Liquidation spree – cash heavy

I have substantially liquidated a large position in my portfolio today and am sitting on an approximate 50% cash position yielding precisely 0.00%. The majority of this is denominated in US currency. I have no interest in swapping it for Canadian currency at this time.

For various reasons, while I have thought about investing cash temporarily in 30-year treasury bonds, at this time I prefer the comfort of plain cash. There are quite apparent liquidity issues concerning US treasuries (on an institutional level) that alerts my brain to a form of tail risk that I can’t quite express in words.

I have substantially completed nibbling on a small equity position in a company that I have not disclosed but since I am aiming for a 2% position and have obtained 1.3% to date, you can guess what kind of conviction I have for the underlying company. Looking for a double in a year for the reasons that the market is pricing in worse profitability than what will actually occur, and the industry the company is in can be described as fairly un-sexy at present.

Pinetree Capital (TSX: PNP.DB) will be redeeming more debentures at the end of this week and this will also result in a further injection of cash. There will likely be another redemption notice coming between now and the end of August which will clear out half of the remaining position, and the last half will occur between October and maturity (May 2016).

My largest equity holding is now Genworth MI (TSX: MIC) that I have held on since 2012. At its current price I am not interested in liquidating or purchasing more shares.

I am completely out of ideas and thus the next seven months may be a very boring period of time for portfolio management. I have a bunch of interesting companies that I have researched, but valuations are nowhere close to the point where I would pull the trigger. Examples include cash generators like Rogers Sugar (TSX: RSI) where I would ideally purchase under $4 a share. Companies like this I have on my watchlist, but are nowhere close to where I would want to purchase them with an acceptable margin of error.

I would not want to be a portfolio manager for a firm that required 100% deployment of capital. The decisions at this point would not be pleasant and I would take an extreme perspective of putting capital in the most defensive equities as possible. Most (if not all) of these have been bidded up due to the low interest rate environment.

For now, I wait and twiddle my thumbs.

Beef prices and demand destruction

Here’s an article on the CBC about the state of high beef prices (and how they are here to stay for years to come).

There are a few lessons here.

One is that these market-affecting events typically have causes that span a timeframe greater than a calendar year. For instance, this spike in pricing can likely be traced back to 2011 when there was a significant drought that affected most of the corn and grain-producing regions in the USA. The drought was a multi-year event.

When cattlemen cannot obtain enough feedstock for their livestock, they switch to liquidation mode. Beef prices paradoxically went to relative lows at the beginning of the drought but have skyrocketed (as far as food inflation prices go) ever since.

It will take some time for the supply-demand balance to restore itself. However, the other lesson here may be one of demand destruction – have steak prices gone high enough that people will permanently reduce their demand for the product, resulting in a reduction of overall volumes?

The analogy to the crude oil market is also fairly straight-forward in terms of things not coming to any equilibrium over the span of a calendar year.

Retail prices of beef (and other food products) over the past few years are available from Statistics Canada. Onions, carrots and white sugar are the only three things that have dropped in price from April 2011 to April 2015. (As a side note, celery is roughly equal in price, and onions, carrots and celery make the staple Mirepoix that is a classic mix for sauteing, so at least I won’t be giving that up in my diet).

A couple ways of playing the beef situation financially that come immediately to mind (although both do not make any sense under the circumstances). One are through food processors, e.g. Tyson Foods, (NYSE: TSN). There are few “pure beef” processors out there, but one that does come to mind, indirectly, is Leucadia’s (NYSE: LUK) very ill-timed purchase of National Beef Packing Company. I have no interest in either company (either short or long).

For those brave souls, however, cattle futures on the CME are the purest play on beef prices. They are not the purest play on beef volumes, however, which would be easier to play than the price of beef.

Anecdotally, I have noticed my own consumption of beef (especially my favourite cut of steak, rib-eye) decline as I generally look at the opportunity cost of the CAD$27/kg price vs. other meats that I am equally competent at cooking. Also there is the other option of buying tougher cuts of beef and a competent cook can prepare these in a manner that are palatable (e.g. thin-cut stir-fry), but it just isn’t the same!

A small note and investing in the lottery!

Almost everything I’ve put bids on (very near the market) have creeped away from the bid. It is also not like I put a ten million dollar limit order in the market either – I break things away into very small sized chunks and scale in as market volatility takes pricing lower (or vice-versa in the event of a sale).

My lead hunch at this point is to simply buy into long-dated US treasury bonds (e.g. NYSE: TLT) and just sit and wait and be patient for other opportunities as they may arise. If long-term 30-year yields go to about 3.2-3.3%, I just may pull the trigger. But if anything is like how things have been throughout the year, it is going to be a very boring year. Maybe I am slightly resentful that had I did the TLT route in early 2014, I’d be sitting on a rough 20% gain at present.

I will also point out that the Lotto MAX is at $50 million plus $33 million bonus draws which means that you have a better than 1-in-a-million probability with a $5 fee to win a million. Although the expected value of the lottery of course is negative, it almost seems like the only real chance of getting a big payout is through this medium compared to what I am seeing out in the markets at present.

Sad times indeed!

Maybe I should have invested in the CPP instead

The Canada Pension Plan reported a 2015 fiscal year-end (their fiscal year goes from April 1 to March 31) performance of 18.7% gross, or 18.3% net after fees.

Over the past 10 years, the CPP has realized a 6.2% real rate of return, while in order to remain sustainable they require a 4% real rate of return. When dealing with a $250 billion dollar fund, two percent compounded over 10 years makes quite a big difference.

I have had my doubts that the CPP would be able to realize increased returns as it grew simply because they are competing with a lot of other big players for the same pool of income. In a smaller scale, individual investors have to scour the beds of the financial oceans in order to find reasonable risk/reward opportunities.

There is likely going to be increased political pressure to either reduce CPP premiums or raise CPP benefits due to the outperformance of the CPP. It is likely such a decision would be a mistake because in the macroeconomic sense, central bank quantitative easing has inflated asset pricing to extremely high levels. It is very improbable the CPP can maintain its current performance and quite probable that they will pull in more “real-world” rates of returns (i.e. single digits).

However, all Canadians should be happy that the CPP is doing what it did – there is this pervasive myth that the CPP will not be able to pay out for existing and future generations and with the existing payment and benefit regime it is quite likely they will be able to pay for the indefinite future. Assuming you have made maximum contributions to the CPP, you would be entitled to a $12,780/year retirement benefit when you turn 65 years of age. While this is not a huge amount of income, when coupled with Old Age Security ($6,765/year) leaves approximately $19,500/year of pre-tax income which, if properly budgeted, will pay for a basic lifestyle in retirement.

Not finding a lot to invest in

Barring any investment discoveries in the next month, the cash balance I will be reporting in June is going to be a considerably high fraction of the portfolio.

While cash is great, it also earns zero yield.

Compounding this problem is the majority of it is in US currency.

Unfortunately I have done some exhaustive scans of the marketplace and there is little in the way of Canadian fixed income opportunities (specifically in the debenture space) that I have seen that warrants anything than a small single-digit allocation. I would consider these to be medium reward to low-medium risk type opportunities. Things that won’t be home runs, but reasonable base hit opportunities.

Rate-reset preferred shares have also piqued my interest strictly on the basis of discounts to par value and some embedded features of interest rate hike protection, but my radar on future interest rates is quite fuzzy at the moment (my suspicion is that Canadian yields will trade as a function of US treasuries and the US Fed is going to take a bit longer than most people expect to raise rates since they do not want to crash their stock market while Obama is still in the President’s seat).

I have yet to fully delve into the US bond space, but right now the most “yield-y” securities in the fixed income sector are revolving around oil and gas companies.

There are plenty of oil and gas companies in Canada that have insolvent entities with outstanding debt issues, so I am not too interested in the US oil and gas sector since the dynamics are mostly the same, just different geographies.

I’m expecting Albertan producers to feel the pain when the royalty regimes are altered once again by their new NDP government. There will be a point of maximum pessimism and chances are that will present a better opportunity than present.

Even a driller like Transocean (NYSE: RIG) that is basically tearing down its own rigs in storage have debt that matures in 2022 yielding about 7.9%. If I was an institutional fund manager I’d consider the debt as being a reasonable opportunity, but I think it would be an even bigger opportunity once the corporation has lost its investment grade credit rating.

Canadian REIT equity give off good yields relative to almost everything else, but my deep suspicion is that these generally present low reward and low-medium risk type opportunities. Residential REITs (e.g. TSX: CAR.UN) I believe have the most fundamental momentum, but the market is pricing them like it is a done deal which is not appealing to myself from a market opportunity.

The conclusion of this post is that a focus on zero-yield securities is likely to bear more fruit. While I am not going to be sticking 100% of the portfolio in Twitter and LinkedIn, the only space where there will probably be outsized risk-reward opportunities left is in stocks that do not give out dividends. It will also be likely that a lot of these cases will involve some sort of special or distressed situations that cannot easily be picked up on a robotic (computerized) screening.

I would not be saddened to see the stock markets crash this summer, albeit I do not think this will be occurring.