Prem Watsa “The Warren Buffett of Canada” is out with his annual letter, which is available on Fairfax website. Watsa had some very interesting insights throughout the letter. I picked my favorite part of the letter where Watsa talks about hedging, and his thoughts on China. This was all two pargraphs in the actual letter, but for easier reading I made it several pragraphs.
Our hedging programmasked the excellent common stock returns we earned in 2010, of which a significant amount was realized($522.1 million). We began 2010 with about 30% of our common stock hedged. In May and June we decided toincrease our hedge to approximately 100%. Our view was twofold: our capital had benefitted greatly from ourcommon stock portfolio and we wanted to protect our gains, and we worried about the unintended consequences oftoo much debt in the system – worldwide!
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If the 2008/2009 recession was like any other recession that the U.S. hasexperienced in the past 50 years, we would not be hedging today. However, we worry, as we have mentioned to youmany times in the past, that the North American economy may (the emphasis is Watsa’s) experience a time period like the U.S. in the 1930sand Japan since 1990, during which nominal GNP remains flat for 10 to 20 years with many bouts of deflation.
We see many problems in Europe as country after country reduces government spending and increases taxes to help reduce fiscal deficits. We see the U.S. government embarking on a similar exercise (as it has no other option) and all this while businesses and individuals are deleveraging from their huge debts incurred prior to 2008. Meanwhile we have concerns over potential bubbles in emerging markets.
Consider, for instance, what we learned on a recent trip toChina: many house (apartment) prices in Beijing and Shanghai had gone up almost four times – in the past four to five years!; many individuals own multiple apartments as investments with the certain belief that real estate pricescan only go up; and maids are taking holidays so that they can buy apartments also. “Buy two and sell one after it doubles to get one for free” goes the refrain! In his essay in Vanity Fair, “When Irish Eyes Are Crying”, Michael Lewis says, “Real estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long terminvestment real estate has become and flee the market, and the market will crash.” We agree!!Infrastructure and construction spending in China accounts for more than 40% of GDP – a number rarely seen in thepast in any economy. In fact, this demand has resulted in commodity prices going up in a parabolic curve. Combinethe increase in commodity prices, substantially from Chinese demand, with hedge funds and others again trying toallocate money to these very illiquid markets, and you can understand why some of these commodities have exploded in price.
You can read the full letter here.