Author: Sacha Peter

CoronaPanic, Edition 13

As I write this:
S&P 500 -20.4% YTD
TSX Composite -21.7% YTD

Buckle up. After posting 3 monster-sized gains in a row, if you’re into the short-term trading thing it’s probably a good time to harvest a few bucks since the ‘second wave’ will start hitting the headlines. I’ve taken off my S&P 500 exposure, but will add it back on later.

This is where you are going to see supply chains get rationed and there will be further spin-off business disruptions that are second and third-order effects of shutting down half of a country’s economy and shutting in the population.

The numbers will get worse in terms of people confirmed with COVID-19, and the death count will rise. However, the growth of this will flat-line.

This is also the phase where you are going to see significant social unrest in the population. Shutting in a population for a week is one thing, but the second and third week you are going to get a lot of people that are going to be stir-crazy.

The primary thesis is the same, however – the trend between now and half a year later will be up, but there are going to be a lot of dips and drops as this panic continues to resolve itself.

Some other miscellaneous notes.

Tailored Brands (TLRD:US) I’ve mentioned before – they shut down their entire operation in the second half of March. Their stock is somewhat up, but their unsecured debt (July 2022) has cratered to about 25-30 cents on the dollar, and this is a pretty good sign that they’re going to go into Chapter 11. Considering the lease-heavy aspect of their business they are probably going to be using this as a way of breaking the leases, recapitalizing and getting on with it. They’ve got a billion and a half dollars of secured credit, so the unsecured holders are going to get killed (or more precisely, they’ve already been killed).

FTI Consulting (FCN:US) specializes in bankruptcy consulting, and looking at their chart, they’re right up there with toilet paper maker Cascades (TSX: CAS) as having a stock chart you’d never see any huge market dump on.

There is a lot of “liquidity sniping” on the TSX. I don’t know what this is formally called, but I’ll explain. You see a quote at bid 11.50 and ask 12.50, and you think it’s a really good deal at these prices (say you believe it is worth 17), and there is supply coming into the market (i.e. it is a down day in the market). You put in a bid at 11.55, and then some computer puts in a bid at 11.56, and you realize there’s no way you’re going to get any liquidity because the computers are going to beat you. The way you defeat this is to use hidden orders. You put a hidden order in at 11.55, and so when some guy puts in a market order to sell, you get priority at 11.55. The computer then sees the trade and has to adapt to dark liquidity, and it has a much more difficult time to do so – how much of the spread is actually being captured by you? Most brokerages don’t allow hidden orders, but Interactive Brokers does.

CoronaPanic, edition 12

A story of some collateral damage of the Coronavirus: A public example of a margin call – Royal Bank taking one of its clients to the cleaners.

The juicy details are here: 1257000-1257010-https-ecf-nysd-uscourts-gov-doc1-127126628149

3. Specifically, on March 23, 2020, Defendants issued margin calls to Plaintiffs on
the purported basis that the “Market Values” of Plaintiffs’ commercial mortgage-backed
securities (“CMBS”) that are financed through the parties’ Master Repurchase Agreements
(“MRAs”) have drastically declined in value as a result of the current market crisis. According
to Defendants, their calculations of these “Market Values” reveal a purported “Margin Deficit”
that permits them to require Plaintiffs to post large sums of additional cash or securities to meet
margin requirements. Defendants’ margin calls, however, are based on their entirely subjective
and self-serving calculation of “Market Value,” and do not come close to reflecting the
fundamental value of the securities or following the contractually-mandated means of assessing
those values. Indeed, because the “Market” is temporarily frozen, there currently is no objective
means of calculating “Market Value.” Moreover, the MRAs provide that “Market Value” shall
be based on a “price … obtained from a generally recognized source agreed to by the parties or
the most recent closing bid quotation from such a source.” MRA ¶ 2(j). It is entirely unclear
what “source” Defendants have been using to calculate “Market Value” in this illiquid market,
but it is crystal clear that Plaintiffs have not agreed to use it.

…

5. Yesterday (Sacha’s note: this was filed March 25, 2020), Plaintiffs learned that Defendants intend to conduct an auction that
includes nearly $11 million of Plaintiffs’ CMBS—at 11:00 a.m., EDT, this morning.

…

33. Notwithstanding the various government actions designed to return liquidity to
the markets and stave off mass foreclosures, on March 23, 2020, Defendants made multiple
margin calls on Plaintiffs in the total amount of $10,794,000.

Ouch. When playing with debt and leverage, playing with fire. Effectively, this mREIT got cleaned because they believed their definition of “Market Value” was what they believed they will get the assets for, while RBC’s definition appears to be “whatever you can auction the thing for”. Also I truly wonder what’s going to happen with all of this private equity and infrastructure investments going on that don’t have any active market – you can be sure that the level 3 value on balance sheets for the funds and such that own these assets are likely going to get downgraded pretty soon!

And for a final note, take a look at your Canada Pension Plan and ask yourself whether you can trust the stated value on 44% of the portfolio or so (I’m being generous and considering the “Other Real Assets” to be things like gold bars in a vault somewhere)…

When you have $400 billion in assets under management, you’re probably allowed to use your own definition of “Market Value” and not RBC’s.

Accounting-wise, I think the largest scandal-in-waiting is the proper valuation of private and infrastructure assets, or basically anything that doesn’t have an actively trading market. It would not shock me at all to discover there are plenty of assets out there being held on books of funds that are overstated by a significant magnitude.

CoronaPanic, update 11

Today is the day where the “Oh my God, I sold everything a week ago because I was going to get a better price in the month of May when this Coronavirus thing was going to end” crowd realizes that they are done and now have to get that cash back to work, except it is difficult to do anything other than hit asks.

The supply (forced liquidation selling, panic selling) goes away. This results in prices going up since there is still an avalanche of demand. There will also be volatility – except this time on the upside.

Psychologically there is the anchoring effect – people see things that have traded at 10%, 20% below current prices and think if they just wait it will get back there – after all, more and more people are diagnosed with this Coronavirus thing, more people are going to die of it, more people going to ICUs, and all of the carnage in the media, the shut-downs, the horror stories of people that can’t do this or that, etc., etc.

This is wrong thinking. In the lens of the financial markets, it doesn’t matter. In the lens of the financial markets, they will be asking themselves how much companies will make in 2021 and beyond, even though fiscal 2020 will be a disaster.

If you were lucky enough to buy on March 23rd, today (the S&P 500 is at 2530 as I write this) you probably will have made about a fifth to a quarter of the gains that await you over the next three to six months.

However, you won’t get much size in a massive up day like this (unless if you are talking about extremely small quantities relative to company size). There will be a day or two where the news headline will be sour, pronouncements of things never ending, but those will be the days to get proper liquidity. There will also be liquidity provided by supply from people that have gotten hacked to death and want to lower their risk exposure on the up days to limit their losses.

Also, the true liquidity is in the index futures, so if you lack specific names, it’s better than nothing.

My opinion on the actual matter on the ground is relatively meaningless, but I suspect the ‘inflection point’ of cases is turning, so that future growth percentages will taper from this point forward. I also suspect that the true mortality rate will be under a percentage point.

Gold – short-term trap

I know intuitively it sounds like the US turning its currency into toilet paper will result in gold going up in price, but the process will likely take longer than most people realize.

Instead, I’ve gotten a barrage of spam, both from the Drudge Report and some random email that managed to make it past my spam filters with exactly the same message:

This just looks like a trap written all over it, at least in the short term.

Don’t get me wrong, until they start hauling high-grade ore from asteroids from orbit, gold will be a very precious commodity on the planet earth due to having several millenia of cultural value (in addition to having very good industrial value due to its conductivity and ductility). But there appears to be a lot better value elsewhere if you take some basic assumptions on what will be in demand half a year ahead in time.

Things will stabilize, gold will lose its luster (temporarily) and sold to buy yielding assets. But when those yields compress, gold will start looking good again. Not right now, for me, however.

CoronaPanic, Edition 10

Random observations:

Barring any more catastrophic news (e.g. China launching a military invasion), Vix has likely peaked:

There might be another spike up but I’d suspect that this will subside over the coming months as the fallout is now being quantified and known.

I have done some radical portfolio re-alignment over the past couple weeks. I’ve not been thrilled about my performance, which I’d consider to be mediocre at best. The choice to diversify was correct. An acknowledgement of my own stupidity is in the form of index longs on the S&P 500, which is just trying to get a broad-brushed swash of what is going to be a gigantic capital influx because the “borrow at 1%, long at 10%” trade is going to turn that 10% into 8%, 6%, and 4% before we experience the next leveraged crash.

Speaking of what’s above 10% yield, have you looked at anything relating to the debt markets lately? Print up a list, get a dartboard, and throw darts at it, and you’re likely to do good.

Same thing goes for most of the preferred share market, although you have to wonder about the state of those 5-year resets. Still, even if you assume the 5-year GOC bond yield stabilizes at around 50bps, you can buy some reasonably safe income streams. The only problem is when the market rockets up, you’re not going to be able to benefit as much.

Q1 and Q2 results are going to be horribly impacted, and this is going to make the P/E and PEG metric useless as an investment tool going forward for the next 18 months.

There is still going to be a whole bunch of ups and downs at wild magnitude. Resist the urge to buy on a +8/10% up day like today, and resist the urge to sell when we inevitably get a -5% day and you should do well.

Envision what’s going to still sell a year out. Businesses that were looking shaky before this crisis are likely to go belly-up, and even in a recovery will not recover to the extent that others will.

The math of portfolio management is that if you take a bunch of positions at 5% (or any arbitrary number), some will gravitate up, and some will gravitate down. The ones gravitating up are ones that you happened to pick at a reasonable time (or hopefully the choices themselves were skillful) and thus they will have a larger weighting. Thus future changes in these larger weighted items will have a more disproportionate impact on the overall portfolio, while those that slide down will have less of an impact. It’s exactly how capitalization-weighted investing works with indicies – the strong get stronger, while the weak get less capital. And if you pick something that goes up by a factor of 10, you can still have 9 total wipeouts and break even.

Finally, there is going to be an element of luck and iron steel nerves to pick at the entrails of those that get totally crushed by this – cruise lines, airlines, oil production, and anything very retail-driven. If you pick equity survivors out of those (especially those that are regarded as already written off to go into CCAA/Chapter 11), you will receive huge multiples on your investment – but these come at extreme risk of a permanent loss of capital. Ultra-high risk, ultra-high reward.