing yield in any one corner. I know the yield curve is inverted. I'm also not asking them to go all in on 20-year zero coupon bonds for the duration. 

 

I want them to lock in reasonably high yields so you can count on that billion every year and have a reasonable amount of duration to hedge downturns.

 

And the reason I'm so paranoid about it is because they DID miss it once already. They went all short duration in 2016. Were right into 2018 hiking cycle but missed the pivot, never extended duration, and the we sat at 0 income until 2022. 6-years of a bond portfolio basically doing NOTHING from an income or gain/loss scenario. That could have been an extra $3-6 billion pending how you expected them to trade the bonds in covid. We talk about how much the equity hedges have cost... look at the missed income and duration opportunities over that period!

 

This time around I doubt it'd be 6-years, but even 3 years would be terrible This is the ONLY part of their business that lends itself to being predictable and they've already knocked the ball out of the park on the interest rate call. Lock it in! 

Edited February 17, 2023 by TwoCitiesCapital

[Xerxes]

So if you had bought FFH at the same time as Prem did and held it, you would have beaten all the FANGs, and market indices. 

[TwoCitiesCapital]

Seems like the market is over the "wait 2-3 days to respond to earnings" trend. 

 

Multiple expansion might be the next change the market gives us

[MMM20]

7 hours ago, Xerxes said:

So if you had bought FFH at the same time as Prem did and held it, you would have beaten all the FANGs, and market indices. 

I believe FFH would have been the best performing stock in the S&P 500 last year if eligible. And still trading at ~6.5-7x what seem to be sustainable earnings growing low single digits per share long term from here.
 

If yields return to ~0 and so by ‘25 they lose most of that interest income w/o extending duration, really a draconian scenario for that piece, well, ok, you now sustainably have a ~US$20B+ equity portfolio earning ~US$1.5-2B+/year and an insurance engine earning ~US$1B+ looking forward. 
 

I have a hard time seeing how this isn’t worth at least 10x ~US$3-4B operating income with their solid capital allocation and shareholder orientation. That would just put them in line with peers on Trevor’s chart. 

 

Still think this is easily a US$1000 stock right now and probably closer to US$1500.

 

Edited February 17, 2023 by MMM20

[StevieV]

32 minutes ago, TwoCitiesCapital said:

33 minutes ago, TwoCitiesCapital said:

I want them to lock in reasonably high yields so you can count on that billion every year and have a reasonable amount of duration to hedge downturns

I don't care so much about Fairfax maximizing yield in any one corner.

 

Yes, this is why I thought they'd increase duration.  Not to maximize yield, but to lock in  yield for a while.

 

Fairfax generally knows what they are doing with the bonds and the short duration served them very well getting here.  They could certainly be making the correct call again now.

[StubbleJumper]

32 minutes ago, TwoCitiesCapital said:

If the Fed cuts rate back to zero in Q4 of this year, you'll have run off and reduction in rates every quarter of 2024 until the end. 2025 will be the year of near 0 income, but 2024 would be declining every quarter. 

 

If the Fed cuts its rate back to zero in Q4?  It's what 4.5% at the moment?  Your scenario is pretty extreme....like Great Financial Crisis extreme.  And even then it took more like a year.

 

 

SJ

[TwoCitiesCapital]

14 minutes ago, StubbleJumper said:

 

If the Fed cuts its rate back to zero in Q4?  It's what 4.5% at the moment?  Your scenario is pretty extreme....like Great Financial Crisis extreme.  And even then it took more like a year.

 

 

SJ

 

1) it went from 2.50% to 0% in a matter of 6 months going into covid and Fed was cutting rates BEFORE the shut down and covid had even ever been heard of. They don't have to do it in 0.25 or 0.5% increments pending how deep and bad the deceleration is. The fact that they've been hiking 10 months into a deceleration suggests to me it'll get bad

 

2) the only thing that makes me think they may not cut back to 0% is the persistence of inflation. But even going back to 1-1.5% would kill the interest income over a period of 12 months because they're running an average duration of ~18 months. In 12 months time, 2/3 of your bonds will roll to significantly lower yields regardless of what the bottom end of the Fed cutting cycle. This is precisely why I want them to lock it in. Would be much more comfortable with a ~3ish year type duration (which is still WAY short relative to counterparts and the Barclays Aggregate index). 

 

3) while acknowledging labor is resilient and may lessen the impact of the coming recession, MANY economic indicators are at 2008-type levels and there is a general acknowledgement that booms and busts tend to have similar magnitudes. 2020/2021 was obviously an enormous multi-trillion dollar stimulus fueled boom. What does the hangover look like?

 

4) Why does 0% seem so extreme when we spent the vast majority of the last 15-years sitting there? 

Edited February 17, 2023 by TwoCitiesCapital

[Xerxes]

On the duration discussion, my view is that Prem & Co. have a very strong and clear multi-decade view on the secular direction of interest rate (notwithstanding the short cyclicality of it). For them the 2018 pivot and the unseen Covid events that took the rate back to zero are either cyclical in the case of former or coming out of the left field in the case of the latter.

 

But the long-term story is one that is marching upwards.

 

 

[Saluki]

I bought too early (2017 after my first Toronto trip) and those buys have underperformed, but the additions after the pandemic rout in 2020 have made up for that.  At this point, the business keeps growing and they are not doing things like making market calls with swaps and instead using that money and brainpower to grow the insurance business and make opportunistic investments, so I don't plan on selling any shares.  The only FFH shares I have sold have been this year in my retirement account and I moved that over to Fairfax India, which I also like and is a bargain comparatively, IMHO.

 

I have no idea how the market doesn't value FF India like it values the companies on the Sensex. During the pandemic, the P/E of the Sensex reached 36, and FFI is still trading below book for some world class assets that are getting more valuable.  

 

FFH has less moving parts than BRK but it's still difficult for me to follow all the pieces.  Still, the important stuff (record premiums, record profits, combined ratio under 100, opportunistically buying assets then selling them for multi baggers a few years later) seem to be providing consistent steady growth. Still holding and collecting the dividends

 

 

[MMM20]

@TwoCitiesCapital even if we are headed back to 0, that would logically coincide with credit distress and spreads widening out, right? Just seems extremely unlikely that they end up “stuck” at 0% interest income. Taking what the markets are giving us with the inverted curve seems like the right call unless you are trying to show “locked in” interest income for Mr market to capitalize at a higher multiple at the expense of what seems to be the right long term risk reward move for shareholders imho.

[TwoCitiesCapital]

9 minutes ago, MMM20 said:

@TwoCitiesCapital even if we are headed back to 0, that would logically coincide with credit distress and spreads widening out, right? Just seems extremely unlikely that they end up “stuck” at 0% interest income. Taking what the markets are giving us with the inverted curve seems like the right call unless you are trying to show “locked in” interest income for Mr market to capitalize at a higher multiple at the expense of what seems to be the right long term risk reward move for shareholders imho.

 

Perhaps. That did happen in 2020, but Fairfax was sitting at 0 for a long time before that happened as the Fed paused in 2018 and then began cutting long before any blow out occurred in 2020. I liked the moves they did in 2020 - just imagine how much bigger they'd have been had they owned a few years of duration going into it and had actually booked gains on the bonds sold AND on the ones purchased instead of just sitting in cash. Imagine what it would have looked like to have had an additional $1-2 billion in cash from the increased interest received from 2018-2020. It would have been hugely impactful. 

 

Secondly, 3-years of duration is hardly taking undue risks. Nor am I looking for it for purposes of appeasing the market.

 

It helps with business planning knowing you have that $1B coming in consistently. It helps give you the confidence to take those risky/lumpy bets when the world is falling apart because you can use the $1B to do it while knowing there's another $1B coming right behind it if it continues to deteriorate. And lastly you get the optionality of a duration kicker which may allow you to front load $2-3B by selling some of duration to buy credit that has blown out. 

Edited February 17, 2023 by TwoCitiesCapital

[value_hunter]

 

51 minutes ago, TwoCitiesCapital said:

 

Perhaps. That did happen in 2020, but Fairfax was sitting at 0 for a long time before that happened as the Fed paused in 2018 and then began cutting long before any blow out occurred in 2020. I liked the moves they did in 2020 - just imagine how much bigger they'd have been had they owned a few years of duration going into it and had actually booked gains on the bonds sold AND on the ones purchased instead of just sitting in cash. Imagine what it would have looked like to have had an additional $1-2 billion in cash from the increased interest received from 2018-2020. It would have been hugely impactful. 

 

Secondly, 3-years of duration is hardly taking undue risks. Nor am I looking for it for purposes of appeasing the market.

 

It helps with business planning knowing you have that $1B coming in consistently. It helps give you the confidence to take those risky/lumpy bets when the world is falling apart because you can use the $1B to do it while knowing there's another $1B coming right behind it if it continues to deteriorate. And lastly you get the optionality of a duration kicker which may allow you to front load $2-3B by selling some of duration to buy credit that has blown out. 

Correct me if I am wrong. Why they have to sit for 12-18 month (wait for mature) to rotate to long duration bond if they see extreme interest cut coming? Can they just sell their short duration bond (with gain) and buy long duration(with loss) right away so they can lock in long duration?

Edited February 17, 2023 by value_hunter

[TwoCitiesCapital]

12 minutes ago, value_hunter said:

 

Correct me if I am wrong. Why they have to sit for 12-18 month (wait for mature) to rotate to long duration bond if they see extreme interest cut coming? Can they just sell their short duration bond (with gain) and buy long duration(with loss) right away so they can lock in long duration?

 

They CAN do this, but why would you expect them too? 

 

1) they didn't jump into long bonds in 2018 when the Fed halted nor in 2019 when the Fed started cutting. They also never really have acknowledged that they view this as an error to think the approach would be different this time

 

2) if they didn't see value at 4.25% on the 10-year in October, why would you expect them to see value now that it's 3.75? Or 3.25? Or 2.75? Or whatever rate it's at when the Fed finally capitulates and starts cutting? Long end rates typically drop a ways ahead of the Fed cutting which is why the yield curve is so heavily inverted at the moment. It's possible that much of the move down will have already occurred by the time the Fed cuts. 

 

I seriously doubt Fairfax will add long bonds in this environment (unfortunately). But I can't for the life of me understand why they wouldn't be running a 3-5 year duration at this point. 

[StubbleJumper]

1 hour ago, TwoCitiesCapital said:

1) it went from 2.50% to 0% in a matter of 6 months going into covid and Fed was cutting rates BEFORE the shut down and covid had even ever been heard of. They don't have to do it in 0.25 or 0.5% increments pending how deep and bad the deceleration is. The fact that they've been hiking 10 months into a deceleration suggests to me it'll get bad

 

Yes, and now you are positing that it will drop from 4.50 to zero in 9 months, despite the fed having a posture of increasing or, at worst, pausing.  So, in essence, you are suggesting that the decline will approximate that which we saw during the Great Financial Crisis, which was the worst credit crisis since the great depression.  And even at that, in the GFC it took more like 15 or 16 months to drop to zero from rates similar to what prevails today.  As you suggest, it might very well get bad if the economy heads into a recession during 2023 or 2024, but let's try to keep the situation in context.

 

1 hour ago, TwoCitiesCapital said:

2) the only thing that makes me think they may not cut back to 0% is the persistence of inflation. But even going back to 1-1.5% would kill the interest income over a period of 12 months because they're running an average duration of ~18 months. In 12 months time, 2/3 of your bonds will roll to significantly lower yields regardless of what the bottom end of the Fed cutting cycle. This is precisely why I want them to lock it in. Would be much more comfortable with a ~3ish year type duration (which is still WAY short relative to counterparts and the Barclays Aggregate index). 

 

Headline inflation is still significant and will likely remain so until May or June when the year-over-year comps for energy prices and food prices become more favourable (there was a notable spike last spring).  I cannot envision the fed adopting a cutting posture until mid-year at the very earliest.  If interest rates do decline, then interest income will follow a few years later.  That's the reality.  Current duration is 18 months, and Prem suggested during the conference call that it will likely be pushed out to 2-ish years during 2023.  So, you are right, perhaps by 2026 there could be a significant impact on interest income.  But, then again, by 2026 lots of things could happen.  Even with your proposed 3-yr duration instead of the 2-yr that Prem has signalled, you could still get the same outcome, only delayed by another 12 months.  If you are worried about interest rates being low in a secular sense, an additional 12 months is of limited value.

 

1 hour ago, TwoCitiesCapital said:

3) while acknowledging labor is resilient and may lessen the impact of the coming recession, MANY economic indicators are at 2008-type levels and there is a general acknowledgement that booms and busts tend to have similar magnitudes. 2020/2021 was obviously an enormous multi-trillion dollar stimulus fueled boom. What does the hangover look like?

 

Labour has been strangely resilient.  It's unfathomable.  But, I would suggest that most of the indicators that are at 2008-type levels can be safely ignored.  What happened in 2008 was not just a recession like all of the others that we've seen.  What happened was that the financial system almost broke (or maybe it did break).  The issue was not principally an increase in unemployment, but rather that the entire financial system came close to collapse.  Personally, I don't expect to see that in 2023 or 2024.  I don't doubt that unemployment will nudge higher (how could it not!?!), but it is unlikely to be a reprise of 2008 where the fed was trying to keep the financial system from completely falling apart.

 

1 hour ago, TwoCitiesCapital said:

4) Why does 0% seem so extreme when we spent the vast majority of the last 15-years sitting there? 

 

Oh, I didn't say that 0% was extreme.  I did say that 0% by Q4 2023 was extreme when you are sitting at 4.5% in February and the fed has a tightening posture.  In the current context it would be a drastic change to hit zero in 9 months.  Of course, nothing is impossible, just highly improbable.  The reason why we spent much of the past 15 years near zero is that we had the worst credit crisis in nearly a century followed by the biggest public response to a pandemic in nearly a century.

 

In the end, each of us needs to understand what camp we are in.  It could be the "higher for the foreseeable future" camp, which would suggest that a shorter duration is probably okay.  Or it could be the Hoisington/Hunt "secular decline towards zero" camp which would suggest that we all ought to be piling into 30-yr treasuries at the moment.  

 

 

SJ

[bluedevil]

"Brit's growth was driven by Ki, which contributed $834 million to the top line and was up over 100% from the previous year."

 

WOWZA

 

[TwoCitiesCapital]

47 minutes ago, StubbleJumper said:

 

Yes, and now you are positing that it will drop from 4.50 to zero in 9 months, despite the fed having a posture of increasing or, at worst, pausing.  

 

...

 

Oh, I didn't say that 0% was extreme.  I did say that 0% by Q4 2023 was extreme when you are sitting at 4.5% in February and the fed has a tightening posture.  In the current context it would be a drastic change to hit zero in 9 months.  Of course, nothing is impossible, just highly improbable.  

 

0% is essentially the lower bound for all intents and purposes. I understand the Euro took their's slightly negative, but the Fed never has, has suggested they won't, and is the reserve currency of the world which are all things to be considered. 

 

If we agree on that, then the difference in # of cuts isn't important. The Fed literally COULDN'T cut 4.5% in 2020 so it's pointless to debate how much longer that would've taken them. 

 

What is significant is rates went from their peak to 0% in less than 6 months. Said another way, the maximum amount of cuts possible in 6 months time. That's how quickly the outlook changed.

 

I'm giving the Fed 10ish months to do something similar with economic indicators pointing to significantly more weakness. Also of those indicators your suggesting we can ignore - interest rates and the yield curve is literally one of them. I think it's prudent to pay attention to what interest rates are saying about the future of interest rates. 

 

 Also, maybe I'm wrong on timing. Maybe it's Q1 instead of Q4. Or Q2. Point is, that unless if Fairfax extends duration, the interest income will decrease massively over the course of a 12 month period when that happens. 

 

 

Edited February 17, 2023 by TwoCitiesCapital

[MMM20]

I think the guy from Leucadia should be fired for always asking Prem to raise the dividend. In what world is a higher dividend preferable to buying back stock at <7x earnings and arguably 30-50% of intrinsic value? Dividend is worse in every way including tax efficiency. I hope Prem will set him straight on one of these calls and tell him to sell a little bit of stock to create his own dividend if he wants a tax bill so badly.

 

At least we don't have that crazy guy with the thick brooklyn russian accent yelling at Prem for being out of touch anymore, which in retrospect basically bottom ticked the stock.

 

The professional analysts still seem out of touch with what actually matters at Fairfax.

 

Edited February 17, 2023 by MMM20

[Xerxes]

1 hour ago, StubbleJumper said:

In the end, each of us needs to understand what camp we are in.  It could be the "higher for the foreseeable future" camp, which would suggest that a shorter duration is probably okay.  Or it could be the Hoisington/Hunt "secular decline towards zero" camp which would suggest that we all ought to be piling into 30-yr treasuries at the moment.  

 

If one is in this camp (bold/underlined), 1.5 year or so from now, any Fed rate cut that spoils Fairfax's bond portfolio, could be buying opportunity to buy the common stock on the dip, betting that it is a cyclical Fed cut and that it will not go/stay close to zero ... 

 

 

[Xerxes]

Just now, MMM20 said:

I think the guy from Leucadia should be fired for always asking Prem to raise the dividend. In what world is a higher dividend preferable to buying back stock at <7x earnings and arguably 30-50% of intrinsic value? Dividend is worse in every way including tax efficiency. I hope Prem will set him straight on one of these calls and tell him to sell a little bit of stock to create his own dividend if he wants a tax bill so badly.

 

At least we don't have that crazy guy with the thick brooklyn russian accent yelling at Prem for being out of touch anymore, which in retrospect basically bottom ticked the stock.

 

The professional analysts still seem out of touch with what actually matters at Fairfax.

 

 

 

 

 

 

i recall few years ago on the call, the guy from Leucadia said something along the lines of personally owning Atlas. I was like WTF ...

[MMM20]

I get the critical importance of their fixed income investing and duration positioning, so not trying to poo poo that conversation, but at risk of sounding like a broken record, even if interest income goes to ~0 by '25/'26, the stock should *still* have a low teens ROE long term driven by profitable underwriting, something like high single digit long term returns on their equity investments, and a shrinking share count w/ FFH telling us they'll look hard at large buybacks (and at ~50% or less of IV unless the stock really pops this year). A lot of this comes down to the sheer size of their float, which again is equivalent to negative interest rate debt, relative to peer levels. If they can create borrowing at negative 2% or maybe even negative 5% interest, then even ~0-1% interest income on cash/fixed income earns us shareholders a decent spread given the sheer size of the insurance operations.

 

I'm copying this chart from Trevor Scott again b/c it perfectly illustrates how much of a crazy outlier FFH still is on a reasonable estimate for the near year or two, despite now being a ~2x over the past couple years. If you think through the size/strength of their insurance ops and public+private equity portfolio, I just don't get how FFH is worth less than 1.5x BV even in in a worst case scenario where interest income is down huge by '25/'26. Closer to 2x BV, still less than a market muliple of earnings, looks more fair now.

 

 

Edited February 17, 2023 by MMM20

[longlake95]

I'm I reading the IFRS 17 right? This new convention will be MORE lenient on claims reserves and deferred policy acquisition costs, allowing FFH and other to record an benefit to the owners equity account as they transition. So, when a fat tail event comes along and whacks the industry, they give back all the "benefit" back... shouldn't we be promoting MORE conservative reserving?