Canada – Page 10

Back to normal – and re-indexing

Examining the price action of the past couple business days, I think there is a better chance than not that we have received the “flush-out” that I wrote about last week. The morning was packed with market selling before everything went up again. S&P 500 volatility spiked up to the 40% level. The trading was a bit panicky in two waves (how appropriate for COVID-19!). For the most part, I have been content to watch. There might be another ‘wave’ but I think the slow and gradual force exhibited by the central banks will force more capital into the markets.

I have been mildly tweaking my portfolio here and there, but in very minor ways. I’ve lightened up my USD portfolio concentration slightly.

Finally, I note that the TSX will be re-indexing their TSX 60 and Composite indexes next week. I always look at the entrails of index discards because typically if a company is getting trashed out of the index, the stock price tanks because of the automatic supply that gets sent to the market. However, if the underlying company has value, this is a better time than not to add. The only problem is a bunch of other institutional investors do exactly the same thing (reducing the effectiveness of this technique). Needless to say, there is a lot of money passively tracking the TSX 60 and TSX Composite, but most of it is concentrated in the top names.

How do you get into the TSX Composite? (I’ll just do a cut-and-paste job here):

To be eligible for inclusion in the S&P/TSX Composite, a security must meet the following two criteria:

1. Based on the volume weighted average price (VWAP) of the security on the Toronto Stock Exchange over the last 10 trading days of the month-end prior to the Quarterly Review, the security must represent a minimum weight of 0.04% of the index, after including the Quoted Market Value (QMV) of that security in the total float capitalization of the index. In the event that any Index Security has a weight of more than 10% at any month-end, the minimum weights for the purpose of inclusion are based on the S&P/TSX Capped Composite.

2. The security must have a minimum VWAP of C$1 over the past three months and over the last 10 trading days of the month-end prior to the Quarterly Review.

… and to get kicked out:

For Quarterly Review deletions the following buffer rules apply.

1. To be eligible for continued inclusion in the index, a security must meet the following two criteria:
a. Based on the volume weighted average price (VWAP) over the last 10 trading days of the month-end prior to the Quarterly Review, the security must represent a minimum weight of 0.025% of the index, after including the QMV for that security in the total float capitalization for the index. In the event that any Index Security has a weight of more than 10% at any month-end, the minimum weights for the purpose of inclusion are based on the S&P/TSX Capped Composite.
b. The security must have a minimum VWAP of C$1 over the previous three calendar months.

2. Liquidity is measured by float turnover (total number of shares traded in Canada and U.S. in the previous 12 months divided by float-adjusted shares outstanding at the end of the period). Liquidity must be at least 0.25. For dual-listed stocks, liquidity must also be at least 0.125 when using Canadian volume only.

In case if you were wondering, for the overall composite Index, Royal Bank is still 6% of the TSX and Shopify is currently around 5%, so no fears of over-concentration. I remember at one point Nortel was above 20% of the TSX.

Deleted out of the TSX Composite are:
AFN – Ag Growth International
AD – Alaris Royalty
BTE – Baytex Energy
BBD.B – Bombardier
CHE.UN – Chemtrade Logistics
CHR – Chorus Aviation
EFX – Enerflex
EXE – Extendicare
FRU – Freehold Royalties
FEC – Frontera Energy
HEXO – HEXO
MTY – MTY Food Group
SES – Secure Energy Services
SCL – Shawcor

I will offer some mild and not-so-useful commentary – some of these are compelling values. Some of them I’ve written about here before. I’ve looked at the inclusions and don’t like any of them.

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.

Why Canada is getting into trouble

I try to avoid politics in this website other than how they interact with the financial markets (which is a material consideration – don’t face the headwinds of the central banks or federal governments – just ask Albertan oil and gas producers!), but this little interaction in Parliament should be a pretty good indication of the minds of our esteemed Ministry of Finance (MP Pierre Polievre has been a very effective finance critic for the opposition):

(You want the actual answers? Try here.)

I understand what the Minister of Finance is doing from a political angle – he is obviously being given specific advice to not say anything that is clippable in a negative light. So he won’t answer any real questions in Parliament. There are no consequences to not answering questions in Parliament other than public embarrassment, which didn’t seem to hurt the Liberals in the previous election (Trudeau’s blackface, etc.).

Although the USA is blowing more money out the door, one can make the claim that they still have the strongest military and still an extremely powerful economy that, when they actually care about it, can be nearly self-sufficient from a domestic perspective. As a result, they can take ridiculously huge monetary and fiscal actions and will still be in reasonably good shape (inflation would result when claims on currency start flowing in to purchase goods and services, but it would not be a country-ending event). Canada cannot make such a claim as our primary export is natural resources, and we rely on imports for significant amounts of goods. We still have a reasonably decent amount of domestic production, but it is nowhere as robust as the USA. As a result, at the same levels of debt (proportionate to our GDP and population) we are more brittle economically.

Fortunately, the federal entity has had a relatively low amount of debt to GDP, but this is going to change (upwards) very quickly. Our debt to GDP will rise about 15% this fiscal year alone. Canada is structurally unusual in that our sub-soverign entities (i.e. provinces) are relatively more powerful entities than other countries, and as such, to have a proper apples-to-apples comparison, provincial debt should be included with the overall burden – when taking this into light, Canada is slipping into fiscal territory where it should not be going. We’re still miles away from around 1993 where interest expenses on gross debt was a third of our revenues (it was about 7% in the previous year), but it doesn’t take much imagination where you start having a monetary crisis and interest rates skyrocket, and that’ll force some really terrible fiscal decisions to properly regain the confidence of the financial markets.

Unfortunately, by the time that the country has to pay the bills for what is happening today, the people causing the problems will be long gone. It makes Harper’s performance during the 2008-2009 economic crisis (which was in itself instigated by a minority parliament that was going to overthrow him from office if he didn’t spend like mad) look quite good by comparison.

The ultimate irony is if there is enough supply destruction in the US shale market (coupled with lack of capital plus the depletion of the top-tier sites), fossil fuel prices might rise enough to bail out Canada’s energy companies, which would have a positive effect on the country’s finances (and the Canadian dollar). This would be despite the current government doing everything it can to shut them down.

Retailers going belly-up

So far of note: J. Crew (clothing), Neiman Marcus (sort of like HBC – higher end generalized department store), Aldo (shoes).

Pier 1 (homewares) didn’t even need the Coronavirus to take it down.

These are all American, but in Canada some other notables (it’s actually odd how there aren’t a lot of retail companies publicly traded on the TSX – I’m excluding the food-related companies here):

Reitmans (TSX: RET.A) – stock trading at 12 cents – this one isn’t as clear-cut, mainly because at the end of January 2020 they had $89 million in cash in the bank, and the only liabilities were their massive lease payments outstanding. Their business (mid-stream business casual women’s fashions) is a terrible sector. They did caution “the Company estimates that it will need financing to meet its current and future financial obligations”, which is never something you want to be reading, but a bit paradoxical given their still relatively strong cash position. At a market cap of just under $6 million, the market is saying this one is worth way more dead than alive.

Roots (TSX: ROOT) – looks pretty ugly. Debt on the balance sheet combined with an operation that’s not making money, means they’ll have to get more credit in order to continue. Margins are decreasing, expenses are rising, it isn’t looking very pleasant.

Indigo (TSX: IDG) – The only big debt they have is their lease payments, while their retail operation isn’t bleeding THAT much. It’s kind of surprising to think on a normal full-year cycle they do make money. But from March 1, 2018, their stock graph has been a 30-degree ski slope downhill. It’s rare to see declines this smooth. Also, at the end of December 2019, they have $66 million in unredeemed gift card balances. Amazing.

COVID-19 false positives

Apparently Nunavut’s first COVID-19 case was a false positive.

From what I remember reading, it is possible that tests have false positive rates of up to 30%, depending on what’s being tested. Conversely the false negative rates I’ve seen quoted are around 15%, again, depending on tests. I haven’t taken the time to seriously dig into what precisely the numbers are, but you can be sure that in most instances, false positives are rarely corrected to negative and subsequently not reflected in the statistics, while false negatives will eventually become positives later (at least in symptomatic cases).

One of the whole issues of this social isolation is that it’s basically impossible, short of precision testing, to contain it, so efforts are basically about buying time. If these studies of anti-body testing in the San Jose, and NYC area of people having 20-30% antibody rates for COVID-19 are true (hence being already sensitized to it and not being prone to further viral infection), once further confirmation of this broad “already infected” cohort becomes more confirmed, you will see a very suddenly policy change of just freeing up everybody.

The residual hysteria will be with us for at least a year as long as these “second wave” scare-and-fear media reports continue.