The following is an excerpt from a recent Sizemore Capital investment memo: After enjoying gains of nearly 100% in just over one calendar year, we decided that the time was right to sell our position in emerging market infrastructure (PXR). As we wrote in our 4th Quarter 2009 letter to investors, this is a move we have been considering for quite some time. Our growing concern is that China is in the midst of an unsustainable capital spending and infrastructure bubble. While we cannot know when this bubble will burst, we believe the safe and easy money has already been made. Holding this position at this point would constitute chasing returns, which is something we consider dangerous. In our view, it makes sense to take some money off the table so that we will be in position to move quickly should new opportunities present themselves. PXRs market cap is 15% China, 12% Brazil, 9.1% South Africa, 8.9% Indonesia, and 8.2% Russia. With the exception of Brazilwhich we continue to have exposure to via our position in EWZwe consider all of these countries to be high risk at current levels. Should emerging markets in general come under strain, our position in EWZ will also be under review. We have been growing skeptical of emerging markets for several months, but our recent caution was triggered by a number of factors: 1. The view is nearly unanimous on the Street that emerging markets are the place to be invested in 2010. The themes that have been appearing with increasing frequency are the relative decline of the developed world (US, Europe, Japan) and the rise of emerging market giants like China, India, and Brazil. We actually agree with this macro themeover the long term. Technology and globalization have made it possible for poorer and less-developed countries to leapfrog many of the stages of development that todays rich countries experienced. India doesnt even have adequate paved roads, but the countrys cities have world-class internet infrastructure. Similarly, many countries are bypassing the expensive step of laying communications wires and are going directly to cheaper wireless infrastructure. We view this as a major positive; it is clearly good for the world economy if living standards rise in the developing world. Still, it is unclear why this beneficial long-term trend would automatically mean higher stock prices today, particularly when emerging market stocks tend to be geared towards exports to the West, not domestic consumption. Given that all major emerging market indices are dominated by such stocks, we believe the boom in emerging markets is based on false premises. 2. The Pragmatic Capitalist did an excellent job of aggregating the 2010 forecasts from the major Wall Street banks. The overwhelming consensus on the Street was for U.S. stocks to finish the year positive, though not wildly so. This is not something we pay a lot of heed to, as this is fairly standard. In bull markets, Wall Street strategists consistently underestimate the indexes performance, while in bear markets they overestimate it. This is not to say that the strategists are ill-informed or unintelligent; they have access to some of the sharpest minds and the most expansive data in the world. But for lack of better forecasting tool (because none exists), they fall into the common forecaster trap of anchoring and adjustment. At any rate, while we do not take market forecasts seriously, we do like to read them for common themes. And it seems that every bank on Wall Streeteven those that are bearishseem to have a positive view on emerging markets. As natural contrarians, we would view this as a signal to bet the other way. When everyone is bullish on a given asset class, there is no one left to buy. 3. China is starting to draw the attention of some significant contrarian short-sellers. James Chanos, who made a name for himself by shorting Enron and Tyco before their respective implosions, is actively betting against China. And he is doing so specifically by targeting infrastructure stocks, which he sees as being the most vulnerable. While Chanoss comments alone would not be sufficient for us to take action, we do believe that it is only prudent to take the views of such a successful contrarian seriously. 4. Pivot Capital Management published an excellent report outlining how truly excessive Chinas capital spending boom has been. We will refrain from summarizing the entire report, but these facts warrant repeating. Investment accounted for 70% of GDP growth in 2008 Investment accounting for 90% of GDP growth in the first half of 2009 Chinas investment rates far exceed those of even post-WWII Germany and Japan China is experiencing declining marginal returns on its investment spending (i.e. getting less bang for the buck for every dollar invested in capital spending). Decreasing returns are an indication of overcapacity. Chinas urbanization rate is massively understated due to the definitions that China uses (by Chinas definition Houston, Texas is not considered urban despite being one of the largest cities in America. Its population density is too low). Pivot estimates that Chinas true urbanization rate is 20% higher than the quoted 45%. What this means is that continued urbanization will not be the economic boon that many China bulls believe it will be. Anecdotal stories abound of China having a real estate bubble, with prices driven to uneconomical levels by speculators. We take these stories with a grain of salt due to the lack of quality data, but evidence is mounting that prices are rising faster than incomes. According to Pivot, price-to-income ratios are higher in Chinas major cities than they were in Los Angeles or London at their mid-2000s peaks. All of these factors indicate to us that the time is right to exit this position. Could Chinas investment boom continue for months or even years? Absolutely. The U.S. housing boom certainly proved that overpriced markets can get even more overpriced before they crash. But we feel that prudence dictates we make this reallocation now, while we still have a handsome profit. We will also closely monitor our position in Brazil (EWZ) in the event that weakness in emerging Asia spreads to Latin America Regards Buffett
