Value Investing

Trapzee Q3 Letter: A Perfect Calm

Trapzee Asset Management Q3 letter to investors

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Economic growth continues, and although this cycle has been the slowest recovery in post-war history, the slower growth has allowed for a prolonged cycle. Inflation remains low—since peaking in 1980, the U.S. has experienced consistent disinflation. The latest PCE price index figures showed a 1.6% rate, leaving inflation below the Fed’s preferred 2% level since '08, so stimulus continues, keeping interest rates at low levels. The 10-year U.S. Treasury bond hovers around 2.3% and rates in other developed nations are even lower. Unemployment in the U.S. has fallen to 4.1%, near full employment for the economy.
And the variation in these statistics has been minimal. At the same time, the prolonged steady growth has allowed for record corporate profits, led by record high profit margins. No wonder that the stock market is at all-time highs and volatility is at all-time lows. If December is yet another positive month for the S&P 500, it will have been the first time in history that all 12 calendar months were up. Perhaps just a quirk of the calendar, but it’s already noteworthy that there have been 13 up months in a row, exceeding the former 11-month record stretch ending in January 1959. The S&P 500 has also set a record for number of days (over 280 and counting) without a 3% intraday decline. In 2017 there have been only 4 days with 1% or more declines, the least in over 50 years. And the average daily absolute change has been a mere 0.3%, the lowest in over 30 years. This steadiness seems almost too good—the opposite of a perfect storm. A perfect calm.

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Short-term administered rates have been rising as the Fed begins to reduce its stimulus. But the 10-year U.S. government bond yield has been relatively stable around 2.3%. Rates are expected to rise over time from today’s levels. High-yield corporate bond yields have been relatively steady recently too, and now sit at 5.7%. The spread to U.S. Treasuries remains at one of the narrowest in history. Because we have been finding fewer attractive opportunities than usual for our income accounts, we have been holding a larger than usual portion of the accounts in cash while we await more favourable investment opportunities.
We recently bought Zargon 8% Convertible Debentures due December 31, 2019 (at a 16% yield to maturity—high given the substantial asset coverage), NGL Energy Partners 9% Preferred Shares (a pipeline and logistics business with a yield just above 9%) and purchased Sabra Healthcare REIT (with a 9% dividend yield) summarized above in our All Cap section—we previously owned Care Capital REIT which was acquired last quarter by Sabra and were attracted to the merged company, especially after it dipped in price.
We sold Northwest Healthcare 7.5% Convertible Debentures due September 30, 2018 because its price rose (and corresponding yield dipped) and on the expectation that the company would call this bond which it has now. And we parted with the Ruby Tuesday 7.625% May 2020 bonds after the company was acquired and we expected the bond to be redeemed based on the change of control provision, in the months ahead, once the deal closes.
We continue to hold a number of undervalued income positions and collect outsized interest income on these positions due to the depressed prices. Our income holdings have an average current annual yield (income we receive as a percent of current market value of income securities held) of over 8%.
Of note, regarding our top holdings in our income accounts: Enerdynamic Hybrid Technologies debentures should benefit from its restructuring as we stand to receive a new short-term secured debenture for most of our bond’s value with the balance and all arrears in common shares which should be valuable considering the substantial contract announcements the company has made; Advantex Marketing International secured debentures are also being swapped for new secured debentures and significant shares in the company which should also be valuable as we anticipate the company recovering back to its profitability levels of a few years ago; and, Manitok Energy collateralized notes should benefit too once it closes its announced financing.

TAMI Q3 2017