The Daily Reckoning - The Value Of Catastrophe (Dan Ferris)

verfasst von Firmian, 21.01.2004, 19:12

-->The Value Of Catastrophe

The Daily Reckoning

London, England

Tuesday, 20 January 2004


---------------------

*** U.S. markets closed yesterday... brain damage and tech
shares...

*** Sell oil for gold? The Bernanke Paradox...

*** Poor Conrad... coffee... and more!

---------------------

"We have a friend who had a stroke. When he recovered, his
personality had changed. He had been a very pessimistic
investor. But the stroke, he said, damaged the part of his
brain that encouraged negativity. So, he became an
optimist... and has now made a lot of money in biotech
stocks."

We were talking to a group of investment pros - Money Week
magazine's monthly"Roundtable" group. The table was not
round at all; it was square. But the group had already been
drinking long enough so that even though the discussion had
few right angles, there were still some dangerous corners.

"Ha... I knew it..." exclaimed The Daily Reckoning's London
correspondent, Sean Corrigan."You have to be brain damaged
to believe in tech stocks at these prices."

Of course, tech stocks have been the best performers for
the last 12 months. And when it came time for last night's
participants to give us their number-one investment
recommendation, Tom Bulford, editor of a UK small-cap
investment service called Red Hot Penny Shares, came up a
company that at least sounded like a tech."Invox," he
suggested."I don't know what they do... but the numbers are
fantastic."

Everybody has an opinion, of course. Where they come from -
from ourselves or our stars - we do not know.

"I just can't get it out of my head," said hedge fund
manager, Hugh Hendry."From November 1929 until June 1939,
stocks in America rose 50%. People like Jesse Livermore,
one of the greatest investors who ever lived... he got out
in time to avoid the Oct. '29 collapse. But he was
destroyed by the rally, lost all his money and blew his
brains out. And then the bear market resumed and stocks
went down 80%. Anything that goes down that much is bound
to go back up by 50% to 100%... but there's no information
content in it... I don't know what to make of it, but I'm
Scottish... so I've got to be depressed."

"America is running a huge con game," opined Sean Corrigan.
"They've loaded the entire country down with debt. And the
only way they can get out is by inflating their way out.
The Fed has no moral courage... Bernanke has promised to
inflate. They'll do it...

"Everyone wants to keep this global ponzi scheme going. You
know, there are about $23,000 worth of derivatives for
every man, woman and child on the planet. I don't know what
is going to go wrong - China, oil, derivatives - but
something is going to go wrong."

"Yes," added Brian Durrant, editor of the Fleet Street
Letter, UK,"inflation is coming. And long-dated U.S. bonds
must be the biggest sell around."

"But I don't think anything very serious is going to happen
until after the election," replied Dan Denning."In fact,
we could even see a decline in long rates... down to 3%...
What would this mean? Another round of
refinancing... another debt-led, consumer-led boom... Look,
despite the fall in the dollar, the cost of living in
America is not going up. There is still room to cut rates.
The Fed is definitely not going to raise rates before the
election. The only thing that could force up rates would be
the price of oil going up suddenly. Did you see in
yesterday's paper? Dr. Mahathir Mohamad, the former Prime
Minister of Malaysia, gave a speech in Saudi Arabia in
which he urged the Arabs to price oil in gold! He's a
provocateur... and maybe a bit of a nut... but it's an idea
that is bound to attract attention."

"But wait a minute," cautioned Hugh."You're in big danger
of letting yourselves get carried along by your emotions
and prejudices. Everybody thinks things are fine until
after the election... and that's the crowded trade. Somehow,
the market has to find a way to shake people out. That's
what we're going to see. If people think something is going
to happen after the elections, it will happen before..."

We weren't sure whether Hugh meant that the market would
shake people out of their dollar positions... or their anti-
dollar positions. Was it the people who were long bonds who
would lose their grip... or those who were short? Lately,
the dollar has been rising... and bonds have been doing just
fine, thank you. We have a feeling that what we've seen so
far has only been the first stage of a great bear market in
the dollar... which must end in the collapse of U.S. bonds.

A little more from the Money Week Roundtable below... but
first... news from our man on Wall Street:

------------

Eric Fry from the concrete jungle, better known as Lower
Manhattan...

- With the U.S. financial markets closed in observance of
Martin Luther King Day, the foreign stock markets - like
latchkey children - were left to fend for themselves. The
foreign markets managed to make it through the day
unharmed... even without Wall Street's help. Japan's Nikkei
index jumped 179 points to 11,036, while most European
bourses gained half a percent each. South of the border,
the Mexican bolsa also gained about half a percent, while
the Brazilian Bovespa rallied 1% - close to the 6-year high
it reached two weeks ago.

- In the currency markets, the U.S. dollar firmed 0.3% to
$1.236 per euro. Despite last week's dollar rally, few
investors are prepared to sound the all-clear for the
beleaguered buck. Curiously, even amidst the dollar's very
recent"strength," we find the central bank of Japan
continuing to buy dollars to prop up its value against the
yen.

- Of course, the Japanese central bank's dollar purchases
are not so surprising. It buys dollars as habitually as a
Congressman buys votes. What is somewhat more surprising is
the fact that Brazil's central bank is also trying to prop
up the dollar... Yes, it's true; about two weeks ago the
Brazilian central bank began buying dollars for the first
time in five years, trying to stem a rally in the Brazilian
real that threatens the large South American economy's
export-led recovery.

- Many readers will recall that in 1994 Brazil fixed the
dollar/real exchange rate to one-for-one, and managed to
maintain that rate for nearly five years. But the real
"broke the peg" in early 1999, losing half its value
immediately, on its way to losing 75% of its value against
the dollar by late 2002. Throughout those years, the
Brazilian central bank would periodically intervene to
support the real. The idea of selling reals to make it even
weaker would have been unthinkable.

- Since then, however, the formerly forlorn Brazilian
currency has been performing heroically. Over the last year
and a half, the real has jumped 40% against the dollar and
14% against the euro. We doubt the real is on its way to
becoming the world's next reserve currency. Still, we
wonder how soon the dollar might become the next real...

- But the dollar's long-term fate will have no impact on
today's stock market action. To the contrary, when
America's professional traders and investors return to
their Bloomberg terminals this morning, they will find the
global financial marketplace even slightly more agreeable
than when they left it last Friday... The dollar is a little
stronger, global stock markets are a little higher and U.S.
stocks are poised to continue rallying... What's to worry
about?

- The economy is showing unmistakable signs of strength and
technology companies are reporting earnings surprises once
again. For good measure, interest rates are still hovering
at generational lows. Now that the 10-year Treasury bond's
yield has fallen back down to 4%, the mortgage market is
showing signs of life.

- Demand for new mortgages jumped 17% for the week ending
Jan. 9, according to the Mortgage Bankers Association. The
trade group's mortgage refinance index soared 25%. That's
the good news... But before investors rush out to buy the
shares of their favorite mortgage lender, they should know
that the latest refinance reading is nearly 80% below the
record high set last May.

- A graph of the refinance index trend over the last 8
months looks remarkably similar to the Nasdaq's price graph
after its peak in March, 2000... Is there any fundamental
similarity between the refi index and the Nasdaq, or merely
a coincidental resemblance? Was the refi boom a Nasdaq-
style bubble, or just a stroke of good luck... like winning
the lottery?

- And if the refi boom was a bubble, could it reflate, just
like the Nasdaq bubble is attempting to do? We are
skeptical. On the other hand, financial bubbles and"echo
bubbles" are as prevalent in the Greenspan Economy as
corrupt mutual fund managers. Indeed, the economy itself -
or at least the financial part of it - seems lighter than
air.

- May the bubbles never burst.

------------

Bill Bonner, back in London:

***"That's the big question," Brian Durrant tried to
summarize."Is the bull market in bonds over or not?"

We did not say so - we didn't want to interrupt the
conversation - but our guess is that it is not. Which is
not to say that we would counsel anyone to buy them.

"I can't recommend bonds to investors," said Andrew Vaughn,
investment advisor to the Zürich Club."They are just too
risky. You just can't make any good case for holding them."

"I don't see what the problem is," countered Tom Bulford.
"I'd be surprised if the dollar fell more this year. People
don't worry about these macro issues. They just want to
know if they've got the money to make the payments. That's
why British property will go up again this year. As long as
there is money available, there will be no problem."

Bulford's own portfolio of UK small caps rose"more than
50%" last year, he told us. But Hendry's portfolio of longs
and shorts rose more than 100%. Neither claimed bragging
rights; it would invite the wrath of the gods.

"There are TV shows of people who gave up their jobs to
invest in property," Hendry warned again."This has got to
be a bubble...

"And in the U.S. debt is now 350% of the economy... and the
financial economy is more than 4 times as large as the real
economy. This is the real bubble... and Bernanke is trying
to keep it inflated.

"But Bernanke's paradox is this: if he gets the inflation
he wants, he also gets interest rates up... say to 7% or
7.5%. But the real economy can't stand interest rates that
high."

"That's right," agreed Denning."Greenspan gave a speech
recently praising the financial economy. All those
derivatives make it possible for the U.S. to run even
larger deficits, he said, because the markets could sell
the debt onward. But to whom? And at what price? Homeowners
in America are already having trouble keeping up with
mortgage payments - with the lowest rates in half a
century. All it would take would be for these markets that
Greenspan loves so much to discount American debt just a
little bit - driving up interest rates and mortgage
payments in the U.S. - and the real economy will be
destroyed."

*** Asked to give his one favorite investment
recommendation, Hugh Hendry came up with this:

"Coffee. Long coffee. It's been in a bear market for 20
years. They don't even bother to pick the coffee beans in
some places. Buy coffee."

"Instant or decaf?" we wondered.

*** It is a wicked, inconstant world. We say that in
commiseration with our friend Conrad Black. We say 'friend'
loosely; we only luncheoned with him once, a couple of
years ago. Still, we liked his wit and erudition. Conrad
likes history, as we do. In fact, he had recently written a
history of his hero, Franklin Roosevelt. But we liked him
anyway.

But poor Conrad. The papers are all against him. Among many
news sources, Conrad owned the Chicago Sun-Times. But his
"media empire [is] in tatters," says the New York Times.
ABC News reports he was"sacked" by the same. Apparently
his money was not up to his ambitions. There never were
many people on the planet who could afford to live in the
style to which Lord and Lady Black were accustomed, the
press tells us. Too bad Conrad and his wife weren't,
either.

Conrad is a big man and a smart one. In his Palm Beach
house, he installed a $2.5 million fountain. In Toronto, he
built a model of the copper cupola of the dome of St.
Peter's. That he seems to have lived beyond his means
distinguishes him from few North Americans. He merely out-
did nearly all of them in extravagance.

---------------------

The Daily Reckoning PRESENTS: How to make easy money in a
"hard" market - an ideal post-9/11 investment strategy.


THE VALUE OF CATASTROPHE
By Dan Ferris

"August 31 - I paid over $200,000 today in just one day. I
found myself very emotionally upset at the severe
destruction... Everywhere that I stopped the people would
rush around my car, which had the signs of my insurance
company on it, asking for help. People were sitting outside
of what was left of their homes, with their insurance
company's names and their policy numbers written on
whatever part of their home was left standing.

"September 20 - Many adjusters have left- unable to take
the strain. Some did not last for more than a few days.
It's like being in a 'war zone.' I must try and take a day
off to relieve my stress.

"September 28 - I called my wife tonight... While I am
talking to her, there is gunfire in the background. I hope
she doesn't hear it. Yesterday, when I was doing a claim, 3
young men came up to the house with guns. The owner and I
stood outside while they took away what was left in the
house."

These words are from an insurance adjuster's personal
journal of the devastation caused by Hurricane Andrew on
August 24, 1992. At the end of his journal, he says that
when he gets home, he'll tell his wife everything he
couldn't tell her while he was on the ground in Florida.
Then she'll understand why he's going to buy a gun.

To this day, Hurricane Andrew is still the worst U.S.
hurricane on record. Twenty-three people were killed. More
than 135,000 homes were destroyed or damaged, 160,000
people were left homeless and 86,000 lost their jobs.

In just a few hours, the insurance industry lost every
penny of premiums it collected in Florida during the
previous 22 years, plus another $6 billion. Between 1970
and 1992, the insurance industry had taken in about $10.8
billion in insurance premiums in Florida. Andrew caused an
estimated total of $26.5 billion in damages. Just over $16
billion of that was insured.

Hurricane Andrew is still fresh in the insurance industry's
mind, too. To this day, State Farm won't insure many
coastal Florida homes. The state insurance commission won't
approve the 22% premium increase it needs to make it worth
the risk. State Farm's biggest competitor, Allstate, did
the same math. It also asked for a 22% hike in premiums but
only got 15.7%. Allstate won't insure homes on the coast,
and won't renew some policies.

Andrew was the largest insured loss in history until
September 11, 2001. Losses from 9/11 are now estimated in
the range of $40 billion - $50 billion. That's as much as
16% of a whole year's worth of insurance premiums for the
entire United States insurance market ($300 billion), wiped
out in a few hours.

Twelve insurance companies went out of business after
Hurricane Andrew. I asked James Peavey at A.M. Best, the
global insurance ratings firm, if his company kept a list
of which insurance companies went out of business each
year. They don't. But he did send me a report on the
property/casualty insurers covering the years 1993 through
2002. Sure enough, 1993 was the second worst year on record
for insurance insolvencies, with 1.2% of the industry going
bust. The worst year on record was 2002, when 1.33% of the
property/casualty insurers went bust.

Losses from 9/11 removed 38 companies from the market in
2002. We're not talking about a bunch of featherweights,
either. Kemper Insurance Company was the seventh largest
insurer in the United States; it closed and went out of
business. Gerling Reinsurance was the seventh largest
reinsurer in the world. Its property/casualty reinsurance
business is in run-off. That means it's not taking on any
new business. It's simply allowing its existing policies to
expire. SCOR Reinsurance, the French company, was the 10th
largest reinsurance company in the world, and was named
Reinsurance Company of the year in 2000 by The Review -
Worldwide Reinsurance magazine. Today, it's struggling to
stay alive.

As if the lingering malaise of 9/11 weren't enough, there
are more reasons to be repelled by the thought of investing
in the reinsurance business. My favorite is that it's an
awful business, measured by the industry's own favorite
benchmark. The benchmark I'm talking about is a number
called the combined ratio.

Insurance companies bring in money in two ways, insurance
underwriting and investment income. The combined ratio
gauges the profitability of insurance underwriting only. If
you take in $1 of premium and pay out 90 cents of expenses
and losses, your combined ratio is 90%. Obviously, anytime
your combined ratio is below 100%, you are making money on
your premiums. Historically, anything under 90% is superb -
and exceedingly rare. Since 1975, the combined ratio for
the entire property/casualty industry has been below 100%
in only two years. The property/casualty companies are the
ones who buy catastrophe reinsurance. If they have a hard
time making money, you better believe the reinsurers do,
too...

The Reinsurance Association of America tracks the combined
ratio for the entire reinsurance industry. Its latest
report covers the 22-year period from 1981 through 2002.
The combined ratio for the reinsurance industry never got
below 101.5%. The average was 111.60%. In 1981, there were
120 reinsurance companies reporting to the RAA. It's no
wonder that number has fallen steadily for 22 years, with
about 40 companies reporting to the RAA in 2002. For a long
time, the only way most insurance companies stayed in
business was by investing in stocks and bonds. Now that
risk-free interest rates are 4% and Aaa corporate yields
are 5.5%, that's not going to be possible anymore. The
bursting of the biggest stock market bubble in history in
early 2000 didn't help.

Now you know exactly why, by any reasonable yardstick,
reinsurance stocks are still cheap. The 9/11 catastrophe
wrecked a bunch of companies. And insurance and reinsurance
are just crappy, unprofitable businesses fraught with
peril.

Who'd want to put their money into such a business? I
would. Let me explain why you should, too.

Forgive me if this sounds crass. But it's true. Disasters
like Hurricane Andrew and 9/11 are exactly the type of big,
ugly misfortune that creates excellent investment
opportunities. And industries that appear to be universally
reviled are often where the biggest profits lie.

Even before 9/11, property catastrophe insurance premiums
were beginning to rise, after falling for 6 years in a row.
When 9/11 hit, reinsurance premiums shot up 20% to 100% in
the property catastrophe, marine and aerospace lines of
business. Terrorism insurance today is like homeowners
insurance for residents of coastal Florida - often
impossible to get. With so many insurance companies either
gone from the market or in trouble, the market is likely to
remain hard, as they say in the insurance business, for at
least a few years. A"hard" market is one where prices are
rising, and underwriting capacity is inadequate to meet
demand.

What's more, the current hard insurance market will
probably be even longer than the 5-year post-Andrew cycle.
Michael Paisan, insurance analyst for Williams Capital
Group, explains why:"Despite the sideline capital that has
entered in this market in the aftermath of 9/11, it is not
nearly enough to supplant the lost capital. Moreover, the
capital that is entering the market now has to be
disciplined capital (unlike that in 1992) because the low
interest rate environment is not as conducive to cash flow
underwriting as it was back then. Hence, the capital inflow
should not curtail the hardening pricing cycle as it has
done in the past."

After Andrew, about $4 billion of new capital was raised in
about 12 months. About $20 billion of new capital entered
the reinsurance industry within four months following 9/11.
It sounds like a lot, but the supply of reinsurance
underwriting capacity is still lagging demand.

These market conditions create exactly the sort of
opportunity a successful company can profit enormously
from.

One reinsurance company in particular has proven its
ability to take a big hit to the balance sheet, and yet
take full advantage of hard market conditions. Out of
respect for my paying subscribers to Extreme Value, I won't
mention the name here. But I will say the firm specializes
in property catastrophe reinsurance, which covers claims
arising from hurricanes, windstorms, hailstorms,
earthquakes, volcanic eruptions, freezes, fires, floods,
industrial explosions, riots and other man-made or natural
disasters.

Hurricane Andrew provides a perfect case study of how this
company survived - and prospered - in a"hard" market. In
1992, it took Andrew's punch on the chin, like every other
company. When Andrew had got done with its balance sheet,
book value had dropped 16%. But in the next year, the
company managed to raise $95 million of new capital by
selling millions of shares of common stock and bonds. The
strategy paid off. For the next five years, from 1993 to
1997, the firm reported nearly double that amount in
profits... and outperformed the S&P every one of those
years.

Rest assured, the 9/11"hard" market cycle started on an
equally difficult note for reinsurers. But just as
Hurricane Andrew signaled a 5-year hard market boom in the
industry - despite the pain of a big hit to every
reinsurer's earnings and balance sheets - those companies
with proven track records and solid management strategies
will have an opportunity to flourish in coming years. No
matter how despised the industry may seem right now, hard
market conditions will allow which well-managed companies
to prosper - which makes them an ideal contrarian
investment.


Regards,

Dan Ferris
for The Daily Reckoning

P.S. One reason the company I mentioned can take full
advantage of a hard market is that it can do something the
industry as a whole has trouble with - it can actually make
money by selling insurance. The combined ratio we looked at
above indicated that, in the aggregate, the
property/casualty and reinsurance industries do not
generally make money by selling insurance. But compared to
the rest of the reinsurance industry, this company is a
paragon of efficiency. And as hard markets begin, nothing
counts more than solid, efficient management.

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gesamter Thread:

• The Daily Reckoning - The Value Of Catastrophe (Dan Ferris) - Firmian, 21.01.2004, 19:12
  • Dt. Fassung vom Investor-Verlag - Firmian, 21.01.2004, 19:14
    • Re: Dt. Fassung vom Investor-Verlag / Tippfehler.... - - Elli -, 21.01.2004, 19:50
    • Danke - wie immer interessant und so bequem lesbar! Gruss (owT) - Tofir, 21.01.2004, 21:10