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Have we entered the era of macro investing?


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The last 10 years were unlike any other. Total global debt increased by 11% compound rate vs real GDP growth of 4%. Credit growth has outstripped real GDP growth by 275%.

 

Peter Bernholz noted 28 episodes of hyperinflation in 20th century, with 20 occurring after 80s. He found a pattern that a tipping point of hyperinflation occurred after government's deficits reached 40% of its expenditures. The US is past this point. Banks are holding massive excess reserves, which if they decided to deploy or lend out, could increase the money supply by 6 TRILLION, triggering massive inflation.

 

Ken Rogoff along with Carmen Reinhart studied sovereign defaults and put a tipping point of defaults at approximately 4.2x debt/revenue. The US is coming dangerously close. At 16x debt/revenue, Japan may blow up sooner than we all think.

 

With massive tectonic shifts happening in the global economy, consider the performance of traditional value investors versus macro investors. All the winners you can think of off the top of your head - Paulson 07, Burry ('05-'09), Kyle Bass - have been macro guys. Value investors Berkowitz, Paulson '11, Ackman, etc have not done very well at all (first two are down >30% this year).

 

Has value investing become impractical in todays day and age?

 

FWIW, I have been spending an inordinate amount of time on the macro, but have yet to switch my investing style away from cigar butt value to macro.

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I recall a quote by Burry in The Big Short that went something like, I cant pick stocks in good conscience when I can clearly see this storm that is about to hit and make stockpicking meaningless (liberally paraphrasing)

 

I think its also interesting that he's put a significant amount of his assets into farmland. If that isn't a macro play I dont know what is.

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The last 10 years were unlike any other. Total global debt increased by 11% compound rate vs real GDP growth of 4%. Credit growth has outstripped real GDP growth by 275%.

 

Peter Bernholz noted 28 episodes of hyperinflation in 20th century, with 20 occurring after 80s. He found a pattern that a tipping point of hyperinflation occurred after government's deficits reached 40% of its expenditures. The US is past this point. Banks are holding massive excess reserves, which if they decided to deploy or lend out, could increase the money supply by 6 TRILLION, triggering massive inflation.

 

Bernholz's tipping point referred to budget deficits financed almost exclusively by money printing. It's an important point regarding where we might be going, but not where we are.

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Value investing works in all environments.  Macro investing is investing on the unpredictable.  The most I have seen value investors do is make educated high payoff/low loss bets on such events (CDS, protective puts and deflation swaps).  The story of Atlas Investment Corp is interesting in that it bought distressed assets from closed-end funds in the early 1930s and actually increased NAV in this period as a result.  In 1929 NAV was $5 by 1932 it had increased to $7 by 1932.  In 1933, Atlas actually sold for $18 share.  So even in a depression, money can be  made.  The other area that made money was gold stocks because the gold price was increased from $20 to $35 per share.

 

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"I recall a quote by Burry in The Big Short that went something like, I cant pick stocks in good conscience when I can clearly see this storm that is about to hit and make stockpicking meaningless (liberally paraphrasing)"

 

I feel the same way. I would say Watsa is probably the best value manager to bridge macro and value in the last 10 years. If you look at where FFH book value got its growth from over the last 5 years, I would bet you find most of it came from macro over value:

 

off the top of my head and pure high-level estimates of book value gains at FFH in last 5 years:

 

1. $2 billion for CDS gains (bet on financial system collapse)

2. $2 billion long treasuries (deflation bet)

3. $1 billion shorts on market going into 2008

4. $1 billion (taking the shorts off in 2009/10) and riding the equity markets higher

 

That totals $6 billion. The rest was value investing-based alpha and some decent underwriting. There is no question macro was the main driver of FFH gains over the past 5 years. I believe there will be times (once, twice, three times) over the course of a 100 years where much attention should be paid to macro and this is one of those few times. For the other 90 or so years, pay attention mainly to value investing. This would seem natural as fundamental statistics dictate that there should be at least a few times when macro is much more important than value investing (even though value is more important 90+% of the time). Just because something is good to do 90% of the time does not mean its the solution 100% of the time. I think Prem Watsa recognises this and other value greats do not to the same degree.

 

In any case, I agree with that Burry quote. I think a lot of value investors have been in denial. They are in such denial that they think hedging equity or other risk is "doing macro" when in fact inactively not hedging is indeed taking on macro risk (note one could actively not hedge due to a macro bias that central bankers will print money to get the developed world out of trouble). When the masses of value investors take this view to that degree like in 2006-2007, you know you should be against them. 4-5 years later, the bias persists.

 

 

 

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Original Mungerville, I believe you are mistaken, with regards to your understand of what brought about those gains.

 

Those gains, as you mention were in fact company making for fairfax, and thus far have delivered better nominal results than vanilla value investing picks, however you fail to recognize that all those positions had one very clear common denominator. They were asymmetric investments with very little capital require upfront for a potentially very large payout.

 

Looking back after some of them have played out and assuming that this was all "Macro Trading" is in my view a misunderstanding of what actually occurred.

 

Mr. Watsa was able to deploy very little capital to initially protect his portfolio, as it happens a one in a one hundred year storm came about and those little hedges or asymmetric bets proved incredibly fruitful. But it had more to do with the otherside being reckless AIG than Watsa nailing a macro thesis.

 

Going forward, there are very little such asymmetric opportunities when it comes to derivatives, hence Ackman with his HKD bet, trying to actually use rhetoric to influence a government peg. Only such black swan events will deliver the asymmetric returns we witnessed that came about from the 2008/2009 forced deleveraging.

 

Again my position is this. As a responsible value investor, Watsa, noticing that things were getting expensive as a straight forward value investor, put on some really attractive asymmetric bets that absolutely rocked. But there is no lesson to be learned here, for non-professional investors without ISDA's, because you all cannot trade in credit derivatives. An analog in your case would have been to simply scale down positions and buy some out of the money puts circa 2006/2007 if you felt we were in a bubble valuation equity market.

 

And now that Watsa generated such outsized returns as you mention yourself which were basically company makers, it is completely understandable that he wants to protect the downside more than worry about being aggressive, given that he knows what I just said, he got very lucky with the returns those derivatives provided, and he can take his time now before jumping back in with both feet, as far as he is concerned he has a pretty big lead in the race so he can shift down some gears and let the fog clear up.

 

Everyone is in a different situation...

 

 

 

 

 

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Like Greenblatt says, if value investing never underperformed there would be no outperforming over time. The fact that you could argue that it has underperformed in these last few years (although it certainly does not show in my portfolio) is no positive evidence that it is moot at this point. We all know how it all went down last time value was argued to be outdated and many switched to 'growth'.

 

Macro is interesting but unknowable and now that everyones' heads are turned to it I find absolutely no reason to focus on it, just like I won't try and outguess the market on Apple's next quarterly earnings.

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I think it is difficult to ignore the macro environment at this point in time. It is pretty terrifying.

 

The macro environment is basically always terrifying.  Even in the golden age of the post WWII we had the communists, nuclear war, korean war, inflation fears (gold bugs, including Buffett's dad), and lots more.  If you can't find good or great investments at good or great prices, that's one thing.  The macro boogyman is another.

 

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The big banks look cheap.  Therefore, they attract the eye of people looking for value.  However, in varying degrees, the prospects of big banks depend on the macro environment.  Therefore, if one is going to establish a position in the big banks, one needs to have an opinion on the macro environment.

 

Maybe that's why there's more macro talk on the board these days.

 

However, there are other companies whose prospects do not depend on the macro environment; Clearwire, for instance.  I have a suspicion that wireless usage is going to grow exponentially for a while, regardless of whether Italy needs a bailout.

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Original Mungerville, I believe you are mistaken, with regards to your understand of what brought about those gains.

 

Those gains, as you mention were in fact company making for fairfax, and thus far have delivered better nominal results than vanilla value investing picks, however you fail to recognize that all those positions had one very clear common denominator. They were asymmetric investments with very little capital require upfront for a potentially very large payout.

 

Looking back after some of them have played out and assuming that this was all "Macro Trading" is in my view a misunderstanding of what actually occurred.

 

Mr. Watsa was able to deploy very little capital to initially protect his portfolio, as it happens a one in a one hundred year storm came about and those little hedges or asymmetric bets proved incredibly fruitful. But it had more to do with the otherside being reckless AIG than Watsa nailing a macro thesis.

 

Going forward, there are very little such asymmetric opportunities when it comes to derivatives, hence Ackman with his HKD bet, trying to actually use rhetoric to influence a government peg. Only such black swan events will deliver the asymmetric returns we witnessed that came about from the 2008/2009 forced deleveraging.

 

Again my position is this. As a responsible value investor, Watsa, noticing that things were getting expensive as a straight forward value investor, put on some really attractive asymmetric bets that absolutely rocked. But there is no lesson to be learned here, for non-professional investors without ISDA's, because you all cannot trade in credit derivatives. An analog in your case would have been to simply scale down positions and buy some out of the money puts circa 2006/2007 if you felt we were in a bubble valuation equity market.

 

And now that Watsa generated such outsized returns as you mention yourself which were basically company makers, it is completely understandable that he wants to protect the downside more than worry about being aggressive, given that he knows what I just said, he got very lucky with the returns those derivatives provided, and he can take his time now before jumping back in with both feet, as far as he is concerned he has a pretty big lead in the race so he can shift down some gears and let the fog clear up.

 

Everyone is in a different situation...

 

It's no wonder we disagree on the value of hedging so much if you think Prem just "got lucky".

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Moore Capital,

 

What are you talking about?

 

"Original Mungerville, I believe you are mistaken, with regards to your understand of what brought about those gains.

 

Those gains, as you mention were in fact company making for fairfax, and thus far have delivered better nominal results than vanilla value investing picks, however you fail to recognize that all those positions had one very clear common denominator. They were asymmetric investments with very little capital require upfront for a potentially very large payout."

 

If you call - $5 billion plus in US treasuries (many long US treasuries and could be far more than 5 billion as its not worth going to check the exact amount) and $1 billion plus in hedges on the S&P on the way down with the $1 billion plus hedges taken off - "asymmetric investments with very little capital required upfront for a potentially very large payout", give me some of the stuff you are smoking.

 

The only hedge investment on the list I provided that is asymmetric requiring very little capital upfront is the first: the CDS protection purchased which paid out in the $2 billion range on an average investment around $300M plus or minus 100M. #2, #3, and #4 in no way can be characterised in the way you did. This is plainly obvious.

 

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Alwaysinvert,

 

Not talkin' about value investing being moot at this point, and sure as hell not talkin' about switching to growth. I am stating that value investors that don't actively hedge are taking on market risks which they may not want to take on when macro forces are going to be so strong. I am saying that those value investors who say hedging is a macro-call don't understand that going net long stocks is more of a macro call than hedging when macro forces have the potential to be so strong. I am over 100% invested long value and have been for the better part of 10 years however I have also been hedged for the better part of 10 years. I am not saying value is dead. In fact I think value investors who hold any cash now because they are afraid of the macro environment when Berkshire Hathaway is at an earnings yield of 10% looking 13 months out and growing that yield at better than 8-12% annualized are actually making more of a macro call and less of a value play relative to an investor who is 100% long Berkshire and 70 to 100% hedged. 

 

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The last 10 years were unlike any other. Total global debt increased by 11% compound rate vs real GDP growth of 4%. Credit growth has outstripped real GDP growth by 275%.

 

Peter Bernholz noted 28 episodes of hyperinflation in 20th century, with 20 occurring after 80s. He found a pattern that a tipping point of hyperinflation occurred after government's deficits reached 40% of its expenditures. The US is past this point. Banks are holding massive excess reserves, which if they decided to deploy or lend out, could increase the money supply by 6 TRILLION, triggering massive inflation.

 

Ken Rogoff along with Carmen Reinhart studied sovereign defaults and put a tipping point of defaults at approximately 4.2x debt/revenue. The US is coming dangerously close. At 16x debt/revenue, Japan may blow up sooner than we all think.

 

With massive tectonic shifts happening in the global economy, consider the performance of traditional value investors versus macro investors. All the winners you can think of off the top of your head - Paulson 07, Burry ('05-'09), Kyle Bass - have been macro guys. Value investors Berkowitz, Paulson '11, Ackman, etc have not done very well at all (first two are down >30% this year).

 

Has value investing become impractical in todays day and age?

 

FWIW, I have been spending an inordinate amount of time on the macro, but have yet to switch my investing style away from cigar butt value to macro.

 

Nope.  You're measuring over less than a handful of years.  Prem has been so right on macro and made a fortune for Fairfax and its shareholders, but remember that Fairfax was in investment limbo for almost 7 years when they were trying to right the ship.  Should people have thrown the baby out with the bathwater then? 

 

Seven years ago, Prem was the insurance and investment goat, while Berkowtiz was king.  Today Prem is king, while Berkowitz is the goat.  In this business, you are only as good as your last game, and I think too many people are getting lumped into the "has-been" column. 

 

Very, very few people have a long-term horizon when investing.  Many people espouse the philosophy, but in essence they are really traders.  I think people should not read into a couple of years over or under performance, but focus on the underlying philosphy, history and discipline a manager brings.  Even hard-core value investors carry the same underlying temperament and emotional stability of the general public, and thus you see threads like this pop up over time.  When things go sideways for a while, people start to wonder if things are now completely different.  But things are never completely different...they just come in a variety of colors.  Cheers! 

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Nope.  You're measuring over less than a handful of years.  Prem has been so right on macro and made a fortune for Fairfax and its shareholders, but remember that Fairfax was in investment limbo for almost 7 years when they were trying to right the ship.  Should people have thrown the baby out with the bathwater then? 

 

Seven years ago, Prem was the insurance and investment goat, while Berkowtiz was king.  Today Prem is king, while Berkowitz is the goat.  In this business, you are only as good as your last game, and I think too many people are getting lumped into the "has-been" column. 

 

Very, very few people have a long-term horizon when investing.  Many people espouse the philosophy, but in essence they are really traders.  I think people should not read into a couple of years over or under performance, but focus on the underlying philosphy, history and discipline a manager brings.  Even hard-core value investors carry the same underlying temperament and emotional stability of the general public, and thus you see threads like this pop up over time.  When things go sideways for a while, people start to wonder if things are now completely different.  But things are never completely different...they just come in a variety of colors.  Cheers!

 

Parsad, have you ever thought about writing a book? Your take on 'Margin of Safety', more or less.

 

I'd read that! :)

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Parsad, have you ever thought about writing a book? Your take on 'Margin of Safety', more or less.

 

I'd read that!

 

Much appreciated, but I have nothing new to add.  I'm just stealing from what's already out there. 

 

You know, be it in one account or another (personal, corporate, fund), we have owned Berkshire Hathaway now for 13 years.  Fairfax now for almost 11 years.  Itex for 4 years.  Chanticleer 5 years...through the worst periods.  Overstock, on and off again for five years, thanks to the volatility.  I would still be holding all of my Steak'n Shake if it had not suddenly changed to Biglari Holdings!  Another company we just loaded up on, we will hold for at least 5-7 years, if not longer...it's a completely authentic net-net (net cash is greater than market price) and has good growth prospects...we are buying it in all of our accounts. 

 

We've been through the tech wreck, 9/11, Hurricane Hugo, Credit Crunch, the Great Recession, Afghani & Iraqi Wars, the fall of governments in Libya, Egypt and now the possible dissolution of the European Union.  In that time, I have not spent my days wondering if I should be 100% hedged, while going 100% long.  I have not worried about currency fluctuations affecting Berkshire and Fairfax.  I did not wonder how a Greek debt failure would affect Itex.  I didn't spend a second worrying about whether Hooter's might not sell another chicken wing if unemployment in the U.S. went up.  Nor did I care if the housing market would create a catastrophic drop in sales of steakburgers at Steak'n Shake!  I sold Steak'n Shake because I didn't like what the CEO was doing ethically, and it had nothing to do with macroeconomics.  Go figure!

 

The cash rich, micro-cap company that we loaded up on...how will the European crisis affect the cash on their balance sheet?  They aren't leveraged, have no debt, and they are break-even on a quarterly basis or slightly profitable each quarter.  What is going to happen in the macroeconomic environment around me that would justify not buying shares in this business.  If anything should be a concern to an investor in this circumstance, it would be certifying that the books are authentic and the audit accurate.  Not if Italy is going to need a bailout!  Ridiculous this notion and one that I have no interest in participating in.  If markets go up, and some of our holdings get to fair value, we will sell.  If markets go down, we will look for bargains and buy more.  That's it!  Nothing new...same old, same old.  Cheers! 

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Much appreciated, but I have nothing new to add.  I'm just stealing from what's already out there. 

[...]  That's it!  Nothing new...same old, same old.  Cheers!

 

Great post, once again, and it just reinforces my point...

 

I don't think a good book on value investing has to have much that is new to be good. I don't know about others, but personally I've reached the 'diminishing returns' point of new information acquired through reading books about value investing a while ago (the core principles are fairly simple), but I keep reading because it helps keep me on the right track, makes maintaining discipline easier and gives motivation when times are tough.

 

There aren't that many truly great books on value investing, but a lot of times when I read your posts I get the same feeling that I do when reading those; it helps me stay on the right paths, keeps things in perspective (what's really important and what isn't) and refreshes my memory as to what the truly important core principles are.

 

That's why I'd love to have a Parsad on Investing book (even if it's just a PDF e-book) :) I'm sure you've had an interesting investing life with lots of insightful anecdotes and learning events.. In any case, just a suggestion. It's easier to ask someone to write a book than to actually write one!

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That's why I'd love to have a Parsad on Investing book (even if it's just a PDF e-book) I'm sure you've had an interesting investing life with lots of insightful anecdotes and learning events.. In any case, just a suggestion. It's easier to ask someone to write a book than to actually write one!

 

Hopefully, at the end of the day 20 years from now...if not longer...our annual reports will be the book if we are fortunate enough to survive and do well. 

 

I've got every single Fairfax annual report and it actually tells Prem's story better than anything else.  Just like Berkshire's, but I don't have all of the original copies of those!  ;D  Cheers!

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Hopefully, at the end of the day 20 years from now...if not longer...our annual reports will be the book if we are fortunate enough to survive and do well. 

 

I've got every single Fairfax annual report and it actually tells Prem's story better than anything else.  Just like Berkshire's, but I don't have all of the original copies of those!  ;D  Cheers!

 

I'm guessing those annual reports aren't available anywhere except for investors in your fund(s)..?  :'(

 

That's a gift I'd like to get this xmas :)

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I'm guessing those annual reports aren't available anywhere except for investors in your fund(s)..? 

 

Unfortunately yes, as full disclosure of all of our holdings, including our ideas around them, are in the annual reports.  Cheers!

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For what it's worth, my two cents regarding macro and hedging,

 

I'd answer the macro/hedging question with a question: What would you do if you owned 100% of a few quality businesses in your home town?  I suspect you'd spend very little time on the macro (instead focusing on your competitive position relative to competitors), and probably wouldn't spend five seconds worry about hedging the S&P index or anything of the sort. 

 

In my opinion it doesn't make sense to alter ones behavior as an owner just because there's a daily quote via a public market.

 

Allan

 

 

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Moore Capital,

 

What are you talking about?

 

"Original Mungerville, I believe you are mistaken, with regards to your understand of what brought about those gains.

 

Those gains, as you mention were in fact company making for fairfax, and thus far have delivered better nominal results than vanilla value investing picks, however you fail to recognize that all those positions had one very clear common denominator. They were asymmetric investments with very little capital require upfront for a potentially very large payout."

 

If you call - $5 billion plus in US treasuries (many long US treasuries and could be far more than 5 billion as its not worth going to check the exact amount) and $1 billion plus in hedges on the S&P on the way down with the $1 billion plus hedges taken off - "asymmetric investments with very little capital required upfront for a potentially very large payout", give me some of the stuff you are smoking.

 

The only hedge investment on the list I provided that is asymmetric requiring very little capital upfront is the first: the CDS protection purchased which paid out in the $2 billion range on an average investment around $300M plus or minus 100M. #2, #3, and #4 in no way can be characterised in the way you did. This is plainly obvious.

 

LOL exactly so you are saying that buying the safest security in the world with 5 Billion dollars where there is literally no risk of capital loss and then have that security go up 30% when you expected maybe 2-3% because of the federal reserve creating money to purchase that security not another example of asymmetric risk reward?

 

The asymmetry has to do with permanent loss of capital as well.

 

Santyana, yes indeed Prem was lucky, both the CDS and the Treasury position delivered returns that prem could have never imagined, had he imagined those returns he would have deployed even more in the CDS position for example.

 

The same thing happened to friedberg this year, hes up nearly 40% because he was long Bunds, US Treasuries and owned CDS's on European Sovereigns, and he will be the first to tell you hes lucky they have done what they have done.

 

Original Mungerville, all I am saying is this: Inferring from the examples you provided, that Prem is a macro investor is in my humble opinion a misunderstanding of what in fact happened which is that Prem was just being safe with his capital and taking some punts which turned out to be 20 baggers because the federal reserve bailed out AIG with newly printed money and paid out counterparties whole.

 

Burry on the other hand did in fact let his Macro view supersede his value investing principles and bet the farm on this idea. Whether or not that will continue to work for him time will tell, but if you boil down the principles of value investing, Macro should not play a role, only valuations and multiples, in a way when multiples expand too much, too quick, that is most probably a result of a macro risk in the making, but as value investors we should not take any views on the macro at all.

 

I will end with a Buffett quote:

 

The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It is optimism that is the enemy of the rational buyer.

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For what it's worth, my two cents regarding macro and hedging,

 

I'd answer the macro/hedging question with a question: What would you do if you owned 100% of a few quality businesses in your home town?  I suspect you'd spend very little time on the macro (instead focusing on your competitive position relative to competitors), and probably wouldn't spend five seconds worry about hedging the S&P index or anything of the sort. 

 

In my opinion it doesn't make sense to alter ones behavior as an owner just because there's a daily quote via a public market.

 

Allan

 

I think you nailed it on the head Allan!  And obviously, there isn't a whole lot different that you would have done over the last decade from what you did.  Cheers!

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