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Reid has been replaced by Bonita Then, a member of Home Capital's board of directors, until a new permanent CEO can be hired.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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Don't Blindly Accept SEC Filings

Matt Levine of Bloomberg highlights how anyone can file anything on EDGAR, the SEC online report dissemination system (same thing probably can happen in other countries as well?). The person may still be criminally liable depending on what they file but that is after-the-fact, so one shouldn't blindly accept regulatory filings:

The Securities and Exchange Commission's Edgar system for making securities filings is notoriously prone to hacking. "Hacking" maybe isn't the word; it's very low-tech. You submit an application to the SEC, have a notary stamp it, and get back your Edgar ID. Then you can just make whatever filings you want on Edgar. Want to say that you just bought Facebook Inc.? Sure, whatever, go right ahead, knock yourself out. Want to buy stock in a smallish public company, make an Edgar filing claiming that it's being taken over, and then sell your stock on the reaction to the fake news? Yeah that can sometimes work, though not as well as you'd hope
Anyway here's a funny story about a guy who said on Edgar that he had sold his art company to Alphabet Inc. for $3.6 trillion of Alphabet stock. He doesn't seem to have made any money off the fake filing; he just did it for fun, or for art. I don't mind that so much.
Yes, you can literally file anything, including this guy who claimed he is the richest man on earth ;) That was a joke but some people do try to manipulate it for personal gain, which is generally illegal (depending on what they do). Worth checking out the main Bloomberg story.

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Sunday, March 19, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXVIII

2008 Redux:
Mitsubishi UFJ's $9 Billion Cheque to
Save Morgan Stanley

From Andrew Ross Sorkin:
As detailed in Too Big to Fail: How Wall Street and Washington Fought to Save the Financial System — and Themselves, Morgan Stanley received a $9 billion investment from Mitsubishi UFJ in the fall of 2008 that kept the firm from collapsing. The payment was supposed to be wired electronically, but because it needed to be made on an emergency basis on a holiday, Mitsubishi cut a physical check, perhaps the largest ever written. Below is a copy of the $9,000,000,000.00 check.  

Great book by the way--Too Big to Fail. One of the best ones on the Financial Crisis. There is a lot of whitewashing--particularly Henry Paulson's actions during the crisis; and the whole George Bush administration, Ben Bernanke and some of the incompetent bank executives' actions before the crisis--but all the inside details makes up for the book's shortcomings.

Sunday, March 12, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXVII

Charging Bull was controversial and this Fearless Girl statue is bound to be as well...

Sunday, March 5, 2017 2 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXVI

Value of US Residential Real Estate & Rent

Not entirely sure how accurate the figures are but, based on computations by Zillow, Reuters reports that the total value of US residential real estate is around $29.6 trillion. Total rent paid is around $478.5 billion. The rental yield is only like 1.6% -- does that seem right? Anyway, here is the data.

(source: "Data Dive: What $30 trillion will get you," Beth Pinsker, Reuters, January 5, 2017)

Saturday, March 4, 2017 0 comments ++[ CLICK TO COMMENT ]++

Articles for Week Ending March 4, 2017

Various articles I encountered over the last few months that you may find interesting...

  • (Recommended) "When Bankers Started Playing With Other People's Money" by William D. Cohan (The Atlantic, Feb 28 2017) --  (Except from Why Wall Street Matters by William D. Cohan) : When Wall Street investment banks became public: "On April 10, 1970, nearly a year after first filing its IPO prospectus with the SEC, DLJ pulled it off, raising $12 million from the public and as a result fundamentally altering how Wall Street has functioned ever since. “Going public changed Wall Street permanently and forever,” Richard Jenrette (the J in DLJ) told the Times. “If Wall Street had remained in a private mode, it would have acted like a club and been so vastly undercapitalized that someone would have taken it over long ago. There would have been no alternative but to have let the [commercial] banks take over”—something that the Glass-Steagall law, of course, had made illegal."
  • "Toshiba’s Nuclear Reactor Mess Winds Back to a Louisiana Swamp" (Jason Clenfield and Yuji Nakamura, Bloomberg, February 12, 2017) & "How Toshiba Lost $6 Billion" (Jason Clenfield , Yuji Nakamura , Takashi Amano , Pavel Alpeyev , and Stephen Stapczynski, BloombergBusinessWeek, ‎February‎ ‎17‎, ‎2017‎) : Talk about total management incompetence. How could you buy a company and declare billions in losses within an year? Now you end up selling your crow jewels--a lucrative memory chip division--just to keep afloat.
  • On Amazon Echo - "Short Cuts" (John Lancaster, London Review of Books, February 2, 2017, Vol. 39 No. 3): Voice could revolutionize computing, especially when partnered with advanced AI. Not sure how close we are to it.
  • "Retail Has Good Reason to Hate a Border Tax" (Shelly Banjo, Bloomberg, Feb 16 2017): Good article showing how free trade can benefit nations. USA lost its clothing manufacturing capability but offshoring has essentially resulted in clothing prices staying flat (to slightly declining) over 25+ years. Believe it or not, USA has the cheapest clothing (adjusted for purchasing power) than any other country. Workers in manufacturing lost their jobs but I would argue that the country as a whole benefitted even more.
  • "Volatility Trades and Explosive Shorts" (Matt Levine, Bloomberg, Feb 10 2017): Talk about total incompetence -- some dude was trying to profit by bombing retailer, Target, and then buying its stock. LOL. Not only is it a criminal action for very little profit--good things most criminals are dumb or else the world would be worse--it isn't even the proper way to profit from declining prices ;)
  • (Highly Recommended) "Dole Food Had Too Many Shares" (Matt Levine, Bloomberg, Feb 17, 2017): Another great article by Matt Levine. Even if you don't care about mergers or Dole Foods or pineapples--yes I realize this story probably won't help you become a better investor--the article provides a good explanation of how share ownership recordkeeping works.
  • "Number of distressed U.S. retailers at highest level since Great Recession" (Ciara Linnane, Marketwatch, Feb 27 2017): I feel retail is outside my circle of competence but occasionally I do get attracted. I doubt retail is being hurt by online as many assume (online share is still kind of low) and wonder if it is due to a possible long-term secular decline in consumption (American consumers can't continue to spend more than they earn, with debt making up the difference, and wonder if we are seeing a change in trend).
  • (Recommended) "Is the Chicken Industry Rigged?" (Christopher Leonard, BloombergBusinessWeek, February 15, 2017): Apparently Geoff Gannon's favourite business article over the last year or so. Can't go wrong reading anything he recommends. Article delves into the competitive pricing of chickens. Lots of photos of chickens for chicken fans ;)
  • Transcript of Warren Buffett Feb 27 2017 CNBC Interview (CNBC, Feb 27 2017): Current thoughts from Buffett on Apple (thinks it is a sticky consumer product), why they don't like to go over 10% holding (never knew of short-swing rule until now), market valuations (thinks equities attractive if rates don't move up materially), border adjustment tax (not in favour and says it is just a sales tax that will impact average consumer), tax reform (doesn't think anything complex can be implemented quickly), 3G capital (thinks they are the best he has seen in a boardroom), self-driving cars (negative for auto insurers but thinks it will take a long time and doesn't think even 10% of cars will be self-driving in 10 years), Amazon (admires Jeff Bezos but retailing is tough to figure out--gives good history of it), Wells Fargo scandal (incentive system may have been an issue but real problem was not attacking the issue when it first came up; says of any problem, "get it right, get it fast, get it out, get it over"), investment climate (thinks it is much harder than past and only a few will succeed but can post good returns with small amounts of capital)
  • (Highly Recommended) "Financiers Fight Over the American Dream" (Sheelah Kolhatkar, The New Yorker, March 6, 2017 issue): Very good long-form journalism on William Ackman's battle with Herbalife. I have no idea what the truth is but the story provides a look behind the scenes, which can provide important lessons for investors.
  • (Recommended) "Buying a Good Business in a Bad Industry" (Geoff Gannon, GuruFocus, Feb 20, 2017) & "What's a No Growth Business Worth?" (Geoff Gannon, GuruFocus, Mar 6, 2012): Kind of scary and not sure if I'm making a mistake but I have been researching a few declining industries recently. So I have been reading some present and historical articles by Geoff Gannon, whom I consider the top freely accessible investment writer. I love reading Gannon's thoughts since he is very closely aligned with what is ideal for small, amateur, investors. I am presently thinking hard about the radio broadcasting industry and office products retailer, Staples (SPLS). Both are declining and in trouble but are they worth it if they drop a bit more? I also started doing some preliminary research on one of the stocks Gannon mentioned, Western Union (WU), which may sell off if Trump administration cracks down on Mexican migrant money transfers.

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