Faber also discusses his investment strategy, prospects for economic recovery and concerns about inflation. Here are my notes for the video:
1. Marc Faber Correctly called the 1987 market crash and stated back in March , 2009, stock market would rally and industrial metal. Lately said loose monetary policy will lead to hyperinflation
2. Stock market has seen its lows as if the market drops, more government stimulus package will come
3. Economic recovery will be disappointing since only Government is creating job but private sector is not. US Federal Budget Deficit will go up
4. For the next 12 months, investors do not want to be in cash. That is lot cash on sideline that may be moved to other asset class, but not into bond. Money could flow into precious metal.
5. But money also can flow into equity. Equity has value in inflationary environment as the replacement cost is inflation hedged
6. Neat term (4-6 weeks), gold may sideline, dollar may strengthen, industrial commodity could come down. but longer term, USD will depreciate, Asian equity will do better than US/Europe equity market.
7. Repeated his assessment for high inflation down the road. there is no political will to reduce the budget deficit. Inflation will go up.
Here is the vide clip:
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1. Sivaram says on Jun 29, 2009 at 9:28 PM:
Does anyone understand what Faber is saying about replacement costs? Isn't it worse for businesses to have higher replacement costs (due to inflation)? I don't get his point about why inflation is good for equities in that context (I'd agree that equities will do relatively well under inflation for other reasons, such as increase in nominal corporate profits)...
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2. Sivaram says on Jun 29, 2009 at 9:28 PM:
Does anyone understand what Faber is saying about replacement costs? Isn't it worse for businesses to have higher replacement costs (due to inflation)? I don't get his point about why inflation is good for equities in that context (I'd agree that equities will do relatively well under inflation for other reasons, such as increase in nominal corporate profits)...
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3. Guruek says on Jun 29, 2009 at 9:46 PM:
I believe he was talking about the physical assets such as inventory, building, machinery, fleet etc.. It will cost more to replace them in an inflationary environment. but these corporates have those in hands already so they have a head start over those do not. Their operations can be viewed as a process of converting these ingredients that was acquired at a nominal lower cost to revenue at a higher nominal price, hence they have an advantage.
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4. Batbeer2 says on Jun 29, 2009 at 11:39 PM:
>> Isn't it worse for businesses to have higher replacement costs (due to inflation)?
1) Agree witk guruek.
2) Take BRS. The main asset is it's fleet of helicopters. They are bought and paid for. With inflation, they will likely generate more cash and retire their debt more quickly. Meanwhile, the price of choppers is likely to rise.
- Book value goes down; real world prices go up. (high roa as a result).
- Debt decreases relative to EBITDA.
- Anyone wishing to start a competing business will need lots of cash.
- Just liquidating the business would yield a nominal profit if inflation is high enough.
Now all that has all sorts of caveats. If management does not build IV over time, there will be no real gain..... but the alternative is holding cash or bonds.......
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5. Sivaram says on Jun 30, 2009 at 10:11 AM:
Thanks for the explanation GuruEK and BatBeer2, but I still don't get it. Unless Marc Faber was being very narrow (i.e. only select companies with no need to replace assets; or natural resource businesses whose assets in the ground may increase with inflation; or companies with super-high-leverage), I think he is wrong. But then again, I'm just a newbie who doesn't work in the industry and may not understand things.
I don't know anything about Bristow Group (BRS) but let's think about that. Let's say inflation is really high for the next 10 years. Bristow will still likely end up having to replace its assets at some point with higher priced ones. Even if the life of the asset is somewhat long, it may still be need to be replaced in 10 years. To me, it sees like the net effect is not positive.
I only see a positive effect if you value the company as on its way to liquidation. In that case, What BatBeer says, "Just liquidating the business would yield a nominal profit..." is true. But the market values BRS, at least I would assume, as a going concern. Bristow seems to be trading below book value but most companies in general trade way above book value. If the makret valued those companeis as a liquidation company, the market would mark down the value of the shares (even if the assets on the books are sold at higher prices than what's on the books (due to inflation), I suspect it would not make up the loss from marking down the premium above book value that shares of most companies presently trade at.)
I'm clearly missing something because I don't see it. Another way of thinking about it is, would you pay more for a company under a highly inflationary environment than now? I would say that I would not. If I invest in a going concern, it will likely have to replace the assets at higher prices, even if not tomorrow, then in 10 or 15 years.
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6. Bizi says on Jun 30, 2009 at 11:06 AM:
I am also doubtfull with this. Inflation is bad for equity.
Thus :
- a firm 100 $ equity with 20 % yield, with an inflation of 12 % and 50 % of tax returns
- 2 $; so in real term, you lose money so the value of the asset goes down with a high inflation rate
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7. Batbeer2 says on Jun 30, 2009 at 12:13 PM:
>> ... Bristow will still likely end up having to replace its assets at some point with higher priced ones.
Indeed. As I see it, well managed companies will do well and badly managed companies will be punished heavily in an inflationary environment. It separates the good from the not so good.
Someone wrote up BRS in April. [www.gurufocus.com]
It subsequently dived. BRS writes off it's assets in 30 years. In practice this turns out to be aggressive !
The sale of the choppers is allways profitable (book profit). Maybe not each and every chopper but every year they book a modest profit for the sale of old aircraft.
Assuming this is a well run business where they do not invest in new choppers without some confidence that they can be operated at a profit.... the replacement of the choppers is not an issue for the owner of the company. It is a cost you would rather not deal with; but it is not a business risk.
The specific thing with BRS is... IMO book value understates liquidation value and the stock has traded well below book a few times in the last year or so.
You buy something that tends to hold it's value over a long period (30 years) and you buy it at a discount. It may not be perfect but I can't think of a better way to protect yourself against inflation.
I don't usually like asset heavy industries but if I am highly confident I'm buying those assets at a discount and the business is predictable..... I will make an exception.
Long story a bit longer....
IMO the best stocks are even better in an inflationary environment. The good ones will do great and the not so good ones are in real trouble. BRS manages its fleet better than say... FLI and it should really start to show if inflation hits the fan.
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8. Cm1750 says on Jun 30, 2009 at 2:59 PM:
I agree with Batbeer, in an inflationary environment, stocks can get hurt given the simple fact that stocks discount future cash flows by risk free rate (10 year treasury) + a 4-5% premium. If inflation hits 10%, the stocks value drops substantially.
The key is finding companies that can raise prices at or greater than inflation. I like PM and others. Another idea that one should look at is CCI - they operate cell towers and lease space to Verizon etc. They have long 7-10 year contracts with inflation escalators so they are protected. The company has a lot of debt, but the company effectively has fixed rates for the next several years. The valuation seems absurd but if you look at the maintenance FCF and the huge operating leverage in the business, it is currently worth over $30/share so buying in the low $20s should give a decent return.
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9. Batbeer2 says on Jun 30, 2009 at 3:01 PM:
>> the value of the asset goes down with a high inflation rate
Inflation MEANS the price of durable assets goes up. Without this effect, there would be no inflation.
In my book, the value of an asset is not the same as it's price. Some assets retain their value (BNI infrastructure; KO brand). Some assets become worth less quickly (an inventory of the latest and greatest PCs).
So... How can owning the best assets be a losing proposition in an inflationary environment ? The trick is to pick the assets that retain their value and buy them cheap. In my BRS example, I have confidence choppers will retain their value over time (I may be wrong; we can debate the issue).
Just for fun, you can invert. What would you rather own ?
- Bonds ?
- Cash ?
- Gold ?
Take any country that has experienced high inflation (Zimbabwe). Plot the stock index against inflation.... you might be surprised.
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10. Bizi says on Jul 01, 2009 at 1:24 AM:
Hello Batbeer
You are right on the fact that we have to find the right investment.
So :
- bonds : yes of course SHORT IT via TBT on the 50's ;-)) ; bonds are the worst investment in the coming years
- Cash : 25-40 % to hunt the momentum and to trade the volatility
- Gold : yes hard assets and gold, silver, and platinum but hedge yourself via selling calls
- equity : yes but the winners will be hard to find and the yield will be lower; the end of "Casino Markets"... ; you have to invest with an inflation bias as you do
What is the surprise of the Zimbabwe chart ?
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11. Batbeer2 says on Jul 01, 2009 at 7:01 AM:
Here is a link.
Basically someone reasoning along your line of thought (previous post) found out that the Zimbabwe stock index did not behave as predicted under high inflation.
[www.thetaoofmakingmoney.com]
and
[www.mises.org]
I expect (and hope) US inflation will come no where near the Zimbabwe situation.
"The ZSE is growing some three times faster than consumer prices. This relative outperformance versus general prices is a result of stocks being a chief entry point for the flood of newly created money. Keep Zimbabwean dollars in your pocket, and they've already lost a chunk of their value by the next day. Putting money in the bank, where rates are pithy, is not much better. Investing in government bonds is the equivalent of financial suicide.
..............SNIP.............
Like compressed air looking for an exit, money is pouring into shares of ZSE-listed firms like banker Old Mutual, hotel group Meikles Africa, and mobile phone firm Econet Wireless. It is the only place to go. Thus the 12,000% year over year increase in the Zimbabwe Industrials."
This is not a fluke. I have experienced high inflation myself and cash really burns a hole in your pocket if high inflation hits.... you go out and buy stocks / a tractor / a years supply of coke.... anything that is likely to hold it's value.... on payday.
6% inflation is one thing. > 15% inflation is something else. 99% of the time the US has inflation between 1% and 8%. Above that, a different set of rules applies.
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12. AlbertaSunwapta says on Jul 01, 2009 at 7:41 AM:
Companies like McDonalds may do well. High inventory turnover rates, lowest cost competitor, foreign exchange earnings... And of course its value locked up in real estate would face sudden periodic upward revaluations by the market.
I'd bet most companies operating under prepaid arrangements would suffer. My guess would be that people would use more credit to buy it now before the price rises - hence credit card companies might do better.
We have the 70s to look at - what general equities did well in the 1970s?
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13. Sivaram says on Jul 01, 2009 at 9:57 AM:
Batbeer2,
Marc Faber stutters and probably doesn't get across his thought properly but my impression is that he is speaking generally about the market. So, although you maybe be right about the specific companies you have in mind, I don't believe you can extrapolate that to the whole market. My impression is that Faber is talking about the whole market.
As for Zimbabwe, Argentina, and others, you are right in pointing out that stocks will do well in nominal terms. But I suspect they will do poorly in real terms. My guess is that hard assets--gold, most commodities, real estate, etc--will be the only ones that post strong real returns as a broad asset. I'll bet gold or crude oil, assuming it isn't wildly overvalued when purchased, will probably outperform companies like Coca-Cola and maybe even Bristow (although you are far more knowledgeable about Bristow and I may be wrong.) As far as I'm concerned, there are very few true inflation hedges. What investors perceive as inflation hedges during good times rarely turns out to be one when inflation really gets going. (Recall the example of Warren Buffett buying, I think it was an, aluminum company in the 70's as a, some speculate, inflation hedge and it wasn't a great investment.)
Posting high nominal returns with poor real returns doesn't help an investor. For instance, many undeveloped and developing countries have high interest rates, so cash/short-term-bonds actuall post seemingly high nominal returns (as an example, Brazil, which doesn't really have hyperinflation right now, has short-term interest rates over 8%.)
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15. Sivaram says on Jul 01, 2009 at 10:10 AM:
ALBERTASUNWAPTA: "My guess would be that people would use more credit to buy it now before the price rises - hence credit card companies might do better."
I'm not so sure about that. Interest rates would skyrocket if inflation was high and credit will probably become very unattractive. There may be a very temporary move but it probably won't move the market valuations of companies very much.
"We have the 70s to look at - what general equities did well in the 1970s?"
I've been trying to find this info and if anyone has it, especially someone who has access to a Bloomberg terminal, I would appreciate it. From what little I know, commodities were the superstars at that time. Some of it was due to political events (such as wars and embargoes) but even if you ignore politics, I think commodities did well (including many metals that have were not impacted by the geopolitics). I'm not really sure about other sectors. I'm curiuos to see if consumer staples did well or not.
The 1970's were also a good time for stockpickers so certain type of investors, such as value investors, may do well.
The tricky thing for inflationists (those I call that expect high inflation) is that the consensus seems to be inflation so it's going to be tough to figure out what is not overvalued. In contrast, the 70's in America, as well as high inflation in countries like Argentina in 2000's or Brazil in the 80's, came out of nowhere. The market wasn't pricing any of it so an inflationist would have had an easy time. In other words, if you blindly bet on commodities, which I believe are good inflation hedges, in the the early 70's or late 60's, you did really well. The market was not pricing inflation and since it was a surprise all these assets were undervalued. In contrast, even though commodities are good inflation hedges, blindly betting on them now is tricky since the makret may be pricing in inflation and they may be overvalued.
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16. Batbeer2 says on Jul 01, 2009 at 10:54 AM:
>> you are right in pointing out that stocks will do well in nominal terms. But I suspect they will do poorly in real terms.
"The ZSE is growing some three times faster than consumer prices."
To me that indicates the index investor is doing well in real terms.
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17. Sivaram says on Jul 01, 2009 at 2:21 PM:
BatBeer2,
That's an interesting point (i.e. Zimbabwe market rose more than reported inflation) but I'm not sure if we can draw broad conclusions from that. One of the things I remember about Zimbabwe was that the government enacted capital controls. Zimbabweans literally couldn't purchase foreign goods without approval. So a lot of money flowed into the stock market. This probably wasn't due to the attractiveness of stocks but because people had no other choice (I believe hoarding commodities was also made illegal.) In fact, the government even shut down the stock exchange for a while because people were using the stock market to "store" money.
I'm also not sure what inflation rates you looked at. There were wide rumours that the reported inflation was nowere near reality. For instance, I remember reading some stories that the official foreign exchange conversion rate did not change much over time (even though Zimbabwe was printing money like it was going out of fashion) whereas the black market rate was completely different.
Anyway, I don't know if what I"m saying above explains why stock prices went up a lot more than inflation but I'm just wondering if this is a good example. Do you have numbers easily accessible for Argentina in the early 2000's or one of the high inflation Latin American countries in the 80's?
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18. Batbeer2 says on Jul 01, 2009 at 3:20 PM:
>> but I'm just wondering if this is a good example.
I wouldn't know that either. Every situation is unique. I believe the Ghanaian stock market behaved similarly over a period from ~2000 to ~2005.
If the example goes to show that you can't draw any broad conclusions; then it's a good example. IMO if the investor has some confidence there will be inflation, investing in the right stocks is a rational choice. Then again, I am biassed. I would buy a great business yielding a predictable > 15% FCF any time.
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19. Stockdocx99 says on Jul 01, 2009 at 5:23 PM:
Batbeer would also buy USG, a company that lost $2.28sh. on continung ops in 2008, is expected to lose another $1.25/sh. in 2009 and to show a $0.25/sh. loss in 2010 (according to the July 3, 2009 Value Line).
Now that's a predictable > 15% FCF, right Batbeer? If Buffett had not loaned them $400 million [covertible at 11.40 through 2018 and paying BRK @ 10% annual interest] they would probably already be bankrupt today.
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20. Batbeer2 says on Jul 02, 2009 at 2:29 AM:
>> Now that's a predictable > 15% FCF, right Batbeer?
Actually, yes.
>> If Buffett had not loaned them $400 million...
He did. By the way, the same can be said for some other companies.
Cyclicals can be bought near the bottom of the cycle or near the top. IMO USG is not near the top. You don't like it, don't buy it. That way you can't lose.
Do you have any thoughts on inflation ?
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21. Sivaram says on Jul 02, 2009 at 10:08 AM:
Stockdox,
Come on. You guys disagreed once and you turn this into a personal battle. Who cares what BatBeer did with USG, which has nothing to do with this topic. We could probably pick a few of your bad picks too but no one, and certainly not me, care about your bad picks (unless it has something to do with this topic, especially about inflation.)
Stop taking things so personally. If you keep thinking every criticism is a personal insult, I'm probably your public enemy #1 (given our econopolitical differences of opinion :) ).
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