Tuesday, March 28, 2017 0 comments ++[ CLICK TO COMMENT ]++

Canadian Real Estate Lender, Home Capital Group, Terminates CEO

Not sure if this an isolated event or a symptom of a possible Canadian housing bubble, but Home Capital Group (TSX: HCG), just terminated its CEO. I don't follow Canadian financials so not sure but I think HCG may be the largest alternative real estate lender in Canada. CBC News reports (Mar 28 2017):

Home Capital announced Monday after stock markets had closed that that Martin Reid, its president and CEO, was out, effective immediately.

Investors responded by sending shares of Home Capital down $2.66 to finish at $25.06 on the TSX.

Reid has been replaced by Bonita Then, a member of Home Capital's board of directors, until a new permanent CEO can be hired.

"Home Capital requires leadership that can bring to bear a renewed operational discipline, emphasis on risk management and controls, and focus on improving performance," said Kevin P.D. Smith, the chair of company's board, in a statement.

In February, Home Capital said it had received an enforcement notice from the Ontario Securities Commission related to its disclosure in 2014 and 2015 about the impact of the company's findings that income information submitted on some loan applications had been falsified, and its subsequent move to suspend some brokers and brokerages.

The company said in February that the OSC issued a preliminary conclusion that Home Capital. failed to meet its continuous disclosure obligations during that period in 2014 and 2015. Home Capital has said it believes its disclosure met requirements.

Home Capital also announced on March 14 that several company officers and directors had also received enforcement notices from the OSC.
HCG has been under attack by short-sellers for a few years now but as someone living in Canada, it's not entirely clear what is going on with real estate.

Canadian residential real estate--not sure about commercial real estate but might be worth looking into that if you are thinking of shorting (likely easier and less costly short for small investors)--looks like a blatant bubble if you look at traditional metrics like price vs rent, price vs household income, average mortgage duration (to pay off mortgage), etc. The numbers make little sense if you look at income or any sort of serviceability metric.

But a lot of the prevalent causes of the American real estate bubble a decade ago (or some of the other ones in Europe) don't appear to be present in Canada. Part of the reason is that everyone (particularly lenders and investors) has learned from the financial crisis and watch for those signs. In other cases, due to the structure in Canada, the same thing doesn't apply. For instance, secrutization was never big in Canada. You also don't have a multitude of lenders/mortgage insurers/etc that was common in USA (partly because Canadian banking is an oligopoly and difficult for smaller/new lenders to survive).

Market is likely pricing in a lot of the negativity surrounding HCG. It is trading close to book value (versus big banks at multiples of book) and P/E is something like 7 if I remember. But then again a lot of the crisis-stricken firms during the financial crisis trading at low valuations as well (the most notable in my eyes was the homebuilders who were trading at really low valuations). One big red flag I see is that the CEO has apparently been in the role for less than an year (although he was president for many years) and the board references "risk management" which is a big concern given how leveraged financials are.

Remains to be seen if the issues faced by HCG are something isolated to the company or a harbinger of something bigger...

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Monday, March 27, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sold: BCE (via MBT merger)

BCE (TSX: BCE) buyout of Manitoba Telecom Services (TSX: MBT) was successfully completed. I ended up with a return of about 1.8%, which is satisfactory.

The best case outcome (if payment was 100% cash) of about 2.1% didn't materialize; instead, I ended up with a mix of cash and stock (original expectation was 0.7% but BCE shares rose (and I didn't hedge) so I gained about a percent from it).

I wouldn't entertain these situations in the past but my portfolio is a little bit larger and transaction costs have come down a lot in a decade, so it is worthwhile for the time being.

Sold: $59.06

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Is the Market Overvalued?

We are in a very unusual time in my opinion. Presently valuations are high--whether you look at P/E (or the inverse, earnings yield), P/Sales, stock market valuation to GDP, Q ratio, or whatever else you want to use--but many argue it is not a bubble.

Generally, the majority can make seemingly plausible arguments for high valuations during the bubble (otherwise you wouldn't end up in a bubble in the first place) so the fact that consensus says there is no bubble doesn't mean much. However, what is different right now, is that the contrarians and those that believe we are in a bubble, can't seem to make a strong case. I think the reason is due to there being no psychological or behavioural elements that are driving the bubble--the mania is missing.

I think what is happening is that the mania is not in stocks but in bonds. The bond market, which is larger than the stock market, has a big bubble. Investors are literally buying bonds without any regard for yield, with big chunks of capital being deployed at less than 2% yields (including some very close to negative yield). Long-term inflation in USA is around 3% so you are essentially look at a loss in real terms. Basically, the mania is in bonds.

The bond mania is impacting stocks hence it is not directly observable in the stock market. That's my view right now.

In any case, if you are a contrarian or macro-oriented, you might want to check out this piece by James Montier of GMO, "Six Impossible Things Before Breakfast" (Mar 2017) [main page link]. Montier is in the minority and doesn't share the general consensus (i.e. enthusiasm for stocks). He goes over 6 things he feels investors are assuming that are likely false. I don't necessarily agree with everything he says--is secular stagnation really due to policy?--but do share his overall stance. I'll just list the 6 items he addresses and leave it up to you to read the piece if you are interested.

In order to make sense of today’s pricing, you need to believe in six impossible (okay, I’ll admit some of them are just very improbable as opposed to impossible) things.

1. Secular stagnation is permanent and rates will stay low forever. As we have argued at length elsewhere, secular stagnation is a policy choice and we could exit it reasonably quickly by implementing appropriate policies.

2. The discount rate for equities depends on cash rates. This is nothing more than a belief. It has no foundation in data and not a scrap of evidence exists that supports this hypothesis.

3. Growth rates and discount rates are independent. This is a very questionable assumption. If, as I believe, it is false, then it makes the “Hell” outcome Ben has discussed in previous Quarterly Letters less likely, unless the first two beliefs hold completely.

4. Corporates carry out buybacks ad nauseum, raising EPS growth despite low economic growth. This would imply rising leverage, which is already close to all-time highs. Remember Minsky: Stability begets instability.

5. Corporate cash piles make the world a safer place. Cash levels aren’t high by historic standards, and valuations are extreme even when cash is fully accounted for.

6. The “Hell” scenario is the most probable outcome. This requires “this time is different” to be true and, unlike Jeremy Grantham, I am not yet ready to assign this exceptionally useful rule of thumb to the waste bin of history. Put another way, Hell requires that stock prices have reached a “permanently high plateau,” and I’m not about to embrace that statement.

Sunday, March 26, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXIX

Plastics & Pollution

A new environmental scourage created over the last 50 years has arisen due to the invention of plastics. Very useful and unique but plastics don't degrade in nature very easily. Unfortunately, they are starting to pollute the oceans on a large scale...

source: "The World's Oceans Are Infested With Plastic" (Niall McCarthy, Statista.com, Mar 22, 2017)

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Saturday, March 25, 2017 0 comments ++[ CLICK TO COMMENT ]++

The Thing About Healthcare...

Adam Davidson of The New Yorker had a good opinion piece about why healthcare is so important and unlike anything else and I thought I would highlight some of his points here. I struggle with healthcare spending and government policy because, on the one hand, healthcare is spiraling out of control and growing way beyond inflation or economic growth (not just in USA but in Canada and most of the developed world actually); but on the other hand, it is so important that as Davidson alludes to below, it should really be thought of more as an investment in the long-run future of the country rather than an expenditure per se.

Titled "What the G.O.P. Doesn't Get about Who Pays for Healthcare" (Mar 23 2017) and directly addressing the Republican Party in USA, Adam Davidson writes (as usual, bolds are by me):

In economics, when a person has some money, they can do one of two things: invest it or use it to buy something they want to consume. Most of the time, they consume. That can mean buying a slice of pizza, or “consuming” a vacation, a movie, or a new car. Health care is typically classified as a form of consumption. But if my relative spent some of his money with a back-pain specialist, who could teach him exercises that would prolong his working life by another decade, shouldn’t that be considered an investment? He would be choosing to forego paying for something that he actually wants today so that he can make more money in the future.
This is a very important point that is largely ignored in all the arguments and shouting matches: a big chunk of healthcare spending actually contributes to the economy in the long run. It's not like discretionary consumption spending whose benefits are very temporary.
In 1993, the economic historian Robert Fogel wrote an influential paper (it was his Nobel Prize acceptance speech) in which he demonstrated that improvements in health accounted for fully half of the economic growth in the United Kingdom in the first two centuries of the industrial revolution. Because of improvements in sanitation, food production, and medical treatment, people were living longer and spending much less time incapacitated by illness and hunger. Health was more important than railroads, electricity, mass production, and every other technology we more readily associate with economic success.
Wow! Until reading this, I never knew that half of the benefit of the industrial revolution was healthcare-related. It sort of makes sense when one thinks about it but it's still not well appreciated. I think things like railroads and mass production probably contributed to the improvement in healthcare (it's hard to isolate causes and effects of specific technologies and scientific advances) but, nevertheless, the main point that improvement in, say, sanitation, contributed mightily to the improvement in society is widely ignored.
If we deny someone care today, we will be paying that cost later, in the form of more expensive treatment or lost years of productive employment.
I think people who try to reform healthcare, often by blindly cutting costs, are completely ignorant of the point above. Namely, long-term productivity is sacrificed and completely ignored.

Having said all that, I think healthcare costs are spiraling out of control and need to be reigned in--this goes for Canada too even though no one is complaining yet (my province, Ontario, spends about 40% of its budget on healthcare, whereas 30 years ago, most of that was spent on building roads, airports, electricity grid, etc--no wonder there is no money for that now). However, I think anyone trying to reform healthcare shouldn't focus blindly on costs. Cutting healthcare has adverse long-term outcomes.

I think the reformers and politicians need to separate out the healthcare costs that prolong people's lives past 70 years (or whatever number you want to pick). This isn't going to be popular with Baby Boomers but the reality is that such healthcare spending has low (to almost zero) long-term societal benefits. I think people should try to cut those costs. Unfortunately that's not going to happen any time soon since the Baby Boomers control most of the voting power in most developed countries.

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Thursday, March 23, 2017 0 comments ++[ CLICK TO COMMENT ]++

The Bizarre Case of Sears Holdings

Concerns that Sears (SHLD) is headed toward bankruptcy have been reignited. The company's shares closed Wednesday down more than 12 percent, falling below $8, after the struggling department store expressed doubt about its future as a retailer. "Our historical operating results indicate substantial doubt exists related to the company's ability to continue as a going concern," Sears said in an annual filing with the Securities and Exchange Commission. (source: "Sears tells investors nothing's changed, despite 'going concern' statement," Krystina Gustafson, CNBC, Mar 22 2017)
Headed for bankruptcy, right? Yet...
Hopes raised by a chairman’s letter on future strategy March 9 were crushed Wednesday when Sears Holdings listed a “going concern” statement in its annual report. The same day, Bruce Berkowitz increased his position in the dying retailer 2.05% in his third purchase of the month. (source: "Bruce Berkowitz Buys More Shares of Sears," Holly LaFon, GuruFocus, Mar 23 2017)

An insider, who owns about 26% of the shares and also owns some loans(?)/debt, adds more common shares*.

Not just that, it is one of the best investors over the last few decades**.

And, he happens to be a value investor***.

I have been thinking about this a lot lately...

Are we looking at a Bill Miller buying Bear Stearns in 2008 (or me buying Ambac)? Or is this one of the rare buying opportunities of our lifetime--Berkowitz used those same words to justify his Sears purchase a few years ago with disastrous outcome?

* Given the precarious situation Sears is in, and the somewhat low prices the bonds are trading at, he could have just bought those (which are trading way below par and will likely earn at least 15% annualized return for the next 10 years if the company doesn't go bankrupt).

** I'm not a huge fan of Bruce Berkowitz--quite frankly, I don't understand his thinking and strategies, from the more recent Fannie/Freddie preferreds to the older bets on St. Joe, and yes, Sears--but he still has one of the best records of any public investor and I admire him as a master contrarian.

*** If this were a different type of investor, say a short-term trader, quant investor, special situation investor, and so forth, it may not signal much. Even with most hedge fund investors, it may not mean much (since they could be hedging or something). But mutual fund value investors tend to buy undervalued stocks so it means a lot.

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