Value Investing World

"Conventional wisdom holds that memory is like a serial recording device like a computer diskette. In reality, memory is dynamic—not static—like a paper on which new texts (or new versions of the same text) will be continuously recorded, thanks to the power of posterior information....Memory is more of a self-serving dynamic revision machine: you remember the last time you remembered the event and, without realizing it, change the story at every subsequent remembrance." -Nassim Taleb, The Black Swan

Hussman Weekly Market Comment: Hot Potato

2012-02-12T19:05:00.001-05:00

We often receive questions relating to the ensemble method that guides our hedging strategy. Along with last week's comment (Notes on Risk Management ), the following section is intended to provide a broad overview.

One of the main approaches we use to estimate return and risk prospects is to group current market conditions among historical instances that are most similar. Each point in history is defined by various "features" based on a broad range of key factors, including valuations, trend-following indicators, market breadth, sentiment, credit spreads, economic factors, overbought/oversold measures, and so forth. In order to make the analysis less dependent on any particular historical period (e.g. postwar data, bubble-era data, Depression-era data), or any single set of indicators, we extend this analysis to a very large number of randomly selected sub-samples across history.

This sort of analysis is an example of an "ensemble method," which has several benefits, the two most important being on measures of "accuracy" and "robustness." It's easy to fit a model to past data, but those models often break down quickly in new data. So to evaluate accuracy, we estimate return and risk on data that the model has not "seen" previously, and find that the ensemble approach generally performs better than alternative methods. Equally important, the ensemble is robust to very large changes in the underlying economic environment, because randomizing over numerous sub-samples of history reduces the likelihood that the model is "over-fitted" to a particular economic environment.

I wish I could say that we anticipated the depth of the 2008-2009 credit crisis so completely that I developed these ensemble methods in advance, already confident in how they would have performed even in Depression-era data. Unfortunately, that's not the case, and shareholders are well aware of the challenges we went through in stress-testing our approach against other periods of credit crisis.

Though these weekly comments forewarned much of what actually occurred during the credit crisis, I certainly didn't anticipate what I still consider to be terrible policy mistakes - particularly the absolute unwillingness to restructure bad debt, in preference for kicking the can down the road with public funds. It was a far cry from how U.S. regulators had responded to the S&L crisis, and how other international banking crises had been successfully addressed (for example, in the early 1990's, the Swedish banking crisis was durably resolved by the government taking receivership of a large portion of the banking industry, wiping out existing shareholders, writing down bad assets, and then taking the banks public to recapitalize them under new owners).

For anyone who was responsible for investing the funds of others, the proper response to the 2008 crisis was to stress-test every method, though I'm not convinced that much of Wall Street has stress-tested anything at all. For us, stress-testing meant taking our models to Depression-era data, because it was clear that events of the time were largely "out of sample" from the standpoint of post-war data. At the time, we were basing our estimates of market risk and return on data since about 1950, which I had - incorrectly - believed was sufficient to capture "modern" market behavior.

While our existing hedging approach performed well in that Depression-era data overall, the occasional losses were far deeper than I was willing to risk for our shareholders. The result was what I called a "two-data sets" problem, which demanded that our hedging methods perform well, out-of-sample, and with tolerable drawdowns in data drawn from both post-war and Depression-era periods. We reached a satisfactory solution in 2010 with the introduction of our ensemble approach. The cost was that in hindsight, my decision to fully stress-test our methods shot us in the foot by missing a rebound in 2009 that we should not have missed, had our present approach been already in hand.

In real-time, our hedging approach has repeatedly demonstrated value over complete bull-bear market cycles, both adding returns and defending against severe market losses (exceeding 50% downturns twice in the last decade). We'll certainly have periods where we appear remarkably out-of-step with the prevailing trend of the market, particularly in overvalued, overbought, overbullish periods of speculation. But defending against losses in these periods is essential to risk management, despite the tendency of bulls to declare victory at halftime. I remain confident that our investment approach will continue to navigate the financial markets effectively over the course of complete market cycles.

Something From Nothing: Lawrence Krauss and Richard Dawkins

2012-02-12T18:47:00.002-05:00

Link

John Mauldin: The Answer We Don’t Want to Know

2012-02-12T18:31:00.001-05:00

2012 will be the 11th time in my short life that I will be able to participate in the choosing of a president of the United States. While it may just be me, it seems like each and every election is cast as the most important election of our time and a defining moment for the American Experiment. The future of the Republic was being weighed in the balance, and only the proper outcome (which would of course be the election of the candidate you supported) would assure its survival. This week we will continue our meditations on the economic choices that confront the world, this time focusing on the US.

We will start with a thought experiment, in which I invite you to think about alternate histories. Just how important are presidents (or leaders in general) to the success or failure of the economy? And then how critical is the coming election this fall? We will assault a few of our most cherished beliefs, both from the left and from the right. If I do not offend you in the first few pages, I invite you to keep reading; I will get to you somewhere.

Jimmy Moore Interviews Mark Sisson

2012-02-11T21:56:00.001-05:00

Link to: Interview with Mark Sisson

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Related book: The Primal Blueprint

Howard Marks on investment careers (2003)

2012-02-11T21:24:00.002-05:00

"One of the most striking things I’ve noted over the last 35 years is how brief most outstanding investment careers are....I don’t think many investment managers’ careers end because they fail to hit home runs. Rather, they end up out of the game because they strike out too often – not because they don’t have enough winners, but because they have too many losers. And yet, lots of managers keep swinging for the fences."

Howard Marks on partner interaction at Oaktree (2003)

2012-02-11T21:21:00.000-05:00

"...our interaction at Oaktree is highly symbiotic, and we’re fortunate enough to appreciate that fact. I know my partners do a better job of portfolio management than I ever did. And they’re glad to have me out visiting our clients, so they can stay back and manage their portfolios."

Taleb/narrative fallacy

2012-02-10T10:45:00.001-05:00

"...the same condition that makes us simplify pushes us to think that the world is less random than it actually is." -Nassim Taleb, The Black Swan

Dairy Queen opens 500th restaurant in China

2012-02-09T17:29:00.001-05:00

International Dairy Queen Inc. has opened its 500th Dairy Queen restaurant in China, and plans to maintain its accelerated growth in that country in 2012 by adding more than 100 new locations this year.

Since the first Dairy Queen opened in Beijing in 1991, China has been the frozen-treat chain’s largest international market. The 500th location, which opened in the Hu Dong financial district in Shanghai, is one of more than 350 Dairy Queen units operated by franchisee Shanghai Shida Catering Management Company.

“With the world’s fastest-growing major economy, China continues to be a tremendous expansion market for the Dairy Queen system, and we attribute that in large part to strong alliances with our development partners here, including Shanghai Shida Catering,” John Gainor, International Dairy Queen’s president and chief executive, said in a statement at the opening in Shanghai. “Today, more than ever, people everywhere are looking for value, but they still want to treat themselves … and we look forward to continued expansion.”

China was Dairy Queen’s largest growth market in 2011, the company said. One-hundred thirty-one of the 271 total Dairy Queen units added during the year were in China.

The country also has been a major expansion driver and international proving ground for the world’s largest quick-service companies. Louisville, Ky.-based Yum! Brands Inc., for instance, derives its largest share of its annual operating profit from its China division, whose same-store sales grew 19 percent for fiscal 2011.

Yum has more than 3,700 KFC locations in China, as well as more than 750 Pizza Hut units there, in addition to smaller systems for its Chinese quick-service concept East Dawning and the recently acquired Little Sheep casual-dining chain. The company plans to open more than 600 units in China in 2012.

Likewise, Oak Brook, Ill.-based McDonald’s Corp. opened 200 restaurants in China in 2011, and plans to build about 250 restaurants there this year. China also is expected to get a large portion of the 450 remodels planned for the company’s Asia/Pacific, Middle East and Africa division.

SocGen’s Edwards: Mervyn King should be stripped of knighthood

2012-02-09T17:21:00.000-05:00

Société Générale global strategist Albert Edwards has said Bank of England governor Mervyn King and former Federal Reserve chairman Alan Greenspan should be stripped of their knighthoods in light of the same fate befalling Fred Goodwin.

Former RBS chairman Goodwin was stripped of his knighthood last month, with the Cabinet Office saying the scale and severity of his actions while CEO of RBS made it an "exceptional case". Goodwin's tenure at the bank ended when it received a £46bn government bailout in 2008-9.

Perma-bear Edwards, however, maintains it was excessively loose monetary policy in both the US and the UK that was primarily responsible for the crisis, rather than lenders and borrowers overextending themselves.

"If knighthoods are being removed for those held primarily responsible for the debacle, shouldn't Sir Alan Greenspan and Sir Mervyn King, like the ex-CEO of RBS Fred Goodwin, be stripped of their honours too?" he said.

Rob Arnott on King World News (2/4/2012)

2012-02-09T11:17:00.001-05:00

Link to: Rob Arnott on King World News

Zebra stripes evolved to keep biting flies at bay

2012-02-09T11:15:00.002-05:00

Why zebras evolved their characteristic black-and-white stripes has been the subject of decades of debate among scientists.

Now researchers from Hungary and Sweden claim to have solved the mystery.

The stripes, they say, came about to keep away blood-sucking flies.

They report in the Journal of Experimental Biology that this pattern of narrow stripes makes zebras "unattractive" to the flies.

They key to this effect is in how the striped patterns reflect light.

…..

Prof Matthew Cobb, an evolutionary biologist from the University of Manchester pointed out that the experiment was "rigorous and fascinating" but did not exclude the other hypotheses about the origin of zebras' stripes.

"Above all, for this explanation to be true, the authors would have to show that tabanid fly bites are a major selection pressure on zebras, but not on horses and donkeys found elsewhere in the world... none of which are stripy," he told BBC Nature.

"[They] recognise this in their study, and my hunch is that there is not a single explanation and that many factors are involved in the zebra's stripes.

"Person to Person": Warren Buffett

2012-02-09T10:20:00.000-05:00

Link

Warren Buffett: Why stocks beat gold and bonds

2012-02-09T10:16:00.002-05:00

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway (BRKA) we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power -- after taxes have been paid on nominal gains -- in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability -- the reasoned probability -- of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a nonfluctuating asset can be laden with risk.

Investment possibilities are both many and varied. There are three major categories, however, and it's important to understand the characteristics of each. So let's survey the field.

Google Talk: Steve Keen

2012-02-08T11:15:00.003-05:00

Link

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Related book: Debunking Economics - Revised and Expanded Edition: The Naked Emperor Dethroned?

Larry Fink.....contrarian indicator?

2012-02-08T10:56:00.001-05:00

From June of 2008:

"We were one of the investors in the Lehman equity offering...Lehman is not a Bear Stearns situation...Lehman is adequately structured in terms of avoiding a liquidity crisis...We believe we're closer to the bottom than another round of calamity."

And today, as reported by Bloomberg:

“Investors should have 100 percent of investments in equities because of valuations and higher returns than bonds, said Laurence D. Fink, chief executive officer of BlackRock Inc. (BLK), the world’s largest money manager.

Investors who seek the safety of treasury bonds will have minimal returns and will not be able to meet their needs with the U.S. Federal Reserve expected to keep interest rates low, said Fink, who in 1988 co-founded the New York-based manager with $3.5 trillion of assets. By contrast, equities are trading at the lowest valuations in 20 or 30 years.”

I don’t think the intrinsic value of the market has grown by close to 100% since 2008-2009, so how someone can keep a straight face when saying valuations are the lowest in 20 or 30 years is beyond me, although I’m guessing it has something to do with where his incentives lie.

Fairfax Newsletter

2012-02-08T09:44:00.000-05:00

Found via the Corner of Berkshire & Fairfax.

Welcome to the Fairfax Newsletter. This is the inaugural issue of a newsletter we will publish on a periodic basis. We seek to accomplish two major goals in publishing this newsletter. First, we intend to promote a broader base of knowledge about Fairfax to all of our employees. Second, we seek to promote and facilitate greater cooperation and interaction across our group, between companies and among employees. In future issues we intend to highlight centers of excellence within the Fairfax group, focus on interesting and novel approaches to building lines of business, and provide profiles of individuals and offices as well as conduct interviews with key executives within Fairfax.