Are we entering the final stage of the bull market?

[ERICOPOLY]

There will be a time when consumer deleveraging will end.  That's been a headwind this entire time.  States have also been raising taxes and the Feds have done the same. 

 

Did they really "pull out all the stops"?

 

I find that pretty hard to believe.  In California a wealthy investor pays a 52% tax rate on mortgage bond income, and a 0% tax rate on municipal bond income.  Can you guess which stop wasn't pulled out?

[goldfinger]

Deleveraging might not end anytime soon:

http://www.nakedcapitalism.com/2013/01/richard-koo-debunks-the-deleveraging-is-almost-done-american-consumer-getting-ready-for-good-times-meme.html

http://www.thestreet.com/story/11971373/1/has-consumer-deleveraging-ended.html

http://www.zerohedge.com/news/2013-05-22/deleveraging-releveraging-and-finding-new-saturation-point

 

Hoisington's Q2 letter pointing out that consumers decreased savings to make up for increased taxes to consume (which can't continue) is not a very positive indicator in my opinion.

[Packer16]

Another data point is Gary Schilling thinks we are halfway there (5 years into a 10 year delevering).

 

Packer

[bmichaud]

Sanjeev - ur entire post is as prescient as that Buffett quote!!

 

[SharperDingaan]

Since when have central bankers ever nailed the turn in an economic cycle? They have undershot growth for the last four years - why would they be right now?

 

Let people fumble around long enough in a dark room, & eventually they are going to find the exit. And when they do find that exit, they are all going to rush out within a very short time of one another. Most would argue that the US is turning, same thing with the UK, & even Greece (absent the noise). At some point the greater risk will be in not participating. It does not mean suddenly going all-in, but it does warrant at least a partial roll-in. If you are right you will have an unrealized gain cutting your risk; if you are wrong, it is only a small exposure.

 

SD

[JBird]

It's difficult for me to understand investment behavior based on general market valuations. As the Nasdaq reached an irrational high in March of 2000, Berkshire simultaneously reached an irrational low. Simply ignoring the folly and buying the business would have returned ~12% compounded annually.

 

Reminds me of the 1994 Berkshire letter, "In our view, it is folly to forego buying shares in an outstanding business whose long term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess?"

[Kraven]

We have more cash today than ever before in our funds.  Either I'm very wrong, or some on here are going to be. 

 

I was fully invested in 2008/2009, selling stuff at 7 times earnings to buy stuff at 3-4 times earnings...and I rode that up over the last four years, slowly building cash in the funds.  People were telling me I was crazy buying WFC at $9, BAC at $5 and BRKB at $68...because the financial world was ending and we were going to see Great Depression 2, even though the S&P's P/E was about at 8.  Guess what?  They were wrong.

 

Now I'm being told that we are in the midst of a prolonged bull market, where people are willing to pay S&P's P/E of 22, because we are in a low-interest rate environment, and that federal governments know what they are doing even though they have precariously increased their debt levels to ridiculous levels over the last four years.  Somehow corporate earnings, which are at historic levels, are going to continue to go up, even though governments have this massive discrepancy between revenues and expenses, especially debt servicing.  Where is the margin of safety in this?  The fantasy is that an energy-independent United States, along with a recovering economy, will be enough.  I don't think so.

 

You guys don't get our annual reports, since it only goes to our partners, but on the inside cover we've always had this quote which is from Berkshire's 2006 Annual Report: 

 

Over time, markets will do extraordinary, even bizarre, things.  A single, big mistake could wipe out a long string of successes.  We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered.  Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.

 

Temperament is also important.  Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success.  I’ve seen a lot of very smart people who have lacked these virtues.

 

I think it's probably the greatest quote I've ever seen when referencing how investment manager's have to have a completely unique way of understanding risk and to be able to think independently.  I think this quote is as important today, as it was in 2006.  Cheers!

 

Good post, but I will ask the question I've asked before. What does it matter?  Unless you are investing in the market what does it matter if its overvalued or not?  Either an individual security is undervalued or it isn't.  Perhaps there are less opportunities and that's fine, but I am trying to understand your point. For me the general market level figures in at the margins. I am more conservative in terms of valuations and that affects both buy and sell decisions. But it never stops me from buying something undervalued and there is still plenty of that.

[Guest longinvestor]

It's difficult for me to understand investment behavior based on general market valuations. As the Nasdaq reached an irrational high in March of 2000, Berkshire simultaneously reached an irrational low. Simply ignoring the folly and buying the business would have returned ~12% compounded annually.

 

Reminds me of the 1994 Berkshire letter, "In our view, it is folly to forego buying shares in an outstanding business whose long term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess?"

 

Agree, perfect time to hold onto BRK thru any market decline.

 

Also the quote by WEB that the farmer owning a large piece of productive land does not rush to sell a portion of it (or all of it) just because someone else suddenly says it is worth less. There is little sense selling something that is worth multiples of what it is now, market price declines be damned. Also, owning BRK allows you the comforting thought that, should the market swoon, they will, without fail, shovel up bargains (again). Any doubts about that? They have many more investing boy scouts @ BRK this time around.

 

"Do nothing" works. Also, I don't need that money right now.

[muscleman]

Good post, but I will ask the question I've asked before. What does it matter?  Unless you are investing in the market what does it matter if its overvalued or not?  Either an individual security is undervalued or it isn't.  Perhaps there are less opportunities and that's fine, but I am trying to understand your point. For me the general market level figures in at the margins. I am more conservative in terms of valuations and that affects both buy and sell decisions. But it never stops me from buying something undervalued and there is still plenty of that.

 

Good point Kraven. If we find cheap things that is actually not a value trap, we should just buy. By holding a lot of cash and speculating that the market may crash and bring undervalued stocks even more undervalued, what is the difference between a value investor and a market speculator?

 

With that said, since this topic is a discussion for speculating the market, here are my two cents (With my rudimentary understanding of George Soros thinking framework):

Market usually goes up, and then suffers from a correction. After a few times, the market will be viewed as invulnerable. When everything is in euphoria, the market will be most vulnerable to crash.

As of today, we are not yet to that point, because there are European and China concerns. Also the US economy seems to be in a slow pace for recovery. It is exactly these concerns that will make today's bull market extra long.

 

The recent market setback in May showed us that Fed is watching the market more closely than ever (Quote from Greenlight Capital Q2 2013 letter). Therefore when the eventual market break kicks in, it will not be caused by Fed's QE ending, because Fed will not end the QE in a way that crashes the market.

 

What we really need to watch out is the recovery of the economy in US, and the European and China problems. If they can fixed quickly, the stock market will soon go into euphoria, and the bull market will come to an end.

 

:)

[Packer16]

In practice, Kraven's comment is right on.  I am finding 50 to 60 cent stocks versus 20 to 30 cent stocks a few years ago.  So I will keep on buying until all I can find is 80 cent dollars.  This is an interesting intellectual conversation but I hope folks don't use it too much in their portfolios or they may be disappointed because there are so many unknowns that go into future returns that even the most plausible ideas will probably be wrong.  I think one of the most dangerous places to be is to have a correct macro prediction as it may lead to think you can do it again.

 

Packer

[Parsad]

Good post, but I will ask the question I've asked before. What does it matter?  Unless you are investing in the market what does it matter if its overvalued or not?  Either an individual security is undervalued or it isn't.  Perhaps there are less opportunities and that's fine, but I am trying to understand your point. For me the general market level figures in at the margins. I am more conservative in terms of valuations and that affects both buy and sell decisions. But it never stops me from buying something undervalued and there is still plenty of that.

 

If you are buying for your own personal portfolio, then as long as you are comfortable with the volatility it won't matter, as long as you are buying cheaper things all the way down.  You give up the optionality of cash, for probably a very modest upside from here...not a great bet. 

 

But for anyone who ran a fund in 2008/2009, and was susceptible to redemptions, did it matter?  You bet your ass. 

 

If Mohnish's redemption date was a little bit later, would he have been able to save his fund?  I would say 25:75 that he would be around today.  If he had no lockup?  Kaput!  How close was Bruce Berkowitz to the end and that was without the calamity of 2008/2009?  The downside always matters when you are managing a fund! 

 

Buffett has the luxury of permanent capital today...he shut his funds down before the 70's correction.  Munger survived it, but not without the type of wounds Mohnish received...thus Mohnish's affinity for Munger...they've been through the war just decades apart.  How would Fairfax survive a 40% correction if they were invested in equities like Markel, but had the same leverage?  It matters.  Cheers!   

 

 

 

 

[bmichaud]

Kraven,

 

You seem to have the quintessential diversified bottoms up approach - thus it may instructive to hear what your returns were from the 2007 top to the 2009 bottom. Would you care to share?

[Packer16]

Sanjeev,

 

You bring up a good point about funds.  For survival they need to have a cash buffer for redemptions if they have no lock-up.  But another question is given the disadvantage of this structure why is it used so much?  In a panic it is very unstable.  Look at Third Avenue for example.  They have bleeding assets for awhile so as a value investor you are forced to sell in the market the past few years.  How can you run a fund like that?  You have the tail waging the dog.  Even if you have bought bargains you are forced to sell because the actions of others.  Isn't forced sellers a situation value investors are supposed to take advantage of?

 

I am surprised there are not more independent advisers developing programs that would divide capital into permanent and not and then giving managers the ability to deploy permanent capital.  This creates a value advantage for clients.

 

Packer

[meiroy]

Please note the big (for then) uptick right before Y2K.  Greenspan thought it was a good idea to put liquidity into the system because of the scare stories approaching the end of millennium.  When that proved to be unnecessary, the withdrawal of that stimulus by early 2000 tipped the market  into it's big slide.

 

Thanks very interesting, could you elaborate a bit?

[CorpRaider]

Putting on my tin hat:  Summers will be the next chairman of the fed.  Between his foot-in-mouth disease and the congressional mess which will flare up in about a month we're looking at trouble: muy selling.  Now, if I'm right, I shall remind you all; if I am not....I was just joking around.

[Parsad]

Sanjeev,

 

You bring up a good point about funds.  For survival they need to have a cash buffer for redemptions if they have no lock-up.  But another question is given the disadvantage of this structure why is it used so much?  In a panic it is very unstable.  Look at Third Avenue for example.  They have bleeding assets for awhile so as a value investor you are forced to sell in the market the past few years.  How can you run a fund like that?  You have the tail waging the dog.  Even if you have bought bargains you are forced to sell because the actions of others.  Isn't forced sellers a situation value investors are supposed to take advantage of?

 

I am surprised there are not more independent advisers developing programs that would divide capital into permanent and not and then giving managers the ability to deploy permanent capital.  This creates a value advantage for clients.

 

Packer

 

Surprisingly, it hasn't hurt us and has worked great.  But I'm a notoriously pessimistic person, whereas most investment managers are optimists!  ;D

 

I would say over the last 7.5 years (since we started), the markets have been incredibly diverse...from bull market induced by loose credit, to a complete financial collapse comparable to only a handful of historical periods, to another bull market again induced by low interest rates. 

 

We were pretty consistent through the entire stretch...greatly outperforming when markets were dismal in 2008, and hanging in there trying to keep up when the S&P500 averaged about 14.5% annualized in the years 2006-2007 and 2009-2013...we averaged 16% annualized in those years.  That was with an average of 35% cash! 

 

So if managers tell you it can't be done, that's BS.  Cheers! 

[Parsad]

Putting on my tin hat:  Summers will be the next chairman of the fed.  Between his foot-in-mouth disease and the congressional mess which will flare up in about a month we're looking at trouble: muy selling.  Now, if I'm right, I shall remind you all; if I am not....I was just joking around.

 

LOL!  Cheers!

[Kraven]

Good post, but I will ask the question I've asked before. What does it matter?  Unless you are investing in the market what does it matter if its overvalued or not?  Either an individual security is undervalued or it isn't.  Perhaps there are less opportunities and that's fine, but I am trying to understand your point. For me the general market level figures in at the margins. I am more conservative in terms of valuations and that affects both buy and sell decisions. But it never stops me from buying something undervalued and there is still plenty of that.

 

If you are buying for your own personal portfolio, then as long as you are comfortable with the volatility it won't matter, as long as you are buying cheaper things all the way down.  You give up the optionality of cash, for probably a very modest upside from here...not a great bet. 

 

But for anyone who ran a fund in 2008/2009, and was susceptible to redemptions, did it matter?  You bet your ass. 

 

If Mohnish's redemption date was a little bit later, would he have been able to save his fund?  I would say 25:75 that he would be around today.  If he had no lockup?  Kaput!  How close was Bruce Berkowitz to the end and that was without the calamity of 2008/2009?  The downside always matters when you are managing a fund! 

 

Buffett has the luxury of permanent capital today...he shut his funds down before the 70's correction.  Munger survived it, but not without the type of wounds Mohnish received...thus Mohnish's affinity for Munger...they've been through the war just decades apart.  How would Fairfax survive a 40% correction if they were invested in equities like Markel, but had the same leverage?  It matters.  Cheers! 

 

Fair points.  There is a huge difference between running personal funds vs outside money.  I know very well what a huge headache it can be and it does provide many of the problems you list. 

 

Where I would quibble with your points though is when you say "You give up the optionality of cash, for probably a very modest upside from here...not a great bet."  I repeat the same question.  Why would it be "modest upside" if the stock is undervalued?  Let's forget about volatility for a second.  If a stock is worth double the current price and the market falls 30% everything being equal (it never is, but let's pretend for a second) doesn't the stock have the same value it did before?  So if you can pick a portfolio of "those" stocks, why is the upside modest assuming you can ride out the volatility? 

 

I think there is often confusion between pricing based declines (i.e. the market is frothy) vs a change in business or economic environment (i.e. a recession or something).  I am never quite sure which of the 2 people fear when they post. 

[Kraven]

Kraven,

 

You seem to have the quintessential diversified bottoms up approach - thus it may instructive to hear what your returns were from the 2007 top to the 2009 bottom. Would you care to share?

 

They are not meaningful.  That is, they are not representative of anything.  I was still working then and had significant constraints on what I was able to buy and sell.  This at times was both a blessing and a curse.  For what it's worth, I had losses, but much less than the market.  Again though, it's not representative of anything either good or bad.

[Uccmal]

 

 

Al,

 

What data would you point to that would indicate we have exited or are about to exit the deleveraging cycle? Debt to income levels have come down globally and here in the US but nowhere near where they were at the beginning of the 30-year debt cycle. It's pretty well documented that growth is stimied when sent levels are where they are - I don't see where the growth is going to from.

 

bmichaud, Just the economic/stock market cycle:  Eventually the debt will be paid down to more reasonable levels, probably faster than we expect.  As the economies improve, tax revenues go up, debt goes down, debt service cost decrease etc., etc.  There is nothing new in all this, except that this has been a longer and deeper cycle than any in the last 75 years.

 

 

 

 

[Uccmal]

I am 100 times less smart than Al but I do not see why it is so obvious we are  in a new secular bull market!

First there is nothing "as usual" in the current recovery. This is the weakest recovery in US history except the great depression and GDP numbers keep on getting revised to the downside quarter after quarter. Then you get continuously declining household income, still unprecedented public and household levels of debt, higher taxes and future lower stimulus when consumers already have decreased saving levels from an already low level, declining money velocity etc, etc, etc... I think there is a lot of hope baked into the cake right now but that's about it. And now we get China slowing at best... :-[

I have a lot of cash right now!

 

Flattery will get you everywhere.  Anyway, agreed it is a slow process.  That doesn't mean it hasn't started. 

[ERICOPOLY]

How would Fairfax survive a 40% correction if they were invested in equities like Markel, but had the same leverage?  It matters.  Cheers! 

 

They currently have about 50% of book value in equities.  A 40% market drop (if their portfolio fell by the same amount) would hit their book value to the tune of 14% before considering the impacts of income and potential capital gains from the bond portfolio.

 

Not really that bad is it?

 

It sort of feels to me like they are emphasizing smooth returns over lumpy returns.

[txlaw]

It sort of feels to me like they are emphasizing smooth returns over lumpy returns.

 

At bottom, this is why I've been a bit concerned about FFH (I don't own any at the moment, btw).  It's almost like they're going for an "absolute return" strategy vs. a "total return" strategy, where they always make positive mark to market returns despite aggregate market movement. 

 

On the other hand, they may believe that the best thing to do for "total return" is to preserve the ability to underwrite as much business as possible because they believe a very hard market will ensue at some point.  If that is the case, they should be more clear about this, rather than saying, we're trying to "protect" ourselves.

 

This is why I continue to be puzzled about the notional value of the equity hedge.  Why 100%?

[ERICOPOLY]

It sort of feels to me like they are emphasizing smooth returns over lumpy returns.

 

At bottom, this is why I've been a bit concerned about FFH (I don't own any at the moment, btw).  It's almost like they're going for an "absolute return" strategy vs. a "total return" strategy, where they always make positive mark to market returns despite aggregate market movement. 

 

On the other hand, they may believe that the best thing to do for "total return" is to preserve the ability to underwrite as much business as possible because they believe a very hard market will ensue at some point.  If that is the case, they should be more clear about this, rather than saying, we're trying to "protect" ourselves.

 

This is why I continue to be puzzled about the notional value of the equity hedge.  Why 100%?

 

When they first put the hedge on at 1060, with 25% notional value, it only protected about 1.75% of book value if the market were to drop back down to 800 level (where they had dumped all of their hedges).

 

Now think about that... 1.75%!  Really???  Honestly why is that "protection" from anything? 

[Kraven]

It sort of feels to me like they are emphasizing smooth returns over lumpy returns.

 

At bottom, this is why I've been a bit concerned about FFH (I don't own any at the moment, btw).  It's almost like they're going for an "absolute return" strategy vs. a "total return" strategy, where they always make positive mark to market returns despite aggregate market movement. 

 

On the other hand, they may believe that the best thing to do for "total return" is to preserve the ability to underwrite as much business as possible because they believe a very hard market will ensue at some point.  If that is the case, they should be more clear about this, rather than saying, we're trying to "protect" ourselves.

 

This is why I continue to be puzzled about the notional value of the equity hedge.  Why 100%?

 

When they first put the hedge on at 1060, with 25% notional value, it only protected about 1.75% of book value if the market were to drop back down to 800 level (where they had dumped all of their hedges).

 

Now think about that... 1.75%!  Really???  Honestly why is that "protection" from anything?

 

Without knowing the details on the hedges, these types of points are what I think of as real world implications.  So to go to all the hassle and expense of doing something to protect 1.75% of BV seems quite worthless to me.  Even with the larger hedges, as pointed out earlier, the protections was 10-15% of BV.  I can't comment on the implications from an insurance standpoint (that is, ensuring safety of appropriate reserves), but separate from that it seems as if the upside missed far outweighs any downside protection.