When There’s Lemons …

This week’s missive will get back to some of the basic block and tackling we face at times as investors.  Not to downplay the market madness, it seems everyone and their brother now has a view on the pandemic. Certainly not immune to the downdraft, in hindsight my decision to sell my taxable Canadian stocks on February 28th makes me look like a genius.  The reality is essentially sheer dumb luck. It did, however, provide the cash to nibble on subsequent down days.

The Canadian IRA Taxability Answer

I did receive my first dividend from TMX Group a couple of weeks ago and to my chagrin saw Canadian tax withheld even though it’s in my IRA.  Obviously one of the outliers I previously referenced. While my appeal failed, my broker did confirm two of my companies reside in this category, the other being Hydro One.   I did gain some insight which I figured I’d share.  

  1. To be processed as compliant with the tax treaty, companies have to use the DTC – which comes with a cost.  Most Canadian companies trading in the US absorb this fee as a cost of doing business.
  2. Canada has their own version of the DTC – CDS which is owned by none other than the TMX group, which uses (at least for US based stockholders) Citi for disbursement without treaty compliance review.
  3. Brokers have no recourse but to withhold Canadian taxes in IRAs for CDS processed dividends.  Meaning there is no tax benefit for US citizens holding non-DTC processed securities.

These two will be sold from the IRA when the markets recover a little.  Meanwhile both are also held in my taxable account where I can claim a tax deduction when taxes are filed.

De-risking Process

With the heightened level of uncertainty, more than a few bloggers have shared their approach towards increased safety.  Dividend Diplomats ran a piece on Debt to Equity Ratios and Chuck Carnavale reviewed a Debt to Capital analysis. While both metrics are fundamentally sound – and I’ll likely add to existing holdings that are on these lists – both share a flaw that is highlighted by the current black swan event.  Companies in unprecedented numbers are drawing down their credit lines or issuing new paper, both of which have an impact on the ratios. I mean, is Disney any less of an investment with $6B additional debt offset by $6B cash? Other than a slight increase in carrying expense, I would argue no but they do have other issues with the magnitude currently unknown.  My take is this is where the ratings agencies theoretically should be earning their keep.

My process is to essentially begin the process of reducing the speculative portion of the portfolio.  Eliminating my one BDC (MAIN – smaller business exposure), Entertainment Properties (high social distance exposure), Newell (a recipient of an SEC subpoena).  This is one time a dividend cut or suspension doesn’t necessarily mean a sell if the purpose is cash preservation. I did reduce – but not fully sell – Cracker Barrel on their delay and suspension.

Additionally, I keep abreast of the news to identify potential opportunities.  You’ve heard the mantra, Don’t Fight The Fed?  How about profiting from the economic stimulus they’re embarking on?  Blackrock is a (partial) proxy for this angle. I say partial as I doubt the fees will generate a meaningful profit to them.

In Parting

As no one knows when and how this will end and I doubt I have the time on my side to play the long game, the better part of valor is to strengthen the hand I have.  Someone younger can carry more risk but caution is warranted in my opinion. Either way, try to make some lemonade from these lemons.

Oh, Hell

the U.S. could see a 20% unemployment rate if the coronavirus pandemic is not properly dealt with.

reportedly, Treasury Secretary Steven Mnuchin, March 17, 2020

Perhaps it was hyperbole in performing some old-fashioned arm twisting with GOP senators, but it sure was a market mover with the DOW dropping 6.73% the following day. It was down 1,000 points when the double whammy hit:

Hell is coming.

Bill Ackman, CNBC interview March 18, 2020

Bill’s context was in urging companies to conserve cash by pausing buybacks, the warning was apparently heard as the markets promptly dropped further, triggering a circuit breaker. Fast forward two days …

Hell is here.

Robert Herjavec, CNBC interview March 20, 2020

The difference obviously being big companies versus small. Then there are the minis. The mom and pop shops – sole proprietors. The ones that operate on a shoestring budget to begin with.

Assuming Mnuchin is the face of the organization – at least in regards to negotiations with Congress – it would appear to be a tacit acknowledgement that the president has been blowing smoke – albeit perhaps for tactical reasons. Realizing a 20% unemployment rate is not a foregone conclusion, as this is a level not seen since the Great Depression, I doubt many investors have come to grips with the current bear market. Time In The Market recently published a view that is rational and insightful.

Yet, if we are on the verge of Hell, it may be useful to understand some of the conditions present when it last arrived:

  • Unequal distribution of wealth
  • High Tariffs
  • Slowing Economy
  • Market Speculation (notably margin use)

While similarities exist, differences include Federal deficit spending and an external catalyst (rather than implosion).

What is stunning is the general lack of foresight now on display. Granted, some industries (airlines) had any contingency plans blown away with various governments forcing their hands. The line being formed by corporations and trade associations less than a month into the crisis is downright obscene. Some requests on behalf of workers are understandable, but it is becoming increasingly apparent that the Trump corporate tax cuts did little to shore up the vitality (or viability) of many companies. At the very least, retained earnings (in theory) should sustain companies for longer periods. History may reflect that this opportunity squandered was a result of greed.

There are some foundational cracks forming as well. Ronin LLC, a clearing firm was dissolved last week and some banks acted to shore up money market funds after significant outflows.

It will be one thing to pass a relief bill. As always, the devil is in the details – specifically the delivery mechanisms. Various ideas have been floated – using existing SBA, ADP, PAYX or US Treasury infrastructure but each has inherent flaws. Meanwhile of the small businesses I’m familiar with; a pizza parlor is now delivery only, an after market auto custom shop is sidelined pending a restart of production lines, and another is working through order backlogs. One – a caterer – has evolved from banquets and corporate events to Non-contact Delivery Foodservice. Various approaches from hunkering down to minimizing losses to retooling the business model. Whether Hell is coming or here already, at least ingenuity remains in full swing!

The Bull Is Dead

Another brutal week in the markets at large as the long running bull market officially died.  It is perhaps fitting it came to an end under the watch of the only president that I can recall that used the stock market as a barometer of his economic prowess.  Perhaps had his team treated the outbreak seriously a little sooner he could have been viewed as managing the outbreak’s severity on the economy as opposed to now being managed by the situation.

The world as we knew it has – at least temporarily – come to an end.  Sports, leisure activities, schools and large gatherings are suspended and working from home is back in vogue.  While the House passed a bill for an initial stop gap measure, Trump finally did declare a national emergency – perhaps bruised by the bad press.  Not helping matters was the meme tweeted by his own staff.

The pace of news related to local and corporate responses to the virus  has been fast moving, one example being the NCAA tournament being changed to an event without fans to outright cancellation.  My initial thought for this week’s topic was how the economic impact of this one event’s lack of fans would impact local economies.  Scratch that research line – but I will share that the play-in game had an average impact to the Dayton economy of roughly $4.7 million, including ticket sales, lodging, restaurants and air travel.  Concession sales benefited Pepsi (PEP), Kroger (KR) and Anheuser-Busch (BUD) as well as a local charity. Airlines serving Dayton are Allegiant Air (ALGT), American (AA), Delta (DAL) and United (UAL).  Arena sponsors (priceless advertising) include Fifth Third Bank (FITB) and Cincinnati Bell (CBB).  Extrapolate that across the other thirteen, larger, multi-day sites and the picture becomes uglier.  Extrapolate further across the overall US economy and all of the events, services and venues potentially impacted and one can easily see why recession worries are on the rise.

One aspect I find troubling in this evolving situation is the confirmation by Treasury Secretary Steven Mnuchin that the administration was considering emergency assistance for affected industries. “This is not a bailout. This is considering providing certain things for certain industries. Airlines, hotels, cruise lines”.  Ignoring the semantics over the ‘bailout’ definition, airlines are perhaps understandable. Hotels, less so due to their existing leverage. But taxpayer money going to cruise lines? Methinks the administration has yet another unforced error looming on the horizon.  

Consider the optics:Royal Caribbean (RCL), Norwegian (NCLH) and MSC are incorporated in Liberia, Bermuda and Switzerland respectively, making them foriegn companies.  Even Carnival (CCL) is not immune having a dual US and UK corporate structure. Adding insult to injury: Only one ship (Norwegian’s MS Pride of America) is US flagged.  All others are flagged Bahamas, Panama or Malta.  While the Jones Act can be cited as the cause – thereby itself needing revisions, my belief, perhaps unfounded, is that these companies use this as an excuse to lawfully circumvent US Labor laws.  Cha-ching!

Another item easily overlooked last week was the Fed’s injection of liquidity into the system.  The rumor mill has been working overtime on this one but the general consensus is that hedge funds and private equity firms have been urging their portfolio companies to draw down their lines of credit – proving once again that cash is king especially in uncertain times.  In the event that the epidemic is little more than an economic blip, this could be considered prudent – essentially, no harm, no foul while generating some income for the banks. The problem I see is if the perception of a bungled operation is allowed to become a reality resulting in greater harm to the economy.

The general investing blogging community has finally awakened to the fact that there’s more than just noise as I’m seeing more posts on the Coronavirus topic.  Other than the drop in portfolio value all else is normal on this front. The dividends keep coming. Overall they are growing with only one cut to report. I was watching with unusual attention the results from my two Hong Kong companies as the virus is literally on their doorstep.  Both cited Coronavirus and the protests as headwinds being dealt with. One (Swire Pacific – SWRAY) maintained last year’s dividend rate while the other (MTR Corp – MTCPY) surprised me with a 2.5% increase. The common denominator being both had retained earnings and lines of credit as a backstop.  Over the next quarter, I believe the number of US companies drawing down their LOCs could be a leading indicator of the direction that this is going, i.e., is the worst behind us or yet to come? Meanwhile, I am selectively averaging down – last week was Australia’s Computershare (CMSQY) and Canada’s Toronto-Dominion Bank (TD).

As always, thoughts/comments are welcome!

The Ongoing Virus Saga

In the markets this week, concerns over Coronavirus continued to be front and center. Not surprisingly caution (finally) took hold amid varying views on the longevity and severity of the impact, including reports of cases in South Korea and Iran.  In a counter programming attempt, the White House, through Larry Kudlow, indicated it was “not an American story” subsequent to the Saint Louis Fed comments stating there is a “high probability” that the outbreak will be a temporary shock.  While it’s become commonplace for the government to talk from both sides of its mouth, the issues I find in the actual data indicate caution is warranted.  

While the slowing manufacturing output is likely a result of supplier delays with the virus, more concerning to me is that for the first time in the Trump presidency the key economic driver of the US economy – the services sector – fell into contraction territory, albeit fractionally.  For good measure, don’t ignore the corporate warnings due to the virus led by the likes of Apple. One contrarian surprise being Caterpillar – although this could be strictly relief that the perceived end of the trade war is nigh.

Complicating any analysis is oil pricing and whether any strength is the result of production cuts, increased demand or refinery maintenance – or some combination.  There remains an ongoing debate among traders as to whether the market is tilting bullish or bearish. So no raging indicators one way or the other are visible.

Reinforcing my concerns are two measures being implemented by China.  The first subsidized loans to key companies that are helping prevent and fight the epidemic.  These rates are as low as 1.32% of which foreign companies, such as 3M are eligible. The second could be the shock that does make this an American story.  China has issued more than 1,600 force majeure certificates to shield companies from legal damages arising from the coronavirus outbreak. The riddle then potentially becomes, “When is a contract not a contract …?”  Keep in mind that next week’s economic data is mostly pre-virus.

In the midst of tax season the initial results look promising.  As many remember, I groused last year (quite a bit) over Trump’s tax cuts actually being an increase.  We decided to accelerate taxable RMDs in 2018 to lower our 2019 tax bracket. To ensure my calculations were correct, I did not modify any withholding rates.  The strategy worked as a refund for 2019 is forthcoming. I’m still a few weeks away from reporting my final tax percentage rate but do know it’s lower year on year.  And yes – unlike candidate Bloomberg I can and do use Turbo Tax, a product of Intuit which is one of my portfolio companies. I did have to smile from the priceless, national advertising they received.

Another element of my consolidation strategy is taking form.  I have decided to eliminate ETFs from the equation. Although there are things to like about them, the downside (for me) is fluctuating payout rates with regression to the mean, partly a result of changes to the underlying components.  Basically, I see minimal upside potential while conceding there is associated risk mitigation I’m giving up. The upside (hopefully) is a slightly higher return in pure equities. I expect to be fully divested by mid-year distributions.

Here’s hoping February is shaping up as a good month for us all!

Dazed and Confused

Which is my state of mind this week. For the most part earnings reports arrived with a caveat – Coronavirus impact to arrive at a future point in time. And the markets generally rose as the can got kicked down the road. So I too moved on to more mundane matters, like:

This is So Wrong!

There comes a time when ones’ sanity is legitimately questioned.  Such a time occurred this past week when reading what I thought was a recent post by the Conservative Income Investor.  Note the publish date of February 3. 2020. While reading this I felt a little like Bill Murray in Groundhog Day while saying over and over this is so wrong.  The root of my disagreement was the section: It pays no dividend. It does one thing especially well: Compound the retained profits, which in this case is all of the profits because the company pays no dividend, at a rate of 15% per year. Over the past ten years, the profits compounded at a rate of 18% per year. The book value has grown by 21% annually.  I mean are we talking about the same SF I added to my portfolio in 2018?  The one that raised this non-dividend by 25% last year? Determined to correct this egregious oversight, I found myself stymied by the inability to leave a comment – which was deactivated.  Perplexed, it was only then I found the small print, “Originally posted 2015-02-26 21:35:26”.  Fact of the matter is they initiated a modern day dividend policy September 15, 2017 – subsequent to the original post.  Fact of the matter is Conservative Income Investor regurgitated the original without regard to updating an environment that changed, leaving me – and who knows how many other readers (if knowledgeable) – in a Twilight Zone scenario.

Up, Up and Away …

The meteoric performance of Tesla has to leave one scratching their heads a little.  Granted, it has finally started to perform as a company rather than a performer in Elon’s three ring circus and recent China results have been favorable – pre Coronavirus.  My assumption had been a significant portion of the rise was a result of a short squeeze as it was one of the most shorted stocks. But this may not be the case as a convergence of factors could be at play.  Like their fourth quarter profit – although largely overlooked is the reason (sale of $133 million worth of regulatory credits to other automakers). It is possible that the corner has been turned though. Then there’s the rise of ESG which you know has become mainstream when Blackrock’s on board.  Perhaps it’s an old-fashioned bubble as millennials flocked to the stock on the SoFi platform. I guess Warren Buffett’s advice is best followed here … “Never invest in a business you cannot understand.”  In this case, I don’t understand the fundamentals at play.

Rounding Down?

I did confirm something I had long suspected.  It is the rare occurrence that I hold the same issue in different accounts but the move of my Canadian stocks from my taxable account to my IRA temporarily accomplished that for at least one dividend payment:

Toronto-Dominion Bank (TD)
    Schwab – $0.56 (USD)
    Motif – $0.5534 (USD)

Now the reasons could legitimately be either 1) Rounding on the exchange rate, 2) Rounding on the applied payment, 3) FX rate when applied, rounding on the handoff between platforms (BK/Motif) or 5) a combination thereof.  

It’s not worth my time to figure out why as I realize the differences are minimal.  But extrapolating a little, these fractional cents on 100 shares would result in an annual difference of $2.64 (assuming a constant exchange rate) which will go into my pocket once the conversion is complete.  Just another little tidbit to assist in keeping the snowball rolling!

Note: This anomaly has only been identified with foreign issues, not domestic

Conundrum of the Week

Last, a side note on ESG investing.  On my to-do list is to develop a framework or mission statement on my strategy.  This is difficult at best on both the macro and micro levels. Will it be a hard core approach or more a negative screening?  Will it acknowledge incremental improvement or pursue a scorched earth policy? Will it recognize that some suspect companies do not profit directly from the market unless possibly through a secondary offering?  Can one be both a contributor and a destroyer?

I present these questions as food for thought as the answers become increasingly murkier as the popularity of ESG increases.

And here’s to your week ahead!

Last Week in the Rear View

IMF growth forecasts for 2020 were released this week and were inclusive of the “momentous” and “remarkable” Phase 1 trade deal between the US and China.  It would appear the critics of the deal win the first round as China’s growth forecast for 2020 was revised higher by 0.2 percentage points to 6%, while that of the U.S. was marked down by 0.1 percentage points to 2.0%.  While I’m sure the diehard Trump supporters will discard this report as another in a long line of “deep state conspiracies”, one opinion worth reading is how China is retooling – whereas where are we? My thinking is the trade deal is at best a Pyrrhic victory for the US – tempered by a possible coronavirus black swan.

In a similar vein, is a recession in store for the trucking industry?  That is perhaps the implication of the 2H 2019 data. Trucking, shipping and freight are indicators I tend to keep an eye on and one possibility is recession – which I discount.  In my view, this slowdown is a return to normalization – coming off the sugar highs of the tax plan of 2017 followed by the tariff front loading of 2018. Others to watch in this space include CAT, CMI and NAV.  There are, however, opposing views, such as Larry Kudlow’s, “You’ve gone from 1.5% to 2% growth. We had it going at almost 4%, then the Fed tightened.” Oh yes, the infamous Fed tightening defense. Well sir, unless your boss can pull another rabbit from his hat, I doubt the ‘blame anyone else game’  has much longer to run.  There does come a point when your policies have to stand on their own merits.

In my inbox this image arrived.

Now, I own CLX, CL, PG, GIS, K, KHC, KO and PEP.  If you’re counting, that’s 8 of the 14 company owners of the 26 listed brands.  In an exchange telling of the times in which we live:

Me: So just because they sold themselves to a larger corporation now makes a product like Burt’s Bees less natural? Or am I missing your point?

Resp: They do tend to alter the original ingredients

Me: Well, I guess since there is no acknowledged standard, natural would be in the eye of the beholder.

Point is the definition of “Sold Out”.  My assumption being a merger or acquisition.  Obviously someone else saw this as a breaking of the “natural” covenant – of which there are no standards.  I cannot prove or disprove the “tend(ing) to alter ingredients” allegation. Another example of society’s ongoing inability to communicate.

The final act for the week was the Steve and Greta show.  In Davos, Mnuchin questioned her economic credentials in regards to climate change.  While he may have been technically correct, his flaws were to attack a school girl on an issue where the US has ceded any moral high ground.  He lost the round “bigly” on optics alone.

My opinion is that even if climate change could be denied, the planet and our environment would be better served by implementing many of the Paris Accord action items.  Greta’s zeal is both her charm and achilles heel. To blast the Paris accord as not being enough may well be correct, but at least it is a beginning.  My preference for the moment is to incentivize constant incremental improvement in the vein of Deming’s Law and to bring the ESG conversation to the forefront.  However, to ignore the realities of economics in this quest is begging for the Law of Unintended Consequences to bite you.  One example being a retooling of worldwide supply chains if plastic containers were outlawed.  Doable, yes – but at what cost and in what time frame. Another example is even more ghastly – Healthcare and Pharmaceuticals.  These two consume roughly 4% of petrochemical production although part of this could be attributed to packaging. Impacted products would currently include Aspirin, Heart valves, Hearing aids, Artificial limbs, Antihistamines, Rubbing alcohol, Cortisone, Anesthetics and more.  Two possible consequences emerge, 1) even greater increases in health care costs, and/or 2) Bringing back Sarah Palin’s (2009) death panel debate except the options today could be a heart valve for someones’ life today versus a possible future life. Oh, the conundrums we face.

As we swing into the final week of January, it’s time to break out the month end reports. For my part, my activity was abnormally high due in part to some initiatives previously discussed. Hoping your week is great!

2019: Year of Turnover

Going into the homestretch of 2019, it’s the time I begin the reflection process and assess the strategy going forward.  Last week presented a broad brush view of my expectations for the new year. This week addresses my portfolio turnover for 2019 and more importantly, the why.

In general, my philosophy is to buy and hold for the long run.  I tend to identify strategies and identify issues that have the potential to benefit.  As a strategy runs its course, rarely do I sell – choosing to stop accumulating instead.  This approach minimizes fees and taxable events.

Currently I hold 231 stocks and 4 ETFs.  During the past year, 13 were lost and 24 added.  Therefore my turnover rate was higher than I like so let’s dig in and see what happened.


M&A is pretty straightforward with the differential being the one I held on both sides of the deal. Dividend cuts are pretty much slam dunks as well – although I did retain one of the cutters.  Management is an unusual one as I typically reserve this for activist actions. This case was tax forms being received that didn’t match SEC reporting. In my view, that deed is worse than cutting the dividend – therefore a sale.  The largest category being strategy. I added one to my 2017 KO bottler strategy, four as part of a new platform test and nine to replicate the cashed out portfolio.  

Mergers are always welcome as long as they arrive with a premium attached, Dividend cuts will always be assessed but will usually be fairly automatic sales.  Activism I dislike but generally hold my nose and ride along. Strategy – I thought ended in 2018 until I tested a new platform and also chose to replicate the granddaughter’s portfolio after having to liquidate it.  All reasonable reasons but all contributors to the action.

Currently I have three new companies on my watch list for 2020 which I’ll only buy at the right price point:

  • MTR Corporation Limited (MTCPY) – Hong Kong’s rail line constantly in the news
  • TMX Group Ltd (TMXXF) – Canada’s stock exchange
  • Coca-Cola Bottlers Japan (CCJOY)

This isn’t to say there won’t be more, only that my going forward inclination is that fewer is probably better.  Notable that US issues are absent although currently I expect only additions to existing positions.

In a nutshell, the majority of turnover was a result of M&A activity (a good thing) tempered by the breaking of the (I think) personal 38 year record for dividend cuts (5 total this year).  Unless there is more M&A on the horizon, my hope is to settle back into a 1-2% annual turnover rate. Even with the move towards $0 commission trades my ultimate goal is a set it and forget it type of portfolio which has served me well for many a year.

Hope your holidays are wonderful!