Are we entering the final stage of the bull market?

[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%?

 

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?

 

Yeah, that is strange.

[stahleyp]

This is a positive for the markets probably :)

 

http://www.valuewalk.com/2013/08/as-sp-500-boom-caution/

[hyten1]

good read in relation to this post

 

http://www.oaktreecapital.com/MemoTree/The%20Role%20of%20Confidence_08_05_13.pdf

 

best sentence

 

"It is easier to know what to do at the extreme, than it is in the middle ground, where i believe we are today"

[Uccmal]

I am sure you have all seen this:

 

http://www.bloomberg.com/news/2013-08-05/americans-with-best-credit-in-decades-drive-u-s-economy.html

[Uccmal]

good read in relation to this post

 

http://www.oaktreecapital.com/MemoTree/The%20Role%20of%20Confidence_08_05_13.pdf

 

best sentence

 

"It is easier to know what to do at the extreme, than it is in the middle ground, where i believe we are today"

 

Sort of sums up all the arguments in the post in one essay doesn't it.  Tx. hyten

[finetrader]

Didn't you hear? I guess you were at the rest room. Bernanke just sang the 'take me out to the ball game' anthem.

[fareastwarriors]

http://www.ici.org/research/stats/flows/flows_07_31_13

[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.

 

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! 

 

I think this is a valid argument, but doesn't this unfairly punish the most loyal partners by constantly worrying about the redemption needs of the least loyal partners?

I know there is probably no good way to fix this except to have a long lockup period for the fund.

[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! 

 

I think this is a valid argument, but doesn't this unfairly punish the most loyal partners by constantly worrying about the redemption needs of the least loyal partners?

I know there is probably no good way to fix this except to have a long lockup period for the fund.

 

You won't know exactly who the most loyal partners are until the shit hits the fan.  Do you really want to find out the answer to that question?  We would prefer if it never came to that.

 

We could implement a long lockup, but then that would contradict what everyone signed up for.  I don't think we need to do that.  We provide something that other partnerships would avoid...simply because it's difficult.  Maybe that gives us an edge to cater to a very specific niche...partners that want above average long-term returns, with more consistent results, and still have access to their capital if needed.  So far our partners are in the top 1-1.5% of managed funds over the last 7.5 years...that's not bad.  Cheers! 

[bmichaud]

Great article in the Economist this week debunking the "low yields = higher PE" nonsense.

Buttonwood__A_misleading_model___The_Economist.pdf

[jay21]

Great article in the Economist this week debunking the "low yields = higher PE" nonsense.

 

This debunks nothing.  If you were told that the 10 year would be 1.5% forever, wouldn't you be willing to pay a higher multiple for stocks?

 

Markets are based upon expectations.  Investors are worried that rates will increase causing a contraction in multiples.  If they knew that rates would decrease, multiples would expand.

 

I did agree with this:

 

"But should it work in theory? The common rationale for the Fed model relates to the “discounted cashflow” approach to valuing equities. Lowering the discount rate you apply to future cashflows increases present value (the share price), other things being equal. The trouble is, other things aren’t equal."

 

There are too many variables when trying to think about equity market valuations.  That is way I don't (try not to?) think about market valuations.

 

 

[bmichaud]

If they knew that rates would decrease, multiples would expand

 

Kind of like how the Nikkei PE has expanded downward with interest rates over the past 20 years?

[jay21]

If they knew that rates would decrease, multiples would expand

 

Kind of like how the Nikkei PE has expanded downward with interest rates over the past 20 years?

 

I meant to caveat my earlier statements with the "all things being equal" qualifier.  Probably makes the linkage a little clearer as well.

[Uccmal]

 

So far our partners are in the top 1-1.5% of managed funds over the last 7.5 years...that's not bad.  Cheers! 

 

Geez, Top 1.5%.  Is that the best you can do....he he. 

[mcliu]

Great article in the Economist this week debunking the "low yields = higher PE" nonsense.

 

This debunks nothing.  If you were told that the 10 year would be 1.5% forever, wouldn't you be willing to pay a higher multiple for stocks?

 

Markets are based upon expectations.  Investors are worried that rates will increase causing a contraction in multiples.  If they knew that rates would decrease, multiples would expand.

 

I did agree with this:

 

"But should it work in theory? The common rationale for the Fed model relates to the “discounted cashflow” approach to valuing equities. Lowering the discount rate you apply to future cashflows increases present value (the share price), other things being equal. The trouble is, other things aren’t equal."

 

There are too many variables when trying to think about equity market valuations.  That is way I don't (try not to?) think about market valuations.

 

As the article says, bond yields tend to reflect inflation expectations which also reflect growth expectations. When investors adjust their discount rates lower to reflect lower risk-free rates, they should, at the same time, adjust their growth expectations lower, hence the multiple shouldn't be significantly higher.

[TwoCitiesCapital]

Great article in the Economist this week debunking the "low yields = higher PE" nonsense.

 

This debunks nothing.  If you were told that the 10 year would be 1.5% forever, wouldn't you be willing to pay a higher multiple for stocks?

 

Markets are based upon expectations.  Investors are worried that rates will increase causing a contraction in multiples.  If they knew that rates would decrease, multiples would expand.

 

I did agree with this:

 

"But should it work in theory? The common rationale for the Fed model relates to the “discounted cashflow” approach to valuing equities. Lowering the discount rate you apply to future cashflows increases present value (the share price), other things being equal. The trouble is, other things aren’t equal."

 

There are too many variables when trying to think about equity market valuations.  That is way I don't (try not to?) think about market valuations.

 

As the article says, bond yields tend to reflect inflation expectations which also reflect growth expectations. When investors adjust their discount rates lower to reflect lower risk-free rates, they should, at the same time, adjust their growth expectations lower, hence the multiple shouldn't be significantly higher.

 

Exactly. In a deflationary environment, bonds can trend towards 0%. That doesn't mean P/E multiples shoot through the roof. Quite the contrary...

 

As long as you have stable, but low inflation P/E multiples will be trending high. As you move from away from that stable level in either direction (high inflation or deflation) P/E multiples will likely come down. Stability is really the key. Given that we've had relatively stable and low inflation for the past few years, it seems like we can only get more "unstable" from here in either the upward or downward direction. P/E multiples will likely compress when that happens, on top of normalizing margins, and we'll find ourselves still within the secular bear market that started in 2000.

 

 

[ERICOPOLY]

If they knew that rates would decrease, multiples would expand

 

Kind of like how the Nikkei PE has expanded downward with interest rates over the past 20 years?

 

Are you saying Japan has had a low PE ratio during the period of deflation?

 

Do you have data on the Nikkei PE?  I keep finding references to relatively high PE ratios, even in recent years.

 

Here is one from 2006 that claims Japan's PE was 33.66 in 2006:

 

http://tickersense.typepad.com/ticker_sense/2006/06/global_pe_ratio.html

 

 

[ERICOPOLY]

Here you go, here is the permanently high PE chart for Japan:

 

http://www.vectorgrader.com/indicators/japan-price-earnings

 

Are we turning Japanese?

[TwoCitiesCapital]

Here you go, here is the permanently high PE chart for Japan:

 

http://www.vectorgrader.com/indicators/japan-price-earnings

 

Are we turning Japanese?

 

P/Es may have stayed high relative to U.S. averages, but it's quite clear from that chart that there was a pretty big compression nonetheless.  First half of the chart shows a multiple range between 40 and 100+. After that the range is between 20 and 40. Still high,  but evidence of major multiple compression.

 

I do think stability is and low rates of inflation or deflation is key. Its my understanding that Japan has undergone persistent,  yet low, deflation.  This still falls right into stable and low rates and shouldn't really be much different from low and stable inflation 

[obtuse_investor]

Here you go, here is the permanently high PE chart for Japan:

 

http://www.vectorgrader.com/indicators/japan-price-earnings

 

Are we turning Japanese?

 

Perhaps...

 

Typical P/E is too noisy. Looking at the CAPE for Japan... since 1975, average CAPE has been 46.1! In Feb 2013, CAPE was 21.6

 

Source: GoldmanSachs: http://www.goldmansachs.com/s/GMeT_othermailings_attachments/63495552913647625076134.pdf

[ERICOPOLY]

Looking beyond it's high PE ratios, Japan's market cap to GDP is not high nor is it's Price to Book.  So basically their earnings have been depressed and their stock market has not traded off of the earnings -- rather, it's being supported by other factors, like the market in relation to GDP or book values.  Or perhaps instead it's the low interest rates after all.

 

I'm more inclined to believe that Japan trades high on earnings due to the collapsed nature of the earnings in relation to the GDP and book value.

[wisdom]

It is worth looking at times when we have had deflation in the past. I had read somewhere that we get deflation every time we have free trade across the globe. That is why 1950 onwards was such as exception because we had the iron curtain.

 

When we look at high debt levels - US in the 30s or Japan in the 90s - we get deflation.

If the QEs and deficits being run by all the large countries have not been enough to ignite inflation - what are the chances that the deflationary forces will overwhelm the inflationary steps being taken even though the govts need inflation. The largest consumers in the world over 50% of the worlds GDP (Europe and US have high debt levels and need to de-leverage0

 

You have higher corporate profit margins. Capitalist/democratic societies are self correcting to a large extent and thus, it is not sustainable and there will be a rebalancing - whether it is increased competition or redistribution - who knows.

 

We have a fairly valued mkt on top of that with limited mispriced opportunities compared to the last 4 yrs.

 

The only reason to believe inflation is the way forward is - money printing.

 

odds aren't in my favour to make bets saying the mkts going much higher and we will have inflation.

 

Though anything can happen.

[ERICOPOLY]

I asked this question before and couldn't get a very satisfactory answer.

 

How do margins come down from competitive forces without competitors expanding/investing/hiring?  Suppose a company is making fat margins, and further suppose this is widespread so that margins are fat in the aggregate... then shouldn't there be some boom in hiring and investment before the margins come down?  You can't launch a competing product without a lot of investment... isn't that true? 

 

I'm interested in understanding the mechanics of what happens in order to bring about the lower margins.

 

I doubt the margins are coming from optimal leverage of existing productive assets -- I thought I heard that we have idle capacity.

 

Or are we getting away with paying too little for labor -- are there pressures that will bring up the labor costs?

Or is debt too cheap?  But isn't this a period of very low rates for a long time, per Watsa and Company?

Or are commodities too cheap?  I thought Watsa and Company believed their pricing went hyperbolic.

Is energy too cheap?  I hear we have natural gas cheap for a lifetime ahead of us, and solar prices will soon fall below cost of fossil fuels.

 

So I would like to hear how competitive forces are going to spring into action without first igniting an investment and hiring boom.

 

 

[bmichaud]

Eric - Attached is an excellent piece by Ned Davis himself on corporate profitability. Perhaps a good springboard for discussion on the topic...

NDR_Focus_on_Profits.pdf

[Guest longinvestor]

It is worth looking at times when we have had deflation in the past. I had read somewhere that we get deflation every time we have free trade across the globe. That is why 1950 onwards was such as exception because we had the iron curtain.

 

Indeed! Do we perhaps have a situation of uber-supply of goods (mostly "wants"), made worse by the demographic bulge of aging in the west?