Why Fairfax Financial Holdings Ltd (FRFHF) Is Negative On US and Europe?


Fairfax Financial Holdings Ltd (OTCMKTS:FRFHF) is confident that the economy in the United States, as well as, the Europe will witness a big downturn. The company has been betting big money on that for quite some time. Both the America and the EU are trying to come out of the Great Recession inflicted upon the world economy in 2008 due to the big financial crisis. After a prolonged period of lower interest rate, the Federal Reserve is trying to hike interest rates for the first time in a decade. Therefore, the company’s bet on the major downturn is undoubtedly a depressed sentiment. Significantly, the bet has been increasing over the years with much of it centered on deflation.

Hedged In Equity Markets

Fairfax Financial Holdings Ltd (OTCMKTS:FRFHF) is involved in hedging of equity and related exposures. At the end of the third quarter, the company’s total exposure towards equity exposure was $5.939 billion.  Similarly, the company has also taken a short position worth around $6.0 billion in respect of equity-connected securities. The net result was that it was holding a slight overall short position. The move suggests that its equity portfolio has been completely hedged against the risk of any weak stock market or prices.

This was in contrast to the earlier position of holding the stocks in respect of equity portfolio. For instance, from the start of the year 2009 and the second quarter of the year 2011, Fairfax Financial Holdings Ltd (OTCMKTS:FRFHF) was holding a long position on a net basis. At that point of time, the company was betting in favor of the stock market going higher. However, the situation has changed after the third quarter of the same year. It was generally a short position with the exception of fourth quarter of 2013, as well as, the current year’s first quarter when it remained long.

Bets On Deflation

The primary reason for Fairfax Financial Holdings Ltd (OTCMKTS:FRFHF) to remain negative in respect of the United States and the European Union was deflation and its impact on the markets. In 2007 – 2008, the company placed a big bet on macroeconomic developments related to the Mortgage market and was correct. However, the current situation is different now. The company is so confident that the biggest economies in the world would experience deflation in the upcoming years. As a result, the company is holding CPI-linked derivatives for long-term positions. The company is holding long-term contracts connected with CPI in respect of European Union, France, Great Britain, and the United States.

Fairfax Financial Holdings Ltd (OTCMKTS:FRFHF) explained how the derivative contracts in respect of CPI-related work for it. For instance, the CPI was 100 in the United States when it purchased the contract. The upward or the downward movement dictates the direction with which it gains or losses. In this case, if the CPI remains at 100 or above after ten year’s time, then the contract will not have any value to be realized. However, if the CPI dips below the 100-mark, then it would gain based on the deflation value the company had. In case, the company had 95, then the different of 5% deflation would be taken into consideration for notional value.

Value Of Bet

Fairfax Financial Holdings Ltd (OTCMKTS:FRFHF) commenced the bet on deflation some five years ago. Since 2010, it has been witnessing a steady growth in the betting of deflation. At the end of the third quarter of the current year, the betting amount was worth $109.2 billion. Deflation is an issue that has haunted Japan.  The Fed has been postponing interest rate hike as one of the reasons was that it wanted to avoid deflation. Interest rates are hiked when there is inflation. The strong Greenback has forced the Fed to hold back interest rates hike in September. Any hike in interest rate hike would further strengthen the currency, which is not good for the American economy. Currency is already playing a big negative factor in corporate earnings.

Bet in Contrast to Long Positions in Companies like BlackBerry and Eurobank

Fairfax’s bet comes in contrast with bets made on the shares of companies like BlackBerry and Eurobank. In recent years the company has suffered a double whammy as it’s hedges have not paid off and it’s equity portfolio has had poor results. The poor equity results come in a 7 year period following the financial crisis in which many have thrived.  The saving grace for the company has been the extremely strong performance by it’s insurance subsidiaries.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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