Will Hurricane Irma cause insurers to drop?

Hurricane Irma is looking like it will blast a path through most of Florida in just over two days:

The media is making it look like that it will be apocalyptic. Indeed, the island St. Martin (famous for having an airport where you can sit on a beach and look up about 100 feet and see a landing Boeing 777 jet) was nearly annihilated. Right now Irma is one of the strongest (if not the strongest) in recorded history, but the question is where it will strike landfall in Florida (if there) and how much it will dissipate by that point – 75 miles can make a material difference in the damage calculation. If it goes through the heart of Miami, there will be tons of damage, but if goes through the western part of the peninsula, there’s a decent chance that the winds will slow down sufficiently by Tampa to still cause a lot of damage, but not the insane amounts the media is making it to be.

Thus while the media hype is overwhelming, the markets are treating certain insurers like the catastrophe is already a done deal, which may not be the case.

This is the classic information mismatch that creates market opportunity.

Canadian interest rates – probably level from here

The Bank of Canada “surprised” the market by increasing rates by a quarter point.

What I am feeling very regretful about is about a month ago I thought they were going to do it, but the BAX futures were assigning a rough 20%-25% probability of them doing it. I should have dipped my toes in there.

Readers of history (and it really feels like history since it happened such a long time ago) will recall that the last time they raised interest rates (from 0.25% to 1.00%) they did it in three consecutive meetings with three 0.25% rate increases.

The Bank of Canada clearly had a target in mind and contrary to what the talking heads on the media have to say about the matter, I think they will hold at 1% for the intermediate term. There are a couple reasons for this, but one is that their original policy stance to stay at 1% (before they dropped to half a point) is that the Bank of Canada has accumulated considerable research that ultra-low policy rates create their own risks by virtue of being so low. There seems to be “mean reversion” to this. The other is that the inflationary threat does not appear to be forthcoming at present, especially now that the Canadian export economy will be dampened by the increased Canadian dollar.

There is also the matter of bringing the short term rates up to a point where the spread between the short-term and 10-year bond will converge to nothing. The federal reserve is going to run into the same problem when their central bankers will be asking themselves a correlation/causation question of whether an inverted yield curve is a predictor of a recession, or whether an inverted yield curve causes one.

Markets are predicting a 70-75% chance that the Bank of Canada will raise rates by the end of the year. If this goes to 80% or higher I’ll probably take a bet against rate increases.

This brings me to my next point, which is the Canadian dollar. It has risen dramatically over the past three months.

In fact, the rise in the Canadian dollar has been my biggest portfolio “miss” over this time – it has generated a lot of paper bleeding since I keep my portfolio balanced between CAD/USD. The Canadian dollar has gone up 6.5% from July 1st of this year, and it has represented a 3.2% drag on performance quarter-to-date. My gut instinct says to increase my own position of USD but I am still reluctant to do so since the momentum of the Canadian dollar feels like it is stepping in front of a freight train. There is probably a logical point to do so (around 85 cents if it gets there?) but it is something I am acutely looking at.

An increase in my USD positioning will mean that my research will be more US dollar-focused. I have been focused on Canadian securities for a considerable period of time, but considering what bland opportunities I have found in domestic markets, it is probably a better for me to set my sights south for investment candidates.

The progress of an inactive portfolio and irreverent thoughts on Cineplex equity

Since May, I have not made any trades beyond consequential ones stemming from the liquidation of KCG (which was bought out for $20/share).

This period of inactivity (three months) has been quite a dry streak in terms of transactional volume. My brokerage firms will probably not like it – the last time I had trade volume (in terms of commissions spent) this low was in 2012 (where my performance was +2.0% for the year). In terms of a fraction of assets under management, it is at a level where even Vanguard would blush at the expense ratio.

My portfolio, quarter-to-date, is up a slight fraction simply due to the resolution of the TK situation and offset negatively by the rise in the Canadian dollar. I’m a bit mystified at the rise of the dollar, but I’m guessing this is something geopolitical resulting from the actions of the US government administration.

One stock that caught the attention of my radar is the plunge in Cineplex (TSX: CGX):

I am going to be apologizing to all CGX shareholders in confessing that I am the reason why the stock price has crashed. The reason? On July 31st, I saw War for the Planet of the Apes at a Cineplex theatre. Graphics were great, but it was an awful movie! Sorry, shareholders!

I wrote over three years ago that I was mystified how the stock was trading so high when it is perfectly obvious that movie theatres are basically going the way of Blockbuster Video. I also do not like it how customers are relentlessly spammed for a good half hour before the actual movie is going to start – I think in our age of explicit advertisement avoidance, this is a net negative. As I wrote before, even at present price levels I would not be interested.

Overall market thoughts – volatility – fossil fuels

This is another rambling post with no coherency. The quarterly reports from companies are flowing in and I am reading them – but there are few companies that are below my price range where I start to care about them in detail. As such, my research pipeline at this point is in the exploratory mode rather than doing detailed due diligence.

It is in the middle of summer and I am not expecting much in the way of volatility – it is truly a summer where major portfolio decision-makers have decided to take away from the trigger switches.

Accordingly I have been sitting and watching with respect to my own portfolio while I do my casual research. Probably my biggest error of omission was watching the solar market rise over the past six months – I’d written them off, along with almost everybody else, as languishing when the price of fossil fuel energy dropped. A lost opportunity there – there was one company in particular which I earmarked, financial metrics looked great, but didn’t even pull the trigger, primarily due to insider selling. If I executed correctly on it, I would have been looking at a double now. Oh well.

An equity chart that caught my attention was the high expectations of investors of Canaccord pulling a great quarter, which came nowhere to fruition:

This is very obviously the chart of expectations crushed after a quarterly report – a regression to the recent mean would suggest a $4.50-ish stock price. I also notice their domestic competitor, GMP, being crushed after their quarterly report.

I also notice most liquid fossil fuel companies are getting hit badly and are close to multi-year lows. In the USA, most of the companies receiving boosts are the ones that have had been relieved of their debt burdens through the Chapter 11 process (LNGG is a great example of this). I still don’t think equity holders of fossil fuel extraction companies are going to be too happy over the next 12 months.

I also took notice with Interactive Brokers, and Virtu’s commentaries with respect to Q2-2017 as being one of the lowest volatility environments possible – they are two types of businesses that generate revenues as a function of trading volumes. Volatility correlates negatively with an increase with the broad markets – I am looking for defensive-type companies that will do okay in an environment like present, but will really do well when volatility increases.

Interactive Brokers is a classic example of a great company (they are the best at what they do by a hundred miles over everybody else), but one who’s stock I am not interested in buying at current prices.

Mostly everything in the Canadian REIT sector seems to be over-valued. An interesting trend is that the downfall of retail is somewhat being projected by RioCAN’s chart – trading below book value, it might seem to be an interesting value, but are they able to keep up occupancy and lease rates to businesses that have to compete against Amazon? The residential darling of the market is Canadian Apartment Properties (CAR.UN) but they are most definitely not trading at a price that would suggest a future performance beyond a high single digit percentage point and this is under the assumption that their real estate portfolio asset value remains steady. Trading in the entire REIT sector seems to be entirely yield-focussed which is never a good basis to invest, but it is a good basis to evaluate other investors’ expectations on these entities.

Gold has also been up and down like a yo-yo and might be an interesting bet against dysfunctional monetary policy. Unfortunately my ability to analyze most gold mining firms is generally not that fine tuned.

The liquidity of my overall portfolio is very high (nearly a quarter of the portfolio is collecting dust at a short duration 1.5%), but right now I don’t see much investment opportunity that would suggest avenues for outperformance. I could shove the money into some sub-par debenture (e.g. TPH.DB.F which buys you a 7% coupon until March 31, 2018 maturity) but do I really want to lock my capital into something that is questionable? It is the literal metaphor of picking up pennies in front of a steamroller. My policy is that if I have to force my money to work, chances are the investment decision’s risk/reward is worse than if I just held it in cash and waited for some sort of crisis to hit. I generally define “crisis” as something that will take the VIX above 30%, but it has been awhile since we last saw it:

It is pretty ironic how the election of Donald Trump was foreseen by most pundits to be the end of the world and higher volatility times, but so far the opposite has turned out to fruition. Will it continue? Who knows.

I see a lot of people making the mistake of impatience, and also the mistake of assuming that the index ETFs that they are investing into (Canadian Couch Potato, etc.) will leave them safe through masked diversification – works great as long as there are net capital inflows, but what happens if there is a correlated bust among these products? Will retail continue their conviction when they see a 10% drop in prices, or will they grit their teeth and add to their positions?

I continue to wait. It might be a very boring rest of the year with very limited writing. If you think you’re in a similar predicament, I’d love to hear your comments below.

Stress in Canadian oil and gas

I wrote earlier this year about the downward slopes of Canadian energy companies and six months later, nothing appears to have changed – the trajectory for most of these companies continues to go down.

Commodity pricing is also highly unfavourable – WTIC crude is at US$43/barrel as I write this and the CAD/USD exchange is around 75 cents on the dollar.

So at these price levels, there are going to be plenty of companies that will find it very difficult to make any money.

What hit my radar today is Cenovus (TSX: CVE) taking a hit after their investor day presentation – their CEO is calling it quits at the end of October and planning a $4-5 billion asset disposal. The stock is down to about CAD$9.20/share – noting they raised $3 billion in capital back in April at CAD$16/share when they purchased back their 50% of their partnership in the Foster Creek/Christina Lake projects. Those shareholders must be feeling pretty “steamed” right now, having experienced a 42% depreciation on their capital in a few months.

In their presentation, they stated that the company is break-even at US$41/barrel. You can be sure that if present pricing stays at the current levels, there are going to be a lot more medium-cost producers that are going to start feeling the pinch on their balance sheets – the “bunker down and wait for better pricing” strategy only works when your rivals are out of money and you’re sitting on a treasure chest. Right now, everybody has enough liquidity to last another year or so before things really start hitting the fan.

Equity holders, in addition to feeling already light-pocketed, should continue to worry as debts rise and creditors start taking more and more of any available cash flows out of these corporations.

And as readers know, when there is desperation in the financial markets, that’s usually a good time to invest money. But now still doesn’t feel like the right time.

State of the Canadian Debenture Market

I find the Financial Post’s compilation of Canadian exchange-traded debentures to be a very handy list to refer to. It is not comprehensive (there are a few issuers here and there missing) but for the most part is a full snapshot of the market environment.

Looking at the list, I think it is a very good time for Canadian companies of questionable credit quality to be issuing debt. Most of the debt on this list is trading at yields that do not properly represent (my own evaluation of) their risk.

Accordingly my research time is increasingly on the equity side of things in the non-indexed space. A great example of my readings included the Kinder Morgan Canada prospectus, worthy of a future post!

With regards to the debentures, I’ve sorted the debt by yield to maturity and decided to arbitrarily cut things off at 8%:

IssuerSymbolCouponMaturityYTMPithy Notes
Discovery AirDA.DB.A8.38%30-Jun-18118.28%Way behind secured debt, no control
Lanesbourough REITLRT.DB.G5.00%30-Jun-2259.10%Insolvent
Gran Columbia Gold CorpGCM.DB.U1.00%11-Aug-1843.99%81% mandatory equity conversion
Primero MiningP.DB.V5.75%28-Feb-2021.85%Operational mess, solvency issues
Argex Mining Inc.RGX.DB8.00%30-Sep-1919.07%Illiquid, no revenues!
Toscana EnergyTEI.DB6.75%30-Jun-1817.27%Senior Debt to cash flow is high
Gran Columbia Gold CorpGCM.DB.V6.00%02-Jan-2015.14%I own this
Westernone EquityWEQ.DB6.25%30-Jun-2013.94%Likely equity conversion June 30, 2018
Entrec Corp.ENT.DB8.50%30-Jun-2113.02%Cash flow negative, senior debt high
Temple HotelsTPH.DB.D7.75%30-Jun-1711.78%One month to maturity
Difference CapitalDCF.DB8.00%31-Jul-189.56%Payback not certain
Temple HotelsTPH.DB.E7.25%30-Sep-179.47%4 months to maturity
Fortress PaperFTP.DB.A7.00%31-Dec-199.22%Never figured them out
Temple HotelsTPH.DB.F7.00%31-Mar-188.11%How much $ does Morguard have?

I really don’t see anything worth locking capital into in this table at present prices. I do own one of these convertible debentures, but it is at a price where I would not buy (or sell) – my purchase price is from much lower prices and it is the only debt on this list that gives a warm and fuzzy “secured by all assets and nobody can step in front of me” arrangement.

I also note that the table is missing Yellow Media and Grenville Royalty which are both trading at 9% and 16%, respectively, but they are both unattractive for various reasons.

High Frequency Trading Gone Nuts

Attached was a rather amusing ticker-tape of the bid/ask in a particular stock that I track:

So the algorithm is to raise the asking price a random and rising value from roughly 14-16 cents a share, increasing range, each and every second.

Just imagine if you were the programmer doing this and accidentally got the code mixed up so you were doing the OPPOSITE. Good programming has many layers of fail-safes to prevent this malicious code from ever breaking through, but once in awhile these result in flash crashes. Knight Capital on August 1, 2012 was another famous example (blowing up their own firm on a single trading day).

If you are the counter-party on these incidents you have to react very quickly to take advantage of errant trading. It is rare when this happens. Mistakes like this also affect illiquid products much more.

Stormy seas

When politics is attributed as the reason why the broad market drops by 2% in a day, you know there is more to come (the reason is most certainly not politics).

Brace yourselves – I’ve been continuing to liquidate things and are well positioned for a market crash.

(Update, June 4, 2017: S&P 500 is up 4% since I wrote this, in a huge upward trajectory! Shows you what I know about short-term market timing!)

Avoided another time bomb – Aimia

Aimia (specifically their preferred shares) were suggested to me a year ago as a reasonable risk/reward and a relatively high yield.

I declined. Today is the reason that I saw would likely happen.

Air Canada will be ending their business with them in 2020.

Everything in their capital structure is trading massively down – common shares are down over 50%, and preferred shares are down about 30%.

Good market timers could have bought when the margin calls were starting to flood in at around 10:00am Eastern time. The preferred shares at one point in time were down even more than the common shares.

(Update, I have included the chart of AIM.PR.A for illustration below)

I have no idea what the business prospects of Aimia is (although this news about Air Canada is VERY negative) and thus I will still not touch them.

I will, however, be a little more diligent at liquidating the meager amount of Aeroplan points I still have remaining – companies like Aimia can decrease deferred revenue liabilities by simply increasing the cost of “rewards” that their customers have already pre-paid for (can you tell what I don’t like about their business?).

Another Canadian Finance website of quality

Reminiscences of a Stockblogger (I don’t know his real name) has an excellent post on identifying what makes your edge in the marketplace. His performance has been excellent and his following paragraph resonates with me:

I think I have put up enough years of out-performance to tentatively conclude I have some sort of edge. Its still possible that I don’t; maybe I will blow up yet and these past years will prove to be a statistical aberration. But as times goes on those odds become less likely.

His performance is exceptional when you consider the number of positions he has in his portfolio – I run a much higher concentration than he does. It could be that my historical performance is simply a fluke.