Fixed income comparisons

There are some exchange traded products that are functionally identical but have different market prices. The reason why the prices are different is because of the individual demand/supply characteristics of the securities and individual liquidity preferences – for example, if two issues were otherwise identical in maturity date, coupon and seniority, if one issue was $200M outstanding, while the other was $20M outstanding, you would expect the $20M one to trade for less because of liquidity preference.

Right now on my radar screen, I see 7% coupon, 2028 maturity trust preferreds (backed by corporate senior debt, par value $25) trade at bid/ask 19.1/19.41 for one issue and 19.70/19.94 for another issue. Using the midpoint, we have a 9.83% yield to maturity for the first, and a 9.51% yield to maturity for the second.

The only reason why I am not hammering this difference is because they are non-marginable and you cannot short sell them.

Even more complicated is another issue that has identical characteristics, except it gives off a 6.5% coupon. At the current bid/ask of 17.37/17.50, we get a yield to maturity of 10.29%, which makes it more of a bargain than the other two securities – as long as you are willing to take your returns in the form of capital gains instead of coupon payments. In Canada, for taxable accounts, this is favoured. The cost of this, however, is that lower coupon issues are more sensitive to interest rate changes.

What is interesting is that if the securities in question were zero-coupon, with a 10.29% yield to maturity they would be priced about $3.965/share, while at a 9.51% yield to maturity, they would be $4.531/share, a 14.3% difference. It pays to shop around for your fixed income!

Handbook of Fixed Income Securities

I borrowed from the library the “Handbook of Fixed Income Securities” (Fabozzi) and while I didn’t go through it cover-to-cover (it is as thick as a phone book), I did find his style very good, especially with examples. The art of determining what risks you are taking in the fixed income market is highly quantitative and without the quantitative backing, the benefit you may get out of the book would be limited.

History of stock market crashes

October 28-29, 1929: Marked the beginning of the great depression – although the worst of it was only a couple years later, this was a very powerful signal that something wasn’t right in the US economy. This was characterized mainly by a lot of margin debt purchasing and rampant speculation on equities.

1973 to 1974: Marked the beginning of the rise of OPEC, and concerns about the world supply of crude oil in general. Also marked the beginning of the modern currency exchange systems we see today. This was in the middle of a recession and a period of high inflation (these two together are referred to as “stagflation”) and is the worst possible combination for equity markets.

October 19, 1987 (aka “Black Monday”): Probably the only “true” random market crash, potentially caused with inexperience with complexity through computer program trading, and also the Treasury Secretary mumbling about having to devalue US currency. Federal reserve chairman Alan Greenspan was also new on the job at this time. The US recovered despite having lost 22.7% of its market value for the day. Hong Kong got killed by 45.8%; in all cases buying this crash would have been fruitful. Easy to say when looking at past charts!

October 13, 1989: A small random market crash (6.1% loss on the S&P 500) for no particular reason at all.

October 27, 1997: The S&P lost 6.9% due to the Asian currency crisis and panic selling. This was at the time of the beginning of the run-up in technology issues. Although this was somewhat interrupted by the Long Term Capital Management fiasco in 1998, equities never looked back until February 2000, where they peaked.

September 11, 2001: The largest terrorist attack on US soil, and the biggest death count since the Pearl Harbour attack in December 1941. Equities dropped when markets re-opened a week later, mainly due to insurance and financial firms that had to perform some massive re-balancing after liquidating assets. This would prove to be a local bottom, but not a true bottom until in 2002 when markets finally reached their lows for the decade (up until the 2008 financial crisis).

October 2007 to March 2009: Fresh in everybody’s memory, the financial crisis caused wholesale liquidations in major financial firms, such as Bear Stearns, Lehman Brothers, Wachovia, Washington Mutual, etc. From peak to trough, the S&P 500 lost 56% of its value.

… and after this history lesson, will January 25, 2010 be on the books?

Fiscal Monitor Canada – November 2009

Canada released the November 2009 Fiscal Monitor, which is not too different than the October release. However, the big exception is collections from GST, which is a very good proxy for retail consumption – while October 2009 to October 2008 was down 8.5%, in November, it was up 16.6% from November 2008. On a year-to-date basis, in October it was down 16.5%, while in November it was down 12.0%, a remarkable improvement, but still down from fiscal 2008.

Is retail spending increasing in Canada, or is this just statistical noise?

All other metrics, including personal income tax collection (a proxy for employment as most of the taxes collected are through payroll deductions), corporate tax collections (a proxy for corporate profitability) and GST collection (a proxy for domestic consumption) are down.

The other comment is that for the 8 months of the year, the fiscal trajectory suggests the deficit will be about $54.4 billion.

Market timing – Half luck, half skill part 2

You never know what you’ll get once you get into a position. Psychologically, the first few days after one gets into a position is the time that one typically pays most attention to it, at the cost of ignoring the rest of your portfolio.

With the First Uranium debentures example, my execution in hindsight was horrible – they traded as low as 65 cents today. Assuming an execution at that price, it would have resulted in a current yield of 6.5% plus a capital gain of 19.7% annualized if they paid off at par. You add these two and it’s roughly 26% you are looking at annualized, again, assuming a payoff at par 2.5 years down the line.

It appears that this was some frightened investor (likely a fund) that dumped at the bid and wanted to get out of there – now the bid/ask is 68/72 cents.

Unfortunately, looking back at charts is rather useless in terms of market timing and the only question is whether the position is still worth as much as the existing market value thinks it is. I think the debentures are still the better risk, especially at 26%. There are significant operational issues, but there is so much capital locked up in the project that they’ll have to deliver for somebody – whether it’s the equity owners, or whether it’s the debt holders that may eventually take control of the firm.