Prem Watsa, Chairman and CEO of Fairfax FinancialCharla Jones/The Globe and Mail
Just how bearish is Fairfax Financial CEO Prem Watsa?
When it comes to the outlook for the North American economy, Mr. Watsa has rarely been a glass-half-full kind of guy. But these days he's so certain the stock market is on the verge of tumbling that he's willing to happily give up hundreds of millions of dollars in potential investment gains.
In anticipation of a market meltdown, Fairfax began hedging its stock portfolio, and by the end of last year it was hedged to the tune of 105 per cent – meaning Fairfax is essentially shorting, or betting against, the market.
While Fairfax is a property and casualty insurance conglomerate, it has come to be known in the public eye for its investment prowess after a few prescient calls, most notably bets that it made prior to the financial crisis that paid out handsomely when large global financial institutions fell on hard times.
On Thursday the company announced that its insurance underwriting profit came in at $73.7-million for the third quarter, reversing a year-earlier loss of $105.3-million. But its investment losses in the latest quarter were $26.3-million, compared to a whopping $1.6-billion investment gain in the same period a year ago.
The investment losses this quarter, as in some earlier quarters this year, stem from the hedges, which will hurt Fairfax any time that stock markets rise.
In the last nine months Fairfax's stock portfolio has made $523.7-million (U.S.) in realized and unrealized gains, while its hedges have cost $864.8-million in realized and unrealized losses.
But Mr. Watsa is sticking to them. And he's put about one-third of the firm's investment funds (or $8.1-billion) in cash, saying he doesn't believe that markets are compensating investors for the risks they're taking at current levels. He would rather be defensive and lose out on potential gains than take any risk of losing capital.
Fairfax's investment team's outlook is similar to that of a number of bearish market researchers who say there's more to worry about than to not worry about these days. Last month Deutsche Bank released a long-term asset return study called "A journey into the unknown." It pointed out that a number of economic and financial variables are at levels that they've never seen in hundreds of years, adding heaps of uncertainty to financial markets.
For instance, core long-dated bond yields hit all-time lows this year. The longest data series on that is for Holland, whose 10-year yields this June hit their lowest level in 495 years of data. Ten-year U.S. treasuries hit an all-time low in July. And this year the Bank of England hit a record for the size of its balance sheet relative to GDP. "Never before in observable history have so many countries had such long periods without sustainable surpluses," the Deutsche Bank report said. "The level of uncertainty concerning the future must be extremely high."