Category: Canada

The 2021 tax loss selling screen… or the “bottom 50” of the TSX

Posted below are 50 companies with a market cap over $50 million (i.e. weeding out those that actually went completely bust during the year) that have the worst year-to-date stock performances from 2021. I also include a short one-liner description of these companies and/or quick thoughts. This is as of closing prices on November 12, 2021.

Themes / Notes:
The “top 50” lost 72% to 36% of their market value during the year;
Gold mining or shiny metal companies (whether they actually are operating or theoretical) populate 20 of 50 of these;
Bio/pharma (or medical instrumentation) companies were 8 of 50;
Cannabis and related are 7 of 50;
Hydrogen or “clean energy” are 4 of 50.

When looking at these 50, there were none of them that passed my own personal screens for being worthy of a watchlist placement. Your mileage might vary. There is no “best of the worst” here, I really don’t like this year’s crop of tax loss candidates, at least the top 50.

Looking at the 52-week losers on the TSX

In these strange times where Facebook employees can’t get into their own building because of some technical issue, and half the world has to resort to the indignity of SMS because WhatsApp is down, I bring you some observations on which companies have fared the worst over the past 52 weeks.

In general, the list contains a lot of gold and silver miners that have done the worst, coupled with some biotechnology companies. Marijuana has also not done very well.

I try to avoid gold mining companies like the plague and hence I do not really want to dive into any of them, but notable names which stood out include New Gold (TSX: NGD), Sandstorm (TSX: SSL) and an old friend in Gran Colombia Gold (TSX: GCM).

Outside of this sector, the known and recognizable names on the loser lists is quite sparse. Mediagrif, now mdf (TSX: MDF) is a company that I’ve looked at in the past but have not invested in them. They were a fairly benign SaaS company (probably their most known software offering was MerX) that recently executed on a large-scale acquisition last August with a subsequent equity offering. This acquisition sucked up the cash on their balance sheet and added some leverage to purchase a company that is barely profitable. Large acquisitions very rarely work out and the stock price is certainly reflecting this. People tend to view the entire SaaS sector monotonically when in reality, there are huge valuation rifts between various software offerings – you can’t simply slap on a Constellation Software-sized price to sales ratio on every company that does SaaS!

Another name which caught my attention was MAV Beauty Brands (TSX: MAV). This is a branding reseller company (i.e. take generic products, put a brand label on them, and get them on the shelves of stores). Some of you may guess that I am not the biggest consumer of hair products. You would likely see this company represented in the shelves of Shopper’s Drug Mart. The company is mildly profitable, but they’re not exactly in the best competitive position – just go to the hair-care section at the store and you’ll see why. At a market cap of CAD$90 million they might seem cheap, but they also have a US$140 million term loan to deal with which really guts the valuation proposition.

Moving further down the list of 1-year losers, we have Ballard (TSX: BLDP) which I won’t dissect further – they continue to execute on their very successful business model of raising equity financing every decade when there is hype regarding hydrogen power: “On February 23, 2021, the Corporation completed a bought deal offering with a syndicate of financial institutions for 14,870,000 shares of the Corporation at $37.00 per share, resulting in gross offering proceeds of $550,190,000 and net offering proceeds of $527,291,000” – this will last them another 6 or 7 years!.

The first name which got me legitimately interested was Richards Packaging Income Fund (TSX: RPI.UN), which looked like they were a somewhat-COVID victim, but upon subsequent research I also tossed this one in the discards pile. If they were trading at half of what they were currently, I might have been more interested.

We all remember the toilet paper craze from Covid-19 and KP Tissue (TSX: KPT) was one of the companies that benefited from Covid-19. No longer – you can take a look at them now. They are an extremely leveraged entity.

Finally, something else that caught my attention was Saputo (TSX: SAP), the dairy conglomerate, and they are reaching 52-week lows and are likely candidates for year-end tax-loss selling. Covid-19 has disrupted the business and its profitability. While the stock is still at a healthy price, if it depreciates by another 1/3rd or so, it may get into value territory. Dairy is effectively controlled and protected in Canada by Saputo, Agropur (a co-op) and Parmalat (European-owned), which gives it some monopoly-type characteristics.

Overall, the pickings are very, very slim. The companies that have dropped over the past 52 weeks have really done so for proper reasons. I’m not finding a lot of value out there, and the low P/E names are mostly in the fossil fuel space and they have appreciated extremely.

Bank of Canada stopping quantitative easing?

Since the beginning of July, the Bank of Canada’s balance sheet hasn’t really gone anywhere. This is despite stating in the July 14th interest rate announcement that they would be continuing QE at a $2 billion/week rate.

Before COVID-19 began, the Bank of Canada historically has held about $75 billion in government bonds and $25 billion in (short term) treasury bills.

Today, the balance sheet consists of about $6 billion in treasury bills and $414 billion in government bonds.

The size of the Bank of Canada balance sheet is the same on August 11th as it was on September 1st. I would expect the balance sheet to increase slowly with QE but this hasn’t been happening.

For every asset there is either liability or equity, and in this case, the liability is the amount due to Members of Payments Canada (the big banks) – they collectively are owed about $276 billion as of the last September 1st snapshot.

We will see what happens on September the 8th when the next rate announcement is made. Given the ongoing federal election, there will be a lot of eyes on this report from non-traditional viewers.

On the US side, things still show no sign of stopping – it’s QE forever there.

This monetary froth, one way or another, ends up inflating the value of yield-bearing assets. The most obvious targets are government bonds themselves, but as money permeates up the risk spectrum, anything with a yield gets bidded up, making future returns on capital much lower, to the benefit of incumbent asset holders.

General Market Comments

The last two weeks of summer, psychologically speaking, are the two weeks before labour day weekend. Families are still on holiday (whatever types of holidays are still available with the myriad of Covid-related disruption around us), children are not at school, and the weather is usually warm enough that one wants to stay outside before the big Canadian winter freeze commences.

In the markets, this also means institutional managers are in the same boat – major policy decisions on how to steer the computerized program trading will likely be made after labour day.

So I do not put much stock in market action that is occurring, other than to observe that the TSX and S&P 500 is at an all-time high:

The Nasdaq 100 is also the same way. Both US indexes are a functional proxy for Apple, Microsoft, Amazon, etc. The S&P 500’s top 10 is about 28% of the index, while the Nasdaq 100’s top 10 is just over 50% of the index.

The TSX’s top 10 are: SHOP, RY, TD, BAM.A, ENB, CNR, BNS, BMO, CN and CP. They are about 40% of the index.

You would think the markets reaching all-time highs would generate some news headlines. It has been exactly the opposite. What do we hear about today?

1. Disaster in Afghanistan
2. Disaster in Covid-19 (take your pick: vaccines not working, variants, travel curbs, ‘fourth wave’, etc.)
3. Disaster in supply chains
4. Disaster in climate (take your pick: hurricanes, wildfires, droughts, heat waves, etc.)
5. Disaster in the Liberal Party of Canada (OK, OK, this was a joke – I will write about the Canadian election later)

The one thing that has clearly NOT been a disaster are people that have their capital in return-bearing assets. Indeed, it has been a disaster if you were NOT in the markets. The TSX is up about 17% year-to-date, while the S&P is up 21%. If you’re lagging this number, you’re effectively ‘falling behind’.

This rise in the stock market continues to be fuelled by monetary policy, with the USA and Canadian central banks still vacuuming up treasury bonds like no tomorrow; and also fiscal policy, with both governments spending like crazy.

The cash will circulate in the economy until the point where it ends up locked in bank reserves, which currently earns a very low rate of interest and will continue to do so for the indefinite future. Individuals that have satisfied their material needs have no other choice but to put their capital into the asset markets, lest they lose purchasing power.

This is the market we have been seeing post-COVID-19, until at such point we do not.

We are well into seeing the price ramifications in this monetary/fiscal regime. The front-row-center for many is the elevated cost of residential housing in urban centers. Indeed, even second and third-tier cities/towns have had an influx of capital just simply because of the people escaping the urban centres. Because of the elevation of such asset pricing, correspondingly, the cost of everything else rises to bake in the extra capital required to use the land.

We also see the impact on the stock market.

The physical world is where things get interesting with regards to the impact of monetary/fiscal policy. Although most of what happens in finance is a transaction of electrons, the physical world is messy. Primary industries produce the raw materials necessary for the functioning of society, and this includes food, energy and minerals. Somebody needs to produce this. As the debasement of currency continues, it stands to reason that the elevated cost structure will result in these commodity prices elevating.

Almost everything (with the exception of gold and silver) has risen since the start of the Covid pandemic.

The result of the increase in commodity prices will be a price transmission on the physical side of the economy that we will have not seen since the 1970’s. This will likely continue until we see a market dislocation event. I do not know what or how this will take place, but when it occurs, it will be like a 9.0 Richter Scale earthquake right next to where you live. And just like earthquakes, it will be very difficult to predict.

Until then, and especially as the conventional media has completely tuned the masses away from the rising stock market, the major indexes are most likely to continue their existing trajectories.

Brilliant marketing for yield-challenged investors

The chase for investment returns in our zero interest rate environment incentivizes the creation of all sorts of financial products to give one the perception of yield.

Indeed, I can promise you today a 10% yield. Just give me $100 and I will give you a 10-year yield of 10% a year, starting with a 10% distribution 365 days from now. Boom, guaranteed yield!

But hold on, it isn’t enough that I hold onto your capital for a decade, I want to charge some management expenses.

So how about you give me $100 today, and I’ll give you a target 8.5% yield. That might change if I can’t actually generate the returns, or if I can’t find more people to give me money to pay you.

A good example of yield-promotion financial instruments are split-share corporations, which appear to no longer be in vogue. There has to be new financial products that promote high yields!

Cue in the marketing geniuses at Hamilton, who have spammed the media with their “Target yield of 8.50% with monthly distributions” fund!

I couldn’t resist looking at the detail of the financial wizardry to make it happen.

This is a fund-of-funds:

And the strategy: “The fund seeks to replicate a 1.25 times multiple of the Solactive Multi-Sector Covered Call ETFs Index (SOLMSCCT), comprised of equal weightings of 7 Canadian-listed sector covered call ETFs.”

In other words, there is some person that puts in a buy order for 7 ETFs, and does it with 20% margin (i.e. buy $125 of funds with $100 of equity).

The geniuses at Hamilton don’t even have to program any software to manage the covered calls or the index balancing – they leave it to the constituent funds to doing so. The fine-print prospectus references a semi-annual rebalancing to equal-weight the funds, and to keep the leverage between 123% to 127%.

The 8.5% indicated yield is not in the prospectus, but it is clearly the marketing pitch. 8.5% divided by 1.25 is 6.8%, which is the basis for this yield claim.

For this, they charge 65 basis points.

A pretty good business for them.

I find this phenomena of covered call ETFs and the promotion of covered calls to be highly over-rated. Most retail people perceive covered calls to be free money (“even if I do get called out, it is at a price that I would have wanted to sell anyway”), but there is a significant exchange of future upside capital appreciation for a “yield” today. This yield is not free, especially during times of low volatility. Implied volatility of options tend to drop when the underlying price appreciates, and vice-versa. The best time to get the highest option yields (when implied volatility is the highest) is typically during a market crash, which is precisely the time you do not want to be selling the capital upside of equities.

Conversely, at that exact moment tends to be the ideal time to sell put options, but few people in the heat of a market crash want to do so, and indeed, selling puts during a market crash is not the most financially productive activity since the amount of upside you capture is limited to the put premium. There is no free lunch in this game although slick marketing makes it appear to be the case.

The TSX 60 currently yields around 2.7%. At 125% leverage, it would yield around 3.4% ignoring the interest cost. If you got rid of Shopify (about 10% of the index now!) that yield rises to about 3.7%. Is it a stretch to think the capital component of the TSX will rise 5% in the future? Maybe. But the sale of 2-month at-the-money covered calls on the TSX right now is 1.4% and that more or less locks in a (unleveraged) 4% return with only capital downside. The 2-month covered call option yield if you wish to retain about 2% capital upside is about 40 basis points. When you include a friction of 65bps MER, I don’t see how the math works at all.