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Prem Watsa's Cautious Approach to Investing Is Paying Off

August 12, 2011 | About:
Prem Watsa has been preparing for deflation, while other great investors like Seth Klarman have been preparing for inflation.

Watsa's Fairfax has been selling corporate bonds and buying U.S. Treasuries and select muni bonds, both of which have performed very well in the past month, as investors panicked and there was a flight to safety. For munis, 65% of the muni bond portfolio is insured by Berkshire Hathaway, and essentially all of the rest of the muni bonds are from essential services like large airports or transportation systems, or from large states like California.

Prema Watsa has long predicted that government bonds will continue to be the best performing asset class – even though U.S. government debt loads have contributed to the economic turmoil, because it is still a risk-free asset.

Here are Watsa's top holdings currently:

ABH

AbitibiBowater

others

17,008,276 457,012 15.03% +28.52% +3.34% History

DELL

Dell Inc.

Technology Hardware & Equipment

22,693,489 329,283 10.83% -0.04% 0 History

JNJ

Johnson & Johnson

Pharmaceuticals & Biotechnology

5,184,300 307,170 10.1% -24.69% 0 History

SD

SandRidge Energy

Oil & Gas Producers

21,307,600 272,737 8.97% 0 0 History

ICO

INTERNATIONAL COAL GROUP INC.

Basic Resources

22,577,788 254,903 8.38% 0 0 History

LVLT

Level 3 Communications Inc.

Fixed Line Telecommunications

139,276,421 203,344 6.69% 0 0 History

KFT

Kraft Foods Inc. Cl A

Food & Beverage

5,365,751 168,270 5.53% 0 0 History

FTR

Frontier Communications

Fixed Line Telecommunications

18,620,000 152,684 5.02% 0 0 History

WFC

Wells Fargo & Co.

Banks

4,511,530 143,016 4.7% 0 0 History

USB

U.S. Bancorp

Banks

4,448,310 117,569 3.87% 0 0 History

Companies like JNJ, DELL and KFT, are defensive quality securities which should do well even in bad economic times.

The sector weighting also reveals a very defensive posture. In late 2009, Watsa had 56% of the firm's assets in financials; today it is only 9%. Consumer goods, on the other hand, went from 6% in mid-2009 to 25% currently.

In his latest shareholder letter, Watsa stated that:

"We wanted to protect our gains, and we worried about the unintended consequences of increasing our hedge to approximately 100%. Our view was twofold: our capital had benefited greatly from our 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 fiscal deficits. We see the U.S. government embarking on a similar exercise (as it has no other option) and all this many problems in Europe as country after country reduces government spending and increases taxes to help reduce while businesses and individuals are deleveraging from their huge debts incurred prior to 2008."

What a great macro call only months before US debt was downgraded and the euro zone crisis really heated up again!

Below is an interesting excerpt followed by a link to a full article from The Globe and Mail about Watsa's bets paying off:

“We have said for some time that we think this is a 1-in-50-, 1-in-100-year event,” Mr. Watsa said in an interview Wednesday. “Which means that it’s like Japan or the 1930s, because there’s too much debt in the system.”

The recent sharp downward revision of U.S. economic growth in the first quarter, from an already low 1.9 per cent to 0.4 per cent, cemented Mr. Watsa’s view that deflation is all but inevitable. And he believes that U.S. Federal Reserve Board chairman Ben Bernanke has run out of ammunition to prop up the economy, despite the Fed’s promise to hold rates extremely low for two more years.

Mr. Watsa, who has become a fan of Japanese economist Richard Koo, also believes that the Obama administration and U.S. Congress could be making a fatal error by cutting spending.

“The worry is this,” Mr. Watsa said. “You have interest rates at zero per cent, you have had deficits coming down, meaning reduced government spending, which means there’s no ammo left for the governments of the world, particularly the United States. So what do you do next to get the economy going?”

As the U.S. grapples with its debt, Mr. Watsa believes that excessive borrowing in the Chinese property market threatens to take down the world’s second-largest economy. He visited China earlier this year and met numerous people who owned three or four apartments – apartments whose prices had risen fourfold in as many years.

If events unfold as Mr. Watsa thinks they might, Canada will not be immune. If the U.S. economy goes into recession as commodity prices are falling, this country will not skate through unharmed.

“This is not a short-term thing,” Mr. Watsa added. “We think we’ll be going through some tough times for many years.”

Click on the following link for the full article-

http://www.theglobeandmail.com/report-on-business/economy/fairfaxs-watsa-sees-dirty-thirties-pain-ahead/article2125759/

Disclosure: No position in Fairfax

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


Rating: 4.9/5 (8 votes)

Comments

superguru
Superguru - 3 years ago
As usual great and timely article Jacob. My thinking matches Mr. Watsa's exactly. I think we are headed for lost decade and positioned in dividend paying large cap quality stocks and emerging bonds and munis.

"Mr. Watsa, who has become a fan of Japanese economist Richard Koo, also believes that the Obama administration and U.S. Congress could be making a fatal error by cutting spending."

Exactly what I said in this forum few days back. Govt. should be spending.

yswolinsky
Yswolinsky - 3 years ago
Thanks for the kind words Super.

I am no macro-economist but about about every country in the world is facing serious problems. The global economy is so interconnected that anyone of those problems getting out of hand i.e. Eurozone collapse ($16 trillion economy), Japan (numerous problems, still $5 trillion economy), China's bubble bursting (they buy every commodity in the world, will especially hit Australia but hurt every exporter), or the US (~25% of global GDP) which has many obvious problems could slip into double dip etc. would vibrate across the world.

My apologizes for the very informal grammar in this comment.

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