Site is back online

It appears that due to some stale installations of WordPress on my web hosting account, somebody managed to inject a whole bunch of garbage into the server that is running this website.

From what I can tell the initial intrusion happened in late August, while the thing that caused the site to go down happened on the morning of September 19th.

The script that ran on the machine injected files across practically every available directory on the server. It wasn’t a very subtle hack. It allowed the host to act as a ‘pass through’ – if you ever wonder why hacks these days are almost impossible to geo-locate, it is because they are almost always done through infected servers and this makes things incredibly difficult to trace after the fact.

Anyway, after many hours of polishing off my ancient UNIX skills, I’ve managed to restore this site from my backups and things should be back to normal again.

Divestor is back online – for now!

I could not imagine how anybody that doesn’t know how to navigate within an SSH session could solve this without getting external assistance (read: $$$$). Things are getting really complicated these days.

Cash ETFs

I’m sitting on some relatively heavy losses (0.7%) in my investment in the Canadian Short Term Bond Index ETF (TSX: XSB). The loss was a result of speculating that an average 3-year yield would perform better than a short-term cash account. Needless to say, it is annoying that had I just kept the cash in the account (even earning zero-yield, as Questrade generously offers on cash) I would have done a lot better.

Now that the Bank of Canada has cranked up short-term interest rates even further, the yield curve is flatter and spot yields are about 70bps lower than 1-year yields. The compensation for duration is quite low.

So while I contemplate flip-flopping to even shorter maturities than 3.11 years in exchange for a boost-up of about 100bps on spot rates, we look at the cash ETF options (alphabetical order by ticker symbol):

(TSX: CASH) – info – gross yield 378bps – MER 13bps
(TSX: CSAV) – info – gross yield 296bps (pre-BoC 75bps increase on Sept 7) – MER 16bps
(TSX: HSAV) – info – gross yield 375bps – MER 12bps
(TSX: PSA) – info – net yield 359bps – MER 17bps

All four of the above trade with penny spreads on the TSX in sufficient liquidity volumes.

For comparison, Interactive Brokers offers 276bps on their CAD cash yields. The question is whether it makes sense to flip cash for near-cash, and for each $10,000 transaction, it would cost approximately $2 in commissions to make a trade for approximately 90bps of yield, good for a $90/year difference, or $7.50 monthly.

The question then becomes whether the structural risk of the cash ETF (What happens if the market makers decide to quit? What happens in a true market crisis where everything blows up? What happens if the “cash” investments the ETF invests in goes belly up? What happens if the custodial arrangements the ETF management has turns out to be fraudulent or defective, etc.?) becomes worth it for a $7.50/$10k monthly difference. Is it worth a 360bps difference? Likely. Is it worth a 90bps difference? Probably not.

Bank of Canada – raising rates and NOT killing kittens

Right on the front of the Bank of Canada website:

A lot of press was made about this, and the distraction phrase here is “cash”. Yes, they did not print cash, but they sure as hell injected a bunch of money into the system in the form of bank reserves!

The logic is as disingenuous as writing the following:

“#YouAskedUs if we killed kittens to finance the federal gov’t.

We didn’t.”

The original inception of the central bank is that it is supposed to perform independently of the government to fulfill its mandate (which is set by the government and is currently to maintain inflation at a level of 2%). Independence is supposed to give the central bank credibility, but since we are now in the era of the politicization of everything, the central bank is now playing politics, which certainly won’t help its credibility.

Anyway, back to the present, the Bank of Canada raised 0.75% today, largely on expectations.

Key points in the release, with my comments:

* consumption grew by about 9½% and business investment was up by close to 12%.

It is very easy for consumption to increase this level when inflation is 7.6%! This is a lagging indicator.

* Given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further.

October 26: 0.25% increase to 3.5% unless if something really, really terrible happens in the next seven weeks (say, a stock market crash). The non-market consensus outlook that I’m putting some probability towards is that they will continue to raise 0.25% each meeting until there is the obvious break in demand.

Implications and thoughts

It has been a very long time (about 15 years) where short term interest rates were at these levels, just before the 2008 economic crisis. The risk-free rate is a relevant parameter for most financial calculations. Right now, you can lend the Government of Canada your money for a year and receive a 3.75% guaranteed (nominal!) return. When going out to the corporate bond market, this represents an effective floor on an investment – why bother lending your money to Nortel or Shopify at 3.75% when you can just do it with the government for zero risk?

One reason could be that the corporate world will give you a return for longer than a year – and indeed, a 5-year government bond now yields 3.3%. The question of where long term interest rates go from here is a fascinating one, but if we ever return to the zero-rate environment again, a guaranteed 3% return is golden.

It is instructive to look at the progression of quantitative tightening. December 22, 2021 was the peak of Bank of Canada holdings of government bonds, approximately $435 billion. There is also a (relatively) small amount of provincial and mortgage debt on the books, but we will focus on the bonds. As of August 31, 2022 the Bank of Canada holds $381 billion ($54 billion or 12%). We have data on the “Members to Payments Canada” (bank reserves held in the Bank of Canada) – a reduction of $78 billion there. There’s a $24 billion gap there. What happened?

One factor is that the Government of Canada has been raising more money than expected. Their net cash position with the Bank of Canada rose $30 billion in the prevailing time period. On the fiscal side of things, there is much less pressure on the financial markets to raise debt capital simply because tax revenues have been skyrocketing – this is one of the effects of inflation – everything is valued with nominal dollars. This fiscal cushion gives monetary policy some extra runway before having adverse effects on the longer term interest rates. The government will continue to roll over its debt at higher rates of interest, but they have a very large cash cushion to work with, and if the indications suggest, they will be reporting a significantly lowered budget deficit when they do the fiscal update this November (just in time for more spending to “alleviate the cost of living”!).

What will this mean for the equity markets and asset markets in general? Tough times! It is much, much more difficult to make significant sums of money in a tightening monetary policy environment. Instead of the customary multiple boosts, returns (if any!) will likely be much more correlated to traditional metrics, such as net income and free cash flow, and any gains in corporate profitability will likely be offset to a degree by the P/E multiple compressing due to the risk-free rate rising. Be cautious.

Cenovus Energy’s relatively small dividend

Cenovus Energy (TSX: CVE) is Canada’s second largest oil producer (behind CNQ), featuring two flagship oil sands projects, Christina Lake and Foster Creek. Unlike CNQ, they have downstream capacity just a shade short of their production levels. Needless to say they have been producing a lot of cash flow.

Compared to the top three (CNQ, Suncor and CVE), Cenovus’ dividend has been relatively paltry – the yield has been less than 2% and a very small fraction of the company’s free cash flow.

You might have been wondering why, and it likely concerns the warrant indenture. Specifically, the warrants have a price adjustment if “Dividends paid in the ordinary course” exceeds a certain level:

in the aggregate, the greater of: (i) (a) for the 2021 financial year, $170 million; and (b) for financial years after 2021, 150% of the aggregate amount of the dividends paid by the Corporation on its Common Shares in its immediately preceding financial year which were Dividends Paid in the Ordinary Course for such preceding year;
(ii) 100% of the retained earnings of the Corporation as at the end of its immediately preceding financial year; and
(iii) 100% of the aggregate consolidated net earnings of the Corporation, determined before computation of extraordinary items but after dividends paid on all Common Shares and first preferred shares of the Corporation, for its immediately preceding financial year, in each case calculated in accordance with Canadian generally accepted accounting principles consistent with those applied in the preparation of the most recently completed audited consolidated financial statements of the Corporation;

The relevant clause for 2021 is retained earnings, and it was $878 million at the end of 2021. $878 million divided by 2.016 billion shares outstanding gives you about 43 cents per share, and CVE’s current dividend was raised to 42 cents per share.

For the first half of 2022, retained earnings is sitting at $4.6 billion and this will likely go much higher by year-end. At June 30, CVE had 1.97 billion shares outstanding and thus they can practically increase their regular dividend to match their cash flow once the audited financial statements are released in March of 2023. Until then, they are stuck with their existing dividend and are busy buying back shares and paying down debt in the meantime, in addition to consolidating the 50% share in the Sunrise oil sands and Toledo refinery that they previously did not own. Once they get down to their $4 billion debt target, the company pledged to distribute 100% of its earnings to shareholders – practically behaving like an income trust if you remember those days when Penn West and Pengrowth income trusts were throwing out the cashflow in a similar manner. An annualized $2/share dividend is not out of the question, and this would likely result in the stock trading for higher than what it is currently trading for today.

Today’s contrarian sector – European Banks

This is likely in the “not yet” category, but it is something that I’m paying a little more attention to than most, namely the big European banks.

With the EU reacting to its poor energy policies by enacting demand restrictions, there will surely be further reverberations going forward in terms of the continent’s heavy industry. This will have spin-off impacts in terms of the credit that is extended to various corporations that are sensitive to energy input costs, and creating a whole financial cascade. Who ever thought that negative interest rates would actually have real consequences?

With that said, I’ve looked at various European banking entities, and just doing the most superficial analysis. Numbers are market cap (US billions), P/E, P/B and historical dividend yield.

UK
LYG: Lloyds Banking Group – 33 / 6.6 / 0.57 / 3.9%
BCS: Barclays PLC – 31 / 5.1 / 0.38 / 2.8%

France
BNPQY: BNP Paribas – 57 / 5.6 / 0.49 / 8.5%
SCGLY: Societe Generale – 18 / 7.0 / 0.28 / 8.0%

Germany
DB: Deutsche Bank – 17 / 5.4 / 0.25 / 2.7%
CRZBY: Commerzbank – 8 / 4.9 / 0.28 / 0%

Italy
ISNPY: Intesa Sanpaolo – 33 / 8.8 / 0.51 / 7.0%
UNCRY: Unicredit – 19 / 25.6 / 0.30 / 3.9%

Spain
SAN: Banco Santander – 39 / 4.6 / 0.44 / 4.6%
BBVA: Banco Bilbao Vizcaya Argentaria – 28 / 4.6 / 0.62 / 11.3%

Scandinavia
NRDBY: Nordea Bank (Finland) – 34 / 10 / 1.1 / 16.7%
DNBBY: DNB Bank (Norway) – 29 / 9.9 / 1.17 / 5.6%
SVNLY: Svenska Handelsbanken (Sweden) – 16 / 7.4 / 0.89 / 6.8%

Other notables
UBS: UBS Group (Switzerland) – 55 / 7.0 / 0.97 / 1.6%
ING: ING Group (Netherlands) – 32 / 7.8 / 0.62 / 4.0%

Note that all of the institutions above have international operations and hence they are not entirely exposed to the risks of their domestic markets.

Let’s compare this to Canada (market cap is in billions of USD):

Canada
RY: Royal Bank: 130 / 10.8 / 1.8 / 4.2%
TD: Toronto Dominion: 118 / 10.7 / 1.6 / 4.2%
BMO: Bank of Montreal: 63 / 7.3 / 1.7 / 4.6%
BNS: Bank of Nova Scotia: 65 / 8.7 / 1.3 / 5.8%
CM: Canadian Imperial Bank of Commerce: 43 / 9.4 / 1.3 / 5.4%

One immediate observation is that Canadian banks have much larger market capitalization than their European counterparts. Indeed, looking at the global picture, the USA and China have the largest banks by market capitalization, while the largest European one is BNP, very much behind in the standings.

Needless to say, some of these European bank valuations look compelling at a glance. However, to do the proper analysis of these large (and for the most part, incredibly opaque) institutions, one has to have a grasp on whether their loan portfolios will actually perform and to get a sense of where the geopolitical risks lie. But overall, Europe is trading like a disaster at the moment for obvious reasons (they are a slow-moving financial train wreck happening at the present time) – if, for whatever reason, it is better than a disaster, there perhaps may be some gains to be had in the future from the current depressed levels.

Unfortunately I am not skilled enough to make a nuanced differentiated bet on any specific company above – there are tons of analysts working in the usual institutions that are properly able to gain an edge on which of the above will do better than the rest, but my suspicion is that at some point, an unsophisticated player like myself can probably generate some alpha by constructing an equal-weighted ETF of some of the components above.

I do think I have a better “home field advantage” with the Canadian banks above, but that home field advantage tells me to back off for better values in the future. As far as Europe goes, however, the time is likely closer to a reasonable value bet.

That said, you may wish to disregard anything I say on international bank stocks simply because it does not look like that my investment in Sberbank (a couple days before the sanctions hit) will be materializing anytime soon – my largest one-shot loss in my investing history, assuming it goes to zero (which it effectively is at the moment for non-Russian investors).