Genworth MI buying shares again

Genworth MI (TSX: MIC) filed with SEDI last week that they executed a share buyback in the month of August, purchasing approximately 913,000 shares at roughly CAD$36/share. This is nearly 1% of their shares outstanding. In light of the fact that they were making rumblings in filings a year ago with respect to the adverse consequences of increasing capital requirements with respect to the OSFI policy changes, this is most definitely a signal that they are now in an excess capital situation. The share buyback is at a discount of 13% to book value, so management cannot be accused of wasting value with this purchase (a rare characteristic that I very rarely seem managements of other companies perform when they conduct share buybacks).

Finally, Genworth MI traditionally increases its quarterly dividend rate in the third quarter announcement or announces a special dividend. The current regular quarterly dividend is likely to increase from 44 cents a share to around 47 or 48 cents. Management has a good track record of prioritizing buybacks when the share price is depressed to book or giving out special dividends when the share price is relatively high – I do not view a special dividend as being likely. Although my Genworth MI position is smaller than it used to be in the portfolio, it is a significant equity holding of mine and I see no reason to sell at this juncture, in absence of other opportunities.

Genworth MI Q2-2017: As good as it gets

Genworth MI reported their Q2-2017 results today and it was a blowout positive quarter.

The key statistic is that the reported loss ratio was down to 3% from 15% in the previous quarter – this is an accounting artifact due to the reduced reserving for losses (reserves increased $6 million compared to $30 million in paid claims). While the paid out claims is in-line with previous quarters, the difference is due to accounting for future losses – claims already in progress or claims processed have turned favourable from previous projections. The official explanation:

In the second quarter of 2017, losses on claims decreased significantly due to favourable development as there were fewer new reported delinquencies in Ontario, Alberta, Quebec and the Atlantic Provinces as compared to the incurred but not reported reserve as at March 31, 2017.

As a result, the company’s yearly guidance shifted from 25-35% loss ratio to 15-25%. Delinquent mortgages also slipped down from 2,082 to 1,809, a significant drop.

These two factors alone should be enough to boost the stock price 10% in tomorrow’s trading. Book value is about $41.34/share (which puts today’s closing price at 12% below book).

The only downside is that transactional insurance written is down 5% from the comparable quarter from last year. The portfolio insurance is down considerably but this was anticipated due to regulatory changes of the prior year. Accounting-wise, revenues recognized should continue to increase over the next few quarters as the amortization curve of the unearned premiums (previously written insurance) kicks into full swing.

Their portfolio is relatively unchanged by the increasing interest rate environment – their government and corporate debt portfolio is at a slightly decreased unrealized gain position ($100 million to $87 million), but their preferred share portfolio went from a $19 million unrealized loss to a $12 million realized gain position (which was a nice recovery from their initial investment).

One highlight which won’t get much press is that the company made a good chunk of change on unrealized gains on interest rate swaps from the last quarter. I’ve been tracking the CFO of Genworth MI, Philip Mayers, and the decisions Genworth MI has made on portfolio management has been very sharp.

The company’s reported minimum capital test ratio was 167% this quarter, and this is above their target rate of 160-165%, which means that the company may choose to engage in a share buyback or give out a special dividend if this condition persists – the upcoming quarter has a $0.44 dividend (unchanged) but the company is likely to increase this by 3-4 cents in the following quarter as they continue to build up excess capital.

All in all, this is probably the best quarter that Genworth MI has had in its history from an economic basis. Does it get better for them?

Genworth MI – Q1-2017 and Q2-2017 preview

(Update, July 20, 2017: FYI, Genworth MI reports the next quarter on August 1, 2017)

While Home Capital was going through their issues, I had neglected to report on Genworth MI’s Q1-2017 report.

It was a quarter for the company that was about as good as it gets – their reported loss ratio was significantly lower than expected (15%) and well below expectations. The number of delinquent loans creeped up slightly (2,070 to 2,082) but the loss ratio was the highlight for the quarter. Most of the increase in delinquencies occurred in Nova Scotia and Manitoba.

Portfolio insurance written was also higher than I would have expected ($38 million), but this was due to the completion of paperwork received at the end of Q4-2016. I would not expect this to continue in future quarters.

The geographical split of insurance has not changed that much – Ontario continues to be 48% of the business, while BC/AB is 31% and QC is 13%. Half of the transactional insurance business continues to be at the 5% down-payment level.

Book value continues to creep up, now to $40.42/share. Minimum capital test ratio is 162%, slightly above management’s 157% holding level, and as long as this number is between 160%-165%, management is not going to take any capital actions (i.e. special dividends or share buybacks), although I will note some insiders did purchase shares earlier in the quarter.

The market reaction to the quarterly report was initially very good, but I suspect short sellers decided it was a good time to continue putting pressure on the stock. It got all the way down to $30.50 before spiking up to $38 and now has moderated to $34.70/share, which is a 14% discount to book.

Looking ahead to Q2’s report, my expectations are a more moderate outlook – the loss ratio should creep up to 25% again, and management should be noting that Ontario’s actions to curb foreign property speculation have had an impact on the local residential market. In relation to mortgage insurance, however, if people continue paying their mortgages (they are employed), ultimately real estate pricing does not matter. I think a lot of market participants have failed to make that distinction.

The other question is the impact of increasing interest rates – this will certainly have an impact on the short-term investment portfolio of MIC – including small unrealized capital losses on short-term debt. This will more than likely be offset by gains in their preferred share portfolio, which totalled $456 million on March 31, 2017.

Price-wise, the company is currently too cheap to sell and too expensive to buy. I’ll continue collecting my dividends.

Q2-2017 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2017, the three months ended June 30, 2017 is approximately +0.6%. The year-to-date performance for the 6 months ended June 30, 2017 is +19.3%.

My 11 year, 6 month compounded annual growth rate performance is +18.2% per year.

Portfolio Percentages

At June 30, 2017 (change from Q1-2017):

20% common equities (-4%)
28% preferred share equities (+8%)
31% corporate debt (-7%)
4% net equity options (+1%)
18% cash and cash equivalents (+3%)

Percentages may not add to 100% due to rounding.

USD exposure: 52% (+2%)

Portfolio is valued in CAD (CAD/USD 0.7714);
Other values derived per account statements.

Portfolio commentary

All things considered, the nearly flat performance was a good indicator of a relatively boring quarter – there was very little theatrics to discuss. Major portfolio decisions include liquidating my KCG Holdings equity stake, and retaining the equity options until the last possible nanosecond before expiration. I will promptly liquidate the position if the market is acceptably close to the USD$20.00 cash buyout number (or I will just wait for the transaction to proceed). This will result in an effective liquidation of another 4% of the portfolio. I also have another 4% position in their senior secured bonds which will be called out after the transaction completes, which should be around July 21st (after the quarter-end). The net result of these transactions are that the portfolio is effectively 25% cash and I have no idea where to deploy it beyond VGSH (USD) and VSB.TO (CAD) – at least with those I get paid around 125 basis points to wait.

Sadly my entries into the VGSH/VSB.TO short-term fixed income vehicles has been incredibly lacklustre – with continued threats of rising interest rates, even these short duration vehicles are taking a minor hit of capital value – an inexpensive lesson that yield is rarely risk-free.

I took a single digit percent position in a company trading well under tangible book value and earning positive income and cash flows during the quarter. I estimate when the market wakes up to this position (there has been little if any analyst coverage, nor has there been any public exposure to it at all) it will trade up to double its present value. I won’t write about this one until it appreciates or my original investment thesis is incorrect. There is a credible reason why there is still price pressure even at the depressed levels. The company has spent most of its public life trading around 25% higher than what it is trading at right now.

This was my first new common share position in over a year. I’ve been close to pulling the trigger on some other ones but they didn’t quite reach the correct price point.

I also took a non-trivial stake in DRM.PR.A preferred shares. I’ve been in and out of this over the past couple years, but this time I suspect it will be a staple position for quite some time. It only requires 33% margin so it is not too much of an anchor to keep, especially since the spread between the margin rate and the dividend rate is huge. This is effectively a “cash parking” vehicle until they get called away by the parent company (I was expecting this to happen quite some time ago). When it happens I will have the problem of more capital going from a near-guaranteed 7% tax-preferred income to 1%. It is my hope that management continues to ignore this issue (other than paying quarterly dividends). I wouldn’t buy it at the current premium.

That’s about it for the quarter.

In terms of price movements, there were three items which caused negative portfolio movements. Genworth MI took collateral damage with regards to the collapse of Home Capital Group, but has swiftly recovered from reaching a low of about $30.50/share. At that level, Genworth MI was in the low end of my price range, but it wasn’t low enough that I would re-purchase shares. Conversely, it is too cheap to sell at present prices. So I will be waiting and continuing to collect 44 cent quarterly dividends until the market decides that the equity is worth more.

Teekay Corporation unsecured debt also significantly declined to reflect the calamity that is hitting their offshore division, but I do not believe the underlying value of this debt is compromised by virtue of the value of their natural gas division. This was the primary detractor from my portfolio performance this quarter. At a YTM of 13%, investors have a decent risk/reward situation at current prices.

The third detractor to performance was the Canadian dollar – as it appreciates, although I appreciate the purchasing power, it does detract negatively on my US dollar components. Since my portfolio is nearly 50/50 CAD/USD, each percent the Canadian dollar rises means a half percent drop in my portfolio value.

Finally, Gran Colombia Gold announced they will be redeeming 5.7% of their 2020 senior secured debt outstanding at par. I will be pocketing the cash and looking forward to future payments – this series of debt is first in line, secured by a gold mine and an investor can be patient to collect on the debt. Although I do not have a place to deploy the cash, I look forward to receiving the payment and reducing my concentration in this particular debt issuer (I purchased most of the senior secured debt at around 55-60 cents on the dollar). The two relevant risks here are the political stability in Colombia (which is not bad at present) and the price of gold continuing to meander at its present level – or go higher. 75% of the free cash flows from the company have to go towards redeeming the senior secured debt due in 2020, so over time I will expect to get paid back.

The portfolio underperformed the S&P 500 slightly, while outperforming the TSX. I do not invest for relative returns, but psychologically it always feels better to know that somebody is losing more money than I am. The portfolio in the last quarter has also underperformed my 11.5 year CAGR (Compounded Annual Growth Rate), but this is to be expected given my very risk-adverse positioning at present. I will warn readers that my +18.2% CAGR is likely to decline in the upcoming quarters as making a percent or two each quarter is below the +18.2%/year benchmark.

Outlook

Crude oil markets are trending significantly lower than what most participants thought would be happening. This is having a significant impact on most Canadian oil and gas companies, whom have been continuing to address leverage matters. While prices imply there is pressure, it is not yet at a crisis point that it was back in February 2016, but if the prevailing trend continues, it definitely appears that there will be some more fractures in the Canadian oil and gas space due to excessive leverage levels. There may be opportunities in the debt market at this point (witness the calamity hitting Teekay right now).

In the USA broad market, the S&P 500 is dominated by the top 10 companies (Amazon, Facebook, Google, Netflix, etc.) and when extracting out those liquidity high-flyers, we have a market that is treading water and some targets of opportunity are starting to emerge that have value-like characteristics. However, the US federal reserve is slowly tightening the screws in terms of loose monetary policy and this most certainly will have a continued dampening effect on equity valuation as the cost of capital continues to rise. They are doing this slowly as to not trigger a market crash, but most participants should be alerted that the 30-year treasury bond, currently at a yield of about 2.8%, is not rising despite the rising-rate environment. This is something to be very cautious about.

The Bank of Canada also spooked the markets in the second week of June when they were making public noise about increasing the interest rates. Although I do not predict they will take much action, if any, until the corresponding long bond rates rise, this may have the effect of putting a bottom on the slow and steady decline of the Canadian dollar. Clearly the commodity markets are not helping Canadian currency, and if there is some sort of return in commodities, then the Canadian dollar would actually be better positioned for a rise.

In general, I continue to remain bearish. Although this stance has not been in correspondence with the major indicies (which have risen considerably), my portfolio continues to generate a positive return while remaining extremely risk-adverse at present time. I am of the general belief that index investing continues to dislocate pricing in the market from true value and this trend is not likely to abate until such a point that it is identified that pouring capital in a non-price discriminatory vehicle is not a prudent way to invest money – instead, it is diversifying through obscurity and not achieving true risk reduction.

I am finding it very difficult to invest cash in this environment. It is painful to wait, but waiting I will do.

The average maturity term on my debt portfolio is just a shade over 30 months. This will continue to lower as my issuers go down to maturity. I am not interested in long-duration bonds at all at the moment.

I project over the rest of this year, if things go to a reasonable level of fruition, that I will see another 2-3% of appreciation, while taking little risk. This is also assuming that I do not see further candidates for investing the non-trivial amount of cash in the portfolio. Nothing imminent is on the horizon. My research pipeline has been bone-dry.

To put a polite summary to my investment prospects, I feel stuck. Little in the pipeline and little of inspiration. Waiting is not popular, but it will allow me to preserve capital for the time where it will be more appreciated.

(Update, July 17, 2017: After doing my internal audit, the quarterly performance was revised from +0.7% to +0.6% for the quarter. The year-to-date was revised from +18.7% to +19.3% due to a rather embarrassing formula error on the tracking spreadsheet. The changes are reflected in the numbers above. The 11.5 year CAGR remains unchanged.)

Portfolio - Q2-2017 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
11.5 Years (CAGR):+18.2%+5.9%+8.2%+2.6%+5.6%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%
Q1-2017+18.6%+5.5%+6.1%+1.7%+2.2%
Q2-2017+0.6%+2.6%+3.1%-2.4%-1.6%

Home Capital – Don’t know why it is trading up

The power of Berkshire is strong – why would shares of (TSX: HCG) go up when the acquisition price is so dilutive to existing shareholders (selling 19.9% of the company for CAD$9.55 and another substantial chunk of equity at CAD$10.30 to a 38% ownership interest) and the company cannot even obtain a better rate on a secured line of credit than 9%?

They managed to sell $1.2 billion dollars of commercial mortgages between 97 to 99.61 cents on the dollar, which leaves the question of how much their residential portfolio is worth. How can this investment by Berkshire and the line of credit be good for anybody but Berkshire, or more specifically anybody but common shareholders?

Now that short sellers have been crushed to death, I’m going to guess the next month or so will likely represent the “top” of their stock price. Borrow rates are 75% right now so I’m not touching it.

Book value with this stock purchase, FYI, goes down to under CAD$20/share. So even on a price-to-book metric, HCG is almost trading like a regular mortgage provider – except with the very relevant fact that their cost of capital is well above what they can receive in mortgage interest! How they plan on making money by issuing 5% mortgages and loaning money from the credit facility at 9% or 10% is beyond me. Maybe they’ll make it up on volume!

There is absolutely no reason why Genworth MI should be trading up 10% on this news either. They are in much, much, much better financial shape than HCG, and shouldn’t be trading at less of a discount to book value than HCG is!

Home Capital / Equitable Group Discussion #2

A few news items which are salient as this saga continues:

1. Home Capital announced a HISA balance of CAD$521 on Friday, April 28 and a GIC balance of $12.97 billion. On May 1, this is $391 million and $12.86 billion, respectively (another $220 million gone in a day). Their stock is down 21% as I write this.

2. Equitable announced their quarterly earnings and are up 35%. This was a pre-announcement as they previously stated they would announce on May 11, 2017. They announced:

* A dividend increase.

Between Wednesday and Friday, we had average daily net deposit outflows of $75 million, with the total over that period representing only 2.4% of our total deposit base and with the most significant daily outflows being on the Wednesday. Even after those outflows, our portfolio of liquid assets remained at approximately $1 billion.

Obtained a letter of commitment for a two-year, $2.0 billion secured backstop funding facility from a syndicate of Canadian banks, including The Toronto-Dominion Bank, CIBC, and National Bank (“the Banks”). The terms of the facility include a 0.75% commitment fee, a 0.50% standby charge on any unused portion of the facility, and an interest rate on the drawn portion of the facility equal to the Banks’ cost of funds plus 1.25%. This interest rate is approximately 60 basis points over our GIC costs and competitive with the spreads on our most recent deposit note issuance, and as such will allow us to continue growing profitably.

So their credit facility cost $15 million to secure $2 billion (relative to $100 million for HCG), lasts two years (relative to 1 year for HCG), and also have a standby charge of 0.5% (which is 2.0% less than HCG), and a real rate of interest of approximately 3% (compared to HCG paying 10% for their outstanding amount, and I’m assuming the Bank’s “cost of funds plus 1.25%” works out to around 3%).

I haven’t had a chance to review their financial statements in detail yet. But securing two billion on relatively cheap terms like this is going to be a huge boost to their stock in the short run.

Very interesting.

Genworth MI (TSX: MIC) is also down a dollar or 3.5% today, which is more than the usual white noise of trading. It dipped even lower today.

Home Capital Group, Equitable Group

Home Capital (TSX: HCG) and Equitable (TSX: EQB) have been hammered today as a result of fallout of the Ontario Securities Commission allegations that certain Home Capital Group executives have contravened the various regulations. They continue to perform damage control, today announcing their CFO (who was under the OSC investigation) will be stepping down and other various board changes.

Borrowing rates for Home Capital spiked to 26% today. Equitable, which normally has been an inexpensive borrow, had its cost to borrow rise to 2.75%.

Implied volatilities on options for HCG is also very expensive at present, around 110% for near-dated options and around 90% for a couple months out. EQB does not have options trading on their shares.

There has been an avalanche of media coverage (both in print and social media) about Home Capital and their woes. They have been pushed down to about 25% less than tangible book value.

This spill-over has not occurred to Genworth MI (TSX: MIC) at present.

Canadian Housing Finance stocks, April 13

On April 13, three notable companies associated with Canadian housing pricing fell considerably: HCG, EQB and MIC.

There were a bunch of other companies that had issues, but it looks like that the trio above were fairly pronounced in the day’s list of losers:

April 13, 2017 TSX Percentage Losers

CompanySymbolVolumeClose% Change
Nthn Dynasty Minerals LtdNDM4,841,0272.17-10.3
Intl Road Dynamics IncIRD203,2032.81-10.2
China Gold Intl Res CorpCGG1,269,5942.43-9.3
Home Capital Group IncHCG972,60621.70-8.6
Aphria IncAPH6,005,7937.21-8.3
Equitable Group IncEQB287,51263.41-8.3
Fennec Phrmctcls IncFRX12,5375.50-8.0
Silvercorp Metals IncSVM1,516,9934.94-8.0
Alacer Gold CorpASR1,881,2092.52-7.7
Street Capital Group IncSCB28,4891.40-6.7
Taseko Mines LtdTKO794,6751.52-6.2
Trilogy Energy CorpTET182,4814.95-6.1
Genworth MI Canada IncMIC221,17434.63-6.0
Top 10 Split TrustTXT.UN9,8634.08-6.0
Guyana Goldfields IncGUY916,0127.41-5.4
Golden Star Resources LtdGSC548,2681.09-5.2
Continental Gold IncCNL852,8253.91-5.1
Arizona Mining IncAZ501,4501.96-4.9
Great Panther Silver LtdGPR387,1652.00-4.8
Argonaut Gold IncAR1,036,6442.43-4.7

I’ve been trying to find what caused this spontaneous meltdown in equity prices.

My 2nd best explanation is that Bank of Canada Governor Stephen Poloz is putting a torpedo to the Toronto housing market by making explicit statements about the 30% year-to-year rise in valuations and about how there is no explanation for it. Specifically, he stated “There’s no fundamental story that we could tell to justify that kind of inflation rate in housing prices, and so it’s that gap between what fundamentals could manage to explain and what’s actually happening which suggests that there is a growing role for speculation“, which is a mild way of saying that people are basically trading houses in Toronto like they did with Tulip Bulbs in the Netherlands in 1636.

He also politely stated that if you believe that housing prices are going up 20% year-to-year, it doesn’t matter whether he raises interest rates by a quarter or half point, and he could even raise them 5% and it wouldn’t make a difference (although it would be rather fun to see him try and see all the mathematical financial models predicated on stability go out the window in one massive flash crash).

However, my primary reason why I think the three stocks crashed is a simple announcement:

==========================

Media Advisory
From Department of Finance Canada

April 13, 2017
Minister of Finance Bill Morneau will hold a meeting with Ontario Finance Minister Charles Sousa and Toronto Mayor John Tory to discuss the housing market in the Greater Toronto Area.

A media availability will follow the meeting at approximately 3:30 p.m.

Date and Time
2:30 p.m. (local time)
Tuesday, April 18

Location
Artscape Wychwood Barns
601 Christie Street
Toronto, Ontario

==========================

Being somewhat experienced with the nature of government communications, there is no way you can get a federal and provincial Liberal with a Conservative mayor doing a joint announcement on something without it leaking to the marketplace.

The only question here is how deep they’re going to stick their silver-tipped oak stake into the heart of the Toronto real estate vampire.

Q1-2017 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the first quarter of 2017, the three months ended March 31, 2017 is approximately +18.6%.

My 135 month compounded annual growth rate performance is +18.6% per year, an identical number that is strict coincidence.

Portfolio Percentages

At March 31, 2017 (change from Q4-2016):

24% common equities (-24%)
20% preferred share equities (-7%)
38% corporate debt (-6%)
3% net equity options (+2%)
15% cash (+35%)

Percentages may not add to 100% due to rounding.

USD exposure: 50% (+8%)

Portfolio is valued in CAD (CAD/USD 0.7508);
Other values derived per account statements.

Portfolio commentary

Needless to say this was a good quarter for me. Normally posting a return like this would be good for a year’s performance. Although I do not invest for relative performance, relative to the S&P 500 (+6% for the quarter) and the TSX (+2%) my portfolio had a smashingly good quarter.

I will warn this performance will not be matched in the next 9 months of this year. The upside potential of the current portfolio components is limited. My estimate of this potential, assuming an above-average ideal of things going correct, is 8%. This means about 2-3% a quarter for the next three quarters, and of course things never run that smoothly in portfolio management, unless if you invested in GICs.

In terms of buying activity, this quarter was relatively inactive (less than a percent of the portfolio). On the selling side, my two largest equity components (TSX: MIC, NYSE: KCG) had considerable rises in price, and as such, I did some significant trimming. They are now down to reasonable proportions of the portfolio. I also trimmed some preferred shares. Also assisting the +15% cash position was the maturity of Pengrowth Energy’s debentures (my initial post about them was here). My portfolio now has a positive cash balance for the first time in about a year.

In contrast, I ended 2016 with a -20% cash balance (i.e. a margin position of 20% of the equity of the portfolio). As you can see, it was time to cash some chips. Cashing in some chips results in capital gains taxes to be paid in the next year, but this is the cost of profitable portfolio management. Taxes are a secondary consideration in trading decisions – valuation is the primary driver. I am relatively happy to see the capital gains inclusion rate did not change in Budget 2017, but I do not take the government at its word at all that it will keep this rate steady.

The other corporate debt in the portfolio has an weighted average remaining term of slightly less than 3 years. The corporate debt will collect interest income and will otherwise sit there collecting dust until maturity or being called. At par value, I am not interested in liquidating them until maturity (or if they are called away). Given the short duration, I do not care if risk-free rates rise.

Portfolio Outlook

The decision to play safe this quarter (and likely for the remainder of the year) is obvious to me. Markets have risen significantly in the Trump honeymoon and I do not believe that risks (specifically the so-called “unknown unknowns“) are being truly appreciated at the moment. Everything is seemingly looking good. Things are comfortable. Look at what happened to the S&P 500 implied volatility after Donald Trump got elected (November 8, 2016):

When everybody thinks things are comfortable, this is a formula for future loss when less optimistic scenarios bakes into market pricing. I am not sure when negative sentiment will pervade throughout the market, but these things will always manifest themselves later than one expects – I am probably too early.

It is psychologically difficult to sell yielding securities for non-yielding cash (why sell something that gives away money for something that just sits there and earns zero?), but I must reload my ammunition for when the market truly decides to go into a tailspin. I don’t know the specific reason for the next tailspin will be (or when), but these things usually do occur when people least expect them. The future is always difficult to predict, but right now when I am looking microscopically across the markets for opportunities, I am drawing so many blanks that I need to crawl to a safe place. It might look foolish to duck into the shelter before there is even an inkling of a hurricane or tornado coming in the horizon, but this is how I feel, so I will bunker down.

I had written earlier in my 2016 year-end report that if everything goes well this year I should probably see a low-teens performance. Because of some unexpectedly positive developments in my two largest portfolio components, I have already made a year’s worth of gains in a single quarter. I will repeat that while one can extrapolate this quarter’s performance to future quarters, I would advise it would be a significant error to do so – there is no way this can continue. As I continue to cash up, it will continue to cap my performance gains. If markets rise to my additional sell points, the amount of cash can go 50%, which is a ridiculously high amount. I am also content to hold cash or cash-like instruments for extended periods of time.

Just imagine showing up to work in a finance firm as an asset manager and telling your bosses that you’re holding cash and going to watch movies until the markets drop. While I am not that lazy (I do run occasional stock/bond screens and try to look at the microscopic parts of publicly traded securities which are less prone to overall market fluctuations), when I do some detailed due diligence, it mostly ends up flat. Even worse yet are the IPO and secondary offerings that are hitting the market – there’s a lot of junk being shoved out the door to yield-hungry investors. It reminds me of what they did with the income trusts in the early 2000’s (most of them blew up and lost a lot of people money, other than investment banks and management insiders).

Sadly, market conditions and the selling nature of my portfolio at present means my writing will become more boring until things become more volatile. I recognize this is my shortest quarterly commentary in quite some time – I’m finding little to invest in.

My next challenge is to find a good location to park cash.

Some macroeconomic outlooks

I do have a few convictions that surround my decision-making (or lack thereof). One is that I am of the belief that the US dollar is undervalued and should perform relatively well against other world currencies, including the Canadian dollar. I have generally maintained a policy of keeping the US dollar exposure of the portfolio between 30-70%.

The other conviction I have is that I believe crude oil will continue to be a mediocre performer and indeed, in any sign of any world economic malaise, will take a tailspin from their existing price band. This makes Canadian oil producers (especially in the existing hostile federal and provincial environments) relatively prone if they have debt pressure, especially those contingent on higher oil pricing. At present, a lot of these companies have “value trap” written all over them. A good example will be Cenovus (TSX: CVE), who decided to leverage up, but just imagine the stress their shareholders will feel at US$40/barrel instead of US$50/barrel today. There will be a time to invest in fossil fuels, but not now.

Political outlook

My home province of British Columbia is having an election. Although I project the incumbent party is going to continue to win another majority government, there is a strong anti-incumbency undercurrent which appears to be brewing, which will make motivational aspects of elections (i.e. turnout) crucial. I am not nearly as certain as the result as I was at the beginning of this year when I projected the existing government would cruise to an easy victory.

The main opposition party, the BC NDP, still doesn’t appear to have their act together (I don’t see them focusing on issues that will actually win them the election), but this campaign is going to be quite volatile since the public is only going to pay attention during two weeks of the election period before deciding who they will vote for.

It doesn’t matter how incompetent the BC NDP have looked in the past, it matters how competent they look in exactly those two weeks when the public care.

Portfolio - Q1-2017 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
11.25 Years (CAGR):+18.6%+5.8%+8.1%+2.9%+5.8%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%
Q1-2017+18.6%+5.5%+6.1%+1.7%+2.2%