Finance – Page 22

Takes nerves of steel

In the short term, the market is designed to confuse everybody, but understanding the nature of the confusion is paramount.

Apparently in the past couple days, people have been worried “things will last longer than expected”. I have seen a bunch of stocks get dumped indiscriminately, sort of like a second wave of COVID-19 hitting the financial markets. I’m sure some of you have “felt” this mini-tremor as well. Nervous individuals that have bought shares a week ago are underwater, and are reading these headlines and are starting to panic.

This creates volatility and another round of panicked people want to reach for cash.

The problem is that any time you see a trade on the market, the cash gets exchanged from the person willing to buy the stock to the person that wants to dump the stock. The amount of cash remains the same, just that the valuation of the asset (a residual economic slice of the company in question) changes.

Maybe these people reaching for cash are satisfied with it staying around, effectively taking the cash out of circulation of the economy.

But central banks can wave a magical wand, and exchange bonds for more cash. This cash increases the pressure for demands on assets, which mostly makes its way to the stock market since this is the only game in town where you can get an income. Other routes include real estate (which doesn’t make as much income any more since rents are collapsing as we speak), or commodities (which should retain their value, and in some cases even increase in value depending on their demand). Relatively speaking, the cash becomes less significant with increased liquidity in the marketplace.

So in the medium term, this liquidity getting injected into the financial system will dampen volatility. In the short term there are going to be gyrations in accordance to the changes of participants’ psychologies, which is very rapid as the market tries to price in exactly what will be happening as a result of the COVID-19 reaction.

The cliche is that you need to sell when most participants are too bullish (there’s no incremental demand to convert cash to assets at a price higher than the assets), while the converse is true when more people are too bearish. When everybody wants cash at the same time (like during the third week in March) the result is a crash in asset prices and a huge rise in volatility. The difficult part of timing the bottom is that you have no idea when the last person (institution, pension fund, hedge fund, or a brokerage executing a margin liquidation on a poor client) that absolutely wants to convert the last of their asset into cash at any price he/she can get. You just don’t know, which is why you average when things get a little silly.

I wrote earlier sometimes it is better to be lucky than good, but yesterday evening I placed some volatility orders and they were reasonably well timed to correspond with the peak of this mini-earthquake we’ve had over the past few days (which was also instigated by the upcoming Friday being an options expiration Friday, which tends to increase volatility).

The risk-reward dynamic of the market is that if a trade feels good, it probably is a sentiment shared with others in the marketplace, and hence it is less likely to succeed than if you were very worried going into a position. And believe me, shorting VIX looks easy in retrospect but it takes nerves when you see the stock chart rocket up.

USA negative fed funds rates

I forgot to check my quotations but I see now the markets are predicting a negative short-term interest rate from the US Federal Reserve (a projected -0.06% fed funds rate for 2021):

I note that Interactive Brokers charges you -0.808% to hold CASH Euro balances over 100,000 Euro. Conversely they charge you 1.5% to borrow up to 100,000 Euro (and 1% for the next 900,000 Euro, and 0.5% for the next 149 million).

Notably, at this point, the Bank of Canada is still projected to be steady for the next two years.

However, as economic conditions deteriorate and monetary policy continues on quantitative easing forever, this might not be sustainable.

As we already have some history on European institutions (in addition to Japanese ones) in negative rate environments, there are some general guidelines as far as investment is concerned.

Although the government risk-free rate is going to be suppressed by central bank actions, the ripple effect in the non-government markets will be huge. This is playing out in asset prices right now. It’s not going to end up well for most other than the most financially nimble participants. I’d suggest throwing out the conventional playbook. While COVID-19 is not the cause of this, it definitely accelerated matters.

ETF products that use short-term future contract maturities

If you hold the products mentioned in the title of this post, such ETF products are a legal license to have money stolen from you, specifically in the rollerover mechanism.

There are ways to mitigate this (i.e. involve the rollovers continuously over a longer period of time), but this mitigation removes linkage between true spot pricing and the underlying ETF value.

Also if the ETF is a small fraction of the underlying market, then it doesn’t matter. Life can go on as normal. However, in today’s modern era, there are huge amounts of money swimming around in ETFs, waiting to get picked away by professional traders.

USO was a great example last month. ETFs that blindly were forced to short the short-term month and long the second month – this came in all sorts of forms other than USO as well. Retail oil investors in China, for example, got duped into this. As a result of the widely known rip-off (culminating in the negative 40 dollar futures price), such ETFs were forced to reform their practices to make their trade rip-offs less obvious. Most of them do it much more slowly.

But there are other examples.

Right now I have something on my quote screen that is so glaringly abberant that I had to wipe my glasses and double-check to confirm it was there. It’s something that institutional traders can take great advantage of (quantitative hedge funds must be making a fortune right now) but ol’ retail people such as myself can take some minor benefit to it, being restricted with the amount of margin to put up with such trades.

This chart is a relationship between two financial products. It should not be above zero (it can be at times, but right now is not a circumstance it should be above zero). But it is.

When checking some ETF databases, I can see why this is the case. There’s just too much money moving out of the front month to the second month, especially in relation to the ETF size versus the actual market size.

I’m purposefully vague here because this is clearly an actionable idea.

The lesson for people here is that investing in the wrong ETFs are financially hazardous. But this has always been the case. Just that the inherent structure of certain ETFs always lead to the same outcome – getting your pockets picked by traders.

More Misc market notes

Too much going on today, so will consolidate it into one post.

Everything that is going on is liquidity-fuelled. Central banks buy bonds. Bond yields go down. The equity to bond spread goes in conjunction with this, and hence prices rise. Doesn’t matter what the heck happens to the economy and it will drive most people crazy that do not see this relationship. Eventually they will capitulate and buy at the top, but right now there is a huge wall of worry which favours further equity upside.

* A week ago, I told you about Birchcliff preferred shares – they’re up today and as natural gas strengthens these present a good risk-reward, coupled with some income to boot. I’m sure there are better ways to play the natural gas space with equity (TOU, ARX?). The floor is pretty much in. Dollar-cost average on anything fossil-fuel related over the next couple months and a year later I’m sure it’ll work out.

* Atlantic Power’s performance (and utilities in general) has been disappointing in the COVID-19 recovery, mainly because power demand has dropped as a result of the economic slump. It doesn’t really matter for them as the price of their power generation is secured through power purchase agreements, but it doesn’t bode well for the residual value of their power plants after the agreements expire. After repurchasing 12.5 million shares of their own stock on May 1st, they will not be able to repurchase further equity until 20 business days after the offering concluded (i.e. not until June). I would expect them to resume share repurchases in June, so I suspect that the common shares will be a reasonably good bargain in May. I won’t be adding since this company is a low-medium reward and low risk entity, so it will be like watching paint dry compared to many other offerings in the stock market. But I’m pretty sure that June will see higher prices for ATP than in May.

* I watched Planet of the Humans, available on Youtube until mid-May, which puts a huge hole through the motivations of various environmental activists. Surprise surprise, it’s all about money and not the Earth! Blair King (a professional chemist which I have a very high degree of respect for) has an excellent review on the movie.

The only reason why I mention this movie is because they tear a good strip out of biomass plants as being “renewable energy”, and for a very brief moment, Atlantic Power’s Cadillac plant (the one which had a major explosion and plant fire earlier this year) was mentioned.

* Firms are going to be throwing everything under the bus for the first and second quarter, citing COVID-19. There will be write-downs of all sorts of junk on the books that have been accumulating. Firms that do not blame COVID-19 during the two quarters for various one-time write downs of financial performance are likely to be more honest than not.

* An example of this is BWX Technologies (NYSE: BWXT), which reported earnings yesterday. They have a competitive advantage in nuclear engineering services. They did not blame COVID-19 for anything, probably because nuclear engineering services are booming and they should become at least a US$65/share stock by year’s end. Yes, I own shares. The most profit to be had in the nuclear value chain is not in uranium, people!

* There is an interesting tug-of-war happening in the Yellow Pages right now, which traded more shares today than it has in a long time. Somebody at RBC is very interested in shares, while Canaccord has been on the selling side of the large blocks, mostly around the $10 range. Just announce the takeover bid already, folks!

* I find it probable that the central banks will target a stabilization of equity levels, so they will adjust the rate of their liquidity injections that go into the market. Still, the trend is for further liquidity until unemployment metrics begin to moderate. I will have a comment on unemployment/employment rates in a future post, as this is an interesting topic in itself which has market implications.

* REITs, financials, and insurance companies, in general, I think will disappoint. You can almost take anything that somebody is bullish on whatever that is posted on Reddit CanadianInvestor and just take it off your list of consideration. It is quite remarkable how useful it is, entirely for the oppositely intended reason.

Better to be lucky than good

With sentiment on nearly everything getting better (“Economies to open up”), (“Remdesivir positive results”), (“Deaths less than models projected”), etc., stocks have received a flood of bidding from people sitting on the sidelines.

Things never work in straight lines. Markets never move continuously up. There will be spouts of fake news now and then to throw some sand in the gears. You’ll hear about (“Second wave”), (“Shutdown to last until December”), (“Food shortages”), etc.

This is all media noise. The paradoxical thing is that even though the media is spewing mostly noise these days, one has to pay attention to it since it gives you a very general barometer as to sentiment – if you assume something to be false, but others believe it is true, the fact that you know others think it is true is in itself a valuable piece of information.

Placing orders is always an inexact science. On the buy side, sometimes it makes sense to pound asks, but in most of the cases it is more efficient to just passively place orders on the bid and let the market come to your own price.

However, I have a phrase which is “better to be lucky than good”, which is to say that sometimes you get a clairvoyant fill on your orders, and sometimes it comes up annoyingly short.

A couple days ago I had a limit order in for a stock, and I missed it out by two cents. This wasn’t a penny stock either. That stock is now up about 13% from where I initially placed the order, so I am kind of steamed about it. Unlucky. It was definitely a case of ‘too much too fast’, and they will regress down, but I very much doubt to the price where I nearly hit my limit order.

You probably are asking, “Why not just hit the ask when it is two pennies to your order?”. I usually don’t set my orders in the middle of the trading day, and if the price I set for this particular security was 5 cents higher, I probably would have gotten filled. That’s just the roll of the dice occurring. That’s trading life – psychologically it is irritating (hence this post) but you have to forget it and move on and deal with the reality the market gives you, not how you wish it to be.

Next chart, the May 2020 VIX futures, where you can see my liquidation on blue triangles:

I liquidated my VIX short orders in the market euphoria, and I say I did pretty well on this one. The last order to cover the short was at 31.50 and the low was 31.45. Needless to say – lucky on the exit. I’m looking to get back into this trade at higher prices.

Investing involves a lot of skill, but in short-term situations as these, sometimes you need a good dose of luck.