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Fairfax’s Watsa sees Dirty Thirties pain ahead


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Prem in the news:

 

http://www.theglobeandmail.com/report-on-business/economy/fairfaxs-watsa-sees-dirty-thirties-pain-ahead/article2125759/

 

The U.S. economy appears to be heading toward a lengthy period of deflation such as the one that struck Japan, and there is little policy-makers can do to prevent it, says one of Canada’s most accomplished investors.

 

But it isn’t just the United States and Europe that Prem Watsa is worried about. The potential bursting of a property bubble in China has him even more concerned. And if Chinese demand for commodities dries up at the same time as U.S. consumers are shutting their wallets, then the global economy is in for a lengthy period of pain.

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Hasn't he been saying this for years though? Maybe he's finally right, but he had a gloomy outlook throughout the last couple years, when the market had some of its best gains ever.

 

That statement gives him far too little credit. He bought stocks agressively when the S&P was in the 700's. He hedged at 1060, and today we're at 1170, but arguably, he's got $1 billion (11%) in bond gains just this quarter.

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I described Prem's views at our AGM this year as below, when asked by an attendee what I thought:

 

It's like chess.  We're not as smart as Prem or the rest of the guys at Hamblin-Watsa, so we see 2-3 moves ahead.  He sees 6-7 moves ahead, so while his views may not be appear at this moment or the near future, they do usually appear further down the road.

 

Cheers!

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I described Prem's views at our AGM this year as below, when asked by an attendee what I thought:

 

It's like chess.  We're not as smart as Prem or the rest of the guys at Hamblin-Watsa, so we see 2-3 moves ahead.  He sees 6-7 moves ahead, so while his views may not be appear at this moment or the near future, they do usually appear further down the road.

 

Cheers!

 

And how many moves ahead is Buffett seeing?  :)  What's interesting these days is how differently the two of them see (or at least talk) about the macro economic picture.

 

Not that it really matters much to an individual investor who is just looking for a few massively undervalued companies. But it's interesting nonetheless.

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And how many moves ahead is Buffett seeing?    What's interesting these days is how differently the two of them see (or at least talk) about the macro economic picture.

 

Not that it really matters much to an individual investor who is just looking for a few massively undervalued companies. But it's interesting nonetheless.

 

I would say a couple more than Prem!  ;D 

 

We were buying.  We have to stick to what Ben Graham taught, and for the most part ignore macroeconomic forecasts.  You buy cheap, and then sell dear.  That's all we have control over.  Cheers!

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And how many moves ahead is Buffett seeing?    What's interesting these days is how differently the two of them see (or at least talk) about the macro economic picture.

 

Not that it really matters much to an individual investor who is just looking for a few massively undervalued companies. But it's interesting nonetheless.

 

I would say a couple more than Prem!   ;D  

 

We were buying.  We have to stick to what Ben Graham taught, and for the most part ignore macroeconomic forecasts.  You buy cheap, and then sell dear.  That's all we have control over.  Cheers!

 

Van Hoisington has a good Q2 letter on this topic.  He says we will eventually have a potential for major inflation.  But the drag on the private sector from all the stimulus being directed to the expansion of debt and nonproductive uses will be a huge drag on productive expansion for quite a while, leading to low interest rates for many years as the stupendous debt expansion and overhang will have unintended consequences like the situation in the 1930's.

 

 

Buffett and Watsa may both be right.  The relevant question is: how long?

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Didn't they take cash out of the market place during the 30s? Now they are inject huge, huge sums.

 

The Japanese culture is also a lot different than the US. Japan is more about togetherness and less about ruthlessness. I fail to see why he thinks things will be similar.

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Mr. Watsa has put Fairfax’s money where its mouth is, making investment decisions that cost the Toronto-based insurer substantially in 2010. The company increased the proportion of its stock portfolio that is hedged from 30 per cent to close to 100 per cent in May and June of last year.

 

Its timing wasn’t perfect, and the move cost it $936.6-million as markets rose.

 

I didn't follow this. Does he mean $936 M in unrealized losses?

Otherwise this looks huge to me...?

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Mr. Watsa has put Fairfax’s money where its mouth is, making investment decisions that cost the Toronto-based insurer substantially in 2010. The company increased the proportion of its stock portfolio that is hedged from 30 per cent to close to 100 per cent in May and June of last year.

 

Its timing wasn’t perfect, and the move cost it $936.6-million as markets rose.

 

I didn't follow this. Does he mean $936 M in unrealized losses?

Otherwise this looks huge to me...?

 

I think it's pretty much break even. It cost FFH 936M$ but they had Equity Gains of close to the same amount. True up to a month ago hedges cost them a lot a profit... not the same ballpark today.

 

BeerBaron

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Mr. Watsa, who has become a fan of Japanese economist Richard Koo, also believes that the Obama administration and U.S. Congress could be making a fatal error by cutting spending.

 

“The worry is this,” Mr. Watsa said. “You have interest rates at zero per cent, you have had deficits coming down, meaning reduced government spending, which means there’s no ammo left for the governments of the world, particularly the United States. So what do you do next to get the economy going?”

 

Ha!  I thought that HWIC was paying attention to Richard Koo.

 

These guys are just so darn rational.  If I didn't want to manage my own portfolio, I'd put a large chunk of my portfolio in FFH. 

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Didn't they take cash out of the market place during the 30s? Now they are inject huge, huge sums.

 

The Japanese culture is also a lot different than the US. Japan is more about togetherness and less about ruthlessness. I fail to see why he thinks things will be similar.

 

I think our outcome will be about one half to one third as extensive as the situation has been in Japan in recent decades or the situation in the US was in the 1930's.  It will depend on when the inflation in the money supply allows a substantial amount of the debt to be paid off with depreciating dollars.  This assumes that a future administration will stop throwing money at nonproductive or counterproductive uses.

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since the article I tried to learn about Richard Koos theory on balance sheet recession.

 

I am thinking (and hoping) that it may not occur or be as severe because:

 

-our "strategists" at the fed/government have studied this new disease + will eventually implement rational therapy

 

-we are not starting with assets that are so overinflated (stocks are not at 50+x PE, real estate has taken a hit already)

 

-culture in western business is different in that

 

i. we are willing to take right downs, layoffs

 

ii  more innovations (medicine, internet, software, etc) seem to come out of the west

 

I have banking on a little inflation. With deflation, the consolation is that I can buy more with the dollars I make. I have trouble seeing this still---with Mr Watsa thinking that it will happen---I am trying to figure out what to do  (best I can come up with is to buy more FFH)

 

What do others think?

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Does Prem really think it will happen or does he view it as a worst case scenario and a major fear?

 

There is a big difference between the two. The bet that was made is mainly a hedge to secure the insurance business FFH is in. Wouldn't serious deflation kill combined ratio's when you add the deflation to it? After all, the money you give back is worth more then when you received it, not less as is the case with inflation.

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Does Prem really think it will happen or does he view it as a worst case scenario and a major fear?

 

There is a big difference between the two. The bet that was made is mainly a hedge to secure the insurance business FFH is in. Wouldn't serious deflation kill combined ratio's when you add the deflation to it? After all, the money you give back is worth more then when you received it, not less as is the case with inflation.

The premiums are a fraction of the payments, deflation helps the industry, a building you thought would cost 1000000 to replace only costs 800000, claims are less shareholders benefit.
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Hi Biaggio ... I'm a fan of Richard Koo's ideas.  Glad to see you're reading up on him.  My best advice is to obtain and read his book, "The Holy Grail of Macroeconomics".  Trying to work with the subset of ideas which fit into a one-hour video, or a newspaper article, is like trying to learn Ben Graham's ideas via message boards instead of reading Graham's books.  I don't claim to understand everything that Koo (or Graham) writes, nor do I agree with every bit, but they're definitely more than 75 pct right, and exceptionally perceptive each of them.

ws

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Whether or not FFH is right about deflation is not that relevant.  That they have covered that eventuality, and also another market crash is what is important.  They do think several moves ahead of general economists, and are often right in the long run.  The equity hedge is designed to protect their insurance portolio equities.  This is all so incredibly astute as to be unusual.  If/when there is a significant market crash there will be a handful of insurers who have a worldwide presence, and have enough capital left to write alot of profitable business. 

 

Buffett doesn't appear to use a significant amount of similar hedges.  He has structured BRK to generate capital even in the worst economy in 30 years in the US so he doesn't need to.  His cash flow and cash cushion is the hedge.  Buffett also has the advantage of greater intelligence via his wholly owned subs than anyone other non-government person on Earth.  When he says the US is unlikely to double dip he actually can back it up with data ranging from port shipments, to energy sales, clothing sales, machine and tool sales, etc. etc. etc.

 

I am happy holding roughly 30% of my capital in FFH.  It is a natural hedge for me against market downturns, inflation, or deflation.  The recent plummet seems to bear that out. 

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I agree with Uccmal. Berkshire is basically a proxy to the US economy with its underlying subs (i.e mid american, home-america,NFM,Burlington Northern etc) and Buffett is probably the best person to judge whether the economy is growing/slowing. Also, there are some other things that we fail to spot...ie second order economics.. especially breakthroughs in nanotechnologies/life sciences/robotics in the near future cannot be discounted

 

The advantage of the market economy allows the most efficient allocation of resources. Buffett always keep reminding us that just because we have a lousy 5 years..the system has actually worked tremendously over the past 200 years in even more challenging times (i.e civil war, great depression, WW2, Cold War etc)

 

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Hasn't he been saying this for years though? Maybe he's finally right, but he had a gloomy outlook throughout the last couple years, when the market had some of its best gains ever.

 

He was also "wrong" about housing/debt problem/CDS for a few years. But he did go "all in" into the market in 2009 and put most of the hedges on only in 2010 after the market had gone up significantly.

 

Also, he and HWIC deserve accolades for getting the treasuries calls right at least thrice (long heading into 2008, switch into munis in 2008, then back into treasuries last year) in recent years - these were huge and gutsy calls that went against the crowd (including Buffett and Bill Gross).

 

I described Prem's views at our AGM this year as below, when asked by an attendee what I thought:

 

It's like chess.  We're not as smart as Prem or the rest of the guys at Hamblin-Watsa, so we see 2-3 moves ahead.  He sees 6-7 moves ahead, so while his views may not be appear at this moment or the near future, they do usually appear further down the road.

 

Cheers!

 

And how many moves ahead is Buffett seeing?  :)  What's interesting these days is how differently the two of them see (or at least talk) about the macro economic picture.

 

 

I can't help but wonder whether Buffett's style has evolved because of size, age (in planning his own succession, he may not want to encourage/leave behind a culture that has elements of macro calls), and the Fisher/Munger style of buy and hold. He has admitted to missing the housing crisis (which others did not) so it is not inconceivable he could be wrong about a double dip and stubbornly high unemployment. Maybe, he justs feels "double dip" is too much of a low probability bet to call and he would rather focus on the high probability bet (which is that the US will eventually sort itself out).

 

Fwiw, Prem seems to have a better record of macro calls against Buffett's superior record on underwriting and stopckpicking.

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I think Fairfax can more easily deploy cash versus Berkshire due to smaller size and emerging market opportunities.  In addition, Fairfax seems to be able to take advantage of the ups (going all in when assets are cheap) and downs (hedging and cashing out in a down draft).  This is a strategy used by Frank Martin also and I think will have some success in this market.  I think the hedges are more than hedges but a way to capitalize on sideways markets. 

 

Packer

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Frank Martin is a contrarian investment manager who is a great writer.  His annual commentaries are available on his web site for free and he has written "Decade of Delusions" and "Speculative Contagion".  I have read Decade of Delusions and it is a great stock market history of the 00s from a value investors point of view.

 

Packer

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Frank Martin is a contrarian investment manager who is a great writer.  His annual commentaries are available on his web site for free and he has written "Decade of Delusions" and "Speculative Contagion".  I have read Decade of Delusions and it is a great stock market history of the 00s from a value investors point of view.

 

Packer

 

What's the URL of his website? Thanks.

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