Tag Archives: seeking-alpha

Is The Market Fair? Yes Vs. No

Summary Yes. Mostly. But not entirely. 3 recent exploitable examples. Is the market fair and efficient? Yes. Well, almost always. The second best piece of news I have for you is that markets work quite well. Few activities allow for so much success for the people who don’t even try. If you sign up for a marathon and get to the starting line but don’t try to run, you lose to every other runner. If you don’t try to beat the market, you simply sign up for an index fund or buy a passive ETF in the S&P 500 (NYSEARCA: SPY ), you beat about three quarters of other investors. No. Not entirely. The best piece of news I have for you is that market prices fail sometimes – and do so in ways that are exploitable for profit. One of the best books to date on the subject has one of the worst titles: You Can Be A Stock Market Genius . It reveals the world of spinoffs, merger securities, bankruptcy, restructuring, recapitalizations, stubs, and warrants. It is in such investment opportunities where the price system often fails to accurately reflect underlying value. Today, there are three such investment opportunities where the price system continues to fail. These are not prices that are off a bit. They are prices that are wrong. They include share class trades such as CBS / CBS.A , parent/sub stubs such as Yahoo! (NASDAQ: YHOO ), and closed-end fund IPOs such as CCD . CBS There are two related opportunities in CBS. The first is that there are two share classes, each with the same economic value. According to the company, CBS Corporation has two classes of common stock: Class A, which is the voting stock, and Class B, which is the non-voting stock. There is no difference between the two classes except for voting rights. Shares of CBS Class A and Class B common stock generally trade within a close price range of each other. There are, however, more shares of Class B common stock outstanding, and most of the trading occurs in that class. The second is that it is unlikely that CBS remains a standalone company after a transition from its 92-year-old founder and executive chairman departs his role. (click to enlarge) So, it is reasonable to expect the price difference to converge. Given the likelihood that it will get a takeover premium, it is probable that the convergence is upward from the current market prices. What should one do with such situations? CBS Class B shares (NYSE: CBS ) are probably a bargain around $50 per share, even if it remains a standalone company. They are even better if Time Warner (NYSE: TWX ) or someone else buys CBS after Redstone’s tenure. But what is even more interesting is that the share class spread will probably go to zero in such a deal. One way to capture this spread is to buy the B shares ( CBS ) while writing calls on the Class A (NYSE: CBS.A ) shares. For example, you can write May 2016 CBS.A $50 calls, These have a $5.40 bid and a $7.50 ask. This is an attractive amount of premium to capture in addition to the share class spread. In an efficient market, this opportunity should not exist. But it is there for the taking. Yahoo! Net of cash, Yahoo Japan, and Alibaba (NYSE: BABA ), the public capital market valued Yahoo’s core business at $0.11 as of the beginning of this month. The structure can probably be resolved in a number of different tax-efficient ways according to this recent analysis. Reasonable people can differ on the value of the core business, but the stub is probably worth somewhere in the range of $4-$5 per share. $0.11 is just wrong. Net of cash and the exposure to BABA and Yahoo Japan, if the process goes badly and the company performs poorly, the stub should at least double. If the process goes well and the company performs well, the stub should at least double again. CEF IPOs The CEF IPO is an opportunity to lose 8% of your money quickly, then much the rest slowly. They are useful for investors because they are the financial world’s equivalent of a ski mask on a warm sunny day in that any broker caught with one has identified himself as a likely swindler. While I am a longtime skeptic of boom era IPOs generally, my skepticism is greatest when it comes to initial public offerings of closed-end funds. With industrial IPOs, there is some pre-existing corporate asset being supplied. With CEFs, the IPO is driven by the demand. What CEFs get IPOed? Whatever the retail mass market wants. Whatever is most in favor, priced-in, or trendy is what gets invented and then sold to the trusting public. At least industrial IPOs initially pop 16% or so on average on the first day and only later lose investors’ money. But with CEF IPOs, there is not even that initial pop. Then, average CEFs are down about 8% within three months, 13% within five months, and 19% within a year. While there is a market inefficiency in the repeated ability to sell such CEFs to the public for a 5-10% premium to NAV, the market is subsequently efficient at wrenching that premium out of the price. Over a billion dollars of value has been transferred from CEF investors to underwriters on day one. That is about 8% of the money that they invested. There is zero evidence of skill in the (typically expensive) management of the remaining 92% of their money. It is instructive that only about 4% of investors in new CEFs are institutional investors compared with the 22% of investors following similar industrial IPOs. One recent example is Calamos Dynamic Convertible and Income (NASDAQ: CCD ). This has been a smashing success… for its underwriters are brokers. These wealth transfers are useful tools for investors to identify brokers who are willing to do anything and say anything to take your money. So far, it is right on schedule. The market squeezed out massive underwriting fees, losing 11% of value in 100 days (slightly ahead of the -8% historical average) and 25% within five months, well ahead of the -13% pattern such funds have seen in the past. This was not a problem; this was the plan. These can be good opportunities to buy at deep discounts to NAV. Nobody sells shares for no good reason like an investor who bought them for no good reason. By the time they have sold off, the investors are probably in the market for a new broker while the broker is in the market for his next mark. Conclusion The market is good. It is good enough to trust in its general fairness and approximate efficiency. You can put all of your money in passive exposure to equities, debt, and cash with the confidence that – on average and over time – you will get what you pay for. But it is also imperfect. For diligent bargain hunters, some durable inefficiencies include occasional share class spreads, cheap parent-subsidiary stubs, and broken CEF IPOs. It is possible to beat the market over the long-term by judiciously selecting securities within such categories. Is the market efficient? I find much of the academic literature that indicates significant efficiency to be persuasive, yet in my direct experience, I keep finding lucrative exceptions. What do you think and what have you found? Please use the comment section below to weigh in with your findings.

Asset Class Weekly: The Junk Inside High Yield

Summary High yield bonds were conspicuously absent from the capital market rally on Friday. It is worthwhile for investors to take a look under the hood and consider exactly what they are getting when they are buying into high yield bond market. Risks remain biased to the downside for the asset class. Global capital markets had a marvelous trading day to close out the week on Friday. Almost everything traded strongly higher to close out the week including widely divergent categories such as U.S. stocks (NYSEARCA: SPY ), U.S. Treasuries (NYSEARCA: TLT ), gold (NYSEARCA: GLD ) and copper (NYSEARCA: JJC ) all posting robust gains. But one asset class was conspicuously absent from the party on Friday. It was high yield bonds (NYSEARCA: HYG ), and the fact that this category could not even squeeze out an incremental gain with the rest of the market surging raises an eyebrow to say the least. Given that so many income starved investors such as retirees have found themselves increasingly allocating to this category in recent years in the desperate search for yield, it is worthwhile to take a look under the hood and consider exactly what investors are getting when they are buying into high yield bond market. High Yield Bonds: Not Your Grandma’s Bond Market Many investors fall victim to a common misconception. Stocks are exciting and bonds are boring. Stocks are for those interested in achieving capital growth, while bonds are a safe way to invest and earn some income. Thus, when they see the word “bonds” included in the “high yield bonds” moniker, they make the assumption that these investments are safer than being allocated to stocks. And professionals having thrown around statements like “historically low default rates” in the recent post crisis years has only served to reinforce this potential misconception that high yield bonds are a generally safe place to park your money and capture a meaningfully higher yield. But this is not the case when it comes to high yield bonds. In fact, high yield bonds behave much more like stocks than traditional bond categories like U.S. Treasuries. For example, since the outbreak of the financial crisis in 2007, the high yield bond market has had a +0.74 returns correlation with the S&P 500 Index versus a -0.11 returns correlation with the U.S. Treasury market. In other words, high yield bonds more often than not follow the returns path of the U.S. stock market, not the traditional bond market. This strong relationship between high yield bonds and stocks, not Treasuries, is demonstrated in the following historical returns chart during the financial crisis. For while stocks were plunging lower and U.S. Treasuries were rallying, high yield bonds followed the stock market lower. And when stocks bottomed and started rallying in March 2009 as U.S. Treasuries were cooling, high yield bonds began to rally sharply along with the stock market. (click to enlarge) When High Yield Bonds Become Junk OK, so high yield bonds act more like stocks than bonds. In many market environments, this is a wonderful characteristic that makes them an ideal asset class to own as part of a diversified portfolio strategy. And the name “high yield bonds” certainly sounds welcoming enough. Hey, one might say, I’m making an investment in a bond that is going to earn me a higher yield. Indeed, this is true. But there is no free lunch when it comes to investing or anything else. These bonds are providing investors with a higher yield for a reason. And when it comes to high yield bonds, this higher yield is more often than not due to the fact that an increased default risk is associated with the bonds. After all, these bonds were once widely known as “junk bonds” for good reason. Of course, investing in something that is called “high yield” is a lot more appealing than something that is called “junk”. And the threat is starting to build that they may once again make good on their old fashioned name. During periods of economic prosperity, the default risk associated with high yield bonds (NYSEARCA: JNK ) is typically low. This can also be true during periods of freely flowing liquidity in the financial system. Unfortunately for investors, these low default rate periods can breed complacency, for it does not take long once underlying economic and/or financial market conditions to deteriorate before junk bond default rates start spiking higher. For example, during the period from 1992 to 1998, the default rate on high yield bonds was consistently less than 2%. But after moving meaningfully higher in 1999 and 2000, the default rate spiked toward 13% in 2001 and over 16% in 2002. Putting this in perspective, one out of every eight high yield bonds defaulted in 2001, and for those remaining issuers that did not default in 2001, one out of every six defaulted the next year in 2002. Putting this in yet another perspective, imagine having a ladder of six attractively yielding certificates of deposit (CDs) at your local bank and learning at some point in time that one of these CDs would only be getting paid back at 40 cents on the dollar, or maybe even less, or perhaps hardly at all. From 2004 to 2007, high yield default rates returned to lows below 4%. But once the financial crisis began to set in, credit risk began to explode higher once again. In 2008, the high yield default rate pushed toward 7% and by 2009 it was spiking toward 14%, or one out of every seven high yield bonds. These default rate swings are nothing new for the asset class, for they have been known to periodically occur going all the way back to when they were first entered into the capital markets mainstream leading up to what is now referred to as the junk bond crisis of 1989. None of this is to say that high yield bonds are not an outstanding asset class that has their place in a broader asset allocation strategy. But like many categories they have their periods over time of strength and weakness. And high yield bonds are among those that are exposed to greater risk, particularly event risk, than many other categories due to their reliance on lower quality credit issuance. And it seems that we may be increasingly moving toward such a period of weakness for the category today. Where Are We Today? Today, high yield bonds have returned to their sanguine ways. Since 2010, the default rate has remained consistently below 3%. That is, of course, until 2015 when this rate has crept higher toward the 4% level. Is this recent shift higher in default rates foreshadowing more trouble ahead? Only time will tell, but one has to look no further than the option adjusted spreads of lower quality high yield bonds over the past year. This trend certainly does not bode well, particularly since the high yield bond market does not have a Fed frantically rushing to the rescue like in 2011. Instead, they have a Fed that remains determined to raise interest rates. (click to enlarge) This helps explain why the high yield bond market had not participated at all in the recent stock market rally. For while both U.S. stocks and high yield bonds had been moving lower generally in lockstep with one another since the stock market peak back in May, they began to diverge in late October with stocks rallying higher while high yield bonds continued to falter. For U.S. stock investors, this recent deviation should be troubling, as failure in the high yield bond market has been known to spill over by eventually applying downside pressure to other asset classes including stocks. (click to enlarge) What Junk Is Inside My High Yield Bond Portfolio, Anyway? So what exactly are investors getting when they buy into the high yield bond market. Let’s take a look at some of the individual names. The following are some of the largest holdings from the iShares iBoxx High Yield Corporate Bond ETF. HCA (NYSE: HCA ) Ally Financial (NYSE: ALLY ) Frontier Communications (NASDAQ: FTR ) Sprint (NYSE: S ) Tenet Healthcare (NYSE: THC ) Navient (NASDAQ: NAVI ) Clear Channel Outdoor (NYSE: CCO ) Together, these eight companies make up 12%, or roughly one-eighth, of the high yield bond market by this ETF product’s measure. Included below are the recent stock price charts for these same securities. Also included for good measure is the stock price chart of Linn Energy (NASDAQ: LINE ). While this credit does not rank among the top ten holdings in the HYG, it in many respects serves as a poster child for the challenges that over the past year have plagued the energy sector, which makes up 13% of the entire high yield bond market. Why are we looking at the stock prices of these companies whose bonds are included in the HYG? Because the stock price still represents the market’s view on these companies. And if the stock price is falling precipitously enough, it begins to also make a statement about how investors perceive the liquidity and solvency of the company going forward. (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) What we see from the above charts are representative companies from the high yield bond market that have seen their stock prices recently fall anywhere between -20% to -95%. This raises several key points. First, signs of underlying weakness in high yield are no longer confined to the energy space. The list of companies shown on the above slide set are sourced from a diverse array of industries. And they are all performing poorly to varying degrees. Second, the extreme price volatility along with the sudden sharp downside across a range of high yield bond names including those shown above should at least raise questions about the suitability of a major allocation to high yield bonds in the portfolios of many retirees. Given the characteristics of the stocks of these companies, are these the types of names that are best suited for those investors that cannot sustain a measurable loss in value. Lastly, one could understandably counter the point above by stating that investors are putting money into the bonds of these companies, not the stock. Thus, by moving up the capital structure they are protecting themselves from the extreme downside risk associated with holding the stock. Indeed, this is true, but only to a point. For yes an investor is better served to move up the capital structure to hold a credit that will likely have some residual value in the event of a bankruptcy instead of holding the equity and receiving nothing, but for the investor that can ill afford to see as many as one out of every six credits in their bond portfolio enter into default, getting paid thirty to forty cents on the dollar at best is little consolation for people like retirees that are living on fixed incomes and cannot tolerate exposure to downside even remotely near these levels. Sure, these discounts can provide great upside opportunities for investors in the know, but for many retirees, they are not necessarily well positioned or suited to engage in the art of distressed debt investing with their retirement savings. Recommendations The high yield bond market is finding itself increasingly under fire. It has been steadily weakening in recent weeks despite the broader stock market rally. And underlying fundamental conditions for the asset class continue to deteriorate. While the last several years during the post crisis period have proven kind to the asset class, default rates are now creeping higher. As a result, it stands to consider as we move toward the end of 2015 and into 2016 whether high yield bonds will make good on their previous identity as junk. For more conservative investors, now continues to be a reasonable time to consider scaling back existing exposures to the high yield bond market. For the more assertive investor, a short allocation (NYSEARCA: SJB ) to the high yield bond market may have increasing appeal as conditions in the junk bond market continue to unfold. Disclosure : This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

10 Ways To Destroy Your Portfolio

With the increased frequency of heightened volatility, investing has never been as challenging as it is today. However, the importance of investing has never been more crucial either, due to rising life expectancies, corrosive effects of inflation, and the uncertainty surrounding the sustainability of government programs like Social Security, Medicare, and pensions. If you are not wasting enough money from our structurally flawed and loosely regulated investment industry that is inundated with conflicts of interest, here are 10 additional ways to destroy your investment portfolio: #1. Watch and React to Sensationalist News Stories: Typically, strategists and pundits do a wonderful job of parroting the consensus du jour. With the advent of the internet, and 24/7 news cycles, it is difficult to not get caught up in the daily vicissitudes. However, the accuracy of the so-called media experts is no better than weather forecasters’ accuracy in predicting the weather three Saturdays from now at 10:23 a.m. Investors would be better served by listening to and learning from successful, seasoned veterans. #2. Invest for the Short Term and Attempt Market Timing: Investing is a marathon, and not a sprint, yet countless investors have the arrogance to believe they can time the market. A few get lucky and time the proper entry point, but the same investors often fail to time the appropriate exit point. The process works similarly in reverse, which hammers home the idea that you can be 200% wrong when you are constantly switching your portfolio positions. #3. Blindly Invest Without Knowing Fees: Like a dripping faucet, fees, transaction costs, taxes, and other charges may not be noticeable in the short-run, but combined, these portfolio expenses can be devastating in the long run. Whether you or your broker/advisor knowingly or unknowingly is churning your account, the practice should be immediately halted. Passive investment products and strategies like ETFs (Exchange Traded Funds), index funds, and low turnover (long time horizon / tax-efficient) investing strategies are the way to go for investors. #4. Use Technical Analysis as a Primary Strategy: Warren Buffett openly recognizes the problem with technical analysis as evidenced by his statement, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Legendary fund manager Peter Lynch adds, “Charts are great for predicting the past.” Most indicators are about as helpful as astrology, but in rare instances some facets can serve as a useful device (like a Lob Wedge in golf). #5. Panic-Sell out of Fear And Panic-Buy out of Greed: Emotions can devastate portfolio returns when investors’ trading activity follows the herd in good times and bad. As the old saying goes, “Following the herd often leads to the slaughterhouse.” Gary Helms rightly identifies the role that overconfidence plays when in investing when he states, “If you have a great thought and write it down, it will look stupid 10 hours later.” The best investment returns are earned by traveling down the less followed path. Or as Rob Arnott describes, “In investing, what is comfortable is rarely profitable.” Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions. #6. Ignore Valuation and Yield: Valuation is like good pitching in baseball…very important. Valuation may not cause all of your investments to win, but this factor should be an integral part of your investment process. Successful investors think about valuation similarly to skilled sports handicappers. Steven Crist summed it up beautifully when he said, “There are no ‘good’ or ‘bad’ horses, just correctly- or incorrectly-priced ones.” The same principle applies to investments. Dividends and yields should not be overlooked – these elements are an essential part of an investor’s long-run total return. #7. Buy and Forget: “Buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or decline in value. Wow, how deeply profound. As I have written in the past, there are always reasons of why you should not invest for the long term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) excessive valuation; 6) change in industry regulation; 7) slowing economy; 8) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea. #8. Over-Concentrate Your Portfolio: If you own a top-heavy portfolio with large weightings, sleeping at night can be challenging, and also force average investors to make bad decisions at the wrong times (i.e., buy high and sell low). While over-concentration can be risky, over-diversification can eat away at performance as well – owning a 100 different mutual funds is costly and inefficient. #9. Stuff Money Under Your Mattress: With interest rates at the lowest levels in a generation, stuffing money under the mattress in the form of CDs (Certificates of Deposit), money market accounts, and low-yielding Treasuries that are earning next to nothing is counter-productive for many investors. Compounding this problem is inflation, a silent killer that will quietly disintegrate your hard earned investment portfolio. In other words, a penny saved inefficiently will lead to a penny depreciating rapidly. #10. Forget Your Mistakes: Investing is difficult enough without naively repeating the same mistakes. As Albert Einstein said, “Insanity is doing the same thing, over and over again, but expecting different results.” Mistakes will be made and it behooves investors to document them and learn from them. Brushing your mistakes under the carpet may make you temporarily feel better emotionally, but will not help your financial returns. As the year approaches a close, do yourself a favor and evaluate whether you are committing any of these damaging habits. Investing is tough enough already, without adding further ways of destroying your portfolio. Disclosure: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.