One of the few investors or money mavens who guessed the meltdown was coming is Canada's Prem Watsa, Chair and founder of Fairfax Financial Holdings Limited. In 2003, he and his investor team hedged and bet against markets because they could see catastrophe coming. For a year or so, their results missed the buoyant gains others posted. But when the tsunami hit, Fairfax made $2 billion profit and saved itself from the type of meltdown that AIG and even Warren Buffett's Berkshire Hathaway experienced.
Fairfax's investment team, led by Watsa, has made US$2 billion in profits for shareholders since 2003 and its market cap has gone up slightly despite the worst market since 1929 and the fact that its property and casualty rivals' stock prices have cratered by 26.5% to 97.4%. Fairfax has remained at US$5 billion market cap in the past year while Warren Buffett's Berkshire Hathaway has collapsed from US$219.2 billion market cap to $120.1 billion or the Hartford Financial fromUS$27.4 billion to US$1.7 billion. Or AIG which has collapsed in value.
In the past year, Fairfax has gone from North America's 14th largest public property and casualty insurer to its 7th largest.
Here are excerpts from my interview in The Financial Post with him this week. He has changed course and removed hedges off common stocks in order to begin buying:
Q&A with Prem Watsa:
Q. You removed hedges last week, so do you think the bottom's been reached?
A. "With the S&P drop year-to-date of 50% -- not seen since 1931 -- and how worried the investment community is, it just seemed to us a lot of fear may already be discounted in the stock markets. You can't say this is the bottom, markets are a discounting mechanism and certainly still can go down some; however, we thought it was an appropriate time to close our equity index hedges.
"Before we took the equity index hedges off we asked: Suppose we were wrong and the stock markets go down further, can we handle it? Our analysis indicated we could. Our hedges have done their job, protecting us from the 50% market decline we saw into November. However, we asked ourselves what if the stock markets decline another 50% and - in terms of ratings and capital - all the models we use indicated that we'd be fine.
"As for future stock values, trees don't grow to the sky and markets don't go to the floor, or zero. After a 50% drop, we see a ton of opportunity in terms of stock prices (in relationship to intrinsic values) we have never seen for a long, long time now.
"General Electric has never been valued this cheaply in 50 years. GE at $15-16, represents seven times earnings, over 8% yield -- which takes you right back to the 50s. This is a AAA-rated company. It has a tremendous record and today you can buy it at these very low prices."
Q. What's your advice now to the average investor who you warned should avoid the market in early October?
A. "We are buying many common stock positions at these prices. We are buying with the idea that the stocks we buy could go down in the short-term and that is not going to affect us. You have to be able to buy with cash and not go on margin or borrow money to buy these stocks."
"We would not have taken our hedges off if we didn't think we could survive a further 50% drop in the market, because a further stock market drop in the short-term is also a possibility.
"A good investment now would be a value-oriented mutual fund with a long-term track record but without leverage."
Q. Is the redemption phenomenon, by hedge and mutual funds, nearly finished knocking down stock values?
A. "We have seen more than a 20% decline in mutual fund assets in the last three months and this redemption run can last for some time. The recession may be long and deep and redemptions may continue for some time."
Q. How will the next President-elect Barack Obama affect the economy?
A. "They are pouring money into banks, consumer credit, toxic assets. I'm not sure there is a lot of ammunition left but it looks like the new administration is going to come with a very significant stimulus program. The Chinese have too. At some point these actions will bite and a recovery will begin, but we must be careful to see what the new administration will do."
"Things to watch the new administration on are trade and China, currency, autos, the environment as it affects businesses, interest rates and of course, taxes. If the new administration decides not to do anything on taxes for two years, that could have a very different impact from hiking corporate and capital gains and other taxes immediately."
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