Portfolio Performance
My very unaudited portfolio performance in the first quarter of 2020, the three months ended March 31, 2020 is approximately -10.9%.
Portfolio Percentages
At March 31, 2020 (change from Q4-2019):
76% common equities (+19%)
3% preferred share equities (-12%)
18% corporate debt (+6%)
3% cash and cash equivalents (-12%)
Notional long to S&P 500 (via CME S&P E-Mini Futures)
Notional short to VIX (via CBOE VIX Futures)
Percentages may not add to 100% due to rounding.
USD exposure: 60% (+20%)
Portfolio is valued in CAD (CAD/USD 0.7110);
Other values derived per account statements.
General commentary
The quarter where the world changed. At one point in mid-February, I was sitting at around +7 or 8%, and life was good. I do remember staring at the ArcGIS map from Johns Hopkins University and seeing the Covid-19 curve in China taper off, and this geopolitical risk seemed to be transforming into the wayside until it just exploded into the rest of the world.
Many of us now pretend to be experts in pandemics and have transformed into closet virologists, offering all sorts of predictions, speculation, projections, and adding noise into what is a very noisy datastream.
Unfortunately, if I had more knowledge of how these things work, watching China shut down a hundred million people would have been a very good sign that something very wrong was going to happen here, but just like a lot of us (including most world governments that were too paralyzed to act otherwise) were caught flat-footed. It was pretty awful. I think I played the 2008-2009 economic crisis a lot better (basically because I had some forewarning to get out of the way – this pandemic? Nope!).
Indeed, my portfolio at the time was probably aligned the most incorrectly for this pandemic, short of not having any holdings in airlines, cruise ships, or oil production-related stocks. There has been a massive amount of turnover from the previous quarter as I’ve tried to radically change things around since we are living in a new economic paradigm. This is going to take a few months to settle out, but here are some summary conclusions as I see it going forward:
1. Companies that produce stuff/services that’s clearly essential (e.g. consumer staples, some consumer discretionary, depreciable machinery, defense, and soon commodities) should do okay as long as their leverage ratios and debt maturity profiles are not clearly out of whack (definitely requiring case-by-case basis examination). It’s probably a good time to be a bankruptcy and insolvency professional.
2. As international trade lines get cut, companies with international sensitivities will suffer. As a side note, it is going to be interesting to see what Apple is going to do with its manufacturing, in addition to most companies with China sensitivity. Things with China are going to enter into a “Second Cold War” after the Coronavirus. Pull out the USA vs. USSR playbook for some good history here but think of Hong Kong / Taiwan as being West Berlin and West Germany, respectively (with the notable exception that ‘West Berlin’ has a 2047 time limit).
3. I am skeptical about most financial companies (banks, insurance, mREITs and REITs, and financial royalties) going forward. In addition to the obvious debt/royalty defaults that will occur, there is going to be the additional spectre of inflation that will creep into everything, which hurts financial companies the most – the asset-liability matching becomes dysfunctional. Entities that are forced to hold long duration bonds are not going to do well – essentially the bond bull market is over. Zero interest rate policy has reached its terminal conclusion – now that things are zero, there is no escape. Even if those 30-year bonds go from a 1.2% YTM to 0.5% YTM, will it make much difference in the grand scheme of things? Most of the gains on long-term debt is reflected in pricing (just pull up a chart on TLT) and if your company has to rely on 1% coupons, it might as well be zero. Prices will increase in this domain to compensate. For this reason, I am also not a fan of preferred shares in this environment.
4. Oil in about nine months, maybe six or eighteen will skyrocket. The longer that oil is under $30/barrel, the further the bounce is going to be on the other end when supply/demand dynamics results in a supply imbalance. It probably wouldn’t be the worst of ideas to buy long-dated crude oil futures (December 2022 at US$38.75/barrel?).
5. The US defence industry is protected. There’s a lot of spending here, and this will be the last thing to get cut in the second cold war. Anybody thinking that Boeing will go under is kidding themselves, although this may not necessarily translate into the equity holders doing that well.
6. Companies that were able to raise capital in the first two months of 2020 (or to a lesser degree, the second half of 2019) probably did so on what currently looks to be very attractive terms. They might warrant further attention if the proceeds of such funds were to be used for future investment purposes.
7. It has always been a common mantra that senior home facilities was a great investment vector simply because the bulge of the baby boomer generation, in addition to life expectancy increases provides a demographic boost for this type of business. Instead, what we are seeing is that care homes are disease vectors. Relatively speaking, a lot of people’s deaths are accelerated by Covid-19 are located in care homes. I can’t see this helping demand (looking at Chartwell (CSH.UN), Invesque (IVQ), etc.).
8. The macroeconomic situation is precarious, especially for Canada. Just like how the face of the capital markets changed over the course of a couple weeks, the face for a country’s macroeconomic situation can also change in the same time period with all of this debt monetization going on. Canada is sure to run a deficit well over $100 billion (they’ll avoid the headline $200 billion, but right now I’m guessing around $180), and each of the provinces will be doing the same (all-time record deficits). The question is who will be picking up the bill for this, and this bill comes in the form of each dollar paying for less substance (whether this is a product or service). The after-effects of this during the 2008-2009 economic crisis came in the form of asset inflation, but this time it will be different. With trade lines cut, it is pretty obvious that there is going to be some high-grade consumer inflation that will be coming. Not now, but in a year’s time, this will be a dominant message, especially with the pending increase in oil prices. Note this is not going to be Weimar Republic inflation, but it will be at rates that we will not have experienced in a long, long time. As a result, interest rates must rise.
9. Many small businesses, pre-Covid-19 have already been running in a very leveraged state, and Covid-19 tipped them over into insolvency. The net result will be consolidation, and a continued proliferation of “big brand” establishments.
10. Academically, bio-sciences will suddenly have a resurgence, similar to how computer science was all the rage in the late 90’s. I would not be shocked at all that next year there will be a bunch of biotechnology IPOs that deal with virology, but I will also not be surprised at all that most of these companies are basically peddling snake oil through clinical trials.
11. Despite how dysfunctional the economy may seem to be, equities are going to be the only game in town, especially in a monetization situation. It will confound people that there will be such a disconnection between the stock market and the underlying economy, but this is because capital has to earn a return, and in a monetization, you want your assets to be put somewhere that produces goods and services that will be perpetually in demand, and have pricing power that can rise in alignment with costs (i.e. keeping up with inflation). Coke (KO), Beer (TAP) and Smokes (MO) anybody?
12. What industries have a large degree of “stored demand” that can flex back and forth (aside from commodities?). For instance, a hotel chain cannot sell empty rooms in the past. But since people are deferring their vacations right now, will there be a surge in vacation demand in the future? I would think in the instance of vacations, the return of demand will be a slow increase, especially spurred by low prices as capacity utilizations are going to be very low. However, are there industries where demand is simply delayed until the future? Think about this before investing.
13. Likewise, P/E comparisons from 2020 to 2021 are going to be very skewed. Any quantitative investing frameworks are going to be reprogrammed in light of Covid-19. This is analogous to looking at a long-term historical stock chart, and omitting the years 2008 to 2009 as being obviously anomalous.
Psychologically, this has been a very trying time. In general, I am very loss adverse but took a fairly large broadside during this crisis time (FYI if you watch the clip I linked to, the Coronavirus is just like the vessel that is behind the clouds – FYI#2, this was one of the most under-rated movies of the past couple decades and I really wish there was going to be a sequel!). Just like the rest of the planet, I wish I put around 2% of my portfolio in 10% out-of-the-money S&P 500 puts which would have hedged the entire loss and more, but sadly looking at the past like this is not very productive for forward thinking. Now the time is to pick up the bits that have been thrown out on margin liquidations and then be patient for them to double or triple, just like what happened in 2008-2009. However, this recovery is going to take a very different flavour. It won’t be nearly as easy.
Early in the year, yields on subordinated debt of all sorts of issuers were in the mid single-digit YTM. Now unless if the credit of the underlying company is very good, most of the subordinated debt is yielding double digits. There is considerable stress in the debt market, and this does remind me of the 2008-2009 environment, but oddly enough, not as severe where good credits were trading at teens and above YTMs. Preferred shares, likewise, have been thrown out into the trash, but this is also due to a function of the interest rate decreases, which subsequently will be decreasing dividend payouts. Yields will be higher and will likely not compress to the averages in 2019 precisely because of the macroeconomic monetization – simply put, cash is now trash (Ray Dalio was about two months too early in his pronunciation).
Portfolio Alignment
Although the headline numbers (equity / preferred / debt / cash) proportions are relatively level to the previous quarter, the composition within them has changed significantly. I’ve hinted at a few things here and there in previous posts but the turnover in the portfolio is the highest it has ever been.
In addition, the futures position is under the theory that central bank and government actions are going to add so much in the way of liquidity that liquidity sponges (i.e. large cap stocks) will be the prime beneficiaries. As a policy measure this will also dampen volatility. These positions are generally out of character for me, but as they say, extraordinary times requires extraordinary actions.
Commentary on public policy Re: Covid-19
Everybody on the internet has given their opinion on this. It is difficult to write anything on this without being accused of something horrible. I question a lot of the assumptions taken to date in terms of public policy, which has been based on a lot of conflicting information. It is not immediately clear to me that this advice to “flatten the curve” is at all having any effect than had the pronouncement not been made. In particular, there are other jurisdictions that have tried wildly varying strategies that are well known (Sweden, Taiwan, Japan, etc.) versus having no strategy whatsoever (Brazil would be a good example).
The statistic “confirmed cases” has now been rendered meaningless because the limiting factor is the number of tests performed – obviously if you test more people, you will get more confirmed cases. Tests have been rationed to those with symptoms, thus the real “known unknown” will be people that have not been tested that actually have it. The number is probably a lot higher than most think.
Even worse yet is the “confirmed but negative” statistic, which simply is another name for “hasn’t been infected yet”.
I like the example of Iceland (covid.is/data) where you have sampled nearly 10% of the population for Covid-19 (although I do not know how many people have been sampled twice, but even if you assume everybody has been sampled twice, a 5% population sample is huge) and 0.4% of the population has Covid-19, and of the confirmed infected, 2.6% required hospitalization.
The statistic of “deaths” needs to differentiate between “deaths due to Covid-19” versus “deaths with Covid-19”. There is no practical way that these statistics will be obtained. Somewhat more obtainable are the age distribution and comorbidity statistics of deaths, which convincingly indicate that the 60+ and heart condition/diabetic demographic are disproportionately affected by a magnitude of 10 or 20 above everybody else.
(trigger warning) It is possible that Covid-19 is not that much more harmful a bad case of the flu. It doesn’t look that way with everything that is going on, but because so many eyeballs are focused on it, the expression “a hammer only knows how to hit nails” is apt. There is also data that of course shows that Covid-19 is ten or twenty times worse than the flu in terms of spread, and mortality.
Death statistics are quite reliable since death certificates must be issued and tracking of deaths is conclusive (i.e. you don’t need to take a survey!). In the year 2018, approximately 777 people in Canada died daily. About 10 times that much for the USA. Today, one of those shock headlines stated “MODEL: Peak death will strike USA in 11 days when 2,644 die in 24 hrs…“… which is still about a third of the “ambient death rate”. The question is with Covid-19, is the death rate higher than the ambient death rate? I haven’t seen this question addressed.
I always like to think of a “parallel world” example, where you see people lining up to get into the grocery store that are spread two meters apart, versus not having these measures in place – will the death and/or transmission rate truly be impacted in either scenario? Of course, ethics prevents double-blind testing, but I would think the effectiveness of some measures to enforce “social distancing” are completely for show – similar to some procedures that you see around airports in the name of security.
My opinion at present is that the current route that most world governments have taken on Covid-19 will cause more collective damage with stress and economic turmoil (and subsequent spinoff consequences of such) than caused by Covid-19 itself. Political pressure likely forced most democratic governments to shut down, while autocratic ones can put on a semblance of ‘back to normal’ just strictly through misinformation, like how China is basically getting back to work despite there being cases of Covid-19 (the one or two they report is just symbolic, while the actual numbers involved are likely much more). Their “confirmed case” count is likely understated by a magnitude of 10, but came to the conclusion that a lockdown was doing more harm than good.
Looking forward
This might sound a little crazy, but I can see the S&P 500 heading to 4000 before the end of the year.
Q1-2020 - 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.| Year | Divestor Portfolio | S&P 500 (Price Return) | S&P 500 (Total Return) | TSX Comp. (Price Return) | TSX Comp. (Total Return) |
|---|---|---|---|---|---|
| 2006 | +3.0% | +13.6% | +15.8% | +14.5% | +17.3% |
| 2007 | +11.7% | +3.5% | +5.5% | +7.2% | +9.8% |
| 2008 | -9.2% | -38.5% | -37.0% | -35.0% | -33.0% |
| 2009 | +104.2% | +23.5% | +26.5% | +30.7% | +35.1% |
| 2010 | +28.0% | +12.8% | +15.1% | +14.4% | +17.6% |
| 2011 | -13.4% | +0.0% | +2.1% | -11.1% | -8.7% |
| 2012 | +2.0% | +13.4% | +16.0% | +4.0% | +7.2% |
| 2013 | +52.9% | +29.6% | +32.4% | +9.6% | +13.0% |
| 2014 | -7.7% | +11.4% | +13.7% | +7.4% | +10.6% |
| 2015 | +9.8% | -0.7% | +1.4% | -11.1% | -8.3% |
| 2016 | +53.6% | +9.5% | +12.0% | +17.5% | +21.1% |
| 2017 | +31.2% | +19.4% | +21.8% | +6.0% | +9.1% |
| 2018 | +14.8% | -6.2% | -4.4% | -11.6% | -9.1% |
| 2019 | +7.4% | +28.9% | +31.5% | +19.1% | +22.9% |
| Q1-2020 | -10.9% | -20.0% | -19.6% | -21.6% | -20.9% |
| 14.25 Years (CAGR): | +16.0% | +5.2% | +7.5% | +1.2% | +4.2% |
