Francis Chou’s Chou Associates Fund semi annual letter for the first half ended June 30, 2015.
Dear Unitholders of Chou Associates Fund,
The net asset value (“NAVPU” or “NAV”) of a Series A unit of Chou Associates Fund at June 30, 2015 was $121.07 compared to $124.19 at December 31, 2014, a decrease of 2.4%, while the S&P 500 Total Return Index increased 8.8% in Canadian dollars. In $US, a Series A unit of Chou Associates Fund was down 9.2% while the S&P 500 Total Return Index returned 1.2%.
The table shows our one-year, three-year, five-year, 10-year and 15-year annual compound rates of return.
Francis Chou – Factors Influencing the First Six Months Results
Positive contributors to the Fund’s performance during the period ended June 30, 2015 included warrants of JP Morgan Chase & Company and Wells Fargo & Company and equity securities of Chicago Bridge & Iron Company and Sanofi ADR. The Canadian currency depreciated against the US dollar, which also contributed to the positive performance of the Fund.
Securities of Nokia Corporation ADR, Berkshire Hathaway Inc., Resolute Forest Product Inc., Sears Holding Corporation and MBIA Inc. were negative contributors to the Fund’s performance during the same period.
The fund decreased its holdings of Nokia Corporation ADR by 25%.
Olympus Re Holdings Limited was dissolved in February of 2015, and the Fund received a final liquidating distribution in the amount of $643,930.
Francis Chou – Market Commentary
It is tough to find bargains at the present time. There is hardly anything to buy at a compelling price. The few stocks we own are cheap but when the general stock market level is not cheap, it makes us nervous. Our experience has taught us that it is better to sit on the sidelines and wait for developments. However, as we wrote earlier, we continue to worry about several issues:
1) How low can interest rates go? In Europe, some sovereign bonds are trading at negative yields.
2) The Great Recession occurred in 2008, and now it is 2015 – that is seven long years. Although the recovery has been anemic, at least it’s recovering.
3) The velocity of money for M2 is at an all-time low. This can be further highlighted if we hypothesize about what would happen if M2 moved back up to the historical average. If a regression to the mean were to occur – the price levels could be 25% higher than what it is today. Carrying this logic one step further, with the current levels of money-printing growing at approximately 7.2% annualized, this could see a potential price level increase of 50%, if the velocity of money were to move back up to the historical average.
No one can predict the future with any high degree of certainty, but you wonder: if the current policies continue for any extended period of time, when will the chickens come home to roost?
4) Deflationary forces are strong now; eventually, the supply and demand will bring everything into equilibrium as they work through their economic cycles, but you cannot ‘un-print’ money.
5) Stock prices are close to an all-time high if measured by price to earnings ratio, premium to book value or current dividend yield.
6) Junk bonds, the biggest beneficiary of easy money, should be trading at 70, not at 100 cents on a dollar with a 5.5% coupon rate.
7) What happens to the bond and stock markets if interest rates start to rise?
You can make a theoretical case that if interest rates stay as low as they are now for the next 20 years, the stock market is cheap based on the discounted method of valuation. However, when we look at Japan as an example, its stock markets have been at a slump since 1989 — even though interest rates have stayed low for these 26-odd years.
The current conditions make me feel that investors are being set up for heartbreaking disappointment, especially for the unwary.
Francis Chou – Europe and Greece
It appears that Greece has been a basket case forever. It is an eye opener to see that since the year 1800, Greece has spent roughly 50% of its time in default or debt rescheduling. It has too much debt and whatever deal it can strike with the Troika, (the European Commission, the International Monetary Fund, and the European Central Bank) it won’t solve the problem; only give them some short-term relief. The people of Greece will pay to a degree with some austerity problems but in a few more years we will have another round of brinkmanship (negotiations) between the Troika and Greece.
Mark Grant, who is a Managing Director of Southwest Securities and one of the most colorful writers on the Greek recurring bailouts, captures the essence of what the bailout really means with this anecdote. Even when I disagree with his conclusions, he is enjoyable to read.
“It is a slow day in a little Greek Village. The rain is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit.
On this particular day a rich German tourist is driving through the village, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night. The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.
The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer.
The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel.
The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the taverna.
The publican (tavern manager) slips the money along to the local lady of the night drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit.
The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note.
The hotel proprietor then places the €100 note back on the counter so the rich traveler will not suspect anything.
At that moment the traveler comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town.
No one produced anything. No one earned anything. However, the whole village is now out of debt and looking to the future with a lot more optimism. And that, Ladies and Gentlemen, is how any new Greek bailout package is likely to work.”
The Greek debt crisis and fiscal irresponsibility is truly a tragic case but most of it has been institutionalized and has been embedded into the Greek culture. A New York Times article published on May 1, 2010, cast a glaring light on how deep the problem lies.
“In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that
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