Fairfax Annual Letter?

[twacowfca]

Japan is an interesting case study on the end of deflation and the monetization of debt.  If you look at what happens when a central bank prints money to reduce the debt you see that the yen has collapsed but the Nikkei has rallied even more since the BoJ's plans have become more defined.  If this happens to the US and other developed countries then FFH will lose on both ends as the stock hedges will lose money as well as the deflation hedges.  Seeing this makes me even more wary of being all-in on the hedges.

 

Packer

 

I agree.  Our business is a microcosm of the US service and light manufacturing industries. We knew how bad things  were becoming in August, 2008 before others spotted the drastic change in perceptions.  True deflation was massive in late '08 and '09, considering things that are muted when they show up indirectly in the CPI. 

 

The cost of housing went down dramatically for buyers not renters with price declines and low interest rates.  Our part of the US did not experience a bubble in housing prices, but housing prices crashed so much that anyone with halfway decent credit could buy an almost new house for much less than replacement cost even with construction costs down by 30%.  I know two people whose income was formerly too low to qualify for a loan who bought nice houses with principal and interest payments that were half what they would have been four years earlier.  Those bargains are no longer available.

 

We all know what happened to security prices ex UST's and commodity prices in 2008 and 2009.

 

Our labor costs have flatlined with small increases in unit costs cancelled by attrition in the workforce.  Raw material and transportation costs have been flat for the last couple of years , but no longer declining.  Health insurance costs are on the rise and there are hints of future increases in other things.  We will have our first substantial increase in employment costs in quite some time this spring.

People are no longer cutting expenditures or saving drastically.

 

I don't expect a downturn until there is a substantial increase in interest rates.  Near that time, the stock market would be expected to lead the economy down. 

 

Is my prediction better than many others?  Probably so because I am merely extending the observed trend, the only thing that works . . . . Until It Stops Working!  :)

[giofranchi]

If this happens to the US and other developed countries then FFH will lose on both ends as the stock hedges will lose money as well as the deflation hedges. 

 

I am not so sure… stock hedges and deflation hedges are… just hedges! FFH, thanks to leverage and skillful investing, and (hopefully!) profitable underwriting, is able to create much alpha. Just look at 2012: stock hedges went down, deflation hedges went down, BV per share increased 6.5%!

So, FFH surely might underperform 2 or 3 years more, but I don’t see how they could lose money.

Vice versa, if something goes wrong, and in a deleveraging many things can go wrong, FFH will shine.

Again: +6.5% if they are wrong, great results if they are right. Imo, that is the way to go!  :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[Uccmal]

Seeing this is the Corner of Berkshire And Fairfax, funny how the two leaders it was named for, seem to be putting forward differing outlooks.

 

But are they really so different.  FFH has invested billions in the last couple of years, while holding the hedges.  Alot of investment has been internal, expanding the insurance empire. With cash dividended to holdco, and subsiduary holding company cash they have been buying private businesses that are certainly going to suffer if another recession hits. It is looking more and more like a mini berk, excepting the hedges.  Prem, like Buffett is always opportinistic.  I expect they no longer have to take the value garbage such as fbk going forward. 

 

Buffett has been doing the same, using his operating cash flows as his hedge.  Quite frankly, Buffett must have the best real time economic data available of any private investor on Earth.  Berkshire is a microcosm of the worlds supply chain.

 

I love the idea of FFH following WEB and becoming a mini-conglomerate like BRK, but I hate the businesses Prem has bought - flatware, sporting goods, restaurants? FFH needs to follow BRK into more essential services. Buy quality not cheap crap!!  Why not buy a large stake in a small utility company, and grow the position over time when prices are favourable? But buy something better than flatware!!

 

There, I feel much better having vented.......

 

cheers

Zorro

 

I hear you.  However, while they have been investing small sums in these "mediocre" businesses, they have been investing multiples alongside KW.  Those rental payments would be your "utility" company.

 

Its too bad they didn't keep part of First Canadian Place in Calgary. 

[Uccmal]

 

Hi Vinod, Just curious.  Do you still hold FFH?

 

I wonder sometime how they will do going forward.  I think the route to greater profits for them involves expanding the insurance businesses that are profitable, investing the float in wholly owned businesses or partnerships such as Kennedy Wilson.

 

Hi Uccmal,

 

I sold FFH at around $420 primarily due to a major portfolio overhaul in 2011. Given all the economic issues in Europe and its potential impact on US, along with US own set of issues and the opportunity set that is available (BAC/AIG/C/GS), I wanted to have a barbell type portfolio. A large allocation of cash (60-75%) coupled with high leverage via warrants and LEAPS on deeply undervalued businesses. I know FFH is hedged but if 2008-2009 crisis taught me anything it is that only cash is truly liquid. So I sold out of FFH.

 

If BAC or AIG works out while FFH is still available around book I would revert back to FFH. I do not see underwriting profits or growth in float making much of difference to growth in book value. Growth will again likely come from portfolio performance but with the hedges in place the macro has to cooperate.

 

Vinod

 

Makes perfect sense to me.  In the past I have been too restless to just hold cash.  Something I need to really work on getting comfortable with.  It would probably be easier if interest rates were 5-6% on cash as they were most of my life. 

[Shane]

I try not to analyze the investment decisions of HWIC, other than looking at broad characteristics (Hedged).  It adds value to my portfolio to have uncorrelated returns, I want him to think differently than I do.

[mals]

I try not to analyze the investment decisions of HWIC, other than looking at broad characteristics (Hedged).  It adds value to my portfolio to have uncorrelated returns, I want him to think differently than I do.

 

I concur. I see investing in Fairfax Fin as a belief in 1) Prem Watsa and team's investing prowess aided by the leverage, and 2) their alignment of interest which causes them to seek out the most prudent capital deployment.

 

Such massive macro bets worry me also - but the way I see it is that FFH still needs to protect itself from 100 year events differently than, say, Berkshire. BRK is large and can withstand much lowered investment values whereas FFH's insurance business can suffer from temporary impairments.

 

As to whether they can create a good insurance business that generates nearly free float - I do not know nearly as much as people on this board. But with time to build expertise in insurance and with the ability to walk away from business when it is not attractive, I hope that they will get close to less than 100% combined ratio. Although insurance does appear to be a business with little pricing power - so either one has to have lower costs - through underwriting or business model (Geico it seems has both) or less compeition (BRK's reinsurance business and Markel niche businesses may fall in that category).

 

Would love to hear what others think about what one has to believe in to invest in FFH, as to how to reconcile with macro bets that are running into Fed's powerful machine and insurance business profitability.

[vinod1]

 

Vinod1, I am not so sure… FFH BV per share increased 53%, 21% and 33% in 2007, in 2008 and in 2009. Its share price increased 24%, 36% and 5% in 2007, in 2008 and in 2009. Better than cash, right?  ;)

 

giofranchi

 

 

giofranchi,

 

That is almost entirely due to the CDS gains. I do not see that happen in a market crash going forward.

 

I am referring to the fact that if Fairfax did not have CDS gains I think it would have declined along with BRK, LUK, etc. I have benefited a lot from Fairfax during that period but I do not expect a repeat performance. Also I think Market would probably give us some time to load up on Fairfax if any deflation hedges look like they would be a home run. Hence, my preference for cash as a hedge instead of Fairfax. I could be wrong but that is the only way I can sleep well with my portfolio.

 

Vinod

 

 

[giofranchi]

 

Vinod1, I am not so sure… FFH BV per share increased 53%, 21% and 33% in 2007, in 2008 and in 2009. Its share price increased 24%, 36% and 5% in 2007, in 2008 and in 2009. Better than cash, right?  ;)

 

giofranchi

 

 

giofranchi,

 

That is almost entirely due to the CDS gains. I do not see that happen in a market crash going forward.

 

I am referring to the fact that if Fairfax did not have CDS gains I think it would have declined along with BRK, LUK, etc. I have benefited a lot from Fairfax during that period but I do not expect a repeat performance. Also I think Market would probably give us some time to load up on Fairfax if any deflation hedges look like they would be a home run. Hence, my preference for cash as a hedge instead of Fairfax. I could be wrong but that is the only way I can sleep well with my portfolio.

 

Vinod

 

Well, in 2008 FFH gained $2,080 million from equity hedges and $1,290 million from CDS. So, when the markets really melted down, FFH actually gained more from its defensiveness than from its macro call.  :)

Anyway, I understand what you mean, and I like your barbell type portfolio!  ;)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[Uccmal]

 

Vinod1, I am not so sure… FFH BV per share increased 53%, 21% and 33% in 2007, in 2008 and in 2009. Its share price increased 24%, 36% and 5% in 2007, in 2008 and in 2009. Better than cash, right?  ;)

 

giofranchi

 

 

giofranchi,

 

That is almost entirely due to the CDS gains. I do not see that happen in a market crash going forward.

 

I am referring to the fact that if Fairfax did not have CDS gains I think it would have declined along with BRK, LUK, etc. I have benefited a lot from Fairfax during that period but I do not expect a repeat performance. Also I think Market would probably give us some time to load up on Fairfax if any deflation hedges look like they would be a home run. Hence, my preference for cash as a hedge instead of Fairfax. I could be wrong but that is the only way I can sleep well with my portfolio.

 

Vinod

 

Well, in 2008 FFH gained $2,080 million from equity hedges and $1,290 million from CDS. So, when the markets really melted down, FFH actually gained more from its defensiveness than from its macro call.  :)

Anyway, I understand what you mean, and I like your barbell type portfolio!  ;)

 

giofranchi

 

Vinod is likely right.  FFH was way down in March 2009, giving an excellent time to invest, if one had the cash.  This was despite the fact they were booking billions in gains.  In a heavy market sell off FFH will drop too, probably not as much as the S&P, but it will drop.  This likely has little to do with FFH and more to do with shareholders being forced to sell at disadvantages prices to pay for margin calls.  It is only after the dust settles that the gains will bring FFH to new highs.  It is not a perfect portfolio hedge with the time lag.  The closest thing to a perfect hedge is cash. 

[giofranchi]

 

Vinod1, I am not so sure… FFH BV per share increased 53%, 21% and 33% in 2007, in 2008 and in 2009. Its share price increased 24%, 36% and 5% in 2007, in 2008 and in 2009. Better than cash, right?  ;)

 

giofranchi

 

 

giofranchi,

 

That is almost entirely due to the CDS gains. I do not see that happen in a market crash going forward.

 

I am referring to the fact that if Fairfax did not have CDS gains I think it would have declined along with BRK, LUK, etc. I have benefited a lot from Fairfax during that period but I do not expect a repeat performance. Also I think Market would probably give us some time to load up on Fairfax if any deflation hedges look like they would be a home run. Hence, my preference for cash as a hedge instead of Fairfax. I could be wrong but that is the only way I can sleep well with my portfolio.

 

Vinod

 

Well, in 2008 FFH gained $2,080 million from equity hedges and $1,290 million from CDS. So, when the markets really melted down, FFH actually gained more from its defensiveness than from its macro call.  :)

Anyway, I understand what you mean, and I like your barbell type portfolio!  ;)

 

giofranchi

 

Vinod is likely right.  FFH was way down in March 2009, giving an excellent time to invest, if one had the cash.  This was despite the fact they were booking billions in gains.  In a heavy market sell off FFH will drop too, probably not as much as the S&P, but it will drop.  This likely has little to do with FFH and more to do with shareholders being forced to sell at disadvantages prices to pay for margin calls.  It is only after the dust settles that the gains will bring FFH to new highs.  It is not a perfect portfolio hedge with the time lag.  The closest thing to a perfect hedge is cash.

 

Well, after being up +36% in 2008, when the S&P500 was down -37% the same year, it might very well be that FFH stock price sagged in February and March of 2009… But, to take advantage of that, you must have had all the cash needed to invest in a very limited time window (2 months, more or less)… good luck to you!!  ;D And you would have lost all the 2008 gains anyway…  :( Definitely not my game!

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[wknecht]

 

Vinod1, I am not so sure… FFH BV per share increased 53%, 21% and 33% in 2007, in 2008 and in 2009. Its share price increased 24%, 36% and 5% in 2007, in 2008 and in 2009. Better than cash, right?  ;)

 

giofranchi

 

 

giofranchi,

 

That is almost entirely due to the CDS gains. I do not see that happen in a market crash going forward.

 

I am referring to the fact that if Fairfax did not have CDS gains I think it would have declined along with BRK, LUK, etc. I have benefited a lot from Fairfax during that period but I do not expect a repeat performance. Also I think Market would probably give us some time to load up on Fairfax if any deflation hedges look like they would be a home run. Hence, my preference for cash as a hedge instead of Fairfax. I could be wrong but that is the only way I can sleep well with my portfolio.

 

Vinod

 

Well, in 2008 FFH gained $2,080 million from equity hedges and $1,290 million from CDS. So, when the markets really melted down, FFH actually gained more from its defensiveness than from its macro call.  :)

Anyway, I understand what you mean, and I like your barbell type portfolio!  ;)

 

giofranchi

 

Vinod is likely right.  FFH was way down in March 2009, giving an excellent time to invest, if one had the cash.  This was despite the fact they were booking billions in gains.  In a heavy market sell off FFH will drop too, probably not as much as the S&P, but it will drop.  This likely has little to do with FFH and more to do with shareholders being forced to sell at disadvantages prices to pay for margin calls.  It is only after the dust settles that the gains will bring FFH to new highs.  It is not a perfect portfolio hedge with the time lag.  The closest thing to a perfect hedge is cash.

I think it can be seen as an economic hedge if not a perfect market price hedge. If the price doesn't follow the value then one can take advantage of this obvious error (as long as Fairfax has not become overvalued prior to this hypothetical and one has cash).

[ERICOPOLY]

In a heavy market sell off FFH will drop too, probably not as much as the S&P, but it will drop.  This likely has little to do with FFH and more to do with shareholders being forced to sell at disadvantages prices to pay for margin calls.  It is only after the dust settles that the gains will bring FFH to new highs.  It is not a perfect portfolio hedge with the time lag.  The closest thing to a perfect hedge is cash.

 

March 2009 taught me that the time to dump all FFH is during the market bottom.

 

FFH is only 0.5x long the stock market at such a time, and has names like JNJ which simply aren't going to move that much.  Get ye' out of yer FFH matey and into WFC at $8.  Much more bang for the invested buck.

[warrior]

financial

results for the firm are more volatile than its competitors who do employ hedging strategies.

Prem does not mind the volatility, as he a says about lumpy 15%,  the  question is why hedging  100% vs  keeping cash. In fact ,he keeps cash+ 100% hedges ... ? Hence, I would agree with Twacowfca that FFH appears  overhedged  .hedging involves accurate market timing, numerous transactions which is costly , it also means forgoing dividends and offsetting gain on equity...

as we can see at the present  loses are massive. They extended the expiry on hedges as well , considering loses on hedges  and the  present situation it may be  logical move  .

  In fact, I did ask Prem about  FFH hedging all  portfolio.

his answer was that ;a) Sir Templeton was hedging 100% in the last 5 years of his career- (I'm

not sure about the result for Sir Templeton  ,since he started to hedge)

b) he is worry about downside risk such as 1 in 100 event

  in my view ,Prem does, however, has to worry about what will happen if his forecast for a lower stock price turns out to be incorrect  .

 

 

[TwoCitiesCapital]

Japan is an interesting case study on the end of deflation and the monetization of debt.  If you look at what happens when a central bank prints money to reduce the debt you see that the yen has collapsed but the Nikkei has rallied even more since the BoJ's plans have become more defined.  If this happens to the US and other developed countries then FFH will lose on both ends as the stock hedges will lose money as well as the deflation hedges.  Seeing this makes me even more wary of being all-in on the hedges.

 

Packer

 

I think you're looking at a very limited time frame. Japan has been printing money with the encouragement of people like Bernanke and Krugman since the 90s. They just recently announced QE8 (or was it QE9). Has the currency "collapsed" over the past 20 years? No. It's down maybe 20% in the last few months, but it's up a significant amount over the past 20 years if I'm not mistaken. The stock market has also rallied by a similar amount, but still remains at less then 1/3 of its peak value even after the recent rally.

 

If a similar situation does happen in the U.S., we could definitely expect another drop in equities of 50-80%.

 

Secondly, the recent occurrences have been in large part predicted by Kyle Bass. He believes Japan is going through a currency collapse given that they are the most indebted nation in the world. The U.S. is a long way from there, but definitely going down that path, IMO. It might be 10-15 years before we experience similar happenings as Japan right now.

 

I tend to agree with Watsa on being concerned about deflation. We haven't seen deflation because there has been no deleveraging. Private households have mainly delivered by defaulting (not paying down credit) and the government picked up the slack by spending with massive deficits. On a net-net basis, no deleveraging has occurred. What has occurred is that wages are down and prices for necessities are higher meaning less disposable/taxable income to service the same amount of debt. the next crisis will be worse because we're in a much worse spot to handle it.

 

Secondly, I don't know if this is a macro "bet" as much as it is a hedge and our attitudes towards the 2 should be different. Watsa spent what was roughly 1 year of earnings (~6.5% of market cap) on deflation hedges to protect the entire company against a very serious outcome that is definitely a possibility. Not only that, he gave himself the ability to profit from it if it does and place him in a fine spot to swoop in with cash at the bottom. I don't care if deflation happens or not. This is a smart way to protect your business. it is prudent to protect assets and capital when they are in danger even if the danger never materializes. Hindsight is always 20/20.

 

 

[Guest valueInv]

What is the worst case scenario here? What if the stock market had excellent returns and the feds policies caused inflation to kick in ? What is the impact on Fairfax's portfolio?

[plato1976]

good question...

I think it really depends on if fairfax 's equity holding will be better than the index ...

if it does significantly worse, the fairfax book value can be wiped out - very unlikely though

 

What is the worst case scenario here? What if the stock market had excellent returns and the feds policies caused inflation to kick in ? What is the impact on Fairfax's portfolio?

[giofranchi]

What is the worst case scenario here? What if the stock market had excellent returns and the feds policies caused inflation to kick in ? What is the impact on Fairfax's portfolio?

 

If you are referring to the CPI-linked securities, FFH has invested a total of $454 million and sees a cumulative loss of $335 million to date: -74%. Not much damage left for inflation to cause!

This is how I see it:

- Best case scenario: a lot of people will lose a lot of money, meanwhile FFH will earn a fortune.

- Worst case scenario: 2012: a lot of people will earn 16%, meanwhile FFH will earn 6.5%.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

 

 

 

[Guest valueInv]

What is the worst case scenario here? What if the stock market had excellent returns and the feds policies caused inflation to kick in ? What is the impact on Fairfax's portfolio?

 

If you are referring to the CPI-linked securities, FFH has invested a total of $454 million and sees a cumulative loss of $335 million to date: -74%. Not much damage left for inflation to cause!

This is how I see it:

- Best case scenario: a lot of people will lose a lot of money, meanwhile FFH will earn a fortune.

- Worst case scenario: 2012: a lot of people will earn 16%, meanwhile FFH will earn 6.5%.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

I am referring to both the S&P hedge and the CPI-linked securities. Lets take a more plausible scenario. What happens to Fairfax's portfolio if say:

1, The market returns say 12% over the next 4 years

2, And inflation spikes up to 5% in 2014 and stays there for the next 5 years?

 

What happens if both those numbers are higher?

[berkshiremystery]

What is the worst case scenario here? What if the stock market had excellent returns and the feds policies caused inflation to kick in ? What is the impact on Fairfax's portfolio?

 

If you are referring to the CPI-linked securities, FFH has invested a total of $454 million and sees a cumulative loss of $335 million to date: -74%. Not much damage left for inflation to cause!

This is how I see it:

- Best case scenario: a lot of people will lose a lot of money, meanwhile FFH will earn a fortune.

- Worst case scenario: 2012: a lot of people will earn 16%, meanwhile FFH will earn 6.5%.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

I am referring to both the S&P hedge and the CPI-linked securities. Lets take a more plausible scenario. What happens to Fairfax's portfolio if say:

1, The market returns say 12% over the next 4 years

2, And inflation spikes up to 5% in 2014 and stays there for the next 5 years?

 

What happens if both those numbers are higher?

 

valueInv,...

 

you have to see it from another perspective. Because of the S&P hedging and the CPI-linked securities hedge shareholders are not receiving the returns on the equity portfolio, but are effectively receiving the delta between Hamblin-Watsa’s returns and the overall market. Based on my knowledge of HWIC's long term historical portfolio returns, I personally feel very comfortable with this delta return.

 

 

[Guest valueInv]

So there are no scenarios under which it could cause a significant loss? If yes, what are they?

 

I'm trying to figure out what the risk is here.

[giofranchi]

What is the worst case scenario here? What if the stock market had excellent returns and the feds policies caused inflation to kick in ? What is the impact on Fairfax's portfolio?

 

If you are referring to the CPI-linked securities, FFH has invested a total of $454 million and sees a cumulative loss of $335 million to date: -74%. Not much damage left for inflation to cause!

This is how I see it:

- Best case scenario: a lot of people will lose a lot of money, meanwhile FFH will earn a fortune.

- Worst case scenario: 2012: a lot of people will earn 16%, meanwhile FFH will earn 6.5%.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

I am referring to both the S&P hedge and the CPI-linked securities. Lets take a more plausible scenario. What happens to Fairfax's portfolio if say:

1, The market returns say 12% over the next 4 years

2, And inflation spikes up to 5% in 2014 and stays there for the next 5 years?

 

What happens if both those numbers are higher?

 

Well, I guess somewhere in between my best and worst scenarios…?

 

Of course, inflation can cause damage to an insurance company that goes well beyond its portfolio of investments. But it could also be the trigger that finally puts an end to the present soft market, and starts a new hard market in which FFH could expand significantly.

 

Anyway, valueInv, I sincerely hope the S&P500 won’t return 12% for the next 4 years… because by then we will be living a stock market bubble that rivals 1999… and it will be almost a certainty that my generation ends up spending its entire productive life without any meaningful stock market appreciation… I don’t know if I can call it a tragedy, but surely it won’t be pleasant!

 

Here is what I wrote a few days ago to my partners:

 

Yesterday I finished reading "Lords of Finance - The Bankers who Broke the World" by Liaquat Ahamed, winner of the Pulitzer Prize in 2010 and business book of the year for The Financial Times and Goldman Sachs.

 

It is the mirror image of "The Forgotten Man" by Amity Shlaes, and among the two you have the most complete and enjoyable compendium of Keynesian economics the modern reader might find. "Lords of Finance" shows the many strengths of Keynes's thoughts and ideas. "The Forgotten Man", on the other hand, shows its shortcomings.

 

In essence, Mr. Keynes was right: in economics prices are as important as fundamental values. Mr. George Soros would later postulate his "Reflexivity Theory" on this same assumption in his book "The Alchemy of Finance". When prices reach unsustainable high levels, they not only tend to mean-revert, but they also shoot on the downside. That's why policy tools, like money printing (a monetary policy) and deficit spending (a fiscal policy), must be used to prop them up again. That's what happened in 2003, after the dot-com bubble burst, and in 2009, after the subprime and world financial crisis.

The great blunder of central bankers in 1929 was precisely to delay policies aimed at sustaining prices for too long. 3 years had to pass, before Mr. Roosevelt initiated his "New Deal", 36 long months during which the vicious cycle of deflation reinforced itself ever more.

 

On the other hand, when interest rates are kept very low for a protracted period of time and money printing goes on apparently without an end, prices might revert to unsustainably high levels once more. That's what happened in 1937, precipitating the world in another depression (the so-called depression inside a depression), and that's what we risk repeating now.

 

So, Mr. Keynes was surely right, but to engineer the right balance between too high and too low prices is no small feat at all!

 

Prices must make economic sense… anytime they are too low or too high, trouble is on our way. You can bet on it! And, please, look at the image in attachment: in 2009 we barely reverted to the mean growth trend… we came from 20 years of stock market returns above average growth trend, and now we are again well above it. 4 years from now, if the market really manages to achieve a 12% CAGR, we would be flirting with disaster…

 

No, really, the further the market advances, the higher the percentage of my firm’s portfolio I will allocate to FFH… there will be almost nowhere else to hide…

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[giofranchi]

So there are no scenarios under which it could cause a significant loss? If yes, what are they?

 

I'm trying to figure out what the risk is here.

 

Well, a business is always risky. Mr. Watsa and his team start investing in overvalued stocks, and FFH will suffer much. The insurance companies overseen by Mr. Barnard start writing contracts which make no sense, and FFH will suffer much.

I see much more operating risks, than strategic ones.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

[obtuse_investor]

Forbes interview with Gary Shilling; talking about the "grand disconnect" that Mr. Watsa mentioned in his Annual letter this year.

 

http://t.co/Ur39RIyvzk [video + transcript]

 

[Grenville]

Forbes interview with Gary Shilling; talking about the "grand disconnect" that Mr. Watsa mentioned in his Annual letter this year.

 

http://t.co/Ur39RIyvzk [video + transcript]

 

nice video, thanks for the link, helpful to get more color on Prem's comments from the letter

[DynamicPerception]

Also enjoyed the video.