Author: Sacha Peter

More completely random ramblings, and even less marketable commentary:

VIX has been above the global financial crisis 2008-2009 levels:

Are the “short volatility” funds going to re-enter the market at this point?

In particular, the leveraged ETF that I use to examine volatility, TVIX, had a massive spike up before subsiding:

Opened at 892, topped out at 985, closed at 646… my god! Trading or gambling at this point?

Option expiration this Friday – I’d think most of the specialists have already hedged off risk, but there are usually games played on the last day of options trading which cause volatility. Put sellers are going to be assigned.

Although pension funds are the last thing that are on people’s minds right now, companies with large defined benefit pension liabilities are going to be facing a haircut of about 15-20% if they are a typical 60-40 equity-bond split. Guess what? You’re on the hook as well since the government has plenty of people on its pension payrolls! Here in British Columbia the public service pension plan is decently managed, but in other less credible jurisdictions, they’re going to have to face the difficult decision – reduce benefits, or force existing workers to contribute more… a lot more. Companies with defined pension benefit plans will also have to make up the shortfall.

The impact on lease defaults is just going to start. Pretty much most companies with IFRS 16 “right of use assets” are sitting on a big fat zero, while maintaining the liability of lease payments. This is not going to end up well for a lot of REITs. Taking a look at Tailored Brands (TLRD), the operators of Moore’s (Canada) and the Men’s Warehouse, for example, in their last 8-K today stated:

On March 17, 2020, the Company issued a press release announcing that in response to the coronavirus and to protect the health and safety of its customers, employees and the communities in which it serves, the Company will temporarily close its retail locations in the U.S. and Canada starting Tuesday, March 17, 2020 through Saturday, March 28, 2020.

On March 19, 2020, the Company issued a press release announcing that in light of evolving government and citizen response to the coronavirus outbreak, it will, out of an abundance of caution and concern for its employees, close its e-commerce fulfillment centers starting Friday, March 20, 2020 through at least Saturday, March 28, 2020, and will suspend the currently limited operations in its retail stores during this period.

This is a big fat zero for at least 10 days of business. Mind you, buying a suit is the last thing that you’d want to do at this moment (so effectively it doesn’t matter whether you actually keep the lights on or not) but the counterparty, the landlord, is going to start feeling a bit of tension, especially when these companies are so close to the brink of wanting to just Chapter 11 themselves out of these agreements. This also explains why companies max out their revolving credit facilities – it is usually the first step before you do a Chapter 11 filing. You want to have enough cash to actually keep things going, otherwise DIP lending at this time is going to be ridiculously expensive.

Even Obsidian Energy (TSX: OBE) managed to get out of massive lease payments in Penn West Center in Calgary – I guess that’s going to be another abandoned commercial building in Calgary soon. Morguard REIT (TSX: MRT.UN) took the hit on that one. That’s what leverage does – all of these carefully planned cash flows balanced with interest payments from debt, and if you lose just a bit of that cash flow, the ratios all go out of whack, covenants get busted, and next thing you know it is a liquidity disaster.

Insurance companies – those with segregated or guaranteed funds will be paying liabilities, and also they have some of their investment portfolio in risk assets (debt that is no longer safe), although one would suspect they would do better than most. Nobody’s also heard a peep from Warren Buffett yet, back in the 2008-2009 days, you had him making $5, $10 billion preferred share deals with Bank of America, and Goldman Sachs during the bottom of the crisis. Nothing to that scale yet. Or perhaps he’s just buying back stock?

It’s also encouraging to see Costco doing as well as it has been. They should be declared a “too important to fail” national security company. Must say in my last visit, their supply chains are still looking mighty good. The employees are doing real hero’s work. Compared to Loblaw (TSX: L) chains (including Superstore, and Shopper’s Drug Mart), night and day difference. It shows.

What’s India’s secret? Over a billion population, but 194 reported cases to date…

Finally… where’s the climate emergency now? From a social/cultural standpoint, I think this event has given everybody a very healthy dose of perspective as to what happens when things go really dysfunctional, and the fact of how smoothly things have been running to date – do we really want to be throwing sand into the gears in the future once this is all said and done?

There’s still too much to look at out there. Found an interesting small software company that feels Constellation Software-ish but sadly without the management that has a huge ownership stake.

Some very random scattered observations. It’s been very difficult keeping your wits together in this environment. I’ve had to limit my “screen time”.

TSX Composite is down 31.3% YTD
S&P 500 is down 25.8% YTD
Canadian dollar is down about 10% YTD
Spot Crude (Western Texas Intermediate) is down 66% YTD

The TSX is down more probably due to the energy-intensive aspects of the Canadian stock market.

Crude, in particular, is trading at a curve that is utterly crazy:
Near month (May) $23.75
December 2020 $30.70
December 2021 $35.55
December 2022 $38.50
December 2023 $40.74

Want to dig a huge hole in your back yard, store 10,000 barrels of oil in there (this is about 1.6 million litres, so not a trivial amount!), and then sell it back to the market in a year and a half? If you can do it for less than about $120k, you’ll make a profit out of it…

I am puzzled how Natural Gas, for the most part, appears to be taking things relatively well – perhaps because they’ve already been beat up so badly? AECO daily pricing has held up quite well.

“The World in Data” guy is doing a huge public service by keeping the COVID-19 statistics accurate.

I don’t trust the data out of China (it’s also easier to treat the flu by sending people into virtual prison!) but South Korea’s ability to track and isolate this is quite impressive.

Hong Kong is also another jurisdiction that has very good capacity to deal with these sorts of things.

A silver lining is that we will soon be able to get more data out of Italy and other European countries to reliably tell us what risk factors are in play – i.e. the Chinese data from the studies of the people that died we can test whether they are reliable or not.

We don’t hear much about the inverted yield curve anymore – the 30-year US bond rate is now 1.9% and rising – inflation?

There has been too much on the radar in terms of what appears attractive if your hurdle rate is a 15% return on investment. If you’re looking for some “safe” investment products, I think the debenture complex of Ag Growth International (TSX: AFN.DB.E, F, G) look pretty attractive – they will give you roughly 17%, 14% and 14% CAGR, respectively over 2.8, 4.3 and 4.8 years, respectively. This has to be weighed against buying the equity (currently at $18) which you can make a pretty good argument that it will trade at its previous historical levels at $45 after everything is said and done. You’ll make 50% on the safer debt investment, but you’ll presumably make 150% on equity in a normalization scenario.

I have taken a position in Chemtrade debentures (TSX: CHE.DB.D, specifically) – this company produces sulfuric acid, water treatment chemicals, and sodium chlorate – these chemicals are really basic for industrial processes in electronics, pulp and paper, and other industries. Their equity (in the form of an income trust) has typically been a yield darling, but I suspect they are going to cut even further as a result of Covid-19. But the company does generate plenty of cash and while they are over-leveraged, they will survive this. They have a senior debt to EBITDA covenant which they may get close to but this is rectified by pulling the plug on the distribution. I’ve been watching Chemtrade for ages now, and while I was never thrilled about the relatively high valuation of their income trust (it traded as a yield vehicle) the underlying business is strong.

A comment on Canadian REITs – For the last five years or so, RioCan (TSX: REI.UN) has been trading at a close level to around CAD$27/unit. Today it is $15.69. While obviously there is going to be some lease impairments on companies that simply can’t afford to pay the bills anymore (restaurants, mom and pop shops, and just retail overall in general even without the assistance of Covid-19), eventually this land will get repurposed and produce income yields again. With interest rates being very low, when this rush for cash is abated, these types of income vessels are going to be very popular again. Don’t even get me started on residential entities like CapREIT (TSX: CAR.UN) that are still trading at levels that astonish me. There aren’t that many REITs to sift through, and while I think they are not going to post extraordinary returns when there is the inevitable bounceback, they are relatively “safe” – you can be sure those mortgages will be renewed on even the worst retail properties.

The markets have been limit-up, limit-down so many times over the past two weeks I have lost count when there have been volatility pauses. But these are also markets where if you want to sell, you should only do so on one of those limit-up days, and if you want to buy, you have to do it on one of those limit-down type days. This volatility has been more insane than I have ever seen it, and this includes the global economic crisis of 2008-2009. This probably also means that if you can keep your sanity you might be able to make some money out of it, but it requires a seriously wild ride to get to and from – if you don’t get cashed out.

Almost everything is trading at elevated yields that we have not seen in ages. Dividends are probably going to get cut across the board from a lot of companies, and P/Es are going to be sky-high after Q1/Q2 results get reported.

GFL’s IPO (TSX: GFL) was done at the cusp of the market meltdown, and they’ve held up surprisingly well. Considering that garbage collection is one core duty of society that can’t be stalled out, I can see why. They might stand a decent chance of recovering quite well (I’d choose them over the REITs for example).

Throughout this process the supply chain has been quite resilient. It has only been a week since the lockdown and as far as I can see, things are still available. Aside from some silliness involving toilet paper and other products, goods are still flowing. This is important. There are two large logistic companies in Canada, Transforce (TSX: TFII) and Mullen (TSX: MTL), and both are very well run, and both are trading at lows. While this sector will obviously take damage during the lock-down, it is a privileged sector that currently has priority.

Finally, quant funds have had their models absolutely destroyed, and just like Long Term Capital Management, are being forced to rapidly unwind. Leveraged funds, especially on fixed income, for example, have likely tried to scramble. As soon as this supply pressure abates, there will be upside volatility. Traders that are keeping cash on the sidelines likely won’t have much time to take action in this event – it will probably be just as violent going up as it was down. I’ve been on the wrong side of a lot of this to date, so take these words with grains of salt!

“Cash is trash” (January 21, 2020) are the famous words that were spoken by Ray Dalio just before the point where you actually wanted to have cash. This should have been a warning sign to sell everything.

As much as I like Ray’s writings, I think he was the only person that was more worse positioned than myself during this CoronaPanic. Unfortunately for him (and his hedge fund), he will probably be the profile guy that was similar to Ralph Acampora saying in October 1998 during the pits of the Long Term Capital Management unwind and Asian financial crisis that “we are in a full bear market”, right before the Nasdaq tripled over the next 18 months.

There is also another phrase, which goes as follows:

You don’t have to make money the same way you lost it.

As far as the stock market is concerned, I think this week will feature the maximum of volatility. Since everybody is talking about flattening curves these days, the curve that is being flattened right now is the second derivative of bad news coming out of the CoronaPanic. The whole world knows that the USA is going to receive a whackload of Covid-19 cases and all of these doom-and-gloom headlines are under Drudge (including -10% GDP, millions dead, etc, etc.) which are complete fiction, but this is what the media is designed to do.

So today, at the risk of sounding like Dalio, I’ll make the proclamation that cash is trash. Today feels like a “normal day” in terms of how things are trading, and how the markets are once again facing a ‘wall of worry’ as they inch higher. This confidence will eventually culminate in some form of “fear of missing out”, just after droves of people start liquidating their portfolios – they will see the markets climb up higher and higher, and then curse their fortunes.

You can invest your money now in practically anything that doesn’t involve tourism, extraction of oil, and GICs and in half a year, you will very likely be up. While of course I don’t ever give guarantees, relative to interest rates, large-cap equity is going to make too much of a return on capital relative to government bonds – the risk premium to holding equity right now is huge.

So if you don’t even know where to put your money, there is always the option of the S&P 500, which can easily be done by just purchasing futures and shutting off the media. Most of the large-cap demand will float here regardless. Take a look at the top 50 of the S&P 500 and intuitively other than Chevron and Exxon (27 and 29 currently on the list) all of the other companies you can easily envision not being mortally wounded in any manner post COVID-19.

Now I’m going to talk about currencies and a little political commentary on Canada.

The Canadian dollar has gotten hacked to death, and is sitting at 70.5 cents to the USD, and my guess is that this is going to go lower, probably bottoming out to 65 cents after everything is said and done. The correlation with oil and gas is well known, but also contributing to this is the lack of our competitive capacity – this is what happens when you have a government that is all too eager to subsidize and allocate capital to those companies that provide little in the way of economic substance (what ever happened to these so-called “superclusters” that was part of the excuse to hand billions of dollars to partisan supporters’ companies?). Couple this with uncompetitive regulatory and taxation regimes, and you get exactly that result – a loss in purchasing power. Life will be getting more expensive in Canada, simply because collectively as a nation we don’t have our act together. What happens when you promote one industry over the expense of another is that you still have a lack of confidence in the “favoured industry” simply because you never know when the government of the day will flip the switch and go against you.

Fortunately this can be corrected, but it takes time and a change of cultural mindset, the latter of which unfortunately I do not get the sense is going to be happening. If we weren’t propped up by the USA, it would very likely have slipped into an Argentinian-type scenario (early 20th century) where eventually the erosion of competitive strength results in an economic collapse.

The only good news for individual Canadians is that they can hedge themselves against this by buying American equities.

The US currency itself is not exactly a safe haven in the medium term – they are going to be blowing out records amount of money in the next half year, and this is going to result in some form of depreciation. However, most of this capital is going to get dumped into assets with return features that are inflation-adjustable – those companies that can maintain pricing power in an inflationary situation will be golden. Get ready for the costs of everything going up, much more so than we have traditionally seen in the past. The only solace is you can protect yourself.

You can also buy gold. It should do reasonably well as long as the liquidity crisis is over.

I’ve been slowly adding a lot of diversification to my portfolio. It is very spread out right now. I’ll discuss some positions in future posts.