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Warren Buffett On Charlie Rose Sept 30.


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I love his comments (or lack thereof) about Europe - he knows it's a terrible situation. It's going to get ugly over there, and even if they bail out the banks, the private sector is going to be forced to deleverage at an even brisker pace than we are at over here.

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bichaud, the only thing that surprised me in the whole interview was Buffett's comments on Europe near the end. He is normally quite positive about most issues and he is clearly worried about Europe. He also feels we are near the end - at a point where hard decisions need to be made (I loved Charlie's comment about kicking the can down the road and then Buffett commented they better not kick it too hard).

 

Buffett said the Euro banks were encouraged to hold sovereign debt (did not have to hold reserves against it) and this let the banks lever up and earn an extra bit in earnings per share. He also commented about the challenges of forming a currency union without following it up with a political or fiscal union. Hard to see how Europe manages through this one without major issues developing.

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bichaud, the only thing that surprised me in the whole interview was Buffett's comments on Europe near the end. He is normally quite positive about most issues and he is clearly worried about Europe. He also feels we are near the end - at a point where. hard decisions need to be made (I loved Charlie's comment about kicking the can down the road and then Buffett commented they better not kick it too hard).

 

Buffett said the Euro banks were encouraged to hold sovereign debt (did not have to hold reserves against it) and this let the banks lever up and earn an extra bit in earnings per share. He also commented about the challenges of forming a currency union without following it up with a political or fiscal union. Hard to see how Europe manages through this one without major issues developing.

 

And he said that in ten years Europe will be stronger and the world won't collapse as a result of the oncoming crisis.

 

That is extremely easy for someone with a 100 year time horizon to say and just go ahead and load up on Wells Fargo or BAC and forget about what the price action does for ten years. Not so easy when you're managing somebody's personal capital and you have to explain to them some time in the next year or two why their WFC/BAC holdings are 50% lower than cost as a result of "temporary" events going on in Europe and that if they wait ten years they will be fine.

 

I'm not at all saying we're getting back to March 2009 lows, but I think as Prem CLEARLY demonstrates in his interview, we are in an environment entirely different than anything experienced since the Great Depression. Thus it is not prudent to invest as such. I know MMT is tends to fall on skeptical ears, but if one takes the time to learn it, then the austere environment Europe currently faces, regardless of bank bailouts, would scare the crap out of them. We're running a 10% deficit over here and are barely growing. Europe despises our deficits and is looking to balance their budgets. They are almost to the T following the blueprint the US laid out in the 1930s for how NOT to manage an economy in a deleveraging environment. Ya the US will muddle through, but there is a very good chance sky-high SP 500 eps estimates will come careening downward in the next year, bringing the market down with it. Our companies do not do business in a bubble - we're tied to the health of the globe, and if Europe enters a recession, let alone a depression, earning power will be affected. Earning power is already overstated given well above average profit margins, thus are very susceptible to external shocks.

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When do your investees need thier money?  If they need it in a few years, then they should not be invested in non-hedged equities.  If it is longer, then maybe the best course is to explain that they may loose a portion of there capital in a given year but will over the long term recoup it.  Alternatively, you can hedge using S&P 500 puts as Frank Martin does but your returns will be lower.

 

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Well said bmichaud, especially the following observation (which most seem to completely ignore):

 

Earning power is already overstated given well above average profit margins, thus are very susceptible to external shocks.

 

Even lower interest rate and falling commodities price will likely help profit margin further. But fear is powerful, when ppl don't invest and spend because of that, the market is toasted.

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Around 19:08 Buffett said he made a lot of money on Freddie Mac and Fannie Mae mortgage pass throughs.

 

(1) What the heck is a mortgage pass through? CDO?

(2) Anyone know anything about this trade? It sounds interesting.

 

 

It's just agency backed MBS, nothing exotic.  He did it years ago and apparently made a big capital gain as well as the income.

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Well said bmichaud, especially the following observation (which most seem to completely ignore):

 

Earning power is already overstated given well above average profit margins, thus are very susceptible to external shocks.

 

Even lower interest rate and falling commodities price will likely help profit margin further. But fear is powerful, when ppl don't invest and spend because of that, the market is toasted.

 

Temporary factors will assist margins in the short-run, but as Grantham says (in not so many words), if net profit margins were not mean reverting, then capitalism would be considered a failure. High margins attract competition, thus profit margins are extremely mean reverting over time.

 

Let's take the O&G industry for example. With commodities at all-time highs, profit margins for the O&G industry are at elevated levels, thus all sorts of competition will be drawn to drilling for oily liquids all over the US. We can see how this is already driving up the cost of oil field services, and when the underlying commodity ultimately corrects, independent/unhedged/leveraged E&P companies will be in trouble. Side note, all commodity bulls check out this article (http://pragcap.com/randall-wray-on-the-commodity-bubble)

 

Competition is perpetually eating away at Apple, Google, Yahoo, HPQ, etc.. etc... and will eventually bring those margins down over time. Cyclical companies such as Caterpillar & Cummins admittedly are relying HEAVILY upon the China economic machine - how long is that going to last?

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When do your investees need thier money?  If they need it in a few years, then they should not be invested in non-hedged equities.  If it is longer, then maybe the best course is to explain that they may loose a portion of there capital in a given year but will over the long term recoup it.  Alternatively, you can hedge using S&P 500 puts as Frank Martin does but your returns will be lower.

 

Packer

 

My investees want me to beat the market by a particular margin on average over time. If I think we are in a secular bear, we're entering a recession, AND the environment is unlike anything we've seen since the Great Depression, then something like the banks are not going to perform well through that environment. If the market goes down 20% and I'm holding something that goes down 35%, I need to return 54% to break even while the market needs to return 25% to break even.

 

So ya over time my investees will break even, but unless I'm cranking on the upside, I'm better off holding something that will strongly outperform in a flat to down market than something that is highly sensitive to economic movements, then when there is blood in the streets and the marketplace is being put up for sale I want to buy banks, industrials and materials (banks are pretty close to that point, but I believe asset values are overstated and liabilities are understated and we have a lot more pain to go through). It sounds very much like timing, but it is very much valuation. Banks' "normal" earning power is being overstated by the marketplace as a result of investors treating this recession as a post-WW2 recession. We're going to be awhile before getting back to normal, and there will most likely be more pain between now and then - thus I believe I will be able to buy the banks at a better discount to intrinsic value than currently available. Similar with cyclicals (peter burke mentions this above) - CAT appears cheap, but earnings are not at mid-cycle earnings right now, they are well above and HEAVILY reliant upon China. Look at Deere and Mosaic - both look cheap based on current earning power but current earning power is above mid-cycle levels and again dependent upon a commodity boom.

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cyclical companies earnings est have come way down. but lots of those stocks are down 50% already. see the specialty chemicals. I really doubt the estimates for food drug and other consumer non durable estimates will come down much. financials? dirt cheap and reflective of a terrible backdrop. and tech? hp is at 5 times, msft and intel at 9 times, cisco at 10 x. great companies sell at 15 x. prices already reflect a lot of the bears waiting for Prem's scenario to unfold. Buffett tells you to value businesses. look bottom up not top down. I see a lot of people get caught in the "macro" moment, afraid to buy cheap stocks because of "what's out there". this of course has always been a mistake.

 

There's room for both buying cheap stocks and creating a margin of safety within your portfolio via holding cash and/or hedging. My rhetoric may sound like I'm 100% hedged as Hussman is, but I'm actually 75% net long at the moment. Once the market hits fair value I will most likely be 100% net long in spite of my belief that we could go well below fair value and stay there for an extended period of time. To be fair, the 75% net long is made up of several "event" situations, so the actual exposure to the market may be lower than that, but that is more the result of being able to find more special situations/events than a diversified portfolio of long ideas with strong return prospects (i.e. 30% IRRs).

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Around 19:08 Buffett said he made a lot of money on Freddie Mac and Fannie Mae mortgage pass throughs.

 

(1) What the heck is a mortgage pass through? CDO?

(2) Anyone know anything about this trade? It sounds interesting.

 

 

It's just agency backed MBS, nothing exotic.  He did it years ago and apparently made a big capital gain as well as the income.

 

Thanks.  How can someone purchase one of these? Something you'd have to buy through a prime broker? (not something I want to buy now, just curious)

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Around 19:08 Buffett said he made a lot of money on Freddie Mac and Fannie Mae mortgage pass throughs.

 

(1) What the heck is a mortgage pass through? CDO?

(2) Anyone know anything about this trade? It sounds interesting.

 

 

It's just agency backed MBS, nothing exotic.  He did it years ago and apparently made a big capital gain as well as the income.

 

Thanks.  How can someone purchase one of these? Something you'd have to buy through a prime broker? (not something I want to buy now, just curious)

 

http://lmgtfy.com/?q=how+to+buy+MBS

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Around 19:08 Buffett said he made a lot of money on Freddie Mac and Fannie Mae mortgage pass throughs.

 

(1) What the heck is a mortgage pass through? CDO?

(2) Anyone know anything about this trade? It sounds interesting.

(1) What the heck is a mortgage pass through? CDO?

Mortgage pass through or Mortgage Backed Security (MBS) is just an undivided interest in a group of mortgages. (think of land ownership if you own a condo.)

CDO (in this case, called a Collateralised Mortgage Obligation or CMO), on the other hand, will have a structured payment obligations in tranches.  In short, MBS or pass throughs are less complicated than CMOs.

 

(2) Anyone know anything about this trade? It sounds interesting.

Here's someone who markets these.  (not a recommendation of the product or the company)

http://www.davidlerner.com/collateralized-mortgage-obligations.aspx

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When do your investees need thier money?  If they need it in a few years, then they should not be invested in non-hedged equities.  If it is longer, then maybe the best course is to explain that they may loose a portion of there capital in a given year but will over the long term recoup it.  Alternatively, you can hedge using S&P 500 puts as Frank Martin does but your returns will be lower.

 

Packer

 

My investees want me to beat the market by a particular margin on average over time. If I think we are in a secular bear, we're entering a recession, AND the environment is unlike anything we've seen since the Great Depression, then something like the banks are not going to perform well through that environment. If the market goes down 20% and I'm holding something that goes down 35%, I need to return 54% to break even while the market needs to return 25% to break even.

 

So ya over time my investees will break even, but unless I'm cranking on the upside, I'm better off holding something that will strongly outperform in a flat to down market than something that is highly sensitive to economic movements, then when there is blood in the streets and the marketplace is being put up for sale I want to buy banks, industrials and materials (banks are pretty close to that point, but I believe asset values are overstated and liabilities are understated and we have a lot more pain to go through). It sounds very much like timing, but it is very much valuation. Banks' "normal" earning power is being overstated by the marketplace as a result of investors treating this recession as a post-WW2 recession. We're going to be awhile before getting back to normal, and there will most likely be more pain between now and then - thus I believe I will be able to buy the banks at a better discount to intrinsic value than currently available. Similar with cyclicals (peter burke mentions this above) - CAT appears cheap, but earnings are not at mid-cycle earnings right now, they are well above and HEAVILY reliant upon China. Look at Deere and Mosaic - both look cheap based on current earning power but current earning power is above mid-cycle levels and again dependent upon a commodity boom.

 

If your belief is that it is a secular bear market, why not just hold cash ? you will come out smelling like roses. (assuming you haven't committed to be invested all the time.)

Also, aren't you better off just turning down that kind of investors who chose their time frame rather than yours?

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When do your investees need thier money?  If they need it in a few years, then they should not be invested in non-hedged equities.  If it is longer, then maybe the best course is to explain that they may loose a portion of there capital in a given year but will over the long term recoup it.  Alternatively, you can hedge using S&P 500 puts as Frank Martin does but your returns will be lower.

 

Packer

 

My investees want me to beat the market by a particular margin on average over time. If I think we are in a secular bear, we're entering a recession, AND the environment is unlike anything we've seen since the Great Depression, then something like the banks are not going to perform well through that environment. If the market goes down 20% and I'm holding something that goes down 35%, I need to return 54% to break even while the market needs to return 25% to break even.

 

So ya over time my investees will break even, but unless I'm cranking on the upside, I'm better off holding something that will strongly outperform in a flat to down market than something that is highly sensitive to economic movements, then when there is blood in the streets and the marketplace is being put up for sale I want to buy banks, industrials and materials (banks are pretty close to that point, but I believe asset values are overstated and liabilities are understated and we have a lot more pain to go through). It sounds very much like timing, but it is very much valuation. Banks' "normal" earning power is being overstated by the marketplace as a result of investors treating this recession as a post-WW2 recession. We're going to be awhile before getting back to normal, and there will most likely be more pain between now and then - thus I believe I will be able to buy the banks at a better discount to intrinsic value than currently available. Similar with cyclicals (peter burke mentions this above) - CAT appears cheap, but earnings are not at mid-cycle earnings right now, they are well above and HEAVILY reliant upon China. Look at Deere and Mosaic - both look cheap based on current earning power but current earning power is above mid-cycle levels and again dependent upon a commodity boom.

 

If your belief is that it is a secular bear market, why not just hold cash ? you will come out smelling like roses. (assuming you haven't committed to be invested all the time.)

Also, aren't you better off just turning down that kind of investors who chose their time frame rather than yours?

 

I didn't say anything about time frame - the only requirement is that I beat the market over time, and IMO holding BAC as it falls from $6 to $3 as the market falls 25% does not constitute beating the market. And instead of holding cash as you mentioned, I'd rather A) hold something that has a strong chance of increasing its intrinsic value no matter what the environment at an attractive price (i.e. Pepsi selling for $60 with a 6% payout, 6% growth and a $100 fair value), or B) something with an event tied to it. Then when there is blood in the streets and nobody wants to own emerging markets, cyclicals, industrials, banks etc... etc... then I will roll my economically insensitive names and event stocks into beaten down stubs selling for 10 and 20% of intrinsic value.

 

I was thinking about this today on my way into work - the beautiful thing about this business is that we can all be right at the exact same time. Berkowitz can be right on BAC buying it at $15 if in fact it does go to $30 over a five year period, while at the same time I can be right holding off on BAC until $8 because I am waiting for a price that will yield a 30% IRR over a 5-year period.

 

Applying a little bit of logic to BAC though will lead one to conclude that given that we are in an environment VERY DIFFERENT than anything we've experienced since the Great Depression that $30 probably isn't an appropriate fair value for BAC considering the write-downs that are still to come, the less-than-transparent balance sheet, and the possibility for further dilution. So assuming a $20 fair value and my 30% 5y IRR requirement, I'm only just now getting interested in BAC at $5.38 per share. Following my gut even further tells me that this POS is probably not worth more than $15 considering their inability to appropriately disclose what the true value of their assets and liabilities are and the hole that is most likely in their balance sheet - thus I won't get interested in this until $4 per share.

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