An Illustration Of Trapeze’s Four Pillars – A Bearish Outlook

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An Illustration of Our Four Pillars – A Bearish Outlook by Randall Abramson, CEO & Portfolio Manager of Trapeze Asset Management

Four Pillars: A Disciplined Approach

Micro Tools


  • Valuation Model which uses the bottom-up DCF values

Value Philosophy

Equity Securities

Large Cap: Systematically uncovering global large cap stocks

Trapeze’s large cap investment universe consists of approximately 1,000 of the largest companies in the world that meet a $20 million daily trading liquidity threshold. We sort and filter this universe using several valuation methodologies, including our proprietary discounted cash flow model called The Trapeze Valuation Model or TVM™.  Figure 1 illustrates Nike’s historical TVM™ (we did not own Nike in client accounts during the period shown).

Figure 1. Nike Inc. Dec 31 2001 – June 15, 2012

Small/Medium Cap: A treasure hunt

Searching for undervalued small and medium cap stocks is akin to a treasure hunt.  Our portfolio managers and research analysts scrutinize securities utilizing information gleaned from myriad sources, including a universe of closely monitored stocks, filters and screens, outside research analysts, corporate regulatory filings, newspapers and periodicals, other like-minded investors and our diverse business contacts.

To assist Trapeze’s security selection, we draw on specialized independent research, such as a service that identifies sell-side analysts with the best track records and determines the “quality” of corporate earnings. We also subscribe to assorted research services to gain disparate market and macroeconomic perspectives.

Margin of Safety

We believe that securities purchased at a meaningful discount to their intrinsic values, with a “margin of safety”, should have lower downside risk. Buying a security at a large discount to its fair market value also mitigates the risk in our business appraisal. To minimize inherent business risk, we seek to purchase securities of strong companies meeting our fundamental criteria and to avoid those that have poor balance sheets or no earnings without the prospect for near-term earnings. We prefer companies with competitive advantages, barriers to entry or unrecognized valuable assets, and wish to avoid those where predictability is difficult. We are attracted to companies with lower than average operational, financial and valuation risk.

Perception of Risk

We strive to avoid permanent loss of capital.  Investments typically experience temporary loss of capital from unwarranted short-term share price fluctuations.  Often, illiquidity from an emphasis on smaller companies can contribute unduly to an outsized fluctuation in price, in our view, a temporary impairment of capital.  From time to time, investments may experience permanent loss, though we wish to minimize this by avoiding companies we believe are overpriced and recognizing when a company’s business model changes adversely.

Short Selling Strategies and Option Strategies

For hedging purposes or for investment purposes to take advantage of market opportunities, we may use short selling strategies or option strategies to the extent such strategies are appropriate and permitted for a client’s account.

Income Securities

We believe that a value approach to income investing, which combines mostly high yield bonds, and periodically dividend-paying equity securities, can provide above average risk-adjusted returns.  We typically seek securities which Trapeze’s analysis indicates are mispriced.  We find these opportunities in a diverse group of businesses across North America which meet our criteria through investment and risk analysis.

For debt securities, we analyze credit risk, including interest coverage and asset coverage to mitigate the risk of permanent loss. Issuer fundamentals, including cash flow and asset valuation, are stress-tested for interest coverage, asset coverage and the ability to honour maturities.


  • Trade optimization tool – ratio of adjusted capital
  • Based on multiples of price-to-adjusted book value

Trade Optimization

In the long run, stocks tend to converge to their fair market values (FMV). However, in the short run, stock prices are governed by investor psychology and can fluctuate above or below their true value. Prevailing sentiment toward a specific stock, sector or even the overall market is constantly changing, influenced by factors such as economic data, exchange rates, and news releases.

TRAC™ is a framework we use in an attempt to capture—in real time—this changing sentiment for individual stocks, sectors or overall markets. TRAC™ charts “Economic Capital”, which is derived by summing operating assets and then subtracting liabilities. Economic Capital is the financial and physical capital used to produce goods and services which translate into cash flow and earnings—the critical inputs to Trapeze’s calculation of FMV.  We apply an array of multiples to adjusted Economic Capital. These multiples tend to act as upper and lower valuation boundaries for a security’s trading price. While we always remain focused on the ultimate magnate—FMV—we believe monitoring these valuations boundaries can aid in optimizing our buys and sells. Figure 2 provides an illustration of a hypothetical stock’s TRAC™ boundaries overlaid on its historical trading price. Our goal with TRAC™ is to purchase stocks trading at (or inflecting up from) a lower boundary and to avoid, sell or short sell stocks trading at (or inflecting down from) an upper boundary.

Figure 2. TRAC™ Chart for Hypothetical Stock


Macro Tools


  • Economic Composite to forecast recessions

Economic Modeling

Monitoring the business cycle is of paramount importance. Since 1965, two-year rolling losses of 20% or more have always been preceded by a business cycle peak. We developed the Trapeze Economic Composite (TEC™) to monitor the business cycle of the major global economies. The cornerstone of TEC™ is the term structure. Research by Estrella and Mishkin (1996, 1998) and Wright (2006) concludes that the term structure (i.e., three-month yields less ten year yields) is a viable tool for predicting business cycle peaks and has a longer lead time than other economic variables.  Trapeze’s research agrees with these studies.

TEC™ calculates the current term structure’s decile rank relative to historical spreads. Other economic variables such as the ISM survey, capacity utilization and the unemployment rate are also converted to a decile rank relative to their historical values. The decile ranks of each variable are combined to one master rank. When the decile rank of the master rank records a value of one, then a TEC™ business cycle peak warning signal is triggered. In our historical study of U.S. business cycles, TEC™ business cycle peak warnings preceded actual business cycle peak dates (as defined by the National Bureau of Economic Research, NBER) by an average of 289 days. Figure 3 shows the historical NBER cycle peak dates, TEC™ warning signals, and the historical trading price of the S&P 500 Index. Since 1960, the average decline for the S&P 500 Index following a TEC™ warning signal for the U.S. economy to the subsequent S&P 500 Index low was 26.1%. The latest TEC™ warning signal for the U.S. economy occurred on October 27, 2006, 430 days before the NBER peak date of December 2007.

Figure 3. TEC™ and NBER cycle peak dates.



Estrella, Arturo and Frederic S. Mishkin (1998), “The Yield Curve as a Predictor of U.S. Recessions,” Current Issues in Economics and Finance, 2.
Wright, Jonathan H. (2006), “The Yield Curve and Predicting Recessions,” Finance and Economics Discussion Series Working Paper No. 2006-7.


  • Relative Indicator of Momentum—a sophisticated moving average to warn against bear markets

Market Risk Analysis

Market drawdowns can occur outside the natural ebb and flow of the business cycle. TRIM™ is an algorithm we have developed that combines market volatility and momentum to model transition points that forewarn of a potential shift from a bull market to a bear market (a market decline greater than 20%). We use TRIM™ to monitor numerous global markets and commodities. Applying TRIM™ to the S&P 500 Index between 1950 and 2009 identified nine negative transition points. Although not all of those transition points were followed by a bear market, the average decline of the S&P 500 Index after each negative transition point to the subsequent low was 23%.

Figure 4 illustrates the two negative transitions in the S&P 500 Index for the last two bear markets, where the S&P 500 Index broke below its TRIM™ band. Together, TRAC™, TEC™ and TRIM™ can act to corroborate “sell” signals, hopefully allowing us to raise cash, short stocks (where we are so authorized by clients), and/or hedge Trapeze’s portfolios with options strategies (where we are so authorized by clients).

Figure 4. S&P 500 (Dec 1990-Dec 2011) with TRIM™ overlay


An Illustration of Trapeze Asset Management’s Four Pillars – S&P 100 (Feb. 2, 2016)

After trading in line with full value, based on Trapeze’s TVM, the index has declined about 10% from its recent high. TEC is not flagging a recession and has not done so since October ’06. However, TRIM has recently triggered a sell signal for the S&P 500, forewarning of a bear market, its first such signal since March ’08. Over 80% of the major market indexes we follow have given TRIM sell signals. TRAC has also triggered sell signals as the index has detached from its ceiling. The next TRAC floor is currently equivalent to approximately 1660 for the S&P 500 which would return the major U.S. stock indexes to attractive levels at around a 20% discount to our TVM valuation.

Trapeze Asset Management's Four Pillars

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