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The Second Stage of the Rocket: "Maybe it's okay to buy."


omagh
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With the spate of improving news lately, I think that we're now moving into Stage 4 in John Train's fictional essay on market cycles and behavioural investing.  It appears that the bullish calls are now being made.  Paulson and Fisher are here.  Who's next?  Who's Nouriel Roubini?

 

http://www.marketwatch.com/story/paulson-co-turns-bullish-on-housing-economy-2010-04-21?pagenumber=2

Paulson & Co. covered, or closed, many of its short positions recently and that showed up in stronger returns in April, the fund manager noted. The firm has been "much more aggressive" in positioning its Advantage funds to "participate in a stronger economic recovery," Paulson said.

 

http://www.forbes.com/forbes/2010/0510/finance-emerging-markets-yield-curve-value-portfolio-strategy.html

there are many reasons to expect a good return on stocks in 2010. Here are five you likely haven't heard elsewhere.

 

http://online.wsj.com/article/SB10001424052748703404004575198492075706082.html?mod=WSJ_latestheadlines

Long-term mutual funds saw net buying for the latest week on continued strength for bond funds, while stock funds in the U.S. and abroad also reported inflows, according to the Investment Company Institute.

Total estimated inflows were $9.04 billion for the week ended April 14. For more than a year, the lion's share of investment in mutual funds has gone to bonds, which typically thrive in a lower-interest-rate environment. Meanwhile, stock funds have failed to consistently attract new interest despite the equity market's sharp rally.

 

The excerpt from Train's 1994 essay:

3. The Surge Continues: "Prices seem high. It's too late to buy."

More months pass and the market establishes an upward channel. Higher prices pull in buying from the institutions waiting on the sidelines. The public moves from feeling that it is too early to buy to suspecting it might be too late.

 

4. The Second Stage of the Rocket: "Maybe it's okay to buy."

A year or so after the bottom, the public, watching from the sidelines, becomes interested. There are a number of downward bounces, or tests, against the bottom of the market's rising channel. Each time, the recovery starts from a higher level.

 

5. Not a Cloud in the Sky: "Buy!"

More months go by, the market is way up and the public is hooked. Business news is excellent. The "standard forecast" is optimistic. Jazzy new funds proliferate. Some particular market area becomes a market darling, if not a mania, and is bid up to irrational levels. We see, also, the latest leveraging toy—this time, the use of derivatives—on a vast scale.

 

Have fun!

 

-O

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I don't know much about stocks yet even I can still find some cheap things in obvious places (cheap if you believe recovery is taking hold).  Citigroup for example, despite the run from $1, still trades at 1.2x tangible equity (plus they are reserved at 6.8% of loan portfolio for loan losses, and their loan losses are falling the last three quarters).  Berkowitz goes so far as to say that they are overcapitalized.

 

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Let's just say it's fully valued.

 

On one part we have a stock market with high expectations about the future and a future that doesn't look like a clear blue sky.

 

Ericopoly is right, there are still some good buys right now but it's getting thinner. The investment environment is getting a lot harder then a year ago.

 

Beerbaron

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I have been calling for a pull back since 10k and have been dead wrong. I have also made more money now than at any other time (3 years or so in investing). The market seems expensive, but my stocks are fairly cheap. Interesting times, I plan to keep dancing.

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It's too hard to say whether the market will pull back anytime soon, but I can tell you that I have a 20% cash position just in case and that the positions I hold are all still very undervalued.

 

I am overweight financials at the moment.

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I'll be honest with you, I used to hate the cost of Prems hedges but have learned a lesson - he knows when to hedge better than I and has access to better hedges and research than I.

 

So, I am still holding a good chunk of FFH - i feel safe on the downside.

In the meantime we (he) has been really stocking up on alot of high yield stuff - mostly good quality stuff assuming no monster Cats - the cash register is chinging alot - who cares the market doesnt get it. They didnt get it before either.

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Regarding insurers, I believe many will prove to be good to very good long term holds (at current pricing levels). However, before valuations take off the industry likely needs an event to move from a soft to a hard market. When this happens expect a great amount of volatility.

 

For most insurers underwriting is deteriorating (as business is shrinking and the expense ratio is increasing). Interest and dividend income is low. Realized/unrealized gains will be minimal. Reserve releases will be slowing. But most are overcapitalized. We need something to happen to soak up a bunch of that capital (like an above average catastrophe season). The event will likely result in a drop in prices of insurers setting up a one in 10 year buy opportunity. Absent an event we likely will get chinese torture... a 12 to 24 month process of slowly declining results with the stocks going no where.

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Smazz, I currently hold a sizable chunk of FFH for similar reasons. FFH is like a hedge fund. Why would I think that I am able to earn a better return than Prem and his team? With the stock once again trading at about BV this has historically proven a decent time to invest with Prem and Co.

 

The moves they have been making the past 5 or 6 years have simply been outstanding. One area I was hoping they would get better at was underwriting... the purchase of Zenith (outstanding underwriters) should improve their skill set in this area moving forward. They really are positioned to do well in so many different areas. And the best part is we know they will continue to pull rabbits out of the hat in the coming year and year(s)...

 

It has been fun to watch them perform their magic. But I do believe their best is yet to come. 

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Viking,

 

At the AGM, Mark Ram, and Doug Libby commented on the primary insurance underwriting climate at this moment.  To my recollection Mark commented that NBs competitors in Canada were showing revenue increases.  At the same time they have been releasing reserves.  He seemed to allude in a indirect way that they were underpricing and it was going to catch up at some point.  The reason their CRs looked so good is due to the reserve releases.  I dont want to elaborate here as I am not clear on the procedure but evidently there is some flexibility in insurance accounting to do this (fudge the numbers - my words).  The FFH CEOs and their teams are schooled deeply to reduce the business written when it is not profitable and to take the time to improve their talent pool. 

 

Doug Libby discussed C&Fs stance on the whole thing.  He indicated that C&F is looking into new lines of business where there is no expertise and less competition rather than trying to compete on price in existing lines.  Their reduction in premiums also bears this out.  I think Doug also mentioned preparing for the next soft market - after the pending hard market- in such a way that they insulate themselves (I guess similar to Markel) in the future.

 

Finally Zenith's CR has gotten hammered as well for the same reasons as FFHs.  I think this is part of the reason that Stanley Zax wanted to sell to FFH.  He can get the best of several worlds, as FFH can as well.  FFH gets the benefit of Zax's actuarial talent pool, and Zenith gets the benefit of FFHs investment team, and is relieved of the issues of being a public company. 

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Al,

 

I spoke with Doug after the meeting and he elaborated on this, suggesting that the other insurers may have already "turned the corner" and were now under reserved. He doesn't believe the estimates that the industry as a whole is still over reserved.

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