Prem Watsa (Trades, Portfolio) is often described as “Canada’s Warren Buffett (Trades, Portfolio).” He said in his letter to Fairfax Financial (TSX:FFH) shareholders released on March 7 that his common stock portfolio is fully hedged. He then highlighted some of his reasons for being bearish:
1. The U.S. total debt/GDP ratio is at a very high level and significant deleveraging is yet to come. This applies to Europe and the UK also.
2. Economic growth in the Western world is still very weak in spite of huge monetary and fiscal stimulus by the Fed and the ECB. In nominal and real terms, annually since 2009 the U.S. only grew by 3.9% and 2.3%respectively (while Europe grew by 1.6% and 0.5% respectively). In spite of this anemic growth, after-tax profit as a percentage of GDP in the U.S. is at the highest level of the last 60 years.
3. Inflation in the U.S. and Europe, after five years of huge fiscal stimulus, is still in the 1% area – and falling. We remind you that it took five years after the stock market crash in 1990 before Japan saw deflation – and this deflation continued for most of the following 19 years.
4. QE1, QE2 and QE3 have helped the financial markets but have not worked in the real economy. What happens when everyone realizes that the Fed and the ECB have no more bullets?
5. There is a monstrous real estate and construction bubble in China, which could burst anytime. It almost did in 2011 but China increased its credit growth significantly since then.
6. Reaching for yield continues everywhere, with junk debt at record low yields, emerging market debt in U.S. dollars at very low yields and corporate bonds at very low spreads. Many emerging market countries also have significant external debt in foreign currencies. All vulnerable to a ‘‘risk off’’ run on the bank!
In the past four years Fairfax has had significant losses due to its hedging program while waiting for the “grand disconnect” from the fundamentals to disappear. The losses from his hedges, mostly unrealized, have been $3.9721 billion since 2010. He then compared his figures to his hedging losses of $498 million from 2003 to 2006. The hedging losses reversed into $4.658 billion in gains from 2007 to 2008.
The time frames are now lining up. Watsa’s previous hedges took until the fifth year to materialize into gains. We are now in year five of his latest hedging program. If a downturn in the markets is heading our way, Fairfax Financial is positioned to better maintain its value. Using the symbol, FRFHF, Fairfax was up 9.5% compared to the S&P 500 being down 38.47%. FRFHF is the ordinary share that is priced in U.S. dollars.
Here is a chart from 2003 to the market bottom on Mach 9, 2009, comparing Fairfax Financial to SPY, the SPDR S&P 500 ETF: