Thursday, March 31, 2011

The “I don’t know” school of investing

From Howard Marks’ July 2003 Memo (“The Most Important Thing”):

One thing each market participant has to decide is whether he (or she) does or does not believe in the ability to see into the future: the “I know” school versus the “I don’t know” school. The ramifications of this decision are enormous.

If you know what lies ahead, you’ll feel free to invest aggressively, to concentrate positions in the assets you think will do best, and to actively time the market, moving in and out of asset classes as your opinion of their prospects waxes and wanes. If you feel the future isn’t knowable, on the other hand, you’ll invest defensively, acting to avoid losses rather than maximize gains, diversifying more thoroughly, and eschewing efforts at adroit timing.

Of course, I feel strongly that the latter course is the right one. I don’t think many people know more than the consensus about the future of economies and markets. I don’t think markets will ever cease to surprise, or thus that they can be timed. And I think avoiding losses is much more important than pursuing major gains if one is to achieve the absolute prerequisite for investment success: survival.


Book: The Most Important Thing

Malcolm Gladwell to speak at Molloy College on THE PERILS OF OVERCONFIDENCE

Looks interesting for those in the NYC area:

Molloy College Presents

Business Leadership:


Featuring Keynote Speaker:

Malcolm Gladwell
Phenomenal best-selling author

at the
Joe and Peggy Maher Leadership Forum

Hays Theatre, Wilbur Arts Center
April 15, 2011
9:30 a.m.
Panel Discussion Following Keynote

Bill Gross – April 2011 Investment Outlook: Skunked

Previous Congresses (and Administrations) have relied on the assumption that we can grow our way out of this onerous debt burden. Perhaps we could, if it was only $9.1 trillion, as shown in Chart 2. That would be 65% of GDP and well within reasonable ranges for sovereign debt burdens. But that is not the reality. As others, such as Pete Peterson of the Blackstone Group and Mary Meeker, have shown much better and for far longer than I, the true but unrecorded debt of the U.S. Treasury is not $9.1 trillion or even $11-12 trillion when Agency and Student Loan liabilities are thrown in, but $65 trillion more! This country appears to have an off-balance-sheet, unrecorded debt burden of close to 500% of GDP! We are out-Greeking the Greeks, dear reader.

If so, and if the USA were a corporation, then it would probably have a negative net worth of $35-40 trillion once our “assets” were properly accounted for, as pointed out by Mary Meeker and endorsed by luminaries such as Paul Volcker and Michael Bloomberg in a recent piece titled “USA Inc.” However approximate and subjective that number is, no lender would lend to such a corporation. Because if that company had a printing press much like the U.S. with an official “reserve currency” seal of approval affixed to every dollar bill, that lender/saver would have to know that the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation – surely unthinkable, 2) surreptitiously via accelerating and unexpectedly higher inflation – likely but not significant in its impact, 3) deceptively via a declining dollar– currently taking place right in front of our noses, and 4) stealthily via policy rates and Treasury yields far below historical levels – paying savers less on their money and hoping they won’t complain.


Related link: "USA Inc."

Wal-Mart CEO Bill Simon expects inflation

U.S. consumers face "serious" inflation in the months ahead for clothing, food and other products, the head of Wal-Mart's U.S. operations warned Wednesday.

The world's largest retailer is working with suppliers to minimize the effect of cost increases and believes its low-cost business model will position it better than its competitors.

Still, inflation is "going to be serious," Wal-Mart U.S. CEO Bill Simon said during a meeting with USA TODAY's editorial board. "We're seeing cost increases starting to come through at a pretty rapid rate."

"We're in a position to use scale to hold prices lower longer ... even in an inflationary environment," Simon says. "We will have the lowest prices in the market."

Major retailers such as Wal-Mart are the best positioned to mitigate some cost increases, Long says. Wal-Mart, for example, could have "access to any factory in any country around the globe" to mitigate the effect of inflation in the U.S., Long says.

Still, "it's certainly going to have an impact," Long says. "No retailer is going to be able to wish this new cost reality away. They're not going to be able to insulate the consumer 100%."


Related previous post: Is Warren Buffett Worried About Hyperinflation?

Specifically, this comment from David Poppe:

I agree with that. Wal-Mart’s competitive advantage, the reason Wal-Mart has the lowest cost, is in large part because it has a substantial advantage in distribution versus almost anyone. Target has not expanded in the same kind of tightly concentric circles because Target requires a little bit higher demographic neighborhood for the store to work and be successful. So it’s not as simple an issue for them to just build them out two miles at a time across the country.

So Target’s strategy is a little bit different. Target’s got low cost but they will never be as low as Wal-Mart’s. They will never have as many stores as Wal-Mart because Target has a narrower customer base. On the other hand, however, I would say Target has a pretty desirable store base because they opened a lot of stores in large metro markets that will be difficult for Wal-Mart to penetrate. I think they’ll both be successful, but Wal-Mart certainly is and will continue to be the low cost provider. Bob talked about companies that are well-positioned for inflation — I can’t think of too many companies that are better positioned for hyperinflation than Wal-Mart.

David Sokol on CNBC

Link to video: David Sokol on CNBC

Wednesday, March 30, 2011

David Sokol resigns from Berkshire

A top executive of Berkshire Hathaway who was believed to be on the inside track to one day succeed billionaire Warren Buffett as CEO has resigned suddenly.

Buffett said Wednesday that David Sokol's resignation letter, delivered by his assistant late Monday, came as a "total surprise." But the resignation letter arrived less than two weeks after Buffett learned about stock trades that Sokol made before Berkshire announced its $9 billion acquisition of chemical company Lubrizol.

Buffett said Sokol, who had been serving as chairman of Berkshire's MidAmerican Energy, NetJets and Johns Manville units, indicated that he wants to spend more time on philanthropy.

"As I have mentioned to you in the past, it is my goal to utilize the time remaining in my career to invest my family's resources in such a way as to create enduring equity value and hopefully an enterprise which will provide opportunity for my descendents and funding for my philanthropic interests," Sokol wrote.

Buffett said twice before, most recently about two years ago, Sokol had spoken to him of resigning for similar reasons but Buffett and other board members convinced him to stay with the company. He accepted Sokol's resignation this time.


Warren Buffett's press release: Warren E. Buffett, CEO of Berkshire Hathaway, Announces the Resignation of David L. Sokol

GR-NEAM Reflections: April 2011 - Earthquake Now, Windstorm Later

Thanks to Matt for passing this along.

The Manual of Ideas: Jacob Wolinsky's Interview with Guy Spier

Related previous posts:

Microsoft’s Odd Couple - By Paul Allen

Found via Simoleon Sense.

It’s 1975 and two college dropouts are racing to create software for a new line of “hobbyist” computers. The result? A company called “Micro-Soft”—now the fifth-most-valuable corporation on earth. In an adaptation from his memoir, the author tells the story of his partnership with high-school classmate Bill Gates, until its dramatic ending in 1983.

February 2007 Paper: How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?

Executive Summary

The mortgage-backed securities (MBS) market has experienced significant changes over the past couple of years. Non-agency (“private label”) securities, which are not guaranteed by the government or the government sponsored enterprises, now account for the majority of MBS issued. This report reviews the rise of collateralized debt obligations (CDOs), the relaxation of lending standards, the implementation of loan mitigation practices and whether these structural changes have created an environment of understated risk to investors of MBS. The authors go on to measure the efficacy of ratings agencies when it comes to assessing market risk rather than credit risk. They determine that even investment grade rated CDOs will experience significant losses if home prices depreciate, leading to broader imbalances in the U.S. economy that, if left unchecked, could lead to prolonged economic difficulties.

Investment Strategy: All About the Benjamins - By Mark Spitznagel

Thanks to Jason for passing this along.

Charlie Rose Interview with Lee Kuan Yew


Tuesday, March 29, 2011

Chou Funds: 2010 Annual Report

Found via The Corner of Berkshire & Fairfax.

We went through a traumatic financial crisis in 2008 and 2009 and you can argue that under exceptional circumstances, the Government can, maybe should, intervene in the economy, as the U.S. Federal Reserve (Fed) did with massive quantitative easing starting in 2008. As we all know, governments everywhere have intervened in securities markets for decades by artificially lowering interest rates during declines and artificially supporting prices. That said, I’m always uneasy when this happens, primarily because such interventions skew the markets and make it difficult for investors to determine the soundness of a business and its prospects for future success.

Most Highlighted Kindle Passages from Seneca’s Letters

Currently the most highlighted Kindle passages from Seneca’s Letters from a Stoic. For other books, go HERE.

Nothing, to my way of thinking, is a better proof of a well ordered mind than a man’s ability to stop just where he is and pass some time in his own company.
Highlighted by 49 Kindle users
To be everywhere is to be nowhere. People who spend their whole life travelling abroad end up having plenty of places where they can find hospitality but no real friendships.
Highlighted by 38 Kindle users
It is not the man who has too little who is poor, but the one who hankers after more.
Highlighted by 76 Kindle users
You ask what is the proper limit to a person’s wealth? First, having what is essential, and second, having what is enough.
Highlighted by 46 Kindle users
Limiting one’s desires actually helps to cure one of fear. ‘Cease to hope,’ he says, ‘and you will cease to fear.’
Highlighted by 46 Kindle users
Fear keeps pace with hope. Nor does their so moving together surprise me; both belong to a mind in suspense, to a mind in a state of anxiety through looking into the future. Both are mainly due to projecting our thoughts far ahead of us instead of adapting ourselves to the present.
Highlighted by 48 Kindle users
There is no enjoying the possession of anything valuable unless one has someone to share it with.
Highlighted by 47 Kindle users
Associate with people who are likely to improve you. Welcome those whom you are capable of improving. The process is a mutual one: men learn as they teach.
Highlighted by 66 Kindle users
‘Any man,’ he says, ‘who does not think that what he has is more than ample, is an unhappy man, even if he is the master of the whole world.’
Highlighted by 47 Kindle users
‘If you shape your life according to nature, you will never be poor; if according to people’s opinions, you will never be rich.’
Highlighted by 57 Kindle users

Most Highlighted Kindle Passages from Gladwell's Outliers

Currently the most highlighted Kindle passages from Outliers: The Story of Success, By Malcolm Gladwell. For other books, go HERE.

Success is the result of what sociologists like to call “accumulative advantage.”
Highlighted by 1659 Kindle users
Achievement is talent plus preparation. The problem with this view is that the closer psychologists look at the careers of the gifted, the smaller the role innate talent seems to play and the bigger the role preparation seems to play.
Highlighted by 1161 Kindle users
Their research suggestes that once a musician has enough ability to get into a top music school, the thing that distinguishes one performer from another is how hard he or she works. That’s it. And what’s more, the people at the very top don’t work just harder or even much harder than everyone else. They work much, much harder.
Highlighted by 1151 Kindle users
The idea that excellence at performing a complex task requires a critical minimum level of practice surfaces again and again in studies of expertise. In fact, researchers have settled on what they believe is the magic number for true expertise: ten thousand hours.
Highlighted by 948 Kindle users
Practice isn’t the thing you do once you’re good. It’s the thing you do that makes you good.
Highlighted by 2269 Kindle users
Those three things—autonomy, complexity, and a connection between effort and reward—are, most people agree, the three qualities that work has to have if it is to be satisfying.
Highlighted by 3466 Kindle users
Hard work is a prison sentence only if it does not have meaning. Once it does, it becomes the kind of thing that makes you grab your wife around the waist and dance a jig.
Highlighted by 1297 Kindle users
if you work hard enough and assert yourself, and use your mind and imagination, you can shape the world to your desires.
Highlighted by 1438 Kindle users
Success is a function of persistence and doggedness and the willingness to work hard for twenty-two minutes to make sense of something that most people would give up on after thirty seconds.
Highlighted by 1472 Kindle users
Outliers are those who have been given opportunities—and who have had the strength and presence of mind to seize them.
Highlighted by 1984 Kindle users

Changes in the Inflation Rate Matter as Much to Investors as the Level - By Bill Hester

The topic of inflation tends to be a tool used by both sides of the debate about stock market performance. It's argued that because corporations can pass on rising prices of raw goods to consumers, earnings will keep pace with inflation, so equities are a good hedge against inflation. It's also argued that because the 1970's was a terrible decade to own stocks, very high rates of inflation must be bad for equities. As in many discussions surrounding financial market topics, there is some truth in each of these arguments. But the full story tends not to lend itself to such broad generalizations. As John Hussman observed a few weeks ago, stocks can benefit from inflation once it is widely anticipated and well-reflected in valuations, but otherwise, stocks are not a very good inflation hedge in periods when inflation is rising.

Maybe one of the most underrated risks regarding inflation is the speed at which it is rising, even if that increase is off of a low base. It's not high levels of inflation that precede important stock market declines, but instead how rapidly inflation is rising relative to its recent trend. And when you mix an overvalued market with rapidly rising inflation, bad outcomes tend to follow.


The start of a contraction in valuation multiples has historically come long before high levels of inflation. Rather, it's inflation rising faster than its recent trend - sparking concerns of higher longer-term inflation - that increases risk aversion among investors. When these periods occur alongside high P/E ratios, the contraction in multiples has usually been substantial. Ben Bernanke recently told Congress that he is confident that the recent rise in the rate of inflation will be temporary, and that inflation expectations are unlikely to become unhinged. Stock investors must be able to share that belief and that forecast, because a change in longer-term inflation expectations – even from a low base – would increase stock market risks importantly.

GMO’s Market Outlook: "Disappointingly Overvalued"

Opportunities across US and foreign assets classes are unattractive, according to Ben Inker, the head of asset allocation at the Boston-based global money manager Grantham, Mayo, van Otterloo & Co. (GMO). Neither the equity nor fixed income markets hold the potential for investors to earn acceptable inflation-adjusted returns, Inker said.

Inker delivered the keynote address at a conference on the global outlook and investment strategies held at Babson College on March 25.

Markets were “desperately overvalued” in mid-2007, prior to the financial crisis, Inker said. Since then, they have gone from “very interestingly cheap” in March of 2009 to today’s level, which he called “disappointingly overvalued.”

“This is where the life of an asset allocator gets very difficult,” he said. “Unfortunately right now we are not exactly sure what the right thing to do with our clients’ money is.”

Normalized P/E ratios are not extraordinarily rich, Inker said. He said the market is typically valued at 15 times earnings, and today it is priced at a ratio of 18.

A bigger issue, though, is that corporate profits are “unsustainably high and are going to come down,” Inker said. He said that we have just witnessed the fastest recovery of corporate profits in history, and they are already well above the average for other post-recession periods.

Analysts have forecast that profit margins are going to get to a level never seen before in history, Inker said. One reason is that capacity utilization in the economy is very low, and when it has been low in the past margins have expanded.

Inker doesn’t believe increased utilization will drive profits higher in this environment. Profits are defined in economic terms as the sum of net investments and dividends, less savings by the rest of the economy. The latter two terms tend to be fairly stable over time, and changes in net investments are what have caused profits to rise and fall, he said.

In the last 20 years, though, higher profits have been more a result of the government running a 9% deficit, Inker said, than of higher investment. Inker said that from 1952-1986 profits and capacity utilization had a positive correlation of 0.57; since 1987, however, that correlation was -0.17.

Even if net investment were to triple – which Inker said isn’t actually that hard to do – and if the government went to a “sustainable level of deficits, there just isn’t enough money out there for corporations.”

Bonds offer disappointing prospects for other reasons. Government yields are now at 60-year lows, Inker said. The last time yields were this low was in the 1940s, and bonds then were a “spectacularly bad investment for length of time longer than most professional careers,” he said. Indeed, for the next 40 years, bond investors suffered worse returns than cash investors.

Monday, March 28, 2011

Rick Bookstaber: Human Complexity & Financial Markets

Found via Simoleon Sense.

In a recent post I discuss the limitations of neoclassical economics and the strain of behavioral economics that remains tethered to it. I argue that they fail because the market is inhabited by people, heterogeneous and context-sensitive, who do not live up to the lofty assumptions of mathematical optimization and Aristotelian logic that underlie these approaches – and do not do so for good reasons.

The nature of complexity also is different in the economic realm from that in physical systems because it can stem from people gaming, from changing the rules and assumptions of the system. Ironically, "game theory" is not suited to addressing this source of complexity. But military theory is.

John Mauldin: Unintended Consequences

The central banks of the developed world are printing money and are engaged in a very-low-interest-rate regime. What does that mean for emerging markets? It is more than just a dilemma, it is a tri-lemma – they have problems not just coming and going but also sitting still! I am in Zurich tonight after a long day, with a 4:30 AM wake-up call to get back home, but deadlines are deadlines. So, to make this one easier on me as well as hopefully instructive for you, you will get chapter 15 of my new book, Endgame, in which coauthor Jonathan Tepper and I speculate about the future of emerging markets in general and investments in them in particular.

It’s 2026, and the Debt Is Due - By N. Gregory Mankiw

The following is a presidential address to the nation — to be delivered in March 2026.

Hussman Weekly Market Comment: QE2 - Apres Moi, le Deluge

Last week, a number of Fed officials came out in tandem with essentially the same message - the Fed's policy of quantitative easing is likely to end with QE2. It's important to think carefully about the implications of this for the markets. My impression is that investors are still in something of a "momentum" mentality both with respect to the market and the overall economy, and it's not clear that they've pieced out the extent to which this has been reliant on various stimulus measures that are now drawing to a close.

It is clear that the effect of QE2 has not been to lower interest rates, or to materially expand credit. Rather, QE2 has been built on two blunt forces. The first is that increasing the stock of non-interest bearing money in the economy toward $2.4 trillion, all of which has to be held by somebody, the Fed has created a market environment that has raised the prices and lowered the returns on all competing assets in order to accommodate that equilibrium. As asset prices are bid up, their expected future returns fall, and the process stops at the point where on a risk-adjusted basis, no asset is expected to achieve returns that compete meaningfully with cash (at least over some horizon of say, a year or two). The second force has been purely rhetorical. The opening salvo in QE2 was Bernanke's public endorsement of risk-taking in the Washington Post. Strikingly, he has seemed to eagerly take credit for the speculation in the stock market, particularly in small cap stocks, while denying any culpability for the commodity hoarding and dollar weakness that predictably results from driving real short-term interest rates to negative levels.

In our view, quantitative easing has been a reckless policy, not only because it has fueled what Dallas Fed president Richard Fisher calls "extraordinary speculative activity," but because aside from a burst of short-term optimism, the historical evidence is clear that fluctuations in stock prices have very little impact on real spending (the so-called wealth effect is on the order of 0.03-0.05% for every 1% change in stock prices). People consume off of perceived permanent income, not off of fluctuations in the prices of volatile assets. Now, it's true that QE2 has probably been good for a fraction of 1% in additional GDP, which should be sustained over a period of a year or two, and though we haven't observed real activity or actual industrial production that matches the optimism of survey-based measures such as the ISM indices, it's clear that some pent-up demand was released. Still, the links between monetary base expansion, stock values, and GDP growth are tenuous at best. The most predictable outcome was commodity hoarding, where our expectations have been fully realized, with awful consequences for the world's poor, not to mention for geopolitical stability.

So for our part, we'd be happy to see the termination of QE simply because it is misguided, reckless policy. In contrast, most of the Fed officials pulling back on their enthusiasm for QE argue along the lines that "the economy is strong enough now to do without it," which is unfortunate because it leaves the door open to continue this sort of lunacy should the economy weaken again.


The belief that low real interest rates are helpful is the result of confusing the demand curve with equilibrium itself. Yes, strictly from the demand curve, lower real interest rates are associated with greater demand for capital investment and so forth. But if we want growth, then what we really desire is a persistent outward shift in the demand curve. We want increased desire for real investment and employment at every level of real interest rates. Meanwhile, on the supply side, higher real interest rates help to induce a shift from consumption toward savings that can be directed to finance that new investment. In equilibrium, then, what generally precedes strong economic growth is an upward movement in real rates. Trying to engineer low real rates, which is what the Fed seems to want, is an attempt to move along the existing demand curve, which can never, in itself, be the source of sustained growth, and harms savers at the same time (as the Fed's Richard Fisher observed last week, it only works to "continue the injustice against the virtuous.")

Friday, March 25, 2011

Bloomberg Video: Buffett Says Avoid Long-Term Bonds Tied to Lower Dollar

Thanks to Matt for passing this along.

Link to: Buffett Says Avoid Long-Term Bonds

Glenview Capital - Larry Robbins Annual Letter to Investors

Found via GuruFocus.

Seth Klarman Videos - March 2009

The Seth Klarman videos below are making their rounds again, but they are worth reviewing, so here they are. I had originally linked to them HERE, which will take you to the Ben Graham Center for Value Investing site that has a lot of other great videos as well. Also, be sure to check out Value Walk’s Seth Klarman Resource Page.

Dylan Grice on Inflation and Gold

Via Zero Hedge.

Today our central bankers are as confident in their ability to control inflation (Mr. Bernanke claims 100% confidence) as they were in the soundness of the financial system in 2006. Yet history suggests they shouldn’t be, for inflation goes back almost as far as we do. In the ancient Greek comedy, The Frogs, written in 405BC, Aristophanes writes that “the full-bodied coins that are the pride of Athens are never used while the mean brass coins pass hand to hand”. His reference to Gresham’s law predates Sir Thomas Gresham’s first observation during the medieval inflation of Henry VIII’s England by around two thousand years. As the play was written during the closing years of the epic Peloponnesian Wars which would have stretched the government’s budget, we can assume that Aristophanes and his audience witnessed inflation first hand.

Like credit crunches, there is nothing new about inflation crises. It’s not something which happened in the past but which we now understand well enough to ensure it never happens again, any more than systemic banking crises were. Yet when we talk about past inflationary episodes, whether in classical times, medieval times or industrial times we read of the same two villains of the peace each time: financially pressured governments and the politicised issuance of money. With the festering off-balance sheet liabilities threatening public sector solvency throughout the developed world, and central banks little more than fiscal puppets and economic cheerleaders (with the exception of the ECB, for the moment), we’re set to reacquaint ourselves with those villains in the flesh.

Shorting mankind’s ingenuity isn’t a smart thing to do. But ingenuity isn’t wisdom. And shorting mankind’s ability to absorb wisdom … well, aren’t you silly if you don’t? With less of the technological risk you’re taking when you buy any other part of the commodities complex, gold is the oldest, purest and simplest way.

New Delhi Television Interviews Ajit Jain

Found via The Rational Walk.

Link to: Ajit Jain Interview (26 min.)

CNBC: Warren Buffett, Bill & Melinda Gates in India

Link to videos:

Investing in India

Philanthropy Push in India

Investing in India's Elite

Thursday, March 24, 2011

Nathan Myhrvold on Charlie Rose


Related previous post: The Game-Changing Cookbook

China’s cheap goods era over

The era of cheap products from China is coming to an end, one of the biggest suppliers of Chinese goods to western retailers warned on Thursday.

Li & Fung, which supplies companies like Walmart and Gap of the US and Debenhams of the UK, said “a new era in sourcing with higher prices” had begun as manufacturers pass on the rising costs of raw materials and Chinese labour to customers.

The Hong Kong-based consumer goods sourcing and logistics company on Thursday reported record annual profits. But Bruce Rockowitz, president of Li & Fung Trading, said: “The biggest topic on the minds of everyone in this business is that higher prices are really here to stay. At this point, retailers are not sure what they can pass on to consumers and what they cannot.”

Higher labour costs in China have prompted Li & Fung to move clothing production to lower-wage countries like Bangladesh, Vietnam and Indonesia. The company said that China now accounted for only 25 per cent of Li & Fung’s supplies of clothing as Bangladesh and Vietnam got more of its business.

Dateline SBS: China's Ghost Cities

Found via Mish.

Vast new cities of apartments and shops are being built across China at a rate of ten a year, but they remain almost completely uninhabited ghost towns.

It’s all part of the government’s efforts to keep the economy booming, and there are many people who would love to move in, but it’s simply too expensive for most.

Video journalist Adrian Brown wanders through malls of vacant shops, and roads lined with empty apartment buildings… 64 million apartments are said to be empty across the country and one of the few shop owners says he once didn’t sell anything for four or five days.

So are the efforts to boost the economy going to end up having the opposite effect and creating a financial crisis for China?

Howard Marks to Present at the 6th Annual Value Investing Congress West

Howard Marks, Chairman of Oaktree Capital Management, is scheduled as one of the presenters for the 6th Annual Value Investing Congress West that will take place on May 3 & 4 in Pasadena, California. Well known for his memos, Mr. Marks is also coming out with a book this year, The Most Important Thing, which should find its way to all value investors’ bookshelves. Much of what he writes in his memos is advice that stands the test of time, as evidenced by the quotes below, which I pulled from some of his memos in the 1990’s.

"Instead, we will continue to try to "know the knowable" -- that is, to work in markets which are the subject of biases, in which non-economic motivations hold sway, and in which it is possible to obtain an advantage through hard work and superior insight. We will work to know everything we can about a small number of things…rather than a little bit about everything.

Convertible securities, high yield bonds and distressed company debt are all markets in which market inefficiencies give rise to unusual opportunities in terms of return and risk. We will continue to exploit these opportunities in a manner which is risk-averse and non-reliant on macro-forecasts."

"It is often said that the market runs on fear and greed, but I believe it usually runs on fear or greed; that is, at most points in time, one or the other predominates."

"Warren Buffett said, in one of my favorite adages, "The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs." Another adage I'm fond of is, "What the wise man does in the beginning, the fool does in the end." No course of investment action is either wise or foolish in and of itself. It all depends on the point in time at which it is undertaken, the price that is paid, and how others are conducting themselves at that moment."

"I feel cyclicality is one of the few constants in the economy and markets. Cycles are the result of human behavior, herd instinct and the tendency to psychological excesses, and these things are unlikely to evaporate. Galbraith cites "the extreme brevity of the financial memory" in explaining why markets are able to move to extremes of euphoria and panic. And few adages have been borne out as often as "What the wise man does in the beginning, the fool does in the end." It is rare for trends to be curtailed at a reasonable point before swinging to the excesses from which they invariably correct."

"There is a right time to argue that things will be better, and that's when the market is on its backside and everyone else is selling things at giveaway prices. It's dangerous when the market's at record levels to reach for a positive rationalization that has never held true in the past. But it's been done before, and it'll be done again."

Readers of Value Investing World are eligible for a $500 discount to attend the Value Investing Congress West on May 3 & 4. To qualify for the discount, please use the link below and the discount code W11VIW4. The discount expires on March 31, 2011. Disclosure: Value Investing World receives a referral fee for registrations generated through the link.

Click to register for the 6th Annual Value Investing Congress West

Wednesday, March 23, 2011

Bloomberg Video: Buffett Says Opportunities Opening Up in India Every Day

Thanks to Matt for passing this along.

Link to: Buffett Says Opportunities Opening Up in India

Prem Watsa's 2010 Shareholder Letter - Fairfax Financial

2010 was a disappointing year for HWIC’s investment results because of the two factors mentioned earlier. Hedging our common stock investment portfolio cost us $936.6 million or $45.61 per share in 2010. Our hedging program masked the excellent common stock returns we earned in 2010, of which a significant amount was realized ($522.1 million). We began 2010 with about 30% of our common stock hedged. In May and June we decided to increase our hedge to approximately 100%. Our view was twofold: our capital had benefitted greatly from our common stock portfolio and we wanted to protect our gains, and we worried about the unintended consequences of too much debt in the system – worldwide! If the 2008/2009 recession was like any other recession that the U.S. has experienced in the past 50 years, we would not be hedging today. However, we worry, as we have mentioned to you many times in the past, that the North American economy may experience a time period like the U.S. in the 1930s and Japan since 1990, during which nominal GNP remains flat for 10 to 20 years with many bouts of deflation. We see many problems in Europe as country after country reduces government spending and increases taxes to help reduce fiscal deficits. We see the U.S. government embarking on a similar exercise (as it has no other option) and all this while businesses and individuals are deleveraging from their huge debts incurred prior to 2008. Meanwhile we have concerns over potential bubbles in emerging markets. Consider, for instance, what we learned on a recent trip to China: many house (apartment) prices in Beijing and Shanghai had gone up almost four times – in the past four to five years!; many individuals own multiple apartments as investments with the certain belief that real estate prices can only go up; and maids are taking holidays so that they can buy apartments also. “Buy two and sell one after it doubles to get one for free” goes the refrain! In his essay in Vanity Fair, “When Irish Eyes Are Crying”, Michael Lewis says, “Real estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long term investment real estate has become and flee the market, and the market will crash.” We agree!!


You know our concern re deflation. Well, Brian Bradstreet of CDS fame came up with a similar idea called CPI-linked derivative contracts. These are ten-year contracts (with major banks as counterparties) that are linked to the consumer price index of a country or region. Say the consumer price index in the U.S. was 100 when we purchased this contract. In ten years’ time, if the CPI index is above 100 because of cumulative inflation, then our contract is worthless. On the other hand, if the index is below 100 because of cumulative deflation, then the contract will have value based on how much deflation we have had. If, for instance, the index is at 95 because of a cumulative 5% deflation over 10 years, the contract at expiry would be worth 5% of the notional value of the contract. That’s how it works! Of course, these CPI-linked derivative contracts, like the CDS contracts previously, are traded daily among investment dealers. Prices in these markets will likely be higher or lower than the underlying intrinsic value of these contracts based on demand at the time. So there is no way to say what these contracts will be worth at any time. However, for a small amount of money we feel we have significantly protected our company from the unintended and insidious consequences of deflation. As an aside, cumulative deflation in Japan in the past ten years and in the United States in the 1930s was approximately 14%.

Tuesday, March 22, 2011