When Prem Watsa speaks, investors listen. The "Oracle of the North" may not get as much fanfare as his peers at Berkshire Hathaway
Recently, in its second-quarter results, Fairfax revealed major shifts in its $22.6 billion portfolio. First, the company increased its short positions on the general market to hedge 93% of its equity portfolio. It shifted nearly half a billion dollars into long-term U.S. Treasuries this year. Most disturbing of all, Fairfax purchased $23 billion worth of protection (notional value) against the threat of deflation in the coming 10 years.
Each move points to a similar prognosis: slow U.S. growth, intermittent deflation, and a generally poor environment for common stocks. It is noteworthy, too, that Fairfax became worried and implemented its short hedge at an average S&P 500 price of 1,063 -- slightly below where it trades today. Seeing such a great investor turn bearish is a disconcerting sign. But before you panic, take comfort in these three facts.
Don't liquidate the farm just yet
One, the company has not yet bet the farm on this diagnosis. Equity and related investments still represent more than 20% of the portfolio, while cash and Treasuries make up a more modest sum. In fact, you can gain considerable insight by comparing the portfolio today to that at the beginning of the Great Recession.
Before then, Fairfax held more than half its portfolio in Treasuries and cash, and it was much less willing to take on equity risk. Now, its portfolio is only a quarter Treasuries and cash.
Two, as an insurance company, Fairfax is playing by a different set of rules than most investors. A drop of a few percentage points may affect where we eat tonight. For Fairfax, a bad market swing can send shorts and ratings agencies circling over its head, and that is bad for business. Insurance doesn't do much good to the customer if the firm behind it is insolvent. Just the fear of it can cause people to panic and customers to pull business. That threat considerably limits Fairfax's tolerance for uncertainty and risk.
Three, despite the gloom, the company still believes its carefully selected equity holdings "will significantly appreciate in value over time." Translation: Watsa still believes his portfolio can outperform. And while the company has been cutting its exposure in equities, it has maintained its large position in two companies: Johnson & Johnson
The Foolish bottom line
If we are trusting Watsa to be right again (and that is usually the smart-money bet), U.S. investors are in for a volatile ride. But individual opportunities exist, especially in investments poised to benefit from rapid worldwide growth. That's why Fairfax's portfolio is overflowing with either international conglomerates or with commodity companies, like International Coal
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Fool contributor Nick Nejad owns shares of Fairfax Financial. Berkshire Hathaway is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor pick. Johnson & Johnson is a Motley Fool Income Investor selection. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.