Frustrating week to date

The quarter-to-date number is astonishingly high, but quite bluntly these are the times like 2009 where you have to reach for the sky.

This week was frustrating because of the velocity of how the market rocketed up.

I’ve had this informal heuristic where my selling reallocation gets conducted when the overall markets are in a buying mood, and does my buying reallocation when the markets are in a selling mood.

This works great until you stop getting down days, where instead you build up excess cash in the portfolio. There is a form of portfolio misallocation going on right now, and it is in the form of zero-yielding cash.

Going from negative 12% cash to positive 12% cash (basically taking advantage of companies that were pounded to death in early April and cashing them out for some quick gains for more durable picks) and then having everything else rocket up still means you’re participating in the market, but other than getting a 500 share fill on a company some of you may have heard of, it’s been pretty tough going – my limit orders haven’t been getting hit.

The markets, for the most part, “feel” like the people that have cashed out their portfolios in March/April are trying to get back in.

I do have notional exposure to the ever-increasingly concentrated S&P 500 but it is mild (the percentage exposure has gone down, and this was fortunately aided by the fact that the rest of the portfolio itself has gone up).

The only future losing investment I can see at this time is long-duration fixed income. Even rate-reset preferred shares, which should be relative underperformers, will be okay for the most cautious investors compared to sticking money in A-AA-AAA fixed income.

The trick here is to not view the cash in your portfolio as (too much of) a liability (yes, my CPA hat is screaming at me that cash is in the asset column, I think the reader knows what I am getting at here). Instead of saying “damn it, I’m just going to hit the ask”, waiting for a day when Trump says something that causes the market to go down a couple percent, or some other equivalent, and then choosing to purchase when the nervous nellies return thinking there will be a second rebound of COVID-19. The latter isn’t happening – the surprise is going to be how quickly COVID-19 will disappear, except in the eyes of the media, and the public knows it.

The question is when the month-long euphoria of re-opening (which will cause a spending boom) ends, what will happen to employment, capital investment, and so forth. There are a lot of questions about the potential re-domestication (I don’t know what else to call this) of certain components of the US economy. Regulatory structures do need to change to give companies incentives to on-shoring manufacturing that has long since been outsourced (mostly to China). In Canada, the only industries that matter in the lens of the current government are the ones encompassing the metropolitan Toronto and Montreal areas, with Atlantic Canada (you can literally look at the 2019 election results map and look for the ‘red’ areas to determine where the government privilege will go), so apply that information strategically in Canadian investment decisions. As in, Bombardier unsecured debt is trading at around 60 cents on the dollar.

Late Night Finance with Sacha, Episode 3

Late Night Finance with Sacha, Episode 3

Date: Thursday, May 21
Time: 9:00pm, Pacific Time
Duration: Projected 1 hour.
Where: Zoom

Frequently Asked Questions:

Q: What are you doing?
A: I’m going to be running a TSX stock screen and doing some very rapid research on some candidates for an hour. Questions during this presentation, both on and off topic, are accepted.

Q: Why are you doing this?
A: Continuing my experimentation in video broadcasting. Who knows, I might learn something from you as well.

Q: Why so freaking late? I live in the eastern time zone.
A: It is late night finance, is it not? I might do ‘afternoon finance’ another time, but not this time.

Q: How do I register?
A: Send sacha@divestor.com an email. Subject line “Late Night Finance May 21”, and in the message body tell me what city and province/state you’re from (or if you’re international, city and country). I’ll reply later (no later than Thursday 8pm) with the zoom channel and passcode to get in.

Q: Are you trying to spam me, try to sell me garbage, etc. if I register?
A: I can hardly manage a mailing list without breaking my own website, what makes you think I will spam you? No, if you register for this, I will not harvest your email or send you any solicitations. Also I am not using this to pump and dump any securities to you, although I will certainly offer opinions on what I see.

Q: Why do I have to register? I just want to be anonymous.
A: I’m curious who you are as well.

Q: If I register and don’t show up, will you be mad at me?
A: No.

Q: Will you (Sacha) be on video (i.e. this isn’t just an audio-only stream)?
A: Yes. You’ll get to see me.

Q: Will I need to be on video?
A: I’d prefer it, and you are more than welcome to be in your pajamas. No judgements!

Q: Can I be a silent participant?
A: Yes.

Q: Is there an archive of the video I can watch later if I can’t make it?
A: No. Eventually when I figure out a good procedure I will enable this.

Q: Is there a limit to the people that can participate?
A: Zoom limits me to 100. I really hope the number isn’t higher than 10.

Q: Will there be some other video presentation in the future?
A: Yes.

Another clothing retailer bites the dust

The fixed costs of leasing for most of these companies is way too high, so CCAA is the only real escape hatch.

Reitmans (TSX: RET.A) finally pulled the trigger on CCAA today, probably to get out of their onerous leases.

My only comment about them is that their balance sheet is still in reasonably decent shape (they have a lot of cash, relatively speaking – $89 million at the beginning of February 2020) and little in the way of debt other than their lease obligations.

Finally, in what had to be the worst-timed substantial issuer bid in stock market history, on July 29, 2019 they repurchased $43.4 million in stock at $3 a piece.  I’ll leave it to the readers to determine the rate of return on this after less than 10 months.

Reality and the markets, weekend edition

I’ve never been asked which college/university major is best for being able to outperform in the markets, but I am guessing that those choosing to major in philosophy (specifically those specializing in epistemology) or psychology (specializing in cognition and perception) will do better than most others, especially finance and accounting (the limited academic exposure I’ve had to finance and accounting suggests to me that the education delivered in these fields still render people ill-equipped to the financial marketplace).

It is becoming increasingly difficult to separate reality and fiction with some of the media reports on various matters. It is like reading the news on the morning of April 1st, except you’re doing it every day. For example, on the trivial matter of Major League Baseball‘s planned re-opening parameters in the light of COVID-19:

Major League Baseball players will be prohibited from taking showers after games and there will be no fist-bump celebrations or spitting sunflower seeds in the dugout, according to a return-to-play guidelines drafted by league officials.

This is a clever article because it hits on what I believe is the “two realities” theme that we are seeing in COVID-19.

In markets, determining what the reality of the market is, the reality of the underlying company you’re looking at, and your own reality are essential elements to determining your standing. For example, if the market has a pessimistic reality, but the actual reality is neutral, you can ‘win’ by going long if you assuming your own read of reality is correct (coupled with a future change in perception of market reality). Knowing your own standing in regards to your perception of reality is the most difficult of these three.

The funny thing is that there is evidence that we do not need to see reality for how it actually is to survive (this is a difficult to understand lecture, but if you do understand it, you will be much better equipped to handle the financial markets than most).

Going back to Major League Baseball, the two realities that this article hits is:

1) Those that believe that the ever-tightening restrictions of activities due to COVID-19 are justified. Those reading this would be “Oh, OK. Makes sense. Showering creates aerosols, people shower in proximity with each other in stadium locker rooms, so it helps prevent the spread. We must all do our part, including Major League Baseball players.” This caters to the ‘acceptance’ crowd.

2) Another reality is “This is completely ridiculous. You expect to play outside in 35C summer heat for three hours, and not being able to shower after?? This is all about control of people through top-down bureaucratic decree, socialism, left-wing politics, etc.”. This caters to the ‘rejection’ crowd.

The ultimate irony is either reaction goes down a path of no return, where intellectually once you’ve committed the costs of reversal are high – the analogy is digging yourself deeper into a pit makes it more difficult to get out of it. Once somebody has bought into a narrative, the chances of that narrative being mentally confirmed with subsequent articles increases. Social media is very good at accelerating and filtering for these processes, which is one explanation for the increasing amount of polarization we are seeing – only for those that have bought into the ‘two reality’ trap.

Human brains are very well wired to analyze two options and make a decision. We have much less of an ability to consider scenarios with three or more options (the paradox of choice), although most of what we see before us are the consequences of multiple variables, and most of the decisions we face actually have more than two options.

Availability bias is something to always be remembered when dealing with reality sortation – are there alternative, not-before-your-eyes explanations of reality that is not being presented in front of you?

Put this into the context of the markets, where the reaction we are seeing to the markets jumping up roughly 30% from the March 23, 2020 lows is “The economy is shut down. Unemployment is well above 10%. Deficits and debts are massively increasing. Businesses are going bankrupt like never before. Why the hell is the market going up?”.

The market knows about the economy, unemployment, deficits, debt, and bankruptcies. What other variables is the market taking into consideration that people fixated on a certain number of variables cannot see?

It is nearly impossible to engage people on any basis than those of their own selected reality. It is very rare where presented evidence actually gets people to change their minds – usually such evidence ends up being reinforced into the present beliefs in a manner that is quite creative. You see this all the time in cults.

One reason why I choose to engage in the financial marketplace is because I have found no better forum that allows you to quantitatively determine the outcome of others’ perception of reality. If you get it wrong, you lose money. If you get it right, you win money. What makes it particularly challenging is in obvious certain cases reality is not at all close to what it actually is – you can still be “wrong” even when being right. A great example of this is if you shorted Tilray stock before September 19, 2018, it would have been a virtual guarantee you would have lost.

(FYI on Tilray – on September 19, 2018 it reached a high of $300 before crashing. If you had shorted the day before, the VWAP was $144, and if you had shorted just a week before the VWAP was $104 – there would have been no way you could have survived the short before September 19, 2018 except with a very small position.)

So my advice for superior performance is simple to write, but very difficult to execute in practice. Make sure not to embed yourself into a reality or narrative too deeply. Be willing to discard it, or shade it down in the face of contrary evidence. Question the veracity of the evidence. And finally, keep your sense of humour whenever you see retail cashiers behind a 2 inch thick bulletproof plexiglass wall, while seeing a fan blowing your potentially COVID-19 infected exhaled breath to the back counter.

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.