Blessed by the Potato

In the clouds of the pandemic, a perfect storm was brewing for Toronto real estate. The units stolen from the residential market by AirBNB were coming back online, at the same time that immigration was suspended and a massive wave of unemployment and economic uncertainty swamped the economy, oh and the city was warning that the lost TTC revenue and extra costs might lead to a huge property tax hike (spoiler: they got a bailout and chose to cut services rather than increase taxes if it gets worse). In a sane world those should have been a handful of pins popping an already frothy real estate market, with an epic, sharp crash to bring us back to sensible price:rent and price:income levels — or at the very least an Alberta-style soft landing that takes the froth out.

But we don’t live in a sane world, and instead we have a K-shaped recovery. Except unlike the K-shaped recovery people talk about for people and the jobs market, where one group is having a really bad year with no light at the end of the tunnel yet (e.g., anyone whose livelihood revolves around music festivals, conventions, or personal services), while another has virtually uninterrupted income and lower expenses (e.g., many people who work primarily on a computer and who only had to go into the office in the first place because of a lack of imagination and will from their corporate overlords), in the real estate market it can be the same property with two divergent outcomes.

The rental market has taken a big hit in the downtown core, especially the microcondo segment that was most ghost hotel-y and the least fun to quarantine yourself in. Yet prices to buy those units have barely budged. In the burbs, rents are flat-ish, while prices have exploded higher.

And hold on to your butts, because the early indicators are making it look like the first half of 2021 is going to be an absolute ripper. Whether its low rates, or spending so much time at home that makes people want a house, or the freedom to look a little further afield if daily commutes may be off the table for a while, demand is surging, while the deferral cliff (that was one of the elements of the perfect storm that missed) turned out to not be such a big deal.

Now, if you’re just looking for a long-term place to live, then this likely doesn’t concern you — one more blip up on the chart of craziness, while renting continues to be a predictable expense. But if you’re in the FOMO game, or are looking to take a big risk on flipping a place this year, this is a big deal. It’s also so confusing and so hard to see coming, especially if the pandemic has left your own financials in shambles.

Where are people getting the money? How do they even have the energy to go rage-buying houses when things are so terrible?

Well, the upper leg of the “K” is doing just fine, if not even better than before, and they’re the only ones who buy houses anyway. So of course the market would be ripping, why didn’t I see it before?

Buuuuuut, immigration is still down. Tourisim is still down. Employment is still down. The perfect storm may have passed us by for now, with the upper leg of the K doing fine and dandy and as focused on real estate as ever, yet the storm clouds still look to be brewing out there, and are even weighing on the rental sector. If rents are down, why isn’t it affecting the purchase prices of the same units? Will this so-called fundamental stuff eventually matter?

Though rents are a big factor in the value of housing, a part of that to consider is the gearing involved: as rents race ahead, the added rent is essentially pure profit for the landlord (the beauty of a fixed-cost business), allowing a disproportionate increase in the price of the unit. As rents fall, the same should hold true in reverse: the price should fall by more than the decline in rents. However, investors can also speculate on future rents, while the rental market is basically a spot price. So if you believe that all the factors currently holding rent down are temporary, it may be rational to not cut your price by much, or even to down a big ol cup of FOMO FlavorAid. Conversely, if all the demand factors are down for the foreseeable future, and rent inflation may be muted for a long time, then prices should drop a lot — first to catch up with the lowered rent, and then to reverse the expectation for rapidly rising rent that had already been baked into prices.

As always, I look around and renting looks to be the smart move. The price:rent is IMHO more likely to be fixed in the long term by prices coming down than rents going up. But the market can stay irrational for a long, long time, and based on how the spring is setting up, a while longer still.

There’s a parallel in the Gamestop (GME) mania: with a long-term view, you may see a mostly bricks-and-mortar retailer with limited profit potential, worth nowhere near the current price. But short-term supply-demand imbalances (a mania combined with short covering, and options fuckery*) can drive the price up far beyond that, and it’s impossible to know the precise moment it will turn.

* – I believe the technical term is gamma squeeze but I don’t want to have to try to explain it.

I’ve been quite unimpressed with the big banks’ phone systems during the pandemic. Not just the long wait times (nearly two hours the other night with TDDI) which is somewhat expected (it was regularly 45+ minutes in the before-times, and more has to be done remotely these days), but their schedule-a-call services have been particularly disappointing.

My first attempt at a scheduled call was with RBC… who completely ghosted me at the appointed time. That was set up in the first place because the regular phone staff couldn’t answer an estate question after the first hour-on-hold wait. I gave up on trying to resolve it remotely at all, and sat on the issue for a few months until I could deal with it in-branch.

When I went to set up a new youth account for Blueberry, TD wouldn’t let me do it self-serve online — it required an appointment. Fortunately they offered the option of a phone appointment so I could avoid an unnecessary trip out of the house (and the accompanying covid exposure). Which was my second experience with a scheduled call. They did call on time… only to tell me they couldn’t open a youth account over the phone and I had to go into the branch. Someone should tell the web team so the website scheduling the calls doesn’t waste everyone’s time — I got to the schedule a call in the first place from choosing to open a youth account within the website. And while some banking services are essential, I wasn’t going to worry that much about setting up an account for Blueberry that I’d go out to do it during a stay-at-home order.

Anyway, Blueberry now has her very first bank account at Tangerine, which we were able to set up completely online — I didn’t even need to call! How is this still so hard for the big banks?

Ontario provided its updated figures and modelling for covid today. The slides are available here if you want to look at the data without squinting at the video.

It’s not all that unexpected — I was sketching vaguely similar curves and worried about what an even more contagious version might do. But hearing it made real was just crushing. Covid’s on track to challenge heart disease and cancer for the top cause of death in Ontario this year (and will make the top 10 easy). And the strain on the hospital system is delaying treatments (esp. surgeries) which will make those other conditions worse.

But the big, not entirely surprising bad news is the hospital system and ICU beds: we’re just about out of empty ones, and the curve is still rapidly going up and to the right. Surgeries are being cancelled (again), and we’re not far off from very painful decisions about what happens if there’s a car accident.

One thing that’s crushing is that we were so close to getting to zero in the summer, and just opened back up a few weeks too early, without the testing and tracing capabilities ready. Still, the cases were low, everyone had stocked up on masks, and I genuinely thought we could get back to normal-ish with masks, handwashing, and social distancing*. I signed up for curling, expecting we would get a season, esp. with the modified rules of play (everyone wears masks, and things like using one sweeper to maintain 2 m between players at all times) — I had my mask rotation all planned out, and even got contact lenses so my glasses wouldn’t fog up. Schools reopened, and we kind of talked about how important that was for parents to be able to go back to work.

Then the cases started rising in the fall, and we did nothing about it until we’re now finding the hospital capacity getting crushed again. More people are going to lose their dads and other loved ones to cancer because surgeries had to get postponed, again.

I’m depressed and angry and just crushed at the whole thing.

I’m also a touch confused. They showed some data about how many people were moving around — people going to work has stayed steady since the summer, even as Toronto, Peel, and York went into lockdown (code red or grey or whatever). How there was a big spike in people visiting other residences at Christmas (to the surprise of no one). But I haven’t heard much on contact tracing and explaining what’s behind all the transmission. Are masks and handwashing and social distancing working, but some people aren’t compliant, and it’s that movement that’s the problem? Is it schools or workplaces or superspreader weddings? A little bit of everything adding up?

For most of those questions there isn’t much I can do on a personal level. I’ve tried to cut out contact with the outside world as much as possible, stretching out the time between grocery trips to two weeks or so, and our social circle is a completely closed bubble of 5 people. Wayfare has been making homemade masks since the beginning, and she did a lot of research on the best patterns and designs. They’re 3 layers, with two layers of regular (cotton?) fabric sandwiched around a layer of non-woven interface material. They have metal strips to conform to the nose (important to minimize glasses fogging and get the air moving through the material for filtering and not around the material), and straps to tie tightly around the head, which keeps it pretty well sealed all the way around the face. Though she made a few models with noses or cone shapes or whatever, I wear the basic pleated rectangle ones, so there’s no tiny holes from stitching a seam right in front of your nose. I’m sure they’re a step up from disposable surgical masks, even after a few washes. And I’m very good about wearing it whenever I’m indoors (or with another person outside — though I don’t wear one on solo walks).

However, are cloth masks enough, especially with the new B117 variant? Should we all (but especially should I) be wearing a N95-equivalent to go grocery shopping?

* – Circling back around to add: I thought the masks, distancing, etc. precautions would be good enough to get r < 1 so life could return to more-or-less normal. It doesn’t look like those were sufficient in practice (whether it’s non-compliance or whatever is a bit of a moot point as we will have non-compliance, esp. as covid fatigue sets in). We are a long, long way from Covid-zero (and we were really close in the summer!), but that may be the only strategy that lets us avoid the hammer and the dance through the fall based on the current vaccine roll-out projections.

Ontario hit 89 daily Covid deaths today. We could lockdown tonight, go full Wuhan and weld peoples’ doors shut, and it wouldn’t stop us from hitting 100/day by next week — those people already have the virus, it’s just taking time for them to get sick and die. [Though I’d be happy for the universe’s constant need to prove me wrong to kick in here and save a bunch of lives as this turns out to have been the peak]

Lags make it hard to manage things, especially when that management also involves really hard decisions. It’s hard to call for a lockdown when cases are barely into triple digits. But that’s when it has to happen when you only have a few hundred spare ICU beds in the province. Ah well, back to home schooling for at least a few weeks now, though I still don’t actually know what the plan is. Is it Covid-zero?

And of course this is also why we wanted to start curbing the growth in greenhouse gas emissions in the 90s… or now, I suppose.

[Editor’s note: I’ve been sitting on this draft for a few months. Other than compiling some ideas from others and ranting a bit, the post as it is isn’t all that original. I thought the really clever bit would be to add some actual research and back-testing on fads and frauds to semi-seriously answer the question, but that turned out to be too much work and I now realize I’m never going to do that much research and stats even if there’s a chance that it’s more than just a lark. Anyway, I figured you may as well get to read it instead of killing it off. This one certainly isn’t investment advice, and I’m not alleging any companies or people are frauds here — I’m linking to the allegations and cases where I can, innocent until proven guilty, etc. etc.]

Elon Musk tweeted out in the middle of the trading day: “Am considering taking Tesla private at $420. Funding secured.”

Funding was not secured, not remotely. It was one of the most egregious and blatant cases in living memory and the SEC filed fraud charges. It revealed significant problems with corporate controls given that his Twitter account was identified as a channel for official company communications, and looked like a slam-dunk open-and shut case for the SEC.

Yet he settled for a slap on the wrist: no D&O ban, no forced divestiture of his holdings, just a requirement to add two new independent directors, and a $20M penalty (the company also paid $20M). Less than two years later, he got an incredible pay package tied to the stock price, orders of magnitude larger than the fine, despite the company still not producing an annual profit [at the time — it has eeked one out between drafting and posting this] and even clawing back bonuses for its workers. Oh, and despite coming very close to driving the company into the ground along the way (though there was no going concern language in its reporting at the time).

Securities regulators are broken. They are not working to protect investors or provide for rational, functioning markets. It was only at the last minute that the SEC stopped a bankrupt company from issuing more stock that it knew to be worthless. It’s the golden age of fraud.

And it’s not just a SEC problem. Germany’s BaFin failed spectacularly in regulating Wirecard, even prosecuting people working to expose issues at the company, instead of taking their leads and investigating the company (i.e., their jobs). And here in Canada, we have a patchwork mess of regulators. Not just the provincial securities regulators, where even when they get someone, the penalties can be the cost of doing business, but even within a province we can have different regulatory bodies letting problems slide. Bad actors can use the courts as a weapon, and even if you win a SLAPP suit, it can be costly and disruptive to your life, while bad actors buy themselves months or years more time to keep fleecing investors as critics and defenders of everyday investors are forced into silence.

Bad actors have free reign in the capital markets. None has put it quite so boldly as Musk’s “I do not respect the SEC,” (or the 2020 remix) but the days of fearing the wrath of the regulators appear to be a quaint figment of history. And regulatory capture is such a joke they don’t even try to hide it any more.

Indeed, I have heard it said¹ that frauds are some of the best investments out there. After all, they don’t have earnings misses when the numbers are fake anyway.

Or as some have so eloquently put it: Fraud creates alpha².

As an investor, you almost have³ to assign some portion of your portfolio to frauds and fads to keep up. And given that there is no downside any longer, as a CEO or Director of a company, you have a fiduciary duty to commit fraud².

That’s a fine angry rant against the state of the markets as they sit today. If we had elections for OSC or SEC head, I might be just ticked off enough to throw my hat in the ring (or go campaigning for someone with a more protectionist bent). But that’s not how it works. There’s nothing to do but rant and carry on. Yet I keep coming back to that lovely, infuriating phrase:

Fraud creates alpha.

It’s a thing that we say — shaking our heads and laugh-crying — to encapsulate the absurdity of our times. But… is it true? Does fraud create alpha? Like in a systematic way? Should we be checking if it might be a 6th factor in the Fama-French schema to round out size, value, profitability, and investment?

Let’s make it F&F — fads and frauds, because that’s another area where there has been some outsized stock performance lately. Indeed, it’s almost like that litmus test of the Nigerian scams, where the emails are purposefully full of spelling mistakes to try to weed out those who may not be sufficiently gullible. The business models in some cases have no hope of working, or at least will never reasonably justify the stock price⁴. But that’s likely the point — as long as no fundamental analysts are buying it anyway, then the sky’s the limit. 3X revenue may be crazy-sauce in a low-margin business, but once you’re already there, 7X is really no crazier! And with a touch of what some may interpret to be stock manipulation, why not see if we can shoot for 20X while we’re at it?

Many modern “success stories” are incinerators of capital, serially selling stock to fill the hole created by losses and growth for growth’s sake, though as a side effect they have created a world where our lifestyles are subsidized by dumb capital. Oh, and skirting (or at the very least, bending) the law is a key element of disruption for many of these start-ups — from how they pay and treat their workforce as independent contractors, to flaunting municipal taxi, zoning, or other laws, if not securities laws themselves.

We who can recite the Litany of Saint Graham (“In the short run the market is a voting machine, but in the long run it is a weighing machine”) believe that fads and frauds will one day crash. Some people even make their living shorting them. But far too often, they go up first. They go up a lot.

And therein is the question: do fads & frauds create alpha? Now if you hold until they crash — assuming they do eventually crash and burn — then you’d think not, it would be trivial. To cite the Disciple of Graham, a string of impressive numbers multiplied by a single zero is still a zero. But if you take an approach where you rebalance away as they go parabolic, there might be something there. In an equal-weight portfolio of shit, you may not care much when your German payment processor is finally de-listed if your California vapourware company has sextupled in value. It’s skewness of returns in over-drive.

So let’s build an index and backtest. For example, if you buy in as soon as a report or article or forum post first suggests something fishy, and then rebalance away after each doubling (to other F&Fs or a core market portfolio if you run out of ideas), would that generate alpha?

This is the point where I thought actually doing a bunch of research and math would make the post more fun (and maybe even prove or disprove the point instead of just ranting), but it’s also a lot of work and it’s been many months since I first drafted this and I don’t think I’m ever going to get the research/math part done. So I will leave the idea there — maybe someone else with some time on their hands can go back a few decades and see if you can construct an index of fads & frauds and some rules (equal weighting? trend-something?), and see if it provides improved risk-adjusted returns.

1. Likely Carson Block on a podcast — apologies to whoever said it as I didn’t keep the source, but I think it was a podcast and not an article if that helps.
2. I think this can be attributed to TC. There’s probably more in here that can be attributed to the Chartcast.
3. No you don’t especially if you’re a smart passive investor, this is a whiny post and not actual investment advice.
4. I have heard it said (Chanos?) that one of the worst things for a fad company to do is to make a profit because it’s stock will crash when it suddenly goes from being valued based on some dream about TAM to being valued on a price/cash flow or price/earnings basis.