12 Responses to “August 9, 2013”

1. Drew says:

   August 10, 2013 at 9:38 am

   Any idea why preferred shares have been getting hit lately while broader bond markets have been largely range bound?

2. nervousone says:

   August 12, 2013 at 11:30 am

   Hi Drew,

   As you probably know, there’s been piles of unending press predicting the end of “tapering” by the US Fed. This has contributed to plenty of downside behaviour on the general markets . . . gold has been hit, market indexes, oil also hit, and the long bond yield has gained about 40 – 50 bps since the start of the tapering hysteria, to sit around 3%.

   Although bonds have been pretty firm in this area for a couple of weeks as you point out, prefs continue to slowly get hit to the downside. Why? Well, for the perps, general fear of a pounding such as what happened 3 or 4 years ago is probably causing general miscellaneous selling interest to pick up.

   For the rate resets, new locked in levels at still pretty low long rates are making the investment somewhat risky (look at FTS.PR.G recently reset and locked in under 4% . . . ouch).

   You’ll know if the hysteria is justified if issuance picks up on the perpetuals. The banks tend to favour resets now, but perps could come back into vogue with any number of potential issuers. If this happens, you’ll know issuers want to lock in before rates start to rise, and the last perp bloodbath was made non too pleasant by a veritable “flooding” of the market, mainly by the financial issuers.

   Many pref investors probably see this coming, and are waiting for the opportunity to start to pick these up, possibly well below $20/share. Since there are more sellers than buyers right now, the drifting effect continues.

   Just a “situation analysis” opinion . . . maybe James could comment on this.

3. jiHymas says:

   August 12, 2013 at 2:40 pm

   I think the dramatic increase in spreads shows that this is overdone.

   The Credit Crunch was about credit, so one would expect widening … but this episode is about the return of good times and broad-base interest-rate increases … so spreads should, if anything, narrow.

4. Nestor says:

   August 12, 2013 at 6:03 pm

   the market is expecting higher rates. there is uncertainty how high rates go and how fast. there is uncertainty if/when and by how much the fed will “taper”.. if one expects at least 50 bp higher rates, then what would the preferred share be worth. if rates go up 200 bp ?

5. jiHymas says:

   August 13, 2013 at 12:00 am

   It’s no secret that for any given scenario under discussion, it is possible to construct a worse scenario. We saw lots of that in the Credit Crunch.

   What will preferred shares be worth if a giant asteroid hits the earth causing 90% of all life on the planet to die AND THEN nuclear war breaks out AND THEN we are invaded by giant three-armed Kaloodges from the planet Kludge? What will preferred shares be worth then? Huh? How much then?

   Scenario analysis is a perfectly reasonable methodology for asset allocation and portfolio construction, but you have to consider a reasonable number of scenarios and – the hard part – assign them a probability. Then you estimate how well your base portfolio performs in each scenario and come up with a distribution of possible values. Then you optimize your portfolio according to some kind of objective function. It’s very rarely done well.

   If you choose to believe that “rates” (whatever they are) are going to go up 200bp and you choose to assign a 100% probability to that particular scenario, then by all means construct your portfolio according to that analysis. You don’t need my permission. In fact, I’ll be happy to help you construct a portfolio that will do well in such an event, for my usual modest fee. However, the bond market indicates that the consensus is overwhelmingly opposed to this evaluation of probabilities, but the consensus has been wrong before and it will be wrong again. Good luck!

6. Nestor says:

   August 13, 2013 at 5:30 am

   sorry Jim. i probably didn’t express my thought correctly. in answering the original question, “why are pref’s getting hit, while the bond market is rangebound”.. i think it’s the anticipation of higher rates, and the uncertainty of what the fed is going to do.

   i don’t expect the fed will raise rates any time soon. however, the effect of “tapering” will have some effect on the bond market. rates have already gone up since Bernanke has hinted at tapering, so that may already be factored into the bond market. (kind of reminds me of late 1993-1994, when Greenspan raised rates in Feb ’94 by 1/4% and the bond market went nuts, anticipating several more hikes in the space of a few weeks)

   don’t know if that was more clear. all i was trying to say was that perception and reality are two different things here. and it’s the perception that rates will go higher causing prefs to sell of more. the reality i think, is that we’re in for an extended period of low rate environments.

7. jiHymas says:

   August 13, 2013 at 7:19 am

   Sorry if my reply was more pugnacious than it should have been.

   The threat of tapering has had some effect and the realization of it – whether this comes sooner or later – will have a further effect that is currently, as you say, unknown.

   But eventually fixed income yields will reflect monetary policy (at the short end), inflation expectations (at the long end) and credit quality (for … um … credit). I just don’t see any inflation happening! I see a global economy that is just dragging along despite extraordinary monetary stimulus. So while I project headwinds for the preferred share market in the short term (by which I mean five years out), I find it hard to believe that the yields that we’re seeing on PerpetualDiscounts are justified by the fundamentals.

   And I agree with you that perception is a big driver here. Retail has heard a little bad news about tapering, has seen their June month-end statement and has concluded that it’s November ’08 all over again and everything will trade in the ‘teens before Christmas.

   I have seen some market chatter to the effect that prefs are getting hurt because all the Big Boys are on holiday and won’t be back until September. I’m never quite sure how seriously to take that sort of argument (“Not very” or “Not at all”?) but the fact that it is being made is at least an indication that I’m not the only one who’s bewildered.

   A nice side-effect of the downdraft is that low-spread FixedResets are being priced much more rationally and quality spreads are looking more realistic as well.

8. nervousone says:

   August 13, 2013 at 10:31 am

   I’ve heard that the planet Kludge does not allow short-selling! Maybe it’s the place to invest!

   The big boys on holiday? I can’t see that as a market-moving factor with relatively thinly traded prefs, but it could be a contributor.

   Putting market timing on the back burner for a minute, and replacing it with “market-event risk” as a scenario analysis consideration, how about this:

   The fed has to stop tapering soon . . . after all, how much long term damage can this perpetual money printing exercise produce without negative consequences? The FOMC cannot allow it. Having said that, the inevitable announcement of tapering will result in some pretty easy to predict [and probably very short term] behaviour: markets will get pounded, gold will continue it’s trip to the deep south, and long bond rates will probably continue to rise, only faster. I suspect the market has only “priced in” a bit of this, since the job numbers continue to be weak.

   If the long bond yield gains 50 bps to reach three and a half percent, stocks such as MFC.PR.B, RY.PR.A, WN.PR.E, CCS.PR.A, etc. etc. will all be trading in the $17 – $20 range . . . like they did during the credit crunch. This is not really star gazing; it is pretty much 100% certain. Remember, they’ve moved from $25 to their current $21 – $23 range pretty fast.

   I guess pref share holders need to hope for a very, very slow return to the “good times”! (or maybe a one way ticket to Kludge!)

   Great spirited conversation here, guys!!

9. nervousone says:

   August 13, 2013 at 4:07 pm

   uh oh . . . the long Canadian yield closed + 8bps to 3.09% today . . . James, I know you despise market timing, but, well . . . I think you know the rest . . .

10. Nestor says:

    August 13, 2013 at 5:27 pm

    a backup in yields, will kill any economic recovery. especially if it’s too much too fast.

    as for what price the prefs would be on a 50 bp increase, i’d go over the “modified duration” article Jim has on his site.

    my guess, is that most prefs have already factored in that 50bp increase in yields, if not more, and are not likely to sell off much more.

11. adrian2 says:

    August 14, 2013 at 8:42 am

    If the long bond yield gains 50 bps to reach three and a half percent, stocks such as MFC.PR.B, RY.PR.A, WN.PR.E, CCS.PR.A, etc. etc. will all be trading in the $17 – $20 range . . . like they did during the credit crunch. This is not really star gazing; it is pretty much 100% certain.

    Since you’re “pretty much certain”, I’ll take the bet, with the corresponding odds: I’ll give you $100 if you’re right, you give me a million if you’re not. Deal?

    Adrian

12. nervousone says:

    August 14, 2013 at 12:05 pm

    Hi all!

    Nestor, you earlier asked in this same thread what a pref share would be worth if the bond yield rose 50 bps . . . now you believe that 50 bps are priced in already. I understand your confusion. It is difficult to accurately predict the behaviour of prefs simply on long bond movement. However, spreads are widening on many of these issues, and price drifting seems to be in place; therefore, I see this continuing until the “big bang” fed announcement about tapering, when we could have a day or two of really nice buying opps on some of these!

    Which brings me to adrian’s somewhat confusing odds calculation. You want 10,000 : 1 odds on my suggestion that some prefs could trade in the $17 – $20 range once the long bond gains 50 bps? Are you sure you want to do that? WN.PR.E has dropped another .35/sh to $22.58 today . . . SLF.PR.D is down to $20.91 . . . CCS.PR.A has traded at $21.79 today . . . and this is with the long bond unchanged since yesterday.

    adrian, that would be the easiest $100 bill I ever made (regardless of your wild odds request!)

    Let’s just hope the bond market settles down a bit, and all the pref paranoiacs and short-sellers start to come to their senses!