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Prem Watsa Is Fully Hedged

March 17, 2014 | About:
Chris Mydlo

Chris Mydlo

41 followers

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:

1395089621777.png


Rating: 4.2/5 (6 votes)

Voters:

Comments

AlbertaSunwapta
AlbertaSunwapta - 9 months ago

"Bubbles don't usually stop until sensible investors, value investors, and prudent investors have been hung out to dry and kicked around the block. That hasn't happened yet, so that tells you there is probably quite a bit left in this rally." - Jeremy Grantham

Jeremy Grantham: Learning to Live With a Stock Bubble

By Lawrence Strauss March 15, 2014, Barrons

robdainard
Robdainard premium member - 9 months ago

That does seem to be the conventional wisdom these days, which would suggest it might be right to not give it too much attention.

kfh227
Kfh227 premium member - 9 months ago

The question is, what are his hedges?

puts against he S&P 500?

chris mydlo
Chris mydlo - 9 months ago

Fairfax's largest hedges are equity index total return swaps of the Russell 2000 and CPI-linked derivatives. They have swaps on other indices, too. There is a line stating that he is short certain equities, but they are not listed individually.

Alberta Sunwapta has a good point. How long is Watsa going to wait for the losses to reverse? The plus side is that he is just hedging his positions and not maintaining an overall short position.

AlbertaSunwapta
AlbertaSunwapta - 9 months ago

In the late 1990s I bought Loews as they were shorting over priced tech shares. They lost of ton of money (something like a billion?) and finally threw in the towel.

Still, we don't always need an actual bubble to form before the market drops. That seems to be a new bit of conventional wisdom appearing everywhere these days.

Dr. Paul Price
Dr. Paul Price premium member - 9 months ago

Hmmm. Hedging losses of $4.47 billion and eventual gains of $4.65 billion.

Not really worth the time, effort or trouble on such a big asset base.

vgm
Vgm - 9 months ago
Prem always adds the caveat that, although he's hedged, markets and economies "may muddle through". In fact he says he hopes they do. And certainly Buffett was very sanguine a couple of days ago in stating that world markets are "not remotely close" to a crash. Howard Marks (Trades, Portfolio) has also stated recently that we are not in any kind of bubble. Everyone can see that stocks are generally fully priced, with pockets of overvaluation - and even pockets of undervaluation. "Proceed, but with caution" is Marks' advice. Sounds about right.

I'd kill to get Buffett, Klarman, Watsa and Marks round a table to debate their views!

gerrydjr
Gerrydjr - 9 months ago

If you were to be a Warren fan, I've always heard him mention that he doesn't care about the macroeconomic environment, doesn't care what the fed is doing or what any other country is doing for that matter. He is only interested in purchasing the parts or whole of individual companies of high quality that will do well over the long-term, and always optimistic of America over the long-term.

vgm
Vgm - 9 months ago

Gerry - yes, agree. This is what he wrote in the Annual Letter, February 2014:

"In the 54 years we [Buffett and Munger] have worked together, we have NEVER foregone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions."

It's a very strong statement. The future is always uncertain, however, and markets will continue to have pops and drops and corrections. It will be interesting to see if Watsa's "grand disconnect" comes to pass or whether we "muddle through".

Torben Loevendal
Torben Loevendal premium member - 9 months ago
I wonder Warren Buffett (Trades, Portfolio)'s opinion on March 14 2014, that he does not see a major crash in the stock market over the next 2 years.



Has he changed his two previous calculations on the stock market is overvalued?

01 Market valuations

The ratio of the total market value of GDP , Warren Buffett (Trades, Portfolio) 's " the best single measure of how

valuations stand at any given time , "stands at 117,7%. This fact is already

higher than pre-crisis peak of 107% and is higher than any time except the

go-go years of the late 1990s, when it reached 141% . Its historical mean is

about 85%.

02 Warren Buffett (Trades, Portfolio) said in Fortune Magazine 22 November 1999

"In my opinion , you have to be wildly optimistic to expect that corporate profits as a percent of GNP, for any sustained period last much more than 6% .... Maybe you'd like to argue for a different matter. Fair enough. But give me your assumptions . "

The current standard is at June 30 2013 to 84.66 % above their long-term historical norm over 50 years



vgm
Vgm - 9 months ago

"What Would You Do If You Were Prem Watsa (Trades, Portfolio)?"

Interesting perspective from Jeff Bronchick at Cove Street Capital: http://covestreetcapital.com/Blog/wp-content/uploads/2014/03/Cove-Street-Capital-Strategy-Letter-16-March-14.pdf

vgm
Vgm - 8 months ago

"Fairfax and Their Bets - Now Looking In From The Outside"

http://azvalue.blogspot.ca

I didn't see this posted on GF (apologies if it was) but thought it worth reading.

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