Another bullet fired into the heart of Aimia

The Aimia (TSX: AIM) zombie keeps on moving but when the corpse will finally lie down and die is another good question.

Today, it was reported that Esso’s partnership with Aeroplan will terminate at the end of May 2018. Instead, the loyalty program partner that will be picked up is the Loblaws’ (TSX: L) optimum program.

One of the issues when valuating the fundamentals of businesses that have setbacks (and judging whether they can make comebacks or turnarounds) is to determine whether the blow they suffer was critical. In the case of Aeroplan, it was Air Canada and the threat of substitutions. Although Aeroplan/Aimia used to be a subsidiary of Air Canada, it was spun out for financial reasons and it is pretty clear that Air Canada knows that there are other alternatives available (such as doing it in-house). The psychology damage done when you lose your major business partner, coupled with the effect that your business depends on large volumes of customers trying to collect aeroplan miles for the purpose of flying, suggests that the subsequent network effect (or opposite thereof) will significantly devalue Aimia’s offerings. Another way of thinking about this is a negative economy of scale, but from a marketing perspective. Or what would happen if some other competitor to Ebay spontaneously stole 90% of auctions from EBay (we’re talking in the late 90’s/early 2000’s context, not the present day EBay).

The other buzz is that Air Canada is just negotiating for a better deal (since Aeroplan is set to expire in June 2020) but this is wishful thinking. Likewise, Aeroplan can’t just sign up any other airlines spontaneously since it takes quite a bit of time to link up with the electronic information systems of competitor airlines (there is potential they will sign up with a new discount airline brewing in Canada, but the volume of this business will be much, much less and Aeroplan will not be able to receive commercially acceptable terms like they had with Air Canada).

This all points to a huge value trap situation still with Aimia, as I’ve been trying to illustrate since the Air Canada/Aeroplan collapse.

Personally I have cashed out anything of value from my Aeroplan account. As an interm measure they will be (and I notice they have already) devalued their existing rewards to offset their deferred liability balance.

Implications of Canada-USA trade disruption

All of this talk about Donald Trump liking Justin Trudeau in the media was a fantasy perpetuated by the current government to try to paint a picture of how we can “get along”.

Of course, the undercurrents were anything but – not only were there significant trade disputes ongoing (softwood lumber to name one), but the rumblings of NAFTA being pulled and other Canada-US relationship issues are significantly material issues that were not being given sufficient attention.

So now the USA is firing another salvo in the attempt to negotiate a better deal – steel and aluminum tariffs. This is part of a broader negotiation strategy relating to NAFTA and will continue to hurt Canada’s (and Mexico’s) economies because of capital investment uncertainty.

Already with the election of Donald Trump it is perfectly evident that relatively fewer want to invest in Canada when the relative risk/reward ratio is being seriously skewed by corporate hostility in both federal and provincial governments in Canada, coupled with a very business-friendly climate in the USA. This pressure will likely continue with the current presidency.

The gross incompetence of our existing federal government at getting anything done (other than throwing money down a black hole) will be costing Canadians dearly in terms of continuing to decrease our standard of living.

The math on trade disputes is pretty simple.

The United States represents the vast majority of the Canadian export economy (about 75%).

Canada represents about 15% of the United States’ trade exports.

As a result, the USA can inflict much more economic pain to Canada than the other way around. As a result, when the USA decides to tighten the screws (like they are with this speculated tariff on steel and aluminum), it is one more step to negotiating a more beneficial trade deal.

What does this mean for the markets?

Likely in Canada, a lower interest rate as the economy will slow further. This would also decrease the value of the CAD/USD pair.

Canada Budget 2018: Speculation

I speculated this earlier in my 2016 annual report, but these options for the Canadian government are most certainly still in play:

1. Flow-through share deductions will be eliminated.
2. Employee stock option deduction will have a full, instead of half inclusion rate, OR the amount will be capped to some nominal amount (e.g. CAD$50k allowed or something).
3. Taxation of capital gains on principal residences is going to have some restrictions (time, or value) placed.
4. Partial inclusion of capital gains will rise (right now a Canadian taking a capital gain will include 50% of the gain as income; I speculate this will increase to 2/3rds or even 3/4).
5. I do NOT believe the non-tax exemption for private and public health plans will be scrapped. This would be a political nightmare for the government compared to the rather esoteric notions on the items, but this was floated around last year.
6. The GST will rise (probably to 7%).
7. Corporate income taxes, on large corporations, will rise.

The Canadian government is going to be more and more desperate for money – with rising debt and rising interest rates, the interest bite will expand once again (the debt is roughly $650 billion, so a 1% rise is a $6.5 billion interest hike on a $300 billion budget). It is also very unlikely the existing government will focus on cost reduction, hence, they will be looking at every corner to pick away revenues. The items above seem to be the lowest lying fruit, although they each will come with their own political costs. The botched implementation of a corporate tax reform on passive income was met with a significant amount of opposition. The politically easier route would be to simply rack up the deficits and not offend anybody, especially since there will be an election within 20 months.

Markets are lulling people into a false sense of security

Been busy looking at various securities (trying to pick the entrails of the crash earlier this February), but still haven’t found anything too compelling. I will especially note on the fixed income side of things there appears to be a lot of traps hiding (similar to Toys R Us unsecured debt last year went from 90 cents on the dollar to 20 cents in about a week). Want another value trap? Here is another.

I’m going to warn readers that things may be quite boring for the next little while. Investing right now seems to be a matter of forcing money to work and that is a recipe for losing it. So I’m continuing to wait.

One last observation:

Do you think this is the market trying to lull people into a false sense of security? Convincing people that the mini-crash we had in early February 2018 was just some sort of aberration due to the overwhelming amount of money betting against volatility?

Instead, people should be paying attention to this chart:

The trajectory here, if the last six months is repeated in the next six months, should frighten people. Coupled with the reverse of quantitative easing eating away at the general liquidity of the marketplace (move the slider on the bottom of the chart to show 2017-01 and beyond), is a recipe for asset price compression. Almost everybody of my generation has only seen rock-bottom interest rates and loose monetary policy during their adult lives. Adjusting to a culture where interest rates are not zero may take some getting used to.

State of the overall markets – suggestions needed

The S&P 500 is now down 3.5% year-to-date, while just last week I was writing about how it was up 7.4%. This, my friends, is over a 10% drop in the market in just 9 trading days. Incredible.

There will be a bit more vomiting but things will stabilize once all of the volatility-linked financial instruments continue their algorithmic unwinding. There has been a surprising lack of candidates out there that appear to me to be obvious victims of margin liquidations (unless if you so happened to own XIV!).

Yield-based financial instruments (prefereds, corporate debt) appear to be doing just fine. REITs have shown weakness, but probably due to markets pricing in the increasing rate environment. The Canadian markets haven’t been disproportionately affected – probably because the Canadian markets were never up that big to begin with. I’ve only seen significant damage in fossil fuel companies, but for obvious reasons (the federal and provincial governments are trying everything possible to kill the sector).

One of my talents that sets me apart from most others is my ability to side-step market crashes. I’ve done it in my very early years of investing in 2000, I did so in 2007-2008, 2016, and this week. I’ve had a few false alarms (I am financially paranoid), so I am not claiming perfection. Normally when circumstances become so obvious to invest (like it was in the first quarter of 2016), I do so, and go on margin. Right now, I’m roughly at 30% cash.

I’ve been trying to figure out how to deploy cash. One would think that a 10% market crash in two weeks would unearth some opportunities. If I find things exceptionally cheap, I have no problems dipping 10, 15 or even 20% in margin depending on the valuation parameters. But it’s nowhere close to doing this.

Something I’ve found very frustrating is there’s still nothing on the radar that has really attracted my visceral instincts.

I’d appreciate some suggestions.