Thursday, 3 March 2016

The Intersection of (gulp) Technical Analysis, Globe and Mail, and Fairfax

I haven't posted in a while because I'm in the midst of tax season and I haven't had time to post much.

I stumbled across the following article from the Globe's Rob Carrick on Fairfax at the end of February. The article, in my opinion, is silly.  Judge for yourself.  Copyright and all rights reserved globe and mail.  Link here.

The reason I think this article is just plain silly (and I'm holding back here), is because Mr. Carrick attempts to makes a case for Fairfax being a hedge against a market crash, and I personally think that the concept of Fairfax being any sort of hedge is just wrong.  For starters, Mr. Carrick compares the performance of Fairfax vs. the S&P TSX composite.  Given that Fairfax's equity portfolio is primarily comprised of S&P500 constituents, and given that Mr. Watsa himself compares the performance of the hedged investment portfolio vs. the S&P 500 in his annual letters (see below), I wonder how the S&P TSX composite slipped into the comparative analysis at all, but this is probably just me being a nit-picky idiot.

Here's a monthly study of Fairfax juxtaposed to both the S&P500 and the TSX Capped Composite Index ETF.  Since 1998, Fairfax has, for the most part, lagged both the S&P500 & the TSX Capped Composite Index in terms of cumulative performance.

Relative to the S&P TSX Capped Composite, Fairfax has outperformed visibly since mid-2014, which makes intuitive sense given the Canadian market's exposure to all things commodities.  In terms of relative outperformance vs. the S&P 500?  Not happening.

Here's a closer look at the weekly performance vs. the S&P500 over the last 5 years.  With the exception of the last couple of months, no dice.  The S&P500 has outperformed.

Unquestionably though, Fairfax has performed exceptionally well since 2012, returning just over 12% on a compound annual basis, but facts are facts, this is about the same as that returned by the S&P500 over the same period (before considering FX return of a Canadian investor holding an S&P500 equivalent equivalent basket in USD vs. Fairfax).

And then there's the timing of Mr. Carrick's article, about 1 week removed from a $735M bought deal offering, the proceeds of which are to be used towards the acquisition of shares of Eurolife Insurance Group Holdings S.A. (a Greek insurance co.) and ICICI Lombard General Insurance (an Indian insurance co.).

On the subject of the timing of the article and the prescience of the concept of Fairfax as a hedge, my thoughts are as follows.

If the entire investment hypothesis is "buy Fairfax as a hedge because Fairfax has hedged close to 100% of its invested float, and everyone in the market (i.e., looney land) piles in believing it's a hedge that will work as a hedge, at what point does the idea stop being a hedge? i.e., at what point does the theoretical price of being a hedge not become a hedge?  The stock was bid up close to $800 in late January as the market nose-dived, but the price of the hedge became stupid relative to what was actually being hedged.

Case in point, the invested float is close to100% hedged. This has cost premium in order to maintain over time. So with no alpha from the invested float (and arguably no investment income ‎either as it gets eaten up by the cost of maintaining the hedge), investors are left with exposure to the insurance businesses only, his other bets (Greek bets, blackberry, etc), and a smattering of esoteric bets with un-quantifiable payoffs.  I'm certainly not smart enough to take a stab at what the deflation bets may pay-off over time.

Personally, I would prefer to own Berkshire. Yes, you are exposed to the equivalent of owning SPY inherent in owning Berkshire, but the lower SPY goes (and the lower Berkshire goes), the more sense it makes to buy equities as they get less risky.

I was reading prefblog this morning, and couldn't help but notice that James Hymas alluded to the following regarding Fairfax's bought deal:

So in the context of the above, here is my rebuttal to Mr. Carrick's very timely buy Fairfax as a hedge argument:

The bought deal unsold shares means that the underwriters have inventory to sell‎, and given that the stock isn't the most liquid on the best of days, this could be an opportunity to revisit wanting to own Fairfax at the right price. 

I think good to cancel orders just above $640 make sense given the supply overhang. Technically, it may well become a self fulfilling prophecy, as participants start to realize that the underwriters have inventory they need to sell, this could result in a good chunk of pressure on the common in my opinion as they front run the underwriters and force their hands.

Avg trading volume is around 27k shares/day. 27k x $709 / sh = ‎$19.3m notional value per day.Unsold inventory = $735m x 50% = ‎$367.5m

Days to sell:$367.5 / $19.3m per day = about 20 days assuming the market can absorb it over a month... which is doubtful. I'm guessing at 20 days with no further pressure on the stock.

Here's where technical analysis comes in handy. It can be used to identify possible supply/demand zones in terms of support. 

My target on the underwriter's puking? Between $625 & $640 (about $70-$85 below current):

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