Buffett widens lead in $1 million hedge fund bet

Link to: Buffett widens lead in $1 million hedge fund bet

FORTUNE -- Results are in for the sixth year of the competition sometimes called the $1 million bet, and Warren Buffett -- once a piteous straggler in this 10-year wager on stock market performance -- has opened up a sizable lead over his opponent, New York asset manager Protégé Partners. Buffett's horse in the bet is a low-cost S&P index fund, and Protégé's is the averaged returns to investors (after all fees) of five hedge funds of funds that the firm carefully picked for the contest. 

At the end of 2013, Vanguard's Admiral shares -- the S&P index fund that's carrying Buffett's colors -- were up for the six years that began Jan. 1, 2008 by 43.8%. For the same period, Protégé's five funds of funds, on the average, gained only by an estimated 12.5% (a figure minutely uncertain because some of the funds lack final figures for 2013). 

By the terms of the bet, the names of those five funds of funds have never been publicly disclosed (though Buffett knows their identity). It has always been assumed that one of the five is a hedge fund of funds run by Protégé itself.

Bill Gross – February 2013 Investment Outlook: Most ‘Medieval’

Link to: Most ‘Medieval’

So for those of you who don’t live in Washington State or Colorado or others who are a little miffed at this example, let’s just put it this way. P/Es of 3 or P/Es of 15 or P/Es of 0 are intimately connected to the amount of available credit. So are interest rates. If there was only one dollar to lend and someone was desperate to have it, the interest rate would be usurious. If there was one trillion dollars of credit and no one was eager to borrow for some reason or another, then the rate would be .01% like it is today and for the past five years in my personal money market account. The amount of credit and its growth rate are critical to asset prices, and of course asset prices in our modern economy are critical to growth and job creation and future prospects for investment. We have a fiat/credit/debt-based economy that depends on the continuous creation of more and more credit in order to thrive and some would say – even survive. We need those pigs and more of them. And they need to circulate and be traded – what some would call “velocity” – in order to keep the economy growing. Our South Sea island economy never did change until the new crop was discovered, but concurrently, not until the pigs started to be traded for it. 

And so? Well, to use the U.S. as an example, we officially have 57 trillion dollars’ worth of credit (stocks not being part of the Fed’s official definition) and probably 20 trillion more in what has come to be known as the “shadow” system. But call it 57 trillion because the Fed and Chart 1 do. 

It used to grow pre-Lehman at 8–10% a year, but now it only grows at 3–4%. Part of that growth is due to the government itself with recent deficit spending. A deficit of one trillion dollars in 2009–2010 equaled a 2% growth rate of credit by itself. But despite that, other borrowers such as households/businesses/local and foreign governments/financial institutions have been less than eager to pick up the slack. With the deficit now down to $600 billion or so, the Treasury is fading as a source of credit growth. Many consider that as a good thing but short term, the ability of the economy to expand and P/Es to grow is actually negatively impacted, unless the private sector steps up to the plate to borrow/invest/buy new houses, etc. Credit over the past 12 months has grown at a snail’s 3.5% pace, barely enough to sustain nominal GDP growth of the same amount. 

Is there a one-for-one relationship between credit growth and GDP? Certainly not. That is where velocity complicates the picture and velocity is influenced by interest rates and the price of credit. But with QE beginning its taper, and interest/mortgage rates 150 basis points higher than they were in July of 2012, velocity may now negatively impact the equation. MV=PT or money X velocity = GDP is how economists explain it in old model textbooks. Actually the new model should read CV=PT or credit X velocity = GDP but most economists are classically trained to the Friedman model, which viewed money in a much narrower sense. 

So our PIMCO word of the month is to be “careful.” Bull markets are either caused by or accompanied by credit expansion. With credit growth slowing due in part to lower government deficits, and QE now tapering which will slow velocity, the U.S. and other similarly credit-based economies may find that future growth is not as robust as the IMF and other model-driven forecasters might assume. Perhaps the whisper word of “deflation” at Davos these past few weeks was a reflection of that.

 ..................

The Bill Gross piece reminded me of this quote from Richard Duncan, which I had posted previously:

“Total credit in the United States surpassed $1 trillion for the first time in 1964. Over the following 43 years, it increased 50 times to $50 trillion in 2007. That explosion of credit changed the world. ” –Richard Duncan, The New Depression

The Absolute Return Letter, February 2014: Challenging the Consensus

Link to: The Absolute Return Letter, February 2014: Challenging the Consensus 

Investors are overwhelmingly bearish on bonds going into 2014. In this month’s Absolute Return Letter we challenge that view and look at various reasons why the bond market may surprise most people and deliver a positive return this year. In no particular order, those reasons are: 

- The emerging market crisis escalates further;
- The Eurozone crisis re-ignites;
- The disinflationary trend intensifies and potentially turns into deflation;
- The economic recovery currently underway proves unsustainable; and/or
- Flow of funds provides more support for bonds than anticipated.

Bruce Berkowitz's 2013 Annual Letter

Link to: Bruce Berkowitz's 2013 Annual Letter

Our largest issuer position, at nearly 50% of assets, is in AIG common and warrants. Our second largest, at 15%, is in Bank of America common stock. Both are designated Global Systemically Important Financial Institutions. In other words, they are too important to fail, have significant value beyond their fortress-like balance sheets, and are capable of distributing healthy earnings to owners through dividends and/or buybacks of common stock. Yet, both trade at discounts to book value.

Headlines shout of Sears’ disastrous 2013 loss of $12 per share. A longer history shows that since the merger of Sears with Kmart, about 9 years ago, Sears has distributed over $66 of cash per share via buybacks and spin-offs and has paid down $27 per share of a pension liability that is no different, in our view, from debt. Fairholme research estimates that the fair value of Sears’ net assets exceeds $150 per share. If our research is accurate, we expect Sears’ market price of $38 to increase to this value over time.

Two of our best performers during the period were Fannie Mae and Freddie Mac. Both are absolutely essential for uniquely-American, affordable mortgages. If you disagree, try getting a 30-year, sub-5% mortgage outside of the United States. In 2008, both companies agreed to U.S. conservatorship and extraordinarily harsh terms and conditions during a time of global crisis. The plan worked. Fannie and Freddie saved the day, repaid nearly every penny of cash received from the U.S. Treasury, and can look forward to resuming a prosperous future based just on the aging of assets held. However, many believe Fannie and Freddie will be victims of a government-sponsored expropriation that brings our country closer to a future conceived by George Orwell in his novel, 1984 . We disagree.

On the macroeconomic front, U.S. fiscal responsibility and U.S. energy independence are on the horizon! Economic progress will eventually lift interest rates, which will depress asset valuations. However, our banks and insurers should more than counter this weight with a lifting of margins between earning assets and paying liabilities. Overall - a net positive.

The Fund’s portfolio prices remain a third below our growing estimates of intrinsic value... If history is any guide, expect these two measures to converge one day. For now, we believe, the difference between them to be a large margin of safety.

 [H/T Will]

Teddy Roosevelt’s 10 Rules for Reading

Link to: Teddy Roosevelt’s 10 Rules for Reading

1. “The room for choice is so limitless that to my mind it seems absurd to try to make catalogues which shall be supposed to appeal to all the best thinkers. This is why I have no sympathy whatever with writing lists of the One Hundred Best Books, or the Five-Foot Library. It is all right for a man to amuse himself by composing a list of a hundred very good books… But there is no such thing as a hundred books that are best for all men, or for the majority of men, or for one man at all times.” 

2. “A book must be interesting to the particular reader at that particular time.” 

3. “Personally, the books by which I have profited infinitely more than by any others have been those in which profit was a by-product of the pleasure; that is, I read them because I enjoyed them, because I liked reading them, and the profit came in as part of the enjoyment.” 

4. “The reader, the booklover, must meet his own needs without paying too much attention to what his neighbors say those needs should be.” 

5. “He must not hypocritically pretend to like what he does not like.” 

6. “Books are almost as individual as friends. There is no earthly use in laying down general laws about them. Some meet the needs of one person, and some of another; and each person should beware of the booklover’s besetting sin, of what Mr. Edgar Allan Poe calls ‘the mad pride of intellectuality,’ taking the shape of arrogant pity for the man who does not like the same kind of books.” 

7. “Now and then I am asked as to ‘what books a statesman should read,’ and my answer is, poetry and novels – including short stories under the head of novels.” 

8. ”Ours is in no sense a collector’s library. Each book was procured because some one of the family wished to read it. We could never afford to take overmuch thought for the outsides of books; we were too much interested in their insides.” 

9. “[We] all need more than anything else to know human nature, to know the needs of the human soul; and they will find this nature and these needs set forth as nowhere else by the great imaginative writers, whether of prose or of poetry.” 

10. “Books are all very well in their way, and we love them at Sagamore Hill; but children are better than books.”

[H/T Open Culture]

James Montier: What Worries Me Right Now - By Robert Huebscher

Link to: James Montier – What Worries Me Right Now

The attacks on the CAPE are kind of odd, right? It hasn’t done a bad job. It works. A large part of me says, “Well, if it’s not broken, why the hell are you trying to fix it?” People say, “Well, valuations haven’t mean-reverted for the last 20 years.” My response is, “No, but returns, frankly, have been very poor for the last 20 years.” So there is no inconsistency between a high valuation and low returns.

I think Siegel’s main point is that goodwill accounting misses half of the data. Yes, goodwill accounting has certainly increased the volatility of earnings. But also we had a situation during the crisis, somewhere around March 2009, almost exactly at the bottom, when the accounting authorities suspended FASB rule 157, which was the mark-to-market rule.

All of a sudden, financial institutions could lie with impunity. They no longer had to recognize any of the impact of asset deterioration on their earnings. One can make an equal case on the other side that earnings probably recovered too fast because of that suspension of the rule. That may have created a rather weird pattern. Maybe those two patterns offset, and therefore that is one of the reasons you should take a 10-year average, as the CAPE methodology employs.

The idea of replacing S&P earnings with NIPA earnings is slightly surreal. The S&P is a relatively small number of stocks, whereas NIPA effectively represents very much the entire economy. So the two constituents are very different.

NIPA profits are at extreme highs right now, as are listed-market profits. Basing an evaluation on something that is at an all-time high is almost certainly going to make things look cheaper. To me, this is a strange way of honestly adjusting a valuation measure. I have not yet seen any evidence that the NIPA-adjusted series gives a better return forecast over time than the straight Shiller. That would have to be the hurdle. The burden of proof is on those who think the Shiller model is somehow not useful.

.....

The issue is, as you quite rightly point out, everything is expensive right now. How do you build a portfolio that recognizes the fact that cash is generating negative returns, and bonds are now more attractive than they were, but still not enticing in any great sense?

The answer is, you have to recognize that this is the purgatory of low returns. This is the environment within which we operate. As much as wish it could be different, the reality is it isn’t, so you have to build a portfolio up that tries to make sense. That means owning some equities where you think you’re getting at least some degree of reasonable compensation for owning them, and then basically trying to create a perfect dry-powder asset.

The perfect dry-powder asset would have three characteristics: it would give you liquidity, protect you against inflation and it might generate a little bit of return.

Right now, of course, there is nothing that generates all three of those characteristics. So you have to try and build one in a in a synthetic fashion, which means holding some cash for its liquidity benefits. It means owning something like TIPS, which are priced considerably more attractively than cash, to generate inflation protection. Then, you must think about the areas to add a little bit of value to generate an above-cash return: selected forms of credit or possibly equity-spread trades, but nothing too risky.

You don’t want to be caught reaching for yield.

[H/T ValueWalk]

A Conversation with Kevin Kelly

Link to video and excerpts: The Technium: A Conversation with Kevin Kelly

Introduction - by John Brockman 

A few weeks ago David Carr profiled Kevin Kelly on page 1 of the New York Times Business section. He said Kelly's pronouncements were “often both grandiose and correct.” That’s a pretty good summary of his style and his prescience. 

For the thirty years I've known him, Kelly has been making bold declarations about the world we are crafting with new technologies. He first  began to attract notice when he helped found Wired as the first executive editor. "The culture of technology, he has noted, "was the prime beat of Wired. When we started the magazine 20 years ago, we had no intentions to write about hardware—bits and bauds. We wrote about the consequences of new inventions and the meaning of new stuff in our lives. At first, few believed us, and dismissed my claim that technology would become the central driver of our culture. Now everyone sees this centrality, but some are worried this means the end of civilization. I think we are still at the beginning of the beginning," he says. "We have just started to make a technological society. The technological changes in the next 20 years will dwarf those of the last 20 years. It will almost be like nothing at all has happened yet." 

—JB

Excerpt:

Deliberate practice and study 

Here's something else that's interesting. Everybody who's watching me right now, you and I, we all spend four, maybe more, five years with deliberate study and training to learn how to read and write, and that process of learning how to read and write actually has rewired our brains. We know that from plenty of studies of literate and illiterate people from the same culture—that reading and writing changes how your brain works. That only came about because of four or five years of deliberate practice and study, and we shouldn't expect necessarily that the real mastery of this new media is something we can deduce by hanging around. 

You can't learn calculus just hanging around people who know calculus, you actually have to study it. It may be that for us to really master the issues of attention management, critical thinking, learning how technological devices work and how they bite back, all this techno-literacy may be something that we have to spend several years being trained to do. Maybe you can't just learn it by hanging around people who do it or else just hanging around trying to learn it by osmosis. It may require training and teaching, a techno-literacy, and learning how to manage your attention and distractions is something that is probably going to require training.

GR-NEAM Reflections: 01/31/2014 - Wrong, the Question of Structural Unemployment, and the Problem of Beer Goggles

Link to: Wrong, the Question of Structural Unemployment, and the Problem of Beer Goggles

Ideology explains a lot, and central bankers' belief in suspension of market forces is an unprecedented experiment. Its unwinding has begun in the U.S., and in the long run that is a good thing. How it works out in the nearer term remains to be seen.

Hussman Weekly Market Comment: Pushing Luck

Link to: Pushing Luck

The latest data from the NYSE shows equity margin debt at a new all-time high. Relative to GDP, the current 2.6% level was eclipsed only once – at the March 2000 market peak. In the context of the most extreme bullish sentiment in decades, and reliable valuation metrics about double their historical norms prior to the late-1990’s bubble (price/revenue, market cap/GDP, Tobin’s Q, properly normalized price/forward operating earnings, price to cyclically-adjusted earnings), we view present market conditions as dangerously speculative. 

Before it’s too late, I should note – as I also did at the 2007 market peak just before the market collapsed – that unadjusted forward operating P/E ratios and the Fed Model are both quite unreliable indications of value or prospective returns (see Long-Term Evidence on the Fed Model and Forward Operating P/E Ratios). 

Even the shallow 3% retreat from the market’s all-time highs may be enough to prompt a reflexive “buy-the-dip” response in the context of extreme bullish sentiment here, as the S&P 500 bounced off of a widely monitored and steeply ascending trendline last week that connects several short-term market lows over the past year. Regardless, the potential for short-term gains is overwhelmed by the risk of deep cyclical and secular losses. We presently estimate prospective 10-year S&P 500 nominal total returns averaging just 2.7% annually, with negative expected total returns on every horizon shorter than 7 years. 

Could the stock market’s valuation really be double its historical norm? Yes, this is presently the case for numerous historically reliable measures, including price/revenue, market cap/GDP, Tobin’s Q, and a variety of properly normalized earnings-based measures.

Broyhill Annual Letter

Link to: Broyhill Annual Letter: I'm a Little Crackpot

Last year was a lot of fun for stock investors and our equity portfolios enjoyed the ride, performing exceptionally well on an absolute basis and even better on a risk-adjusted basis. The Broyhill High Quality Portfolio posted a 27.1% gain for the year while maintaining a cash reserve that averaged roughly one third of the portfolio throughout the rally.

Please click on the image below for our annual letter, I'm A Little Crackpot. In addition to an overview of the current market landscape, we discuss the potential catalysts for greater volatility in risk assets and weigh in on the consensus flight from safety. We also discuss our return expectations for stocks and bonds, while providing some perspective on positioning fixed income portfolios today.

The balance of the letter reviews the current opportunity set and a few of our highest conviction investment themes, which include: new positions poised to benefit from reduced commodity costs and an emerging middle class; bottlenecks in energy infrastructure which are nourishing profitability at strategically located refiners; and structurally advantaged businesses with demographic tailwinds, suffering from temporary cyclical pressures.