Category: Finance

The VIX index has been wildly dancing around, but as I write this it is roughly at around 50% at the moment.

April 16, 2025 futures (the predicted VIX 6 trading sessions later) has it at about 34%.

(Update: by the time I started penning this draft to when I hit the publish button, the numbers changed to 45% and 32%, respectively)

We are seeing a continuation of policy disruption and the realization that traditional structures that have existed are crumbling before our eyes. With the elevation of risk, prices are dropping and we are also seeing a deleveraging occurring.

It is always instructive to remember that whenever a transaction is performed, that no cash or assets are lost or created in the process – instead, the price of the asset is marked to whatever the transaction price is. The power of double entry accounting ensures that “Newton’s Law of Accounting” is followed at all times – assets equals liabilities plus equity.

Say your personal balance sheet looks like this:

Assets
Cash – $100
Stocks – $900 (10 shares of XYZ @ $90, mark-to-market)

Liabilities + Equity
Debt – $500
Equity – $500

Your own personal balance sheet has a gross debt to equity ratio of 100%, or net 80% with cash. Your loan agreement with the bank is a gross debt ratio of no more than 150% or a net debt ratio of no more than 100%.

Some other market participants decide to panic and take down the trading price of XYZ down to $60 because they want to raise cash.

Now your balance sheet looks like this:

Assets
Cash – $100
Stocks – $600 (10 XYZ @ $60, mark-to-market)

Liabilities + Equity
Debt – $500
Equity – $200

This is a result of a $300 loss in the value of the stock (whether it is ‘realized’ or ‘unrealized’ does not make a difference here). The loss flows directly down to equity. Now your gross debt to equity ratio has ballooned up to 250% (net 200%) and your bank is calling you asking you to normalize your debt ratios. So you sell half your stock:

Assets
Cash – $400
Stocks – $300 (5 XYZ @ $60, mark-to-market)

Liabilities + Equity
Debt – $500
Equity – $200

The transaction is a transfer of 5 XYZ in exchange with $300 cash from another participant. The gross debt to equity ratio is still 250%, but the net is now down to 50%. You then pay off a couple hundred dollars of debt to abide by the gross debt to equity ratio covenant:

Assets
Cash – $200
Stocks – $300 (5 XYZ @ $60, mark-to-market)

Liabilities + Equity
Debt – $300
Equity – $200

Now your gross/net debt to equity is 150% and 50%, respectively, which is within the bank covenant.

No cash or shares of XYZ were created in this equation. Instead, what happened is that your shares went to somebody else’s balance sheet in exchange for them giving you some cash. However, the payment (and extinguishment) of debt reduced the quantity of assets in the overall system – you gave $300 cash to a bank, which had your debt as an asset on its balance sheet – it performed an asset conversion (a loan to you to cash), while your balance sheet experienced a significant reduction.

Effectively this is what is happening – debt ratios get triggered with asset price drops and this forces cash to be raised – the pressure to liquidate further accelerates the asset price drop.

In other words, the anatomy of a margin call.

Fundamentally, asset prices are supported by cash flows provided by such assets, tempered by factors such as risks of business prospects and what one can get as a risk-free alternate. This does create a bit of a speculative outpouring where you get participants saying that assets such as common shares of NVidia will grow their earnings 25% annually for 10 years straight and the like – and when conditions change to thwart those expectations, the asset price corrects accordingly and those that have borrowed to pay for the stock will be forced to reverse course.

The net result is that those that are over-leveraged will have their assets taken away from them in a washout scenario. This applies to traders, but also to financial institutions that make bad loans and have an inability to abide by their regulatory limits.

It goes to show that high debt environments create huge amounts of volatility – Uncle Warren has preached about this for ages in his Berkshire letters. The irony is that those that have the highest amount of debt will have the highest amount of success relative to their equity – until a washout will take them out. This is best described in Greek mythology in Icarus, who was given a great gift of wings that could make him fly, but was cautioned to not fly too close to the sun otherwise they will melt – and indeed he crashed down to earth. High amounts of debt cause similar results.

When there is a race for cash, participants try to unload whatever is liquid – stocks, bonds and other alternatives. We see on a day like today that Gold is down 2%, and the two main cryptocurrencies (Bitcoin and Ethereum) are down about 6% and 13%, respectively. However, the world’s leading liquid cash substitute, US treasury bonds, typically a safe haven during equity market declines, have their futures down about 2.5% at present. Presumptively, today can be characterized as a race for cash. The race for cash provides opportunity for those that do not have to raise it – and timed well, can result in outstanding returns.

It is still far from the 2008-2009 days where I remember seeing corporate debt securities of credible and stable entities (e.g. telecom firms) trading at 15-20% yields. 2016 was also another ripe environment for fixed income (I remember the preferred share market was ripe with credible double-digit yields at the time). Perhaps my expectations are still too lofty for these types of returns in a 2025 environment that has been bathed in liquidity – if we receive a continued contraction in liquidity, there might be enough forced selling out there to make it happen. We will see.

It is psychologically damaging to see the equity component of the portfolio flailing so badly in this spiral (should I have gone 75% cash instead of 50%?), but I can only imagine how it would be if the portfolio was leveraged long – the financial stress would be considerable. I took a lot of chips off the table a couple years ago for this reason. I would only want to put those chips back on the table when it would seem to be crazy to do it – and believe it or not, it doesn’t seem like that yet, despite the fact that we live in crazy times (the causes of the increasing mental insanity can be the subject of another future post).

Things are starting to get interesting. The S&P 500 is down over 10% now from the mid-February peak and I am sure participants are getting a little skittish about asset pricing.

When things go crazy, it always helps to distill things to fundamental finance and economics and try to pick winners and losers.

One is that assets with higher risk are priced lower.

If your cash flows are 10, 10, 10, … to perpetuity, in a 10% rate environment, the asset will be worth 100. If the cash flows instead are 8, 12, 3, 17, -4, 16, etc., but still averaging 10, all things being equal that asset will be worth less than 100. One operational reason is that if a bank wanted to loan you money for your operation, there might be a chance you would blow a covenant. At the very least, you could take less leverage than the first “stable” operation.

Second, higher returns come from lower pricing.

Using the above example, if you managed to obtain the first asset at a price of 80 instead of 100, you would be sitting on a 12.5% return forever. If you bought it for 120, your return would be 8.3% instead.

Third is that a trade tariff is taxation.

Money that otherwise would go into the input is diverted to government. Governments, not known to being the most productive entities with capital, will likely reduce the overall efficiency of the economic engine.

Fourth – concepts of price elasticity

There are some items of trade that are crucial and have no substitutes. For these inelastic products, an increase in price will have no subsequent diminution in demand. Typically gasoline has been one of these products, but even then there is substitution effects with electric vehicles, or taking public transit, or just driving less. An even less elastic market would be basic food consumption – people need to eat to survive. The most elastic products would be semi-luxury products such as designer clothing and other completely discretionary purchases.

The seemingly “on again, off again” nature of the US administration has rapidly increased the perception of risk, hence lower prices (for financial assets). For price-elastic industries (which are most of them) this is going to have a marked decrease in overall demand due to increasing prices (of the consumable). As the aggregate demand drops, this will also have to corresponding boomerang impact of suppressing prices and create a negatively reinforcing loop. Despite revenues and profits decreasing, the amount of leverage employed to support decreasing profitability will result in a deleveraging shift.

Essentially this might be the start of the unwinding until central banks decide to employ the “plunge protection team” when opening up the monetary spigots once again. We are nowhere close to the conditions where the central banks will go full-blown QE, but you can be sure they are watching in regards to the stability of the financial system if we start hearing rumours of firms going under.

In Canada, we have the short-term rate likely to drop to 2.5% on their April 16 policy meeting. The yield curve has been a shallow “U” shape for some time, a change from the persistent inversion seen a couple years back. However, the introduction of quantitative easing is slowly back on the radar, both in Canada and in the USA – Canada has stopped their tightening, while the USA has slowed down theirs. This has been more gracefully implemented than what happened in 2009 and 2020.

Unlike what happened with Covid-19, I do not have a good radar as to where the opportunity is. I still continue to remain very defensively positioned with a high magnitude of cash, but many of my selections that I have taken small positions I have faced losses with.

The timing is going to be tricky. In bear markets, the bull rallies are usually quite monstrous in magnitude but very short-lived. Valuation-wise, we still have a lot of the S&P 100 in nosebleed territory and the perpetual EPS growth estimates are likely going to be tapered down significantly, which completely busts the rationale for high P/E valuations.

If I am using the year 2000 playbook, this has yet to still play out on the downside. There will be sharp rallies luring participants back in, thinking the worst is over. Cash is a defense – out of all the stupid decisions I made over the past couple years, I do not regret this one.

25 years ago there was a media-induced panic over “Y2K”, which was the perceived shutdown of global computer networks due to the historical coding practice of using two bytes for the year instead of four. For systems coded in the 1970’s it was a valuable savings of two bytes of storage that could be used elsewhere as nobody would be using these systems in the year 2000, right? Unfortunately re-coding ancient computer systems is very expensive (if it ain’t broke don’t fix it… unless if there’s Y2K and then you can justify an unlimited budget!). There were massive doomsday predictions, almost none of which occurred. All of these “experts” put in front of the camera predicting annihilation you don’t hear from today.

In addition to December 1999 being the 8th inning of the dot-com boom, stock markets (especially the Nasdaq) were seeing record inflows of demand and electronic stock trading and day-trading shops became completely in vogue. Back then, E-Trade and Ameritrade are the equivalent of today’s WealthSimple and Robinhood. Stories came about of dot-com instant millionaires with stock option packages, and companies were IPOing left and right and opening trading significantly above their offering price. Companies were trading at valuations that were sky-high and the mere mention of .com (Pets.com, EToys, and too many others to mention), business-to-business electronic commerce (remember Aruba and Commerce One?) or fibre optics (JDS Uniphase and Corning?) would cause stock prices to go even crazier. At your local McDonalds they were handing out free 3.5″ floppy disks or CD-ROMs to get onto AOL (through dial-up networking no less at the blazing speed of 33.6 kilobits per second – for those unfamiliar, that’s 4.2 kiloBYTES per second – about 200 times slower needed to stream a typical 1080p Netflix movie).

More relevantly, so-called “value stocks” were completely shunned and investors such as Warren Buffett (Berkshire was trading at US$51,000 at the end of 1999) were regarded as old news of a past generation, completely unable to cope in the new market of the information superhighway. Berkshire would bottom out at US$41,000 in March of 2000, the peak of the Nasdaq. Buffett even offered to buy back Berkshire stock in the year 2000, an unheard of capital allocation decision for him back then.

There are parallels to the markets of 25 years ago – the election of Trump in some sense portrays the start of a new era in America similar to the dawn of a new millennium (half the voters clearly wanted a change in the presidency), and the mere mention of the nebulous phrase of “AI” would be enough to cause a stock to skyrocket like a dot-com company. The S&P 500 is trading +28% year to date (Nasdaq +32%), while Telsa is up 76%, NVDA up 175%, and I won’t name the additional usual suspects – they are all entirely up. Tesla alone has doubled since the middle of October.

One big difference that does not fit the parallel is that most of today’s high flying companies are profitable with competitive advantages of such companies being perceived to be quite high. Surely there are a lot of AI and blockchain trash out there, but the major corporations are all making solid amounts of profit – the stratospheric valuation for these companies is definitely a parallel, however.

I will insert the concept of the mean value theorem, while somewhat complicated to explain in its full form, has a simple meaning relevant to this conversation – if the average you are seeking is +28%, that means that some components of the set (in this case your stock portfolio) must perform at or greater than +28% in order to achieve a mean of +28%.

Any equity fund manager is measured against the S&P 500 and if you had the fortitude of holding these high-flying companies you could make the average. Unfortunately, when doing a simple stock screen, approximately twice as many US-domiciled entities are trading under +28% compared to above +28%. Due to how typical portfolio allocation works, it is quite unlikely that managers will “let it ride” and instead trim the position along the way – so even the portfolio managers that have the NVidia’s and the like in their portfolios will be diluting their YTD performances unless if they are allowed to run concentrated positions.

As central banks are dropping interest rates and capital once again is rushing its way into the market to make a yield (or more likely – a capital gain) compared to the risk-free rate which appears to be heading well below the “real life experience” rate of inflation, there appears to be a huge gambling urge where once again, “cash is trash” – there is a huge sentiment out there it should be deployed in AI companies and cryptocurrencies. Margin rates for CAD are once again below 4% for institutional level investors and since the whole country is clearly going to the toilet (along with its currency), why not lever up and place a bunch of it in ethereum? This is the type of thinking that I think is going on out there – people are making fortunes with Tesla and Microstrategy, so those holding onto dogs such as Bell Canada and scratching their heads and questioning their existence in life.

I still don’t think this fever pitch has reached its peak. The difficult trade at this point is to buy into these all-time highs. What if Tesla goes to $550, $650 or an Elon-favoured number such as $690.69 per share, and what if this happens in less than three months’ time? What if Bitcoin goes to $150,000? Once the valuations get this high, the valuation itself has long since ceased to be irrelevant – it is the euphoria and psychology of competing alternatives to capital that dominate – until it doesn’t. This is probably why Warren Buffett is sitting on a huge cash stack in Berkshire along with many other so-called “value-oriented” managers – looking at amazement of the valuations ascribed to these entities. I have not seen enough evidence of people capitulating and bragging that they sold BCE to go buy some AI company. It is definitely getting close but not quite yet. Without pressure on equity holders to simultaneously liquidate into cash, prices have no reason to drop.

I look at my own portfolio and ask myself why I even bother to do market research anymore just to underperform people letting it ride on Tesla. For instance, Corvel (Nasdaq: CRVL), by virtue of appreciation, has morphed into my largest position in my portfolio. By far, it is has the most lofty valuation in my portfolio with a trailing P/E of 75. At the time I invested the trailing P/E was around 25 which (especially during the Covid blowup) I thought was rich, but I qualitatively allowed for an adjustment due to its competitive position in the industry. I did unload about a third of it slightly over a year ago at a then-56 P/E, something I thought was quite frothy but so far has turned out to be a negative value portfolio decision. Finally, just today, they announced they were going to do a 3:1 stock split!

One of the reasons why I have not unloaded the whole position (at the 75 P/E level) is an inherent skepticism of my own valuation metrics in this marketplace. Rationally speaking, I should get rid of the position. While I like to think I have a good grasp on the downside metrics, the upside metrics I have been terrible at judging.

Had my Covid-19 strategy simply been to put 100% of my portfolio in this company it would have been quite an acceptable outcome and would have saved me a lot of hassle. Had my Covid-19 strategy simply been to put 100% of my portfolio into Tesla, it would have been an even better decision.

I look at the rest of my portfolio and it is a smattering of companies involved in fossil fuels, manufacturing companies in various industries, and a so far ill-timed retail investment in the left hand side of the USA’s bimodal wealth distribution. These are relatively ‘boring’ and acceptably levered companies that trade at price-to-earnings ratios of around 10-15x, and should, in theory, provide a reasonable return if I slip into a coma and don’t wake up in a couple years. However, I’m becoming less confident over time this relatively conventional thinking is going to outperform or even generate 10%+ returns given what happens to markets that melt down like they did after March of 2000.

I do think holding half cash in the portfolio was a bit too aggressive. You end up looking like a genius if you get a market crash. However, crashes do not happen very often and with the short term interest rate clearly heading below 3% with little evidence that the “street level” of inflation is abating, the cost of cash is becoming a little too expensive for comfort, so I have mildly loosened the purse strings into a few smaller positions. I just might get my secret wish to get back to half cash again, if the existing equity in my portfolio decides to plummet!

The remainder of 2024 will likely not involve much in the way of fireworks. There will likely be a bunch of tax loss selling at year end (look BCE investors!) but the real action is likely to start on January 20, 2025 with the inauguration of President Trump and also later in the year, some speculation on what a change in the Canadian government would entail.

(This was published about 6:50am PST on the day of the 2024 Presidential Election)

I have been on radio silence for the past month and a half for multiple reasons. I haven’t had much time for market introspection, but in light of today’s upcoming event that only occurs every four years, I might as well bat out some ill-informed thoughts. Just be cautioned that my investment radar in 2024 has been extremely poor (some of my disposition decisions have been outright terrible – when I look at stock quotes, it is like needles into my eyeballs), although I do have some good company with people with deeper pockets (looking somewhat enviously at Warren Buffet’s US$325 billion stack of US treasuries at Berkshire Hathaway, who’s probably equivalently pissed off of decreasing short-term interest rates).

The Covid-19 era of investing (specifically from February 2020 to sometime in 2022) was a very unique time in investing in that the playbook was being re-written in real time and we saw things that were never seen before in modern history – including the closure of global borders, economic shutdowns, broad-based stimulus of funds, negative spot oil prices, SPACs, etc. Those that were able to quickly recognize that the world was not going to end and that the world’s governments would be pumping an insane amount of liquidity into the financial marketplace were well positioned for what happened.

We are still living in the aftermath where the financial reverberations of the nuclear detonation are still being processed – albeit there is plenty of radioactive fallout that we see, how this translates into actionable decisions is another matter entirely. Politically speaking, the obvious erosion in our standard of living leads to anti-incumbent headwinds for those already in office, while the incumbents are busy engaging in gaslighting operations to tell the people how great everything is.

Shakespeare’s Macbeth has the famous line at the opening scene of “Fair is foul, foul is fair“, or perhaps the somewhat more modern phase from Orwell’s 1984 of “Freedom is slavery, War is Peace” is apt for this.

The entire financial world has been given about five months of notice that central banks will be decreasing interest rates and this gets baked into market pricing so when the rate drops actually occur, there is no reaction as the changes are anticipated. Instead, what has mystified casual observers is when the central banks started to do 0.5% decreases, the longer duration bond yields have increased.

We have been in an inverted yield curve environment for a very long time – the short end of the curve has been a good 200bps or so above the 10-year bond rate and this has now moderated to about 75bps (and will converge even further with continued short term interest rate cuts). The interest rate environment will be conducive to more “borrow at the short end of the curve and invest and harvest the spread” type investing, we also see the monetary base is continuing to expand once again:

Those entities that have the credit to be able to borrow at the floating rate and leverage it into a higher return on equity will do well. We have already seen this with REITs and other “yieldy” entities being bidded up significantly since the central banks started to signal they are decreasing interest rates.

However, the question continues to remain whether demand will follow as a result of credit availability. Borrowed money will not do very good if it cannot be recycled into activity that generates a profitable return – we are seeing pretty much every single G20 government blowing deficits and without this low-yield government spending, economies grind to a halt and political headwinds get even stronger.

This leads us to the presidential election.

Almost all “news” generated on this matter is utter propaganda. The signal-to-noise ratio is even worse in 2024 than it has been in 2020 or 2016. In fact, much of what is out there is like the equivalent of inferring information from static television. You then have automated engines converting this static into signal and then all the AI Bots out there turn it into purported real information, which is precisely the inverse of how a proper foundation of knowledge should accumulate. This deluge of non-information is spread for both sides of the partisan isles – the game is to silo people into their camps and incite as much emotional carnage on the minds of voters, just to eclipse the threshold that gets them to vote for the selection that they are told to support.

So I don’t pretend to know anything, but can only theorize the most rudimentary framework without looking at any polling, any “news”, or anything in particular. Reading the so-called “news” is damaging in this respect, just as it is when making most investment decisions.

My prediction is that Donald Trump will be elected as the 47th President of the USA. So instead of Grover Cleveland as being the only president serving non-consecutive terms, Trump will be the very rare exception to the history book. In fact, the political circumstances behind Grover Cleveland running three times for president and winning the first and third one has some interesting parallels to the current era, which I will leave as an exercise to the reader.

However, the 2024 presidential electoral result will not be universally acknowledged by the end of November 5, 2024. Indeed, there will be a good chance that it will take until December for this pronouncement to occur – especially the certification of specific state delegations to the electoral college.

There are a few reasons for my overall prediction, but the thesis boils down to some differential analysis of which devil the public is motivated to choose from. Your typical Trump voter from 2020 is still likely to choose him in 2024, but your typical Biden/Democratic voter will have found many more reasons to not support their horse primarily due to eroding economic circumstances – especially “non-elite” populations in urban cores of cities. While urban areas will still vote overwhelmingly democratic, the fraction of people motivated to turn out will shift subtly enough to make a difference in the states that matter. Finally, it is universally regarded that Kamala Harris is a worse candidate than Joe Biden (the Joe Biden of 2020, not the nearly comatose Joe Biden of 2024!) or Hillary Clinton. By virtue of Trump having run in 2016, 2020 and 2024 along with broadly consistent messaging, it creates a relatively easy “control” to compare elections with.

Please note that my political predictions do not constitute endorsements or condemnations of any candidates or parties. I am simply trying to gaze into my (foggy) crystal ball and predict an outcome. There is one easy prediction I will make, however – deficit spending. Cowardly politicians coupled with a public that makes little connection between government spending and the standard of living will continue to result in a steady erosion.

What does this mean for the markets? Less than people imagine – the low-interest rate environment playbook will continue to prevail, but the actual purchasing power of cash will continue to decline. Eventually we will get some sort of situation that will precipitate the reinstatement of quantitative easing – getting your standard 15% return on equity is going to get very difficult in these environments where asset prices will continue to skyrocket along with overall debt levels.

Finally, recall when Donald Trump was winning in the 2016 election, that on the day of the election S&P futures initially traded down about 4% until it came to the realization that Trump was all for a boosted stock market. There will likely be an inverse version of this happening in 2024 – while he is perceived to be positive to the stock market, I believe any such euphoria will be short-lived. The transition period between the election and the inauguration is likely to be very volatile.