"Macro" Musings

[kilroy04]

Where are we in the innings of the 2008/2009 crisis?  A little different way of looking at it but insightful nevertheless.  Below from Fisher's Houston talk that Giofranchi posted.

 

"Scholars know that Shakespearian plays all have five acts. I would suggest that we are but in the third act of a play—we had the tempest in Act 1; the jury-rigging of monetary policy and radical maneuvers by the Fed to save the ship in Act 2; and in the present act, we are back on course but somewhat becalmed, sailing at less-than-desired cruising speed even as we have cranked up an auxiliary motor of large-scale asset purchases. Act 4 will involve the travails and challenges of adjusting our policy course, fine-tuning the motor and rearranging the rigging. And not until the final act will we know whether we have achieved the felicitous outcome that is the hallmark of most romantic plays, or whether the melancholy that defines a tragedy awaits us.

 

The romantic outcome ends, as most all Shakespearian comedies do, in a marriage—in this case, a marriage of sensible fiscal and monetary policy that lifts employment and carries the American economy to new heights.

 

The tragic outcome is one in which the fiscal authorities—the Congress and the president—are unable to provide incentives for risk takers to make use of the cheap and abundant capital the Fed has made available, and the play ends in a debasement of the central bank and the ruination of our economy and lifestyle."

[giofranchi]

Diminishing Returns

 

giofranchi

[giofranchi]

The following dramatic chart shows why Europe no longer has a choice in kicking the can, and what we have said from the very beginning, a Mellonesque asset liquidation of bad "assets" is the only option

--Zero Hedge

 

giofranchi

[Packer16]

I think sentiment and asset allocation is what will keep the market from collapsing.  Stocks are an underinvested asset class versus 2007 and sentiment towards them is negative despite their high FCF yields.

 

The one consideration folks need to consider is that in the past there have been destructive wars every 20 or 30 years.  Since WWII, this has not happened.  The result is a massive amount of accumulated wealth that has not been destroyed and has been accumulating.  The last period of this duration is the post Civil War era (which was 50 year vs. or current 70 years).  These wars produced debts that were used to destroy wealth versus the debt today was used to generate wealth for someone who has is saved somewhere.  The other major change was the former communist countries joining the wealth creation club about 20 years ago.  This massive amount of wealth and search for a safe place for it is what is keeping interest rates down.  I don't see this changing.  These wars created inflation via the destruction of the labor force (disease in the past did this also) and printing of money which monetized the debt created during the war.  This historical destruction is part of what caused PM to regress to the mean (as the cost of labor increased).   

 

Packer

[giofranchi]

The one consideration folks need to consider is that in the past there have been destructive wars every 20 or 30 years.  Since WWII, this has not happened.  The result is a massive amount of accumulated wealth that has not been destroyed and has been accumulating.  The last period of this duration is the post Civil War era (which was 50 year vs. or current 70 years).  These wars produced debts that were used to destroy wealth versus the debt today was used to generate wealth for someone who has is saved somewhere. 

 

Well, it seems to me that debt in the past has always led to war, not the other way around… Total debt / GDP peaked at 300% in the US by 1933, then WWII raged from 1939 to 1945…

Let’s hope we have become wiser… still, we must find a solution to all the debt accumulated during the last 60 years… and European banks must be recapitalized, just like US banks were… I don’t understand how this will be pretty…

 

giofranchi

[giofranchi]

Felix Zulauf on stocks:

 

http://www.businessinsider.com/felix-zulauf-stocks-look-like-gold-2013-5?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+businessinsider+%28Business+Insider%29

 

giofranchi

[giofranchi]

Sustained Pain.

 

giofranchi

[PlanMaestro]

http://www.amazon.com/Unexpected-Returns-Understanding-Secular-Market/dp/1879384620/ref=la_B001K87MBQ_1_1?ie=UTF8&qid=1369334496&sr=1-1

 

http://www.crestmontresearch.com/docs/Stock-PE-Report.pdf

http://www.crestmontresearch.com/docs/Stock-PE-Pinnacle.pdf

http://www.crestmontresearch.com/docs/Stock-Inflation-and-PE.pdf

 

 

[ubuy2wron]

If this has been posted already sorry. He is a bit of a perma bear but I agree with him.

 

http://www.advisoranalyst.com/glablog/2013/05/27/john-hussman-not-in-kansas-anymore.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+advisoranalyst+%28AdvisorAnalyst+Views%29

[Guest hellsten]

"The most-indebted U.S. companies are rallying more than any time in almost four years compared with the rest of the stock market amid the broadest rally since at least 1995.":

http://www.bloomberg.com/news/2013-05-19/leverage-loved-in-equities-spurs-broadest-u-s-rally-since-1995.html

 

About 81 percent of stocks on the New York Stock Exchange are trading above their 200-day moving average, compared with a mean of 55 percent since 2005, according to Bloomberg data.

“One of the most baffling things to a lot of people about the market is they can’t understand why it’s up so much,” James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees $325 billion, said in a May 16 phone interview. “We priced a market for the end of the world that’s never occurred,” he said. “People are starting to capitulate on the end-of-the-world idea.”

[giofranchi]

“One of the most baffling things to a lot of people about the market is they can’t understand why it’s up so much,” James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees $325 billion, said in a May 16 phone interview. “We priced a market for the end of the world that’s never occurred,” he said. “People are starting to capitulate on the end-of-the-world idea.”

 

Sometimes I think I am really dumb… because either I am dumb, or people are crazy! Here we have a person who oversees $325 billion (!!!!!) in investments, saying that we priced the market for the end of the world… Did we?! Really?! Being dumb, I had thought until now that even in March 2009 we just barely fell below the long term average growth trend for the S&P500… Priced for the end of the world?! Not even close!! … But, wait! I MUST be dumb… because we simply cannot afford someone crazy who manages $325 billion!! ;)

 

giofranchi

[giofranchi]

“One of the most baffling things to a lot of people about the market is they can’t understand why it’s up so much,” James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees $325 billion, said in a May 16 phone interview. “We priced a market for the end of the world that’s never occurred,” he said. “People are starting to capitulate on the end-of-the-world idea.”

 

Sometimes I think I am really dumb… because either I am dumb, or people are crazy! Here we have a person who oversees $325 billion (!!!!!) in investments, saying that we priced the market for the end of the world… Did we?! Really?! Being dumb, I had thought until now that even in March 2009 we just barely fell below the long term average growth trend for the S&P500… Priced for the end of the world?! Not even close!! … But, wait! I MUST be dumb… because we simply cannot afford someone crazy who manages $325 billion!! ;)

 

giofranchi

 

Well, now that I think of it, you could argue: giofranchi, please, stop bothering us with your silly assumption that what happened in the past might still be relevant today! We live in a new era, and the long term growth trend for the S&P500 is no more valid today. So, yes!, you are dumb!!

 

To that I would reply: last century was the new era. You remember “How to Minimize Investment Returns” from Mr. Buffett’s 2005 AL?

 

It’s been an easy matter for Berkshire and other owners of American equities to prosper over the years. Between December 31, 1899 and December 31, 1999, to give a really long-term example, the Dow rose from 66 to 11,497. (Guess what annual growth rate is required to produce this result; the surprising answer is at the end of this section.) This huge rise came about for a simple reason: Over the century American businesses did extraordinarily well and investors rode the wave of their prosperity.

 

Here’s the answer to the question posed at the beginning of this section: To get very specific, the Dow increased from 65.73 to 11,497.12 in the 20th century, and that amounts to a gain of 5.3% compounded annually. (Investors would also have received dividends, of course.) To achieve an equal rate of gain in the 21st century, the Dow will have to rise by December 31, 2099 to – brace yourself – precisely 2,011,011.23. But I’m willing to settle for 2,000,000; six years into this century, the Dow has gained not at all.

 

Over the 20th century American businesses did extraordinarily well! Last century really has been a new, extraordinarily prosperous era! Of course, the 21st century could turn out to be… well, a new new era… but then we should be "willing to settle" for 2 million plus!!

 

When people talk about higher margins, and therefore higher returns from stocks, than last century, I always go back to “How to Minimize Investment Returns”.

 

giofranchi

 

[beerbaron]

Every week for the last 18 months I have seen the market go up. Almost daily now we see the S&P jump up 0.5-1%, the economy has not made meaningful improvements in those 18 months. Which leads me to believe that markets have now shifted from valuing stocks to relatively valuing stocks. At the current 0% rate environment the S&P could well reach 2,000,000 after all anything divided by zero is infinity.

 

BeerBaron

[Packer16]

One point I think the "mean reversion" crowd is missing is what is the correct mean and is the mean being examined in a vacuum (like some science experiment)?  If you look at the period shown on the graph you have 2 world wars and the rise of communism in the world post WWII.  These 3 events destroyed large amounts of capital over the 80 years that these events took place.  What if the situation we have now has none of these events.  There has been alot of wealth created as a result.  The wealth in the non-emerging West (US, UK & Western Europe) is being saved in the non-emerging West as it always has but in the rest of the world the wealth is being saved in the non-emerging West (as the probability of return and of wealth is more certain).  This wealth has driven interest rates down and elevated asset prices in the West.  What would reverse this trend to reversion to the mean would occur?  Market reforms in the emerging markets.  What is probability of that?  Not very high in my estimation therefore I think a case can be made for higher asset prices until something changes.

 

Packer

[Guest Dazel]

 

 

Peter lynch is famous for saying if you spent 13 minutes a year studying the economy and market than you wasted 10 minutes....Buffett agreed.

 

If someone just bought the index all the way the along they would have knocked it out of the park..surely buying good companies the same way would have been better yet...

 

Is all of this a waste of time? If Fairfax had done nothing but hold it's positions without ever hedging...meaning no CDS gains and no hedging losses?

 

Is the investing world lost in the idea of a crash and bubbles?

 

Just asking the question....because I have been guilty of spending way too much time on this nonsense and it has cost me time and money.

 

Dazel.

 

 

[giofranchi]

Dazel,

I am not sure about many things… but I am pretty sure about one thing: you and I are the sole responsible for our financial well being. If you choose to completely disregard what’s going on around you, and then lose money, you won’t be able to say: “well, but Mr. Lynch told this and that…”. Or better, you will surely be able to say so, but it won’t bring your money back…

 

Risk control: it is up to you. Nobody else. And my view is it is always better to have no regrets. Because regrets weaken our spirits and undermine our confidence. Even if in the short run it seems that to prevent future regrets costs us some money.

 

To be clear: Mr. Lynch’s career was launched and ended during the most spectacular secular bull market in human history. Why everything he said should be relevant today is beyond me.

 

To be even more clear: Mr. Buffett says he doesn’t care about the economy. Ok, he has $1.2 billion coming in every month to invest… I repeat, I am not sure about many things, but I am sure about another thing: Mr. Buffett’s situation is different from yours and mine.

 

Risk control is paramount and so specific to each situation.

 

FFH: I completely miss how people compare today’s hedging losses with previous CDS and hedging gains… They clearly belong to two different cycles! I would suggest to go rereading Mr. Watsa’s 2012 AL: I think the perspective on those pages is the right one.

 

 

Packer,

You are always very optimistic about human ingenuity, and so am I. But we already find ourselves mired in the midst of the largest pile of debt ever accumulated in human history (as a percentage of our productive capabilities). Those difficult times you referred to were a direct consequence of too much debt accumulated way back then. And it was not as huge a burden as it is today…

I believe in human ingenuity. And I even believe the 21st century could turn out to be a better time for American businesses than the 20th century has been. Nonetheless, I would proceed with caution here… There will be plenty of time to get very rich, once we are on the right path to reduce our liabilities!

 

giofranchi

[twacowfca]

One point I think the "mean reversion" crowd is missing is what is the correct mean and is the mean being examined in a vacuum (like some science experiment)?  If you look at the period shown on the graph you have 2 world wars and the rise of communism in the world post WWII.  These 3 events destroyed large amounts of capital over the 80 years that these events took place.  What if the situation we have now has none of these events.  There has been alot of wealth created as a result.  The wealth in the non-emerging West (US, UK & Western Europe) is being saved in the non-emerging West as it always has but in the rest of the world the wealth is being saved in the non-emerging West (as the probability of return and of wealth is more certain).  This wealth has driven interest rates down and elevated asset prices in the West.  What would reverse this trend to reversion to the mean would occur?  Market reforms in the emerging markets.  What is probability of that?  Not very high in my estimation therefore I think a case can be made for higher asset prices until something changes.

 

Packer

 

Hmmm.

 

Have stocks reached a "permanently higher level"?

[petec]

One point I think the "mean reversion" crowd is missing is what is the correct mean and is the mean being examined in a vacuum (like some science experiment)?  If you look at the period shown on the graph you have 2 world wars and the rise of communism in the world post WWII.  These 3 events destroyed large amounts of capital over the 80 years that these events took place.  What if the situation we have now has none of these events.  There has been alot of wealth created as a result.  The wealth in the non-emerging West (US, UK & Western Europe) is being saved in the non-emerging West as it always has but in the rest of the world the wealth is being saved in the non-emerging West (as the probability of return and of wealth is more certain).  This wealth has driven interest rates down and elevated asset prices in the West.  What would reverse this trend to reversion to the mean would occur?  Market reforms in the emerging markets.  What is probability of that?  Not very high in my estimation therefore I think a case can be made for higher asset prices until something changes.

 

Packer

 

A couple of thoughts.  First, two world wars destroyed a lot of capital but also created a lot of activity (building war machines and rebuilding countries).  I wonder - and I have no idea how to measure this, but I do wonder - whether they destroyed more capital, net, than the various asset bubble-crashes that killed levered investors: Japan, interweb, subprime, etc.  To put it more simply, the market's ability to destroy capital is powerful and undimmed.

 

Secondly, is the developing world really saving in the non-developing world?  Most emerging markets that I know of, especially China, have huge fixed investment numbers.  I think that what drove asset prices up had more to do with lots of workers entering the global workforce (hence inflation down and asset prices up) than emerging market wealth flooding into the developed world.  The more pertinent now question is: how much of the investment we see, whether in non-developing world financial assets or in developing world fixed assets, is a) levered and b) priced to provide a decent return?  My guess is a) lots and b) not much and that, eventually, will determine asset prices.

 

Pete

[Guest Dazel]

Agreed...we are all responsible individually for our investment actions.

 

I am not comparing Fairfax to anything.....simply stated those who did not buy cds' in 2007 and make huge gains in 2008 did not have the embedded "macro" worry burden that Fairfax carries. Markel which was the seed that Fairfax was created "Markel Canada".... they are better off by ignoring what Fairfax spent the majority of the last 7 years worrying about.  Markel has done the same thing they always have pick stocks and keep cash on hand. This is  not a knock on Fairfax as they are brilliant and not a thumbs up on Markel because they are just doing what they always do.

 

The Gold bugs believe they world is ending too...they have been destroyed even though they spend every waking moment predicting the end of the world...

 

 

I am not saying that we should not always be looking at negatives...however,  if you are a value investor buying bucks for 50 cents... where should we spend our time? I am asking the question....now that we are high levels it is obvious we should be looking at safer avenues...but is

safety simply having some cash around?

 

Shorting Telsa would have been right on fundamentals...but you would have lost all your money...is it better not just to stay away from it all together?

 

Dazel.

[merkhet]

Everyone mentions Buffett. Then they say that he has $1.2 billion coming in every year at Berkshire.

 

Few people mention Munger who has consistently said that he has never cared about the general level of markets when he invests.

[giofranchi]

I am not saying that we should not always be looking at negatives...however,  if you are a value investor buying bucks for 50 cents... where should we spend our time? I am asking the question....now that we are high levels it is obvious we should be looking at safer avenues...but is

safety simply having some cash around?

 

Dazel,

I basically agree with you. I just try to modulate my aggressiveness in investing… but I am always on the lookout for a $1 asset for 50 cents! :)

The problem, I guess, is that valuations seldom are etched in stone… they are much more “liquid”… maybe, it is me and only me, but… I am not so SURE about what a company is really worth… any company, I must admit… because I am not so sure my assumptions aren’t biased at all due to external circumstances… I have already told dcollon, but I will repeat it now: the first thought I have every time I think back about 2007 is the following: “I was positive I held investments only in undervalued stocks!”… it might be just a weakness of mine… but 2007 has thought me not to be arrogant or in a hurry to get rich… instead, to always keep some powder dry… just trying to understand how much of it...

 

giofranchi

 

[vinod1]

One point I think the "mean reversion" crowd is missing is what is the correct mean and is the mean being examined in a vacuum (like some science experiment)?  If you look at the period shown on the graph you have 2 world wars and the rise of communism in the world post WWII.  These 3 events destroyed large amounts of capital over the 80 years that these events took place.  What if the situation we have now has none of these events.  There has been alot of wealth created as a result.  The wealth in the non-emerging West (US, UK & Western Europe) is being saved in the non-emerging West as it always has but in the rest of the world the wealth is being saved in the non-emerging West (as the probability of return and of wealth is more certain).  This wealth has driven interest rates down and elevated asset prices in the West.  What would reverse this trend to reversion to the mean would occur?  Market reforms in the emerging markets.  What is probability of that?  Not very high in my estimation therefore I think a case can be made for higher asset prices until something changes.

 

Packer

 

The fact that wealth has not been destroyed recently should result in higher cash flows. Factories, infrastructure, etc. that are not destroyed should be increasing productivity and generating additional cash flows. So I do not see why the multiple that you pay for a given cash flow should increase - except to the extent that the world is much safer than in the past and people are willing to accept lower returns as a result. But this has nothing to do with mean reversion.

 

Mean reversion argument rests on two inter-related factors

 

1. Capitalism - If a company starts making very high returns, it attracts competitors reducing its rates of return to more normal levels. Likewise if a company keeps losing lots of money, it would be acquired, goes bankrupt, etc until the rest of the companies earn at least acceptable rates of return.

 

2. Democracy - In a democratic society if companies as whole start making too much money as compared to wage income, people would vote for politicians/policies to redress this balance.

 

The mean around which profits would revert could change but the above two factors would ensure mean reversion in a capitalist/democratic society.

 

Vinod

[Packer16]

My point is what is the normal situation where the mean should revert?  The wars and communism distorted the mean for which no one seems to be compensating.  Unless of course you expect these to happen to the same degree they have in the past.  Wars increased the profit margins of the victor but destroyed the wealth of the loser.  Communism destroyed the wealth of the countries that implemented it and led to inefficiencies and lower profits for those countries firms.  I am just questioning the underlying assumptions of the argument and how revelent is some of the historical data when captialism and democracy was not in place for a majority of the world (before 1990).  After 1990, I agree that the assumptions were in place but most of the data that the mean reversion is based upon is pre-1990.

 

The higher multiple is due to the larger amount of capital which is chasing fewer opportunuties which will lead to lower interest rates.  Unless there is a trend to destroy capital, you would expect lower returns until an event happens that destroys the capital.

 

As to bubbles destroying capital, they do on paper but they don't destroy the physcial and intellectual assets like wars do.  Also as to emerging markets saving in the developed world, I think if given the choice (many are not) they would invest the West at anytime.  If you talk to folks from emering markets, many of their markets are rigged (like ours were before the depression) and the main savings vehilcle is real estate or Western assets. 

 

Packer

[petec]

 

The higher multiple is due to the larger amount of capital which is chasing fewer opportunuties which will lead to lower interest rates.

 

 

1) I don't think this holds - capitalism also creates a lot more investment opportunities so you do not have more wealth chasing fewer opportunities.  I could even argue that creative destruction ought to lower multiples, all else equal.

 

2) Bubbles do more than destroy paper capital!  They totally wipe out the leveraged, have a massive impact on multiples, destroy physical capital through lack of maintenance in a recession (you think all those subprime homes are in the same state now that they were 6 years ago?) and curb investment in R&D.

 

3) That said I do take your general point that wars and communism may have distorted historic average multiples.  I'd just counter that other things, e.g. monetary policy, are highly likely distorting multiples today.  The bottom line is that margins and multiples revert for reasons related to competition and required returns and that hasn't changed.

 

Pete

[Guest Dazel]

 

Giofranchi,

 

 

I understand  and appreciate where you are coming from...and respect the amount of time and effort it takes to do the due diligence you are doing...

 

Warren Buffett said he and a huge advantage on everyone in the money managing business because he had no memory of the 1929 crash...everyone was afraid of high stock prices even in the 50's...

 

I don' t know if that is the case now...and if I study everything imaginable about the economy in the U.S and the global economy I am not going to know either...

 

Now if I come to the conclusion that I do know because of the studying I do...I will be fooling myself in to feeling safe or fearful....my margin of safety is in the security I buy...not how much I think I know about what the future of the economy.

 

I am not smart enough to figure it all out... But I can value specific assets very well and control greed and fear very well.

 

And GioFranchi...I agree most of all with the fact when your skin is in the game you have a voice in this matter...Peter Lynch and Warren Buffett ain't going to save you...you better have conviction of why you bought it.

 

Dazel.