Friday, January 16, 2009

Biggest meltdown winner: be very wary

Canada’s pre-eminent market oracle, Prem Watsa, has been cautiously buying stocks and bonds since late November even though he doesn’t believe the bottom has been reached.

The crux of the problem
“De-leveraging” is hoarding, paying down debt, postponing expenditures by banks, individuals and companies which is contributing to the recession and deflation of prices, he explained.
The two historical examples of the serious meltdown the world now faces occurred in the 1930s after the 1929 market crash and Japan’s economic malaise since its 1989 meltdown, not as severe but nonetheless serious.
“In the case of both those data points, the de-leveraging was so severe that even though governments built infrastructure and interest rates went to zero the economy did not around,” he said.
“De-leveraging means that the value of houses, for instance, have to go down so low that people will start to turn around to buy them again. It means that factories with excess capacity will have to close until demand returns and makes surviving factories busy again,” he said. “It might take four or five years.”

Political vigilance is critical
The danger signs are if any of the three disastrous policies from the 1930s rear their ugly heads again: tariff barriers; higher taxes to balance budgets or higher interest rates to support currencies.
“These are the kind of things you have to look for as signals about the future,” he said. “If Obama starts talking about `Buy American’ that’s less obvious but is a form of protectionism that may impede a turnaround.”
Another unintended consequence that may loom is the exchange rate issues such as the concern about China’s low value or that Greece, Ireland and Spain have been downgraded by S&P because they are not meeting Euro standards. Their debts and spending are too high.
“One of those countries may leave the Euro or be booted out,” he said.

Overall optimism
Its most recent deal was Northbridge’s privatization and is an example of Fairfax’s financial heft. “We took Northbridge public in 2003 because we needed the money. We owned it for 23 years and its now Canada’s biggest commercial lines company,” he said. “It went public at 1.2 times’ book value at C$15 a share. In the fourth quarter we had a US$350 million dividend from a U.S. investment so we made an offer to buy out the rest of Northbridge for 1.3 times’ book value and a 30% premium to its average trading price or C$39 a share.”
Northbridge shareholders, 67% of whom acceded to the deal, made 20% compounded annually if they had held the stock since 2003.
Watsa also owns a chunk of CanWest whose stock has fallen dramatically, but remains a loyal, long-term investor.
Fairfax is optimistic overall, has been carefully investing and took the hedges off its portfolios this fall but remains vigilant. And Watsa believes that allinvestors should do the same.

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