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Hamblin Watsa wrong with their thesis?


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US industrial production is increasing

US retail sales are increasing

US non-farm jobs being added

US housing affordability at multi-decade high

US consumer debt service at multi-decade low

US price-to-rent at multi-decade low

US bank capital levels at multi-decade high

US banks wrote-off ~500B of losses with write-offs declining

US new home sales / construction growing from a level lower than when US had half the population it has now

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I think he is just wrong. I never understood how the US today parallels the US during 1930's or Japan during 1980's. In both cases banks and businesses were insolvent and consumers were fine. This lead to deflation.

 

In the US today consumers are in debt but businesses and banks are fine. Businesses are especially cash rich. Totally different situation. You can't fire your wife or your children. Consumers just keep consuming.

 

Unless interest rates rise dramatically indebted consumers won't cut back. And interest rates won't rise unless there is significant inflation because this is the only cue for the Fed to raise interest rates. So the only way to get deflation is if the Fed overcompensates for inflation. And significant inflation is also unlikely because consumers can't afford much of it.

 

So you are stuck with noflation.

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US Budget deficit is shrinking.

    - http://www.bloomberg.com/news/2013-05-14/u-s-deficit-to-fall-to-642-billion-says-budget-agency.html

US house prices are increasing.

US Trade balance is improving.

US retail investor is not shying away from the stock market.

US is not experiencing a deflation - yet.

 

1) take anything the CBO says with a very large grain of salt. Their prediction record has been abysmal.

2) housing prices are increasing? Maybe the third time since 2009 will be the charm. Tell me who will buy them when the coming generation is graduating with the largest amounts of student debt and the lowest paying jobs we've seen in a decade?

3) trade balance is improving precisely because individuals can no longer afford many of the imported luxuries they used to buy IMO. Hardly bullish.

4) stock mutual fund flows have consistently been negative up until this year. Not sure if this will last through the next correction or not.

5) deflation takes years to culminate. Even Greece is just now experiencing it. Increased Federal debt has made up nearly every penny of consumer deleveraging. All that's hit the economy has been corporate deleveraging if I recall my numbers correctly. Realize that all interests have to do is go back to the 4-5% they were at before the crash and we're spending more than 30% of current government receipts servicing interest. You don't think that will be a drag on th future economy? Spending will have to be cut somewhere or revenues will have to rise or we can keep interest rates artificially low until we've inflated enough of the debt away where that's not a threat (not bullish for the economy either),

 

 

US industrial production is increasing

US retail sales are increasing

US non-farm jobs being added

US housing affordability at multi-decade high

US consumer debt service at multi-decade low

US price-to-rent at multi-decade low

US bank capital levels at multi-decade high

US banks wrote-off ~500B of losses with write-offs declining

US new home sales / construction growing from a level lower than when US had half the population it has now

 

1) industrial production increasing isn't a substantial part of the economy anymore. I'd say this is more of a lagging indicator and is a small part of a much much larger economy.

2) debt service is only at multi-decade lows due to extremely low rates. What happens when rates rise with a recovey?

3) bank capital ratios mean nothing in light of the trillions of derivatives that they hold on their books with global counterparties who aren't as strong (European banks leveraged 30-to-1 who have gone double or nothing in buying European sovereign debt).

4) the level that housing construction is rising from is meaningless without the context of the overbuilding that occurred. There are still empty neighborhoods with vacant houses in places where the most overbuilding occurred.

5) housing may be the most affordable it's been, but only for those who can obtain credit. Not the easiest task nowadays.

6) non-farm jobs are being added but they're typically low wage, part time jobs that are replacing the full time jobs. Not bullish for real wages (which have been declining for a decade) which means its not all that bullish for the long-term economy. Granted, some jobs are better than no jobs.

 

All of this isn't to say that I think Watsa will be right. It's simply saying arguments could very easily be made for the other side. He's been cautious in his approach to protect capital, not necessarily to maximize short term gains. Also, we're seeing unprecedented amounts of global stimulus that aren't sustainable. What happens when trillions in liquidity stops? The velocity of the dollar has continued to slow and has fallen very far from where it began in 2007. This is not the sign of a healthy economy, but is partly why we aren't seeing inflation from printing.

 

I think Watsa made a very smart choice. He looked at the unprecedented rise in global debt over the last 30 years, asked himself what are the consequences if this goes South, and hedged accordingly. This was a way to protect his business. Could we have profited from it? Sure. Was that the intention? Unlikely. Secondly, you focused on all U.S. statistics but the majority of the deflationary derivatives were written on Europe. Europe does appear to be heading towards a deflationary end game and these may still pay off in the next 5 years.

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US Budget deficit is shrinking.

    - http://www.bloomberg.com/news/2013-05-14/u-s-deficit-to-fall-to-642-billion-says-budget-agency.html

US house prices are increasing.

US Trade balance is improving.

US retail investor is not shying away from the stock market.

US is not experiencing a deflation - yet.

 

1) take anything the CBO says with a very large grain of salt. Their prediction record has been abysmal.

2) housing prices are increasing? Maybe the third time since 2009 will be the charm. Tell me who will buy them when the coming generation is graduating with the largest amounts of student debt and the lowest paying jobs we've seen in a decade?

3) trade balance is improving precisely because individuals can no longer afford many of the imported luxuries they used to buy IMO. Hardly bullish.

4) stock mutual fund flows have consistently been negative up until this year. Not sure if this will last through the next correction or not.

5) deflation takes years to culminate. Even Greece is just now experiencing it. Increased Federal debt has made up nearly every penny of consumer deleveraging. All that's hit the economy has been corporate deleveraging if I recall my numbers correctly. Realize that all interests have to do is go back to the 4-5% they were at before the crash and we're spending more than 30% of current government receipts servicing interest. You don't think that will be a drag on th future economy? Spending will have to be cut somewhere or revenues will have to rise or we can keep interest rates artificially low until we've inflated enough of the debt away where that's not a threat (not bullish for the economy either),

 

 

US industrial production is increasing

US retail sales are increasing

US non-farm jobs being added

US housing affordability at multi-decade high

US consumer debt service at multi-decade low

US price-to-rent at multi-decade low

US bank capital levels at multi-decade high

US banks wrote-off ~500B of losses with write-offs declining

US new home sales / construction growing from a level lower than when US had half the population it has now

 

1) industrial production increasing isn't a substantial part of the economy anymore. I'd say this is more of a lagging indicator and is a small part of a much much larger economy.

2) debt service is only at multi-decade lows due to extremely low rates. What happens when rates rise with a recovey?

3) bank capital ratios mean nothing in light of the trillions of derivatives that they hold on their books with global counterparties who aren't as strong (European banks leveraged 30-to-1 who have gone double or nothing in buying European sovereign debt).

4) the level that housing construction is rising from is meaningless without the context of the overbuilding that occurred. There are still empty neighborhoods with vacant houses in places where the most overbuilding occurred.

5) housing may be the most affordable it's been, but only for those who can obtain credit. Not the easiest task nowadays.

6) non-farm jobs are being added but they're typically low wage, part time jobs that are replacing the full time jobs. Not bullish for real wages (which have been declining for a decade) which means its not all that bullish for the long-term economy. Granted, some jobs are better than no jobs.

 

All of this isn't to say that I think Watsa will be right. It's simply saying arguments could very easily be made for the other side. He's been cautious in his approach to protect capital, not necessarily to maximize short term gains. Also, we're seeing unprecedented amounts of global stimulus that aren't sustainable. What happens when trillions in liquidity stops? The velocity of the dollar has continued to slow and has fallen very far from where it began in 2007. This is not the sign of a healthy economy, but is partly why we aren't seeing inflation from printing.

 

I think Watsa made a very smart choice. He looked at the unprecedented rise in global debt over the last 30 years, asked himself what are the consequences if this goes South, and hedged accordingly. This was a way to protect his business. Could we have profited from it? Sure. Was that the intention? Unlikely. Secondly, you focused on all U.S. statistics but the majority of the deflationary derivatives were written on Europe. Europe does appear to be heading towards a deflationary end game and these may still pay off in the next 5 years.

 

 

I have nothing to add but do I count as an upcoming generation? I graduated in 2011 and I bought a house in 2012 and now I am trying to buy another.  ;D This is in the SF Bay area too so no 200k house for me.

 

Plenty of people still have money.

 

 

As for inflation or deflation, I have no clue!

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They were wrong about credit default swaps from early 2005 to early 2008 too.  What happened from mid-2008?

 

Let me ask you guys something.  Just because things are good and improving in the United States...does that exclude the possibility of a crisis elsewhere around the world?

 

I've been bullish on the U.S. for over four years now since 2008/2009, and I'm still bullish on the U.S. long-term.  But I'm scared shitless of what might happen in Europe and if China's balance sheet isn't quite kosher!  Your investment horizon is far too short to conclude that Fairfax is wrong on their analysis.  Only in hindsight, perhaps at least another five years out, will we know for sure who is correct or not.  Cheers!

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Also for the most part, HW has bet on these idea with options so their loss are capped.  This is the smart way to play the deflation/market overvaluation situations.  The one exception is the equity hedges in which I think they should have purchased LT puts versus outright shorts.  At this point, the outright short has lost much of the profits HW has made in the past.

 

Packer

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As Prem might say, it appears to still be "early days" with this trade.

 

Sure the U.S. has picked up, but look at any industrial company in Europe and sales and order backlogs are doing a cliff dive. Plus who knows what Asia looks like as China cools. I think it is Time to review some photos of Ordos, China.

 

http://www.time.com/time/photogallery/0,29307,1975397_2094502,00.html

 

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US Budget deficit is shrinking.

    - http://www.bloomberg.com/news/2013-05-14/u-s-deficit-to-fall-to-642-billion-says-budget-agency.html

US house prices are increasing.

US Trade balance is improving.

US retail investor is not shying away from the stock market.

US is not experiencing a deflation - yet.

 

1) take anything the CBO says with a very large grain of salt. Their prediction record has been abysmal.

2) housing prices are increasing? Maybe the third time since 2009 will be the charm. Tell me who will buy them when the coming generation is graduating with the largest amounts of student debt and the lowest paying jobs we've seen in a decade?

3) trade balance is improving precisely because individuals can no longer afford many of the imported luxuries they used to buy IMO. Hardly bullish.

4) stock mutual fund flows have consistently been negative up until this year. Not sure if this will last through the next correction or not.

5) deflation takes years to culminate. Even Greece is just now experiencing it. Increased Federal debt has made up nearly every penny of consumer deleveraging. All that's hit the economy has been corporate deleveraging if I recall my numbers correctly. Realize that all interests have to do is go back to the 4-5% they were at before the crash and we're spending more than 30% of current government receipts servicing interest. You don't think that will be a drag on th future economy? Spending will have to be cut somewhere or revenues will have to rise or we can keep interest rates artificially low until we've inflated enough of the debt away where that's not a threat (not bullish for the economy either),

 

 

US industrial production is increasing

US retail sales are increasing

US non-farm jobs being added

US housing affordability at multi-decade high

US consumer debt service at multi-decade low

US price-to-rent at multi-decade low

US bank capital levels at multi-decade high

US banks wrote-off ~500B of losses with write-offs declining

US new home sales / construction growing from a level lower than when US had half the population it has now

 

1) industrial production increasing isn't a substantial part of the economy anymore. I'd say this is more of a lagging indicator and is a small part of a much much larger economy.

2) debt service is only at multi-decade lows due to extremely low rates. What happens when rates rise with a recovey?

3) bank capital ratios mean nothing in light of the trillions of derivatives that they hold on their books with global counterparties who aren't as strong (European banks leveraged 30-to-1 who have gone double or nothing in buying European sovereign debt).

4) the level that housing construction is rising from is meaningless without the context of the overbuilding that occurred. There are still empty neighborhoods with vacant houses in places where the most overbuilding occurred.

5) housing may be the most affordable it's been, but only for those who can obtain credit. Not the easiest task nowadays.

6) non-farm jobs are being added but they're typically low wage, part time jobs that are replacing the full time jobs. Not bullish for real wages (which have been declining for a decade) which means its not all that bullish for the long-term economy. Granted, some jobs are better than no jobs.

 

All of this isn't to say that I think Watsa will be right. It's simply saying arguments could very easily be made for the other side. He's been cautious in his approach to protect capital, not necessarily to maximize short term gains. Also, we're seeing unprecedented amounts of global stimulus that aren't sustainable. What happens when trillions in liquidity stops? The velocity of the dollar has continued to slow and has fallen very far from where it began in 2007. This is not the sign of a healthy economy, but is partly why we aren't seeing inflation from printing.

 

I think Watsa made a very smart choice. He looked at the unprecedented rise in global debt over the last 30 years, asked himself what are the consequences if this goes South, and hedged accordingly. This was a way to protect his business. Could we have profited from it? Sure. Was that the intention? Unlikely. Secondly, you focused on all U.S. statistics but the majority of the deflationary derivatives were written on Europe. Europe does appear to be heading towards a deflationary end game and these may still pay off in the next 5 years.

 

 

I have nothing to add but do I count as an upcoming generation? I graduated in 2011 and I bought a house in 2012 and now I am trying to buy another.  ;D This is in the SF Bay area too so no 200k house for me.

 

Plenty of people still have money.

 

 

As for inflation or deflation, I have no clue!

 

Plenty of people may have money but not enough people are working to sustain it IMO. And at this rate and with these policies in place and Obamacare ready to really kick in, I find it highly unlikely employment will pick up significantly enough to change the underlying problem. I very well may be proven wrong but this sure feels like a game of musical chairs to me. The party is great until the music stops. Watsa has reserved a chair for us shareholders for that moment....should it come. Right or wrong, I agree with that bet.

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As Prem might say, it appears to still be "early days" with this trade.

 

Sure the U.S. has picked up, but look at any industrial company in Europe and sales and order backlogs are doing a cliff dive. Plus who knows what Asia looks like as China cools. I think it is Time to review some photos of Ordos, China.

 

http://www.time.com/time/photogallery/0,29307,1975397_2094502,00.html

 

The photos of Ordos are dramatic, by our standards, but keep in mind that the estimates are that urbanization increase over the next 15 years will be 300 million people.  That's about 12 Manhattans a year, 1 Manhattan every month for the next 15 years.  Approximately 1 America.  Now that's dramatic!

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US Budget deficit is shrinking.

    - http://www.bloomberg.com/news/2013-05-14/u-s-deficit-to-fall-to-642-billion-says-budget-agency.html

US house prices are increasing.

US Trade balance is improving.

US retail investor is not shying away from the stock market.

US is not experiencing a deflation - yet.

 

1) take anything the CBO says with a very large grain of salt. Their prediction record has been abysmal.

2) housing prices are increasing? Maybe the third time since 2009 will be the charm. Tell me who will buy them when the coming generation is graduating with the largest amounts of student debt and the lowest paying jobs we've seen in a decade?

3) trade balance is improving precisely because individuals can no longer afford many of the imported luxuries they used to buy IMO. Hardly bullish.

4) stock mutual fund flows have consistently been negative up until this year. Not sure if this will last through the next correction or not.

5) deflation takes years to culminate. Even Greece is just now experiencing it. Increased Federal debt has made up nearly every penny of consumer deleveraging. All that's hit the economy has been corporate deleveraging if I recall my numbers correctly. Realize that all interests have to do is go back to the 4-5% they were at before the crash and we're spending more than 30% of current government receipts servicing interest. You don't think that will be a drag on th future economy? Spending will have to be cut somewhere or revenues will have to rise or we can keep interest rates artificially low until we've inflated enough of the debt away where that's not a threat (not bullish for the economy either),

 

 

US industrial production is increasing

US retail sales are increasing

US non-farm jobs being added

US housing affordability at multi-decade high

US consumer debt service at multi-decade low

US price-to-rent at multi-decade low

US bank capital levels at multi-decade high

US banks wrote-off ~500B of losses with write-offs declining

US new home sales / construction growing from a level lower than when US had half the population it has now

 

1) industrial production increasing isn't a substantial part of the economy anymore. I'd say this is more of a lagging indicator and is a small part of a much much larger economy.

2) debt service is only at multi-decade lows due to extremely low rates. What happens when rates rise with a recovey?

3) bank capital ratios mean nothing in light of the trillions of derivatives that they hold on their books with global counterparties who aren't as strong (European banks leveraged 30-to-1 who have gone double or nothing in buying European sovereign debt).

4) the level that housing construction is rising from is meaningless without the context of the overbuilding that occurred. There are still empty neighborhoods with vacant houses in places where the most overbuilding occurred.

5) housing may be the most affordable it's been, but only for those who can obtain credit. Not the easiest task nowadays.

6) non-farm jobs are being added but they're typically low wage, part time jobs that are replacing the full time jobs. Not bullish for real wages (which have been declining for a decade) which means its not all that bullish for the long-term economy. Granted, some jobs are better than no jobs.

 

All of this isn't to say that I think Watsa will be right. It's simply saying arguments could very easily be made for the other side. He's been cautious in his approach to protect capital, not necessarily to maximize short term gains. Also, we're seeing unprecedented amounts of global stimulus that aren't sustainable. What happens when trillions in liquidity stops? The velocity of the dollar has continued to slow and has fallen very far from where it began in 2007. This is not the sign of a healthy economy, but is partly why we aren't seeing inflation from printing.

 

I think Watsa made a very smart choice. He looked at the unprecedented rise in global debt over the last 30 years, asked himself what are the consequences if this goes South, and hedged accordingly. This was a way to protect his business. Could we have profited from it? Sure. Was that the intention? Unlikely. Secondly, you focused on all U.S. statistics but the majority of the deflationary derivatives were written on Europe. Europe does appear to be heading towards a deflationary end game and these may still pay off in the next 5 years.

 

 

I have nothing to add but do I count as an upcoming generation? I graduated in 2011 and I bought a house in 2012 and now I am trying to buy another.  ;D This is in the SF Bay area too so no 200k house for me.

 

Plenty of people still have money.

 

 

As for inflation or deflation, I have no clue!

 

The recovery is bifurcated. I've been fortunate to see both sides. I graduated in 2011 in Mississippi. Many friends are still unemployed, or employed at part time jobs, can't afford to move away from home and certainly can't afford to save any significant amount. Me? I had no student debt, moved to Manhattan, got a job and have done well for myself. Most people up here seem to be doing well. Many people I know from MS, AL, LA, GA , etc. aren't. It seems like the upper 10% are doing pretty well. Everyone else is struggling and jogging in place.

 

Congratulations on the houses though. I was trying to buy a piece of rental property 2 years back that was occupied by a Dollar General. Place yielded $50K a year, was on sale for $250K from a motivated seller. I had 20% down between myself and my business partner, had been to the property in person, we had pristine credit, banks approved us on cash flow coverage, collateral, credit scores, business model, insurance, and still refused to give us a loan. Said they don't give loans to new businesses, or they don't give loans to out of state principals, or th don't give loans for out of state properties. Every where we turned we got turned down for reasons that didn't seem to really matter (non-economic reasons). This was banks in NYC and MS. Didnt sound as if banks were too interested in making loans if they're turning away business like that. Can't even imagine what's its like for someone with poor credit and/or no savings.

 

As Prem might say, it appears to still be "early days" with this trade.

 

Sure the U.S. has picked up, but look at any industrial company in Europe and sales and order backlogs are doing a cliff dive. Plus who knows what Asia looks like as China cools. I think it is Time to review some photos of Ordos, China.

 

http://www.time.com/time/photogallery/0,29307,1975397_2094502,00.html

 

The photos of Ordos are dramatic, by our standards, but keep in mind that the estimates are that urbanization increase over the next 15 years will be 300 million people.  That's about 12 Manhattans a year, 1 Manhattan every month for the next 15 years.  Approximately 1 America.  Now that's dramatic!

 

I think when you say Manhattan, people who don't live there  typically think of the entirety of NYC (could be wrong). Just to make things clear in those terms, it's about 2.5 NYCs every year. That being said, this has been the trend for awhile and Ordos has been empty for years, just because that many people are urbanizing doesn't mean they're going to move to the empty cities. They're going to move to the cities where there are jobs. Jobs will be provided by businesses who need customers (also not found in empty cities). I have a hard time seeing these places filled up without the government forcing them to be. Then the question becomes what kind of long term structural disadvantage do they have in that location. Large cities grew to be what they are largely because they were at the center of some big trade activity (close to ports, rivers, or the source of raw materials). They dont just pop up out of nowhere for no reason. Was there a reason that not many people lived these areas of a China in the first place? Probably because they weren't well situated for large cities. Governments without a profit motive often misallocate capital in this way.

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If the laws of China were like Quebec laws I'd arbitrage the legislation. I would move in one of the ready to be demolished building at dirt cheap rent and ask for a shitload of money when they ask me to leave :)

 

BeerBaron

 

Doesn't always work out. Tonnes of these nail houses. Like this one - newly built for 600,000 yuan compensated 260,000 yuan when government decided to put a highway right through it.  Classic picture though.

 

http://news.nationalpost.com/2012/12/03/chinese-nail-house-finally-demolished-from-middle-of-highway-after-duck-farmer-agrees-41000-payoff/

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If the laws of China were like Quebec laws I'd arbitrage the legislation. I would move in one of the ready to be demolished building at dirt cheap rent and ask for a shitload of money when they ask me to leave :)

 

BeerBaron

 

Doesn't always work out. Tonnes of these nail houses. Like this one - newly built for 600,000 yuan compensated 260,000 yuan when government decided to put a highway right through it.  Classic picture though.

 

http://news.nationalpost.com/2012/12/03/chinese-nail-house-finally-demolished-from-middle-of-highway-after-duck-farmer-agrees-41000-payoff/

 

Well China is no Quebec :)

 

BeerBaron

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If the laws of China were like Quebec laws I'd arbitrage the legislation. I would move in one of the ready to be demolished building at dirt cheap rent and ask for a shitload of money when they ask me to leave :)

 

BeerBaron

 

Doesn't always work out. Tonnes of these nail houses. Like this one - newly built for 600,000 yuan compensated 260,000 yuan when government decided to put a highway right through it.  Classic picture though.

 

http://news.nationalpost.com/2012/12/03/chinese-nail-house-finally-demolished-from-middle-of-highway-after-duck-farmer-agrees-41000-payoff/

 

I'm surprised they used all that effort to build around it. Just demolish and keep going. What is the owner going to do? Sue? funny.

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"the laws of China " ?

hehe, give me a break...

 

If the laws of China were like Quebec laws I'd arbitrage the legislation. I would move in one of the ready to be demolished building at dirt cheap rent and ask for a shitload of money when they ask me to leave :)

 

BeerBaron

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