Tim Ayles'  Instablog

With the stock market rallying on everything but fundamentals, sensible humans are selling smart money and insiders are selling stocks into the ramp and getting defensive at this juncture.

If you have sold any stocks as we have, you know that you immediately are not comfortable. With the government on quest to destroy the currency, investors are torn about holding their dollars to invest at lower prices, or putting it into something "safe" like precious metals to fight against inflation that is seemingly here. With cash returning near 0%, it would seem to make sense to invest the cash somewhere else to get a return and not worry about the safety of the money.

To that, I propose a preferred security from Odyssey RE Holdings, and insurance company. The former symbol was ORH, but has been delisted as the company was taken over by another insurance company: FFH Fairfax financial is run by whom I refer to as the Warren Buffet of the North. It was the most profitable company in Canada last year, and the stock price is flirting with all time highs, while most of the market is still down around 30% from it's highs. I'd go so far as to say that Prem is an even better investor than Buffet. During the crash, Prem was in cash, then bought near the lows, and is now about 25% hedged. As you can see, the difference in price of FFH compared to BRK.A is quite impressive:

finance.yahoo.com/echarts

During the last two years of market chaos, FFH is up 30%, while Berkshire shares are down 30% in that same time frame. FFH also had $7 billion in cash as of their Dec 2008 filing (of which much has been invested), but their market value is only slightly higher than that.

All this to say, Fairfax is a financial fortress with an investor who has outperformed Buffet himself at the helm.

So where does ORH preferred shares come in? Well, now that ORH is 100% owned by Fairfax, the preferred shares are wrapped into the financial fortress that is Fairfax financial. The probability that our preferred shares become worthless is low in my estimation. 

ORH offers an A and B series of preferreds. I highly prefer the B series as an alternative to cash.

The reasons?

First, it is currently trading at a 16% discount to redemption value. The company can redeem the shares at $25, but they currently trade at $21.

Secondly, I like the way the interest rate is structured. It is a 3.25% interest rate over the 3 month LIBOR. So it is variable Compared to near 8% fixed rate one could get on the A shares, it seems like a bad deal. But hear me out. The current 3 month LIBOR is about .25%. It can't go much lower. On top of that, the shares are priced 16% lower right now - so that actual income received right now is around 4.4% If LIBOR were to go to 0%, the rate we receive would drop to 4.15%, which is about 40 times greater than the rate paid on cash.

The only direction the interest rate we can get paid can go is up from here. If inflation takes off and the bond market collapses, thus driving interest rates much higher as most people expect, then the income we recieve will go up along with interest rates. So if rates jump from near 0% to 10% - our income per share goes from the currenty 4.5% to over 13%. No need to worry about inflation hurting our fixed income. If rates drop further because bond prices go up, we can benefit from a rising share price.

The flip side is that the price of the security could drop as well. This is the risk. But I feel that any price I can get them under $25 is a deal as I feel there is near 0 chance of Fairfax defaulting on their liabilities. In fact, I secretly hope investors panic and offer me their shares under $20 again as they did during last years crises.

So I do not like stocks at these levels, but at the same time I do not like holding cash. If rates skyrocket due to tanking bond prices, my income is protected. If rates go down, I gain from the value of my shares rising to PAR which is $25. Either way, I see it as a great alternative to cash while I wait for the stock market to come back to more fundamentally sound prices.



Disclosure: NWM clients are long 112,580 shares of ORH-PB and long 850 shares in personal account


Disclosure: Long 112.580 ORH preferred B shares in client accounts and 850 in personal account

Today we are looking at what Doug Kass calls the animal spirits of the market, and beginning to agree with him.

We are taking profits in SLV for a 8%+ gain in a short period of time, and also taking some profits in our longer term positions in the virtual banks - HTS, NLY, and AGNC.

We are looking for spots to re-enter our long thesis on the dollar for a decent sized trade. We will be putting our toe back into UUP and also looking to get long the VIX via VXX or calls on the VIX.

With the markets in froth mode, we are once again about to make the hard trade.

From the long side, we added some MO, and PFE recently based on free cash flow valuations. Those are core longs we plan to hold for some time.

As an alternative to cash - we are taking down a lot of ORH preferred B shares lately. It is only a $50 million issue, and ORH has been bought by FFH - Canada's most profitable company last year and run by one of the world's best investors.

The preferred shares are trading near a 20% discount to redemption price. The key here is that the interest rate is variable. It is 3.25% plus the 3 month libor. WIth the LIBOR near 0 - the rate can't get much lower. If rates take off - the income will go up.

The risk is that FFH goes out of business. I give that about the same chance as Warren Buffet going under since they are in the same lines of business and the FFH CEO seems to be a bit more conservative and hedges his longs. I will be writing an article about this soon.

Just going to write some very random thoughts going through my mind about the market just for documenting......

I have been in the deflation camp for months now after writing in March that the bottom for 2009 was in and that we would see 9000+ on the Dow. When we wrote that, our own clients mocked us. Now that we are in our target range of 9100-10650, we are telling clients the next big move in the market is towards 5000 on the dow over the next year.

The caveat to this is the governments bent on destroying the value of our currency. We bought UUP and sold for a .5% profit when it started to go against us, and will be looking to add UUP again in the future. In the meantime, our portfolios are very bond centered and filled alternative investments. We did add GIS and SLV to the portfolios along with selected corporate fixed income. Because of inflated asset prices, we have moved from slightly net short to back to nuetral after the NFP report did not hammer stocks lower. We will become net short again soon by adding to long positions in SH and PSQ.

Stagflation is becoming a larger concern to us. In stagflation, there is nowhere to hide. Prices to live go up, and asset prices plummet - both stocks and bonds. Commodities might hold their purchasing power, but for retired folks who own gold per se, they have to sell their purchasing power to live, thus giving them a lower and lower capital base. Wall Street is not prepared for stagflation.

We still believe another panic is on the near horizon though, one in which cash will outperform all other assets for a strong but short period of time. Once this next panic is nearing the end, we plan to get long inflation as we feel the government will throw the kitchen sink at the problem. If printing money fixed all problems, why would we ever need to worry? Bottom line, printing money does nothing, and this recent rally is but a facade. Foreclosures are hitting record highs, and banks are contracting lending still. debt destruction is still stronger than the printing the government is doing. This next panic will make the fed put nitrous oxide tanks on the printing press, thus hurling America into a deeper depression than the 1930's. If you want a glimpse of what that could look like, just do some research on Argentina and Iceland. Rising prices for living, while asset prices collapse. It's not fun to be a doom and gloomer, but this administration and Fed leaders should be arrested for what they are doing to enrich the crooks who got us into this mess, while leaving main street to fend for itself. Get ready for a second American revolution.

Long GIS, SH, SLV, PSQ in selected client accounts