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Oaktree Capital - Howard Marks latest memo - On Uncertain Ground


kiwing100
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I enjoyed reading it,... thanks for posting

 

At least he didn't mention we're all going to die eventually, so he must be optimistic.  What I took from it is that he considers corporate bonds as a decent investment option. The rest, to sum it up is: looks bad, really bad, but it's so complex maybe something new will happen and make it better, not the same as before, just better than how it is now. Or maybe it was bad before, we just didn't notice, so it's actually not that much worse now. I read another article yesterday how cheap energy and 3D printing is going to give the USA the edge over Asia and the needed boost to its economy (seems to be quite a few of these lately.) Sounds right to me.

 

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I enjoyed reading it,... thanks for posting

 

At least he didn't mention we're all going to die eventually, so he must be optimistic.  What I took from it is that he considers corporate bonds as a decent investment option. The rest, to sum it up is: looks bad, really bad, but it's so complex maybe something new will happen and make it better, not the same as before, just better than how it is now. Or maybe it was bad before, we just didn't notice, so it's actually not that much worse now. I read another article yesterday how cheap energy and 3D printing is going to give the USA the edge over Asia and the needed boost to its economy (seems to be quite a few of these lately.) Sounds right to me.

 

We might not only get 3D printing, but probably also in a decade some transparent iPad,... where you only hold some type of transparent display/screen in your hands. Like Tom Cruise in the movie "Minority Report". I had last week the chance to see and test this technology in real at some event of SAMSUNG.

 

http://vectorpoint.co.uk/archives/2909

 

http://beforeitsnews.com/science-and-technology/2012/01/samsung-wins-ces-innovation-award-for-smart-window-display-1667269.html

 

 

http://blog.gadgethelpline.com/wp-content/uploads/2012/02/mreport.jpg

 

The real thing, a transparent computer display from SAMSUNG:

http://www.sinbadesign.com/wp-content/uploads/2012/01/Samsung-Smart-Window-at-CES-2012-1.jpg

 

http://www.sinbadesign.com/wp-content/uploads/2012/01/Samsung-Smart-Window-at-CES-2012-2.jpg

 

http://www.sinbadesign.com/wp-content/uploads/2012/01/Samsung-Smart-Window-at-CES-2012-3.jpg

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I have nothing but the utmost respect for Mr. Marks, and OAK is my firm’s fourth largest investment. But I invested with him, because I believe he is one of the shrewdest distressed debt opportunity seekers I know of. On the other hand, when it comes to equities investing, it seems to me that his judgment becomes a little less clear and reliable. Take, for instance, the following opinion from his latest memo:

 

In 1999, when everyone was unworried, the S&P500 traded at more than 30 times earnings. Today the p/e ratio has more than halved, and it is well below the post-World War II average. In addition, dividend and earnings yields on equities are unusually favorable relative to the yields on bonds. There’s no doubt that stocks have cheapened relative to historic parameters – although the case can also be made that they aren’t cheap enough, since future growth is unlikely to be at the historic rate.

 

Now compare that with Mr. John Hussman’s writings of last Monday:

 

There are few times in history when the S&P 500 has been within 1% or less of its upper Bollinger band (two standard deviations above the 20-period moving average) on daily, weekly and monthly resolutions; coupled with a Shiller P/E in excess of 18 – the present multiple is actually 22.3; coupled with advisory bullishness above 47% and bearishness below 27% - the actual figures are 51% and 24.5% respectively; with the S&P 500 at a 4-year high and more than 8% above its 52-week moving average; and coupled, for good measure, with decelerating market internals, so that the advance-decline line at least deteriorated relative to its 13-week moving average compared with 6-months prior, or actually broke that average during the preceding month. This set of conditions is observationally equivalent to a variety of other extreme syndromes of overvalued, overbought, overbullish conditions that we've reported over time. Once that syndrome becomes extreme - as it has here - and you get any sort of meaningful "divergence" (rising interest rates, deteriorating internals, etc.), the result is a virtual Who's Who of awful times to invest.

Based on ensemble methods that capture a century of evidence – from Depression-era data, through the New Deal, World War, the Great Society, the electronics boom, the energy crisis, stagflation, the great moderation, the dot-com bubble, the tech crash, the housing bubble, the credit crisis, and even the more recent period of massive central bank interventions – our estimates of prospective market return/risk have been negative since April 2010 and have remained negative even as new data has arrived. Since early March, those estimates have plunged into the most negative 0.5% of historical instances.

 

I tend to agree with Mr. Hussman’s opinion, as far as equities are concerned.

What I really like is Mr. Mark’s view on corporate investing:

 

An obscure 1958 book, Corporate Bond Quality and Investor Experience by W. Braddock Hickman, is said to have given Michael Milken a lot of his inspiration to popularize high yield bonds and foster new issue and secondary markets for them in the 1970s. In his book, Hickman reports on the performance of corporate bonds between 1900 and 1943. He shows that the lower a bond’s quality and rating, the higher the return from holding it.

This is a very important conclusion. Aside from arguing for high yield bond investing, it shows that even in this period, which included the Great Depression, corporate bond investing was quite successful. What that tells me is that despite the extremely tough economic climate, many corporations were able to make money and service their debt. This supports my belief that corporate investing represents an attractive strategy for uncertain times.

 

giofranchi

 

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Mr. Hussman's quotes sound like a macro guess based upon alot of macro indicators.  Mr. Marks assessment is based upon sentiment.  He has a unique perspective as investing in both equity and high yield.  As one indicator look at Berkshire's Porfolio now versus 1999.  Berkshire has been able to find plenty of investments.  I love Mr. Marks statement on macro statements, namely (1) I don't know, (2) nobdody knows and (3) if you ask an expert for advice and follow it, you'll probably be making a mistake. 

 

Packer

 

 

 

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The key point to pull out of the excerpt of Hussman you quoted was the Shiller P/E ratio.  If Hussman read the excerpt from Marks you quoted, he would point out that one-year P/E ratios have zero predictive power going forward.  Therefore, the fact that P/E ratios have come down considerably from 1999 should not be relied upon to construct a macro forecast.

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Mr. Hussman's quotes sound like a macro guess based upon alot of macro indicators.  Mr. Marks assessment is based upon sentiment.  He has a unique perspective as investing in both equity and high yield.  As one indicator look at Berkshire's Porfolio now versus 1999.  Berkshire has been able to find plenty of investments.  I love Mr. Marks statement on macro statements, namely (1) I don't know, (2) nobdody knows and (3) if you ask an expert for advice and follow it, you'll probably be making a mistake. 

 

Packer

 

Packer,

I know what you mean. But I don’t really think Mr. Hussman is macro forecasting… He is just working with valuations and comparing them to where they have been throughout history. If it is possible to rely on valuation, assessing the future performance of a single company share price, why should it be impossible to do so for 500 companies? Imho, that’s the most important part of Mr. Hussman’s work.

Macro forecasting comes way behind! And I don’t find it neither particular interesting nor useful.

 

giofranchi

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To be clear, I'm not advocating the use of any sort of macro forecast.  What I am saying is that if you DO attempt it, single-year P/E ratios have zero predictive power, in the data.

 

You could probably come up with other methods to inform that single-year P/E ratio to be predictive, besides a cyclically-adjusted methodology such as Shiller's.  Who knows what else might work?  You might be able to use private debt-to-GDP levels to distinguish good from bad?  However, most likely, nothing is going to save you from "false positives" on a year-by-year basis (you might go defensive years too soon).

 

In my opinion, better to just pick bottom-up.  Besides that, just having a sense of the nature of catastrophe (basically, that it is always possible and that you cannot count on seeing it coming in time) is useful.

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(you might go defensive years too soon).

 

Well, imho, you should go defensive years too soon! Remember Mr. Graham who said that anyone, who had not gone defensive by 1926, got killed. Later, from 1932 to 1937 the markets rose for 5 straight years. Then again, from 1938 to 1942 anyone, who had not gone defensive by 1935, got killed again… To go defensive, I mean buy what you like the most and sell short what you like the least. Instead of just buying what you like the most. I would never say don’t buy a true bargain, if you can find one. And Packer is right: true bargain can (almost) always be found. But in a declining market, even a true bargain can become cheaper and cheaper.

 

giofranchi

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Well, imho, you should go defensive years too soon! Remember Mr. Graham who said that anyone, who had not gone defensive by 1926, got killed. Later, from 1932 to 1937 the markets rose for 5 straight years. Then again, from 1938 to 1942 anyone, who had not gone defensive by 1935, got killed again… To go defensive, I mean buy what you like the most and sell short what you like the least. Instead of just buying what you like the most. I would never say don’t buy a true bargain, if you can find one. And Packer is right: true bargain can (almost) always be found. But in a declining market, even a true bargain can become cheaper and cheaper.

 

giofranchi

 

I don't think you necessarily have to be defensive at that level. For example, someone who owns berkshire owns a company that should do well in a bad environment because they have a strong balance sheet and the ability to benefit from bargains.

 

I don't plan on shorting stocks, but I like buying companies that are run in such a way that they can survive and thrive in difficult times (if not thrive immediately, at least come out stronger than their competitors because they acquired good assets in fire sales and such).

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Well, imho, you should go defensive years too soon! Remember Mr. Graham who said that anyone, who had not gone defensive by 1926, got killed. Later, from 1932 to 1937 the markets rose for 5 straight years. Then again, from 1938 to 1942 anyone, who had not gone defensive by 1935, got killed again… To go defensive, I mean buy what you like the most and sell short what you like the least. Instead of just buying what you like the most. I would never say don’t buy a true bargain, if you can find one. And Packer is right: true bargain can (almost) always be found. But in a declining market, even a true bargain can become cheaper and cheaper.

 

giofranchi

 

I don't think you necessarily have to be defensive at that level. For example, someone who owns berkshire owns a company that should do well in a bad environment because they have a strong balance sheet and the ability to benefit from bargains.

 

I don't plan on shorting stocks, but I like buying companies that are run in such a way that they can survive and thrive in difficult times (if not thrive immediately, at least come out stronger than their competitors because they acquired good assets in fire sales and such).

 

Thank you very much Liberty! Yours are truly words of wisdom! And that's why my firm's largest investment by far is in FFH. And I really don’t plan to change that at all, even if today FFH is so much unloved… Actually, today I couldn’t agree more with Mr. Watsa's investment strategy. Today it seems that we are back to 2007: from 2002 to 2007 the stock market was propped up by a roaring housing market, and by a private sector debt which got bigger and bigger, we reached the point of “irrational exuberance”, and a rude awakening followed; then, from 2009 to 2012 the stock market was again propped up, this time by an ocean of liquidity, which succeeded in suppressing any yield on the so-called “safe-heavens”, forcing investors to look for yield somewhere else (the stock market), and almost reaching again the point of “irrational exuberance” (today the Russell2000 ttm p/e ratio is almost 30! Is it going to grow to the sky?!), while all the debt was just shifted from the private to the public sector, but practically didn’t get any better… Why should we be spared a new rude awakening? It seems that we didn’t learn anything… At least, so it seems to me!

In a secular bear market for stocks, when “irrational exuberance” is in the air, I like what Mr. Watsa is doing: buy the best bargains you can find and sell short the Russell2000.

I also like very much what you suggested and I want to point out that I consider your posts among the most well written and informative ones.

 

giofranchi

 

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Thank you very much Liberty! Yours are truly words of wisdom! And that's why my firm's largest investment by far is in FFH. And I really don’t plan to change that at all, even if today FFH is so much unloved… Actually, today I couldn’t agree more with Mr. Watsa's investment strategy. Today it seems that we are back to 2007: from 2002 to 2007 the stock market was propped up by a roaring housing market, and by a private sector debt which got bigger and bigger, we reached the point of “irrational exuberance”, and a rude awakening followed; then, from 2009 to 2012 the stock market was again propped up, this time by an ocean of liquidity, which succeeded in suppressing any yield on the so-called “safe-heavens”, forcing investors to look for yield somewhere else (the stock market), and almost reaching again the point of “irrational exuberance” (today the Russell2000 ttm p/e ratio is almost 30! Is it going to grow to the sky?!), while all the debt was just shifted from the private to the public sector, but practically didn’t get any better… Why should we be spared a new rude awakening? It seems that we didn’t learn anything… At least, so it seems to me!

In a secular bear market for stocks, when “irrational exuberance” is in the air, I like what Mr. Watsa is doing: buy the best bargains you can find and sell short the Russell2000.

I also like very much what you suggested and I want to point out that I consider your posts among the most well written and informative ones.

 

giofranchi

 

Thanks. I'm just trying to apply Buffett's look-through earnings concept to other things (something that others here are also doing -- nothing original about my way of doing things). For example, I look at the leverage (or lack thereof) of the businesses in my portfolio as if it was my own.

 

About FFH, I think Parsad has written very insightful things about their position. I tend to agree with him that their hedged position isn't exactly an 'offensive' position ("we know everything's going to hell and we're going to profit from it like we did in the GFC!") but rather a 'defensive' shift to neutral because of their capital needs as a levered insurance company. They just can't afford big shocks, so I think they're just waiting for either the storm to hit so they can deploy capital at cheaper valuations, or for the clouds to pass so they can go back to doing the kind of investing they've always done without quite as much macro incertitude. I think it's very very smart for them to do, though there are also other ways to be defensive in this environment.

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About FFH, I think Parsad has written very insightful things about their position. I tend to agree with him that their hedged position isn't exactly an 'offensive' position ("we know everything's going to hell and we're going to profit from it like we did in the GFC!") but rather a 'defensive' shift to neutral because of their capital needs as a levered insurance company. They just can't afford big shocks, so I think they're just waiting for either the storm to hit so they can deploy capital at cheaper valuations, or for the clouds to pass so they can go back to doing the kind of investing they've always done without quite as much macro incertitude. I think it's very very smart for them to do, though there are also other ways to be defensive in this environment.

 

Most probably Parsad is right! He surely knows much more than anyone on this board about FFH. Anyway, the numbers I see are: $24 billion of total investments, of which $10 billion are in bonds and $8 billion are in cash, while just $3,8 billion are in stocks. So, even if FFH is holding $18 billion in cash + bonds, is it possible that Mr. Watsa is hedging those $3,8 billion in stocks for contingent insurance losses?

 

giofranchi

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Most probably Parsad is right! He surely knows much more than anyone on this board about FFH. Anyway, the numbers I see are: $24 billion of total investments, of which $10 billion are in bonds and $8 billion are in cash, while just $3,8 billion are in stocks. So, even if FFH is holding $18 billion in cash + bonds, is it possible that Mr. Watsa is hedging those $3,8 billion in stocks for contingent insurance losses?

 

giofranchi

 

I haven't followed FFH's numbers closely for a while, but I think that you have to look at all those versus the equity number. If you have around 8B of equity for 24B of total assets, this means that a relatively small shock to the total assets could wipe out a large fraction of the equity, and they need to maintain a certain equity ratio for their insurance obligations.

 

Someone else please correct me if I'm wrong.

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Most probably Parsad is right! He surely knows much more than anyone on this board about FFH. Anyway, the numbers I see are: $24 billion of total investments, of which $10 billion are in bonds and $8 billion are in cash, while just $3,8 billion are in stocks. So, even if FFH is holding $18 billion in cash + bonds, is it possible that Mr. Watsa is hedging those $3,8 billion in stocks for contingent insurance losses?

 

giofranchi

 

I haven't followed FFH's numbers closely for a while, but I think that you have to look at all those versus the equity number. If you have around 8B of equity for 24B of total assets, this means that a relatively small shock to the total assets could wipe out a large fraction of the equity, and they need to maintain a certain equity ratio for their insurance obligations.

 

Someone else please correct me if I'm wrong.

 

It is clear that even relatively small movements in the value of FFH’s portfolio could have a big negative effect on its equity, but that would imply Mr. Watsa is actually worried about investments results, right? So, all the hedges he put in place are part of his investment strategy. You could argue that a leveraged portfolio is riskier than an unleveraged one, and that’s why hedges are warranted. But, if you take away the $8 billion in cash, investments / equity is 200%, in line with most insurance and reinsurance companies. Take, for instance, Markel Corp., another holding of mine: it has total investments (less cash & equivalents) of $7,9 billion and equity of $3,6 billion. So, investments / equity is 220%, in line with FFH. It also has $2,2 billion invested in stocks. So, for MKL stocks / equity = 60%, while for FFH stocks / equity = 47%: FFH’s exposure to stocks seems lower than MKL’s. Nonetheless, MKL has no equity hedges in place.

Please, correct me, if my reasoning is wrong.

 

giofranchi

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