The case for Deflation and FFH's CPI-linked derivatives

[giofranchi]

For anyone who might be interested.

 

giofranchi

mwo091012.pdf

[Parsad]

For anyone who might be interested.

 

giofranchi

 

Japan had and continues to have restrictive immigration policies.  They had an aging population, poor demographics and little immigration.  Who was going to buy their houses after the bubble?  While the U.S will/may face significant difficulties, I think the fact that more people coming to the U.S., as well as existing residents, will sop up much of the excess housing inventory and slowly elevate prices.  Inflation is going to be a bigger problem in the U.S. than deflation.  Cheers!

[giofranchi]

Inflation is going to be a bigger problem in the U.S. than deflation.  Cheers!

 

Well, of course you might be right! I know much more people who are in the inflation camp, than people who are in the deflation camp. And, as far as the differences between America and Japan are concerned, you surely are right!

But what about the 1930s? They clearly were different times… But probably in the 1930s they were looking back at the 1870s and they were assuring themselves: “Well, those were different times!”. I like to study history (in particular the history of the financial markets), and usually I don’t like to come to a conclusion which is not proved by history.

Anyway, FFH’s CPI-linked derivatives are just a protection: small downside, if inflation is going to be the bigger problem, great upside, if the vice versa is going to happen. Right?

 

giofranchi

 

[Packer16]

I think history shows that in the 1930s , Sweden followed a monetary policy similar to our QE and this prevented deflation.  You can read about it in Irving Fischer's paper on debt/deflationary cycle.  I think we muddle along as we are as there is no inflationary driver in wages which creates most of the persistent inflation and most prices in the developed world are comprised of wages.  A deflationary trend exists however QE and our demographics will prevent it from turning into deflation.

 

Another aspect of the FFH deflation swaps is they were able to be purchased at a low price.  That is one of the reasons they purchased $ and € swaps and not ￥.

 

Packer

[FrankArabia]

aren't the FFH deflation derivatives under water at the moment? how much deflation would it take for the contracts to be in the money?

[giofranchi]

aren't the FFH deflation derivatives under water at the moment? how much deflation would it take for the contracts to be in the money?

 

I think page 16 of Mr. Watsa's 2010 Annual Letter may shed some light on this topic.

 

giofranchi

[bmichaud]

http://macronomy.blogspot.com/2012/09/credit-pareto-efficiency.html

 

Great post by Martin T pertaining to deflation - he touches on the exact issue of demographics as discussed by Dent.

 

Eventually the inflationists will be right, but as Keynes says, in the long run....

[FrankArabia]

thank you Gio! clears everything up.

 

You think he'll make money on those? I looked into buying FFH but given what I am seeing (deflation hedges, equity hedges) I sided that they problably won't be going anywhere (the stock) anytime soon.

 

If you're a shareholder (assuming you're), why do you like it?

[mankap]

Harry Dent is not a credible economist in my eyes.I still have his book' The next great bubble boom' where he predicted Dow will touch 36,000 in 2006-2010.

I think he writes about extremes to capture people's attention but I do not rate him as good forecaster or a good economist.

[A_Hamilton]

thank you Gio! clears everything up.

 

You think he'll make money on those? I looked into buying FFH but given what I am seeing (deflation hedges, equity hedges) I sided that they problably won't be going anywhere (the stock) anytime soon.

 

If you're a shareholder (assuming you're), why do you like it?

 

Look at how underlevered their insurance operations are. Several combined ratio points can come out from there.

 

Deflation hedges are effectively free at this point as FFH has written them down to near 0.

 

Massive optionality potential in several equity positions...ICICI Lombard,RFP,LVLT, IRE...each of which should more than outperform the Russell 2000 at 25x trailing earnings for the forseeable future.

[giofranchi]

thank you Gio! clears everything up.

 

You think he'll make money on those? I looked into buying FFH but given what I am seeing (deflation hedges, equity hedges) I sided that they problably won't be going anywhere (the stock) anytime soon.

 

If you're a shareholder (assuming you're), why do you like it?

 

FrankArabia,

will FFH make money on its CPI-linked derivatives? I really have no clue!

But FFH is by far my largest holding. I think that P&C insurance companies, if they underwrite profitably and are led by a great investor, can really be cash-flow machines! I am perfectly comfortable with Mr. Watsa’s strategy, because I think we were forced into a low-return world, and that caution is warranted here. But, even if I didn’t agree with Mr. Watsa current investment strategy, I would buy FFH holding at book value nonetheless.

My firm has two businesses and I have a lot of managerial work to do every day. I don’t have the time to shift capital confidently from one bargain to the next. If you can, and you are skilled in doing so, I understand that FFH may not be of great interest to you: for instance, ERICOPOLY is up 100% this year and racemize is up 60%+… who cares about FFH, if you can achieve their returns! My job, instead, is simply to extract as much cash as I can from the operations of my firm, and to use it to buy great businesses at good (or very good!) prices. That’s all I try to do. And FFH is as great as any business I know of.

 

giofranchi

[enoch01]

Harry Dent is not a credible economist in my eyes.I still have his book' The next great bubble boom' where he predicted Dow will touch 36,000 in 2006-2010.

I think he writes about extremes to capture people's attention but I do not rate him as good forecaster or a good economist.

 

Anyone who has done the exact opposite of what Dent has recommended the past 12 years probably has made boatloads of money.

 

Look at this list:

 

The Great Crash Ahead (2011)

The Great Depression Ahead (2009)

The Next Great Bubble Boom (2006)

The Roaring 2000s Investor (1999)

The Roaring 2000s (1998)

The Great Jobs Ahead (1995)

The Great Boom Ahead (1993)

Our Power to Predict (1989)

 

If his next book is giddy and bullish, sell.

[giofranchi]

Harry Dent is not a credible economist in my eyes.I still have his book' The next great bubble boom' where he predicted Dow will touch 36,000 in 2006-2010.

I think he writes about extremes to capture people's attention but I do not rate him as good forecaster or a good economist.

 

Anyone who has done the exact opposite of what Dent has recommended the past 12 years probably has made boatloads of money.

 

Look at this list:

 

The Great Crash Ahead (2011)

The Great Depression Ahead (2009)

The Next Great Bubble Boom (2006)

The Roaring 2000s Investor (1999)

The Roaring 2000s (1998)

The Great Jobs Ahead (1995)

The Great Boom Ahead (1993)

Our Power to Predict (1989)

 

If his next book is giddy and bullish, sell.

 

I really don’t care about Mr. Dent or his forecasting track record. All his article is pointing at are the 3D (debt, demographics, and deleveraging) that also Mr. Rosenberg always refer to (or Mr. Shilling). It is not who is talking, but what he is saying. Do you think that QE will effectively fight and solve the 3D? Like Packer rightly pointed out it did in Sweden during the 1930s? Fine! Then we will have inflation. But I don’t care who will be right and who will be proven wrong. I only care about ideas, and if I understand and agree with them, or vice versa.

 

giofranchi

[FrankArabia]

Gio,

 

Its interesting you mentioned FFH is a "great business". No doubt Watsa is a legendary investor, but don't you think FFH is really a "great hedge fund" in that if Watsa (God forbid) something were to happen to him, FFH will problably (saying that with tongue in cheek) not repeat its historical performance? Certainly FFH is not like a BRK where the underlying businesses themselves are industry leading with great moats (perhaps I'm wrong).

 

From what I see, their insurance operations appear  "decent" but not really outstanding per se on the level of a Chubb Corp.

 

I have met a few value guys here in Canada this year and a few of them actually have FFH as their biggest holding.

 

You certainly can do much worst than FFH.

 

 

 

 

 

 

[Uccmal]

Lol, Dent's track record as a contarian indicator is nearly 100%.

 

I wouldn't let what's left of a little bet by FFh to sway me away from investing.  The stock is floating around book again.  I recently added 100 shares back. 

 

Their bets on the long side, as mentioned above, dwarf the CPI derivatives bet.  You really need to put it in context.  It wasthe same size as each of several numerous long side equity holdings.

 

FFh provides awesome downside protection, with a huge upside as well, for a person (me) who has most everything else in US financials. 

 

 

[racemize]

If you can, and you are skilled in doing so, I understand that FFH may not be of great interest to you: for instance, ERICOPOLY is up 100% this year and racemize is up 60%+… who cares about FFH, if you can achieve their returns!

 

Giofranchi, you are much too kind--my 60% will not be recurring!  One other thing to note, I'm holding 13% BRK, 13% FFH, and 6% LUK, so we actually have a lot of overlap, and I still care about FFH!

[enoch01]

Harry Dent is not a credible economist in my eyes.I still have his book' The next great bubble boom' where he predicted Dow will touch 36,000 in 2006-2010.

I think he writes about extremes to capture people's attention but I do not rate him as good forecaster or a good economist.

 

Anyone who has done the exact opposite of what Dent has recommended the past 12 years probably has made boatloads of money.

 

Look at this list:

 

The Great Crash Ahead (2011)

The Great Depression Ahead (2009)

The Next Great Bubble Boom (2006)

The Roaring 2000s Investor (1999)

The Roaring 2000s (1998)

The Great Jobs Ahead (1995)

The Great Boom Ahead (1993)

Our Power to Predict (1989)

 

If his next book is giddy and bullish, sell.

 

I really don’t care about Mr. Dent or his forecasting track record. All his article is pointing at are the 3D (debt, demographics, and deleveraging) that also Mr. Rosenberg always refer to (or Mr. Shilling). It is not who is talking, but what he is saying. Do you think that QE will effectively fight and solve the 3D? Like Packer rightly pointed out it did in Sweden during the 1930s? Fine! Then we will have inflation. But I don’t care who will be right and who will be proven wrong. I only care about ideas, and if I understand and agree with them, or vice versa.

 

giofranchi

 

Sorry, my point was only tangential: Harry Dent is a fantastic contrary indicator.

 

Over the short run, I haven't the foggiest idea what QE will do.  Over the long run, printing money is correlated with unpleasant things.  Maybe 2 of those D's will be traded for other unpleasantness.

 

I'm thinking a basket short of "accurate QE opinions" would do well in the future.

[giofranchi]

Giofranchi, you are much too kind--my 60% will not be recurring! 

 

racemize,

sorry... but I don't believe you!!!  ;D

 

giofranchi

[ERICOPOLY]

I was more than 100% net long in FFH most of the time from 2006 through 2009.

 

The credit bubble was unsustainable -- it was nearly certain to collapse under the weight of defaults, thus the CDS bet had that going for it.  The only question was when.

 

Does the deflation bet bear the same characteristics?  Are nominal price gains something that can go on in perpetuity with a fiat monetary system?

 

[beerbaron]

Its interesting you mentioned FFH is a "great business". No doubt Watsa is a legendary investor, but don't you think FFH is really a "great hedge fund" in that if Watsa (God forbid) something were to happen to him, FFH will problably (saying that with tongue in cheek) not repeat its historical performance? Certainly FFH is not like a BRK where the underlying businesses themselves are industry leading with great moats (perhaps I'm wrong).

 

From what I see, their insurance operations appear  "decent" but not really outstanding per se on the level of a Chubb Corp.

 

I have met a few value guys here in Canada this year and a few of them actually have FFH as their biggest holding.

 

You certainly can do much worst than FFH.

 

Take a look at their bond results, managed by Brian Bradstreet. Watsa is not alone in this he's got an amazing small team!

 

BeerBaron

[Uccmal]

I was more than 100% net long in FFH most of the time from 2006 through 2009.

 

The credit bubble was unsustainable -- it was nearly certain to collapse under the weight of defaults, thus the CDS bet had that going for it.  The only question was when.

 

Does the deflation bet bear the same characteristics?  Are nominal price gains something that can go on in perpetuity with a fiat monetary system?

 

 

No friggin idea....

 

They may well be onto something.  The CAn. Auto Workers just took a 4 yr. 0% increase.  The government of Ontario is freezing all public sector wages, either by legislation or through bargaining. 

 

[giofranchi]

Its interesting you mentioned FFH is a "great business". No doubt Watsa is a legendary investor, but don't you think FFH is really a "great hedge fund" in that if Watsa (God forbid) something were to happen to him, FFH will problably (saying that with tongue in cheek) not repeat its historical performance? Certainly FFH is not like a BRK where the underlying businesses themselves are industry leading with great moats (perhaps I'm wrong).

 

From what I see, their insurance operations appear  "decent" but not really outstanding per se on the level of a Chubb Corp.

 

I have met a few value guys here in Canada this year and a few of them actually have FFH as their biggest holding.

 

You certainly can do much worst than FFH.

 

Take a look at their bond results, managed by Brian Bradstreet. Watsa is not alone in this he's got an amazing small team!

 

BeerBaron

 

Beerbaron,

I certainly agree with you. And I would add that, with Mr. Barnard as head of all insurance operation, I now expect FFH’s underwriting results to improve markedly in the years to come.

Anyway, I want to stress another idea: in my experience, a business so good that even a fool could run it, is the exception, not the rule. Even better: it is an outlier! I can think of Coca-Cola and… well, don’t make me think too hard! Take, for instance, Burlington Northern or Lubrizol (or many other BRK’s businesses): do you think they are going to produce outstanding results without a great management? I don’t think so. Management is important. And a focused and driven management can make their shareholders rich. No doubt about it. If Mr. Watsa, Mr. Barnard, Mr. Bradstreet, etc. would leave, FFH would cease to be the great business I want my firm to be partial owner of. I know it and I am perfectly fine with that. I look for skilled, reliable, and motivated people in the businesses I manage personally. Why shouldn’t I stress this requirement even more in a business that I do not control?

 

giofranchi

[ERICOPOLY]

I was more than 100% net long in FFH most of the time from 2006 through 2009.

 

The credit bubble was unsustainable -- it was nearly certain to collapse under the weight of defaults, thus the CDS bet had that going for it.  The only question was when.

 

Does the deflation bet bear the same characteristics?  Are nominal price gains something that can go on in perpetuity with a fiat monetary system?

 

 

No friggin idea....

 

They may well be onto something.  The CAn. Auto Workers just took a 4 yr. 0% increase.  The government of Ontario is freezing all public sector wages, either by legislation or through bargaining.

 

You are right of course, they may be onto something.

 

However it "only" takes an event like Germany leaving the Euro to significantly diminish the chances of deflation in Europe.  That would devalue the Euro, there would be printing, and with competitive export prices (weak Euro) there would be a better employment picture.

 

 

[Valuebo]

Its interesting you mentioned FFH is a "great business". No doubt Watsa is a legendary investor, but don't you think FFH is really a "great hedge fund" in that if Watsa (God forbid) something were to happen to him, FFH will problably (saying that with tongue in cheek) not repeat its historical performance? Certainly FFH is not like a BRK where the underlying businesses themselves are industry leading with great moats (perhaps I'm wrong).

 

From what I see, their insurance operations appear  "decent" but not really outstanding per se on the level of a Chubb Corp.

 

I have met a few value guys here in Canada this year and a few of them actually have FFH as their biggest holding.

 

You certainly can do much worst than FFH.

 

Take a look at their bond results, managed by Brian Bradstreet. Watsa is not alone in this he's got an amazing small team!

 

BeerBaron

 

Beerbaron,

I certainly agree with you. And I would add that, with Mr. Barnard as head of all insurance operation, I now expect FFH’s underwriting results to improve markedly in the years to come.

Anyway, I want to stress another idea: in my experience, a business so good that even a fool could run it, is the exception, not the rule. Even better: it is an outlier! I can think of Coca-Cola and… well, don’t make me think too hard! Take, for instance, Burlington Northern or Lubrizol (or many other BRK’s businesses): do you think they are going to produce outstanding results without a great management? I don’t think so. Management is important. And a focused and driven management can make their shareholders rich. No doubt about it. If Mr. Watsa, Mr. Barnard, Mr. Bradstreet, etc. would leave, FFH would cease to be the great business I want my firm to be partial owner of. I know it and I am perfectly fine with that. I look for skilled, reliable, and motivated people in the businesses I manage personally. Why shouldn’t I stress this requirement even more in a business that I do not control?

 

giofranchi

 

Management is always important, even when a fool can run the company. We all know what happened at KO some time after R. Goizueta died... Over the long term, I believe there is no company that can be successful with a fool at its helm. Although companies like MSFT are defying my theory.  ;)

[FrankArabia]

a company like FFH is especially reliant on management as its key product (investment returns) is directly at the mercy of management.

 

I am not sure how everybody views FFH, but this is a hedge fund with an insurance wrapper, not the other way around.