Investing Between Crises (Jun-11)

8/6/2019 Investing Between Crises (Jun-11)

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Investing

Between

Crises


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Disclosures

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

This material has been prepared solely for the purposes of illustration and discussion. Broyhill Asset Management is the marketing name for the investmentmanagement business conducted by Broyhill Asset Management, LLC. and its affiliates. Broyhill Asset Management, LLC is an SEC Registered Investment Advisor. Private investment vehicles are offered through Broyhill Wakin General Partners LLC, Surety Capital Management LLC, and Broyhill Strategic

Partners LLC, and are only offered by delivery of confidential offering memorandum and subscription materials to eligible investors who meet certain statutoryand/or regulatory criteria. Each General Partner is a separate legal entity and is affiliated with Broyhill Asset Management, LLC through common ownershipand control.

Under no circumstances should the information contained herein be used or considered as an offer to sell, or solicitation of an offer to buy any security. Any

security offering is subject to certain investor eligibility criteria as detailed in the applicable offering documents. The information contained herein isconfidential and may not be reproduced or circulated in whole or in part. The information is in summary form for convenience of presentation, it is notcomplete and should not be relied upon as such.

Any information, data, statement, opinions, or projections made herein may contain certain forward looking statements, projections, and information that arebased on the beliefs of Broyhill Asset Management as well as assumptions made by, and information currently available to, Broyhill Asset Management. Such

statements reflect the view of Broyhill Asset Management with respect to future events and are subject to certain risks, uncertainties and assumptions(including, but not limited to, changes in general economic and business conditions, interest rate and securities market fluctuations, competition from withinand without the investment industry, new products and services in the investment industry, changes in customer profiles, and changes in laws and regulations

applicable to Broyhill Asset Management). Should one or more of these other risks or uncertainties materialize, or should underlying assumptions proveincorrect, actual results may vary materially from those described herein.

All information, including performance information, has been prepared in good faith; there are no representations or warranty expressed or implied, as to theaccuracy or completeness, of the information, and nothing herein shall be relied upon as a promise or representation as to the past or future performance. Thismaterial may include information that is based, in part or in full, on hypothetical assumptions, models, and/or other analysis (which may not necessarily be

described herein). No representations or warranty are made as to the reasonableness of any such assumptions, models, or analysis. The information set forthherein was gathered from various sources which are believed, but not guaranteed, to be reliable. Unless stated otherwise, any opinions expressed herein arecurrent as of the date hereof and are subject to change at any time. Accordingly, neither Broyhill Asset Management nor its principals or affiliates make any

representations as to the timeliness of any information in this presentation.

Disclosures| 2


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Agenda

The Good News

A Word About Career Risk

The Bad News

Opportunities in a World of Risk

Agenda | 3


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The Fight of the Century

Keynes vs. Hayek | 4


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GoodNews


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We Dodged One Economic Bullet

The Good News| 6


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Growth at a Modest Pace

The Good News| 7


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Profits Back at All Time Highs

The Good News| 8


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Stocks Are Cheap

The Good News| 9

Source: JPMorgan


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And Cash is Trash

The Good News| 10


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Blowing

Bubbles


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Never Ever Be Wrong On Your Own

CAREERRISKMAKESTHE INVESTMENT WORLD GO AROUND

BlowingBubbles | 12

Concept: Courtesy of GMO


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You Can Be Wrong in Company

PRESIDENTIAL CYCLE EFFECTSON SPECULATIVE STOCKS 1964 - 2007

Source: Broyhill Asset Management, GMO Quarterly LetterNight of Living FedOctober 2010

Speculative rally isconsistent with

year three of thepresidential cycle.

BlowingBubbles | 13


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Ultimately, Investors Must Face Reality

STOCKS ARE EXPENSIVE RELATIVETO REPLACEMENT COST

Secular bearmarkets historically

bottom belowreplacement cost.

BlowingBubbles | 14

The Q Ratio is a long term measure of stock market value relativeto the replacement cost of all its underlying companies.Overvalued extremes are indicated in red on this chart. Today,stocks are trading roughly 70% above the historical average.

Source: Broyhill Asset Management, dshort.com


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Tricky Part is Getting the Timing Right

Yet it ralliedfrom 1100 to

over 1500during the next

eighteenmonths.

In June 1998, theS&P was priced

to delivernegative returnsfor the next

decade.

BlowingBubbles | 15

Source: Broyhill Asset Management, GMO


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TimingCreates Career Risk

Yet the marketrallied from1250 back to1500 over the

next year.

Again, in June2006, the S&P waspriced to deliver

negative returns forthe next decade.

BlowingBubbles | 16



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But Value Pulls Stocks Back to Earth

Shortly beyond the1998-1999 rally, stocks

subsequently lostnearly half their value.

After The GreatestSuckers Rally in

History from 2002-2007, stocks fell to

trend losing overhalf their value.

BlowingBubbles | 17


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Stocks for the Long Run Failed

Everyonehas a plan 'til they get punched in the mouth.

- Mike Tyson

BlowingBubbles | 18


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Bad

News


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Comparing Apples to Oranges

THIS HASNT WORKED HISTORICALLY

The Bad News | 20

Source: GMO


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Broadly Speaking, Stocks Are Expensive

S&PAT 24X 10-YEAREARNINGS IS RARELYTHIS EXPENSIVE

The Bad News | 21

Source: dshort.com


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And Priced To Deliver Lackluster Returns

THE RALLYHAS LEFT LITTLE PROSPECTFORADDITIONAL GAINS

Source: Broyhill Asset Management, Hussman Funds

Current estimates based on normalized earnings arefor about 3.3% annual growth, including dividends.

Youare

here

The Bad News | 22


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Under A Variety of Proven Methods

SHILLERPE QUINTILES

You arehere

The Bad News | 23

Source: Broyhill Asset Management, Ned Davis Research


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Source: NBER Working Paper 16334, After the Fall

Economic Outlook is Uncertain at Best

FINANCIAL CRISES CREATEADISRUPTIONOF ECONOMIC ACTIVITY

The Bad News | 24


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A Sub-Par Economic Recovery

The Bad News | 25


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A Number of Factors Choking Growth

The Bad News | 26


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Weakness is Broad Based

The Bad News | 27


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The best investors in the world do not target returns. Theyfocus on risk.

-Seth Klarman

But Crisis Creates Opportunity

The Bad News | 28


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Opportunitiesfor a

High Risk World


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The Case for Cash

Opportunities For a High Risk World| 30


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It Hasnt Paid to Reach for Returns

It is possible for an old, overweight ball player, whose legs and batting eye are

gone, to tag a fast ball on the nose for a pinch-hit home run, but you dontchange your line-up because of it.

- Warren E. Buffett, 1969 Letter to Investment Partners



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Diversification Does Not Reduce Risk

Thesound reason for increasing the percentage in common stocks [beyond

50%] would be the appearance of bargain price levels created in a protractedbear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market

level has become dangerously high.

-Benjamin Graham, 1949 The Intelligent Investor



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A Simple Guideline for Asset Allocation

EQUITYALLOCATIONS UNDERVARIOUS PROJECTED RETURNS

75%

Stocks

25%

Stocks

50%

Stocks


Source: Broyhill Asset Management, Hussman Funds


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Demand aMargin of Safety!

RANGEOF VALUATION ACROSS MARKETSIS EXTRAORDINARILYWIDE

-0.1%

-2.8%

4.6% 4.3%

10.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

US Large Cap Equity US Small Cap Equity US High Quality Emerging Equity Japanese Equity

GMO 7-Year Asset Class Return ForecastsAs of March 31, 2011

Estimates expected returns for Japaneseequities at 5% over the next seven years. If

profit margins rise to international levels,expected returns climb to double digits.


Long blue chips, short junk isa layup over the next ten

years, but anyones guess overthe next ten weeks or months.



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Deleveraging is a delayed and lengthy process often lasting a full decade or longer.

Macro Hedgesto profit fromMean Reversion



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Private Sector Balance Sheets Improving



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But Debt Transferred to Public Sector

CUMULATIVE INCREASEIN PUBLIC DEBT FOLLOWINGABANKING CRISIS

Source: Reinhart & Rogoff, The Aftermath of Financial Crises

In the aftermath of

banking crises over thepast century, public debthas risen on average over

86 percent.



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Invariably Leading to a Wave of Defaults

COUNTRIESIN DEFAULTORRESTRUCTURING: 1800-2006

Source: This Time is Different: A Panoramic View of Eight Centuries of Financial Crisis

The currentperiod can be

seen as a typicallull that follows

large globalfinancial crises.



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Hope is Not an Investment Process



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The European Disease is Contagious

RESTRUCTURINGIS INEVITABLE

European Sovereign CDS

European Financials CDS

Short European Financials

Short Euro

Rates Lower for Longer

TOP INVESTMENT THEMES


Th l h h


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The Elephant in the Room


Th N O


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Theres No Easy Way Out

Opportunities For a High Risk World| 42Source: Hayman Capital

P S Li i k Thi Pi


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Put Some Lipstick on This Pig

TOP INVESTMENT THEMESADFORGOVERNMENT BONDSIN CABS!!

Japanese Sovereign CDS

Japanese Corporate CDS

JPY Put Options

JGB Caps


H d I Wi T il Y L


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The range of outcomes in a deleveraging process can be extraordinarily wide.

Heads I Win, Tails You Lose


Th O i l P f li P


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CHOKING POINTFORRATESIS MUCH LOWERTODAY

The Optimal Portfolio Protects . . .

Opportunities For a High Risk World| 45Source: Broyhill Asset Management, DecisionPoint.com

A i B h E
http://www.viewfromtheblueridge.com/wp-content/uploads/2010/05/30yr-Yield.gif


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Against Both Extremes

GOLDRELATIVETO REAL T-BILL YIELDS : 1968-2011


Chi Th 800 P d G ill


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ChinaThe 800 Pound Gorilla


Hi G C di B bbl ?


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Historys Greatest Credit Bubble?

Chi S b b Hi hl E d


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Chinese Suburbs Highly Exposed

Source:Steve Keens Debtwatch

A i F P l


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Aussie Face Palm

TOP INVESTMENT THEMES

Australian Sovereign CDS

Australian Bank CDS

AUD Swaptions

Short AUD


F d S lli C t O t iti


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Forced Selling Creates Opportunities


B hill B tt Li


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Broyhill Bottom Line

Bottom Line | 52

VALUATIONS & MACRO RISKS SUGGEST INCREASING PRUDENCE

Equity Allocations Should be Below Normal

Focus on Great Businesses at Reasonable Prices

Continue to Seek Out and Invest with Talented Managers

Flexible value-oriented managers should produce alpha regardless of market direction.

Understanding the Big Picture is Critical in a Globally Inter-Connected World

Risk of inflation, currency devaluation and global imbalances must be monitored.

Explore and Evaluate Cheap InsurancePositions designed to protect capital from impairment without pressuring portfolio returns

C t t I f rm ti


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Contact Information

For more information please contact:

Mr. Christopher R. Pavese, CFA

[email protected]

Broyhill Asset Management

800 Golfview ParkPost Office Box 500Lenoir, NC 28645

Phone: 828 758 6100Fax: 828 758 8919

Documents

Investing Between Crises (Jun-11)