Friday, March 17, 2017

Eliminated AFSS: Sold 100 at $25.28 and 50 at $25.25

I was planning to discuss this trade sometime in April but have moved it forward to today based on recent developments. 

I sold based on a queasy feeling about this company that was developing based on what I knew on 3/15/17. I will first describe what I knew before today and then briefly discuss the news from today. 

Subordinated Exchange Traded Bond: $23.65 Down $1.66 or 6.56% 
Common Stock AFSI $17.31 -4.30 -19.90% as of 11:27 today 

In this case subordinated means ranking below senior unsecured debt. Generally speaking, a subordinated bond would be classified as a junior bond senior only to equity capital. 

These transaction occurred last Wednesday. 

A. Sold 100 AFSS Shares at $25.28

Profit Snapshot: +$87.94

Interest is paid quarterly at the fixed coupon rate of 7.25%. Par value is $25. Prospectus  
AFSI has reserved to itself the right to redeem this junior bond at par value plus accrued interest on 6/18/2020 "or on any interest payment date thereafter".
This bond is senior to AFSI's common and equity preferred stocks in the capital structure, but is junior to all existing and future senior debt.
As discussed in a prior post which I am quoting here, "this company is controversial and has drawn criticisms from short sellers about its accounting. I will simply reference some of my earlier discussions on that topic and refer anyone interested to a few SA articles:
Since I have no training in accounting whatsoever, I can not resolve those allegations one way or the other. Their presence, however, causes me to limit my exposure to AFSI in monetary terms." (End of Quote)
The controversy surrounding AFSI's accounting accelerated after the company issued this press release on 2/27/17 which explains why I decided to sell AFSS: 
See also: 
So this brings me up to today.  

B. Sold 50 AFSS at $25.25 Using Commission Free Trade:

Profit Snapshot: +$50.47

The company said today that its financial statements dating back to 2014 should be disregarded: Press Release After Close On 3/16  

It is possible that I may buy back 50 of the 150 shares sold. Other than telling investors to disregard previous financial statements which was implicit in the 2/27/17 release, there does not appear to be anything dramatically new in today's press release, a statement made with substantial trepidation given my ignorance on accounting matters and that the company has not issued clean numbers yet. I will have to wait for lower prices since I am now concerned a lot about both credit and interest rate risk. 

I classify this security as an Exchange Traded Baby Bond that is part of a larger category of Exchange Traded Bonds

Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. A failure to perform due diligence only increases what I call "error creep". Stocks, Bonds & Politics: ERROR CREEP and the INVESTING PROCESS Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.


  1. AFSS Closing Price 3/17/17: $23.16-2.15 (-8.50%)
    Day's Range 22.84 - 24.58
    52 Week Range 22.84 - 26.81

    At a total cost of $23.16 per share, the current yield would be about 7.826%. That is not enough for me to buy back 50 shares given the elevation in credit risk.

    The common shares, AmTrust Financial Services, Inc. (AFSI), closed at $17.58, down 18.65%.

    Day's Range 17.10 - 19.50
    52 Week Range 17.10 - 28.48
    Volume 10,483,691
    Avg. Volume 981,686

  2. Wow, great timing on that sale. Trust the queasy feeling!

    Your ability to monitor the dozens of holdings in your portfolio on a daily basis is impressive. I have my hands full with only six ticker symbols to watch.

  3. South Gent,

    Ditto Cathie's sentiment.

    Given your portfolio size and average size of the positions how are you able to monitor your portfolios AND write the long blog of meaningful contents at such an incredibly frequent pace?!

    Instead of asking you for a fish would you mind teaching us "how to fish"? I think it might also help slow down my aging process (including my deteriorating brain functions).

  4. My portfolio is a mile wide and an inch deep since I wish to limit my exposure to each company in the portfolio. That is one risk mitigation measure.

    Another risk mitigation measure, which applies to both stocks and bonds, is an increasing emphasis on preservation of capital with an income flavor. That is due in part to my opinion that the risk-reward balance for most risk assets is skewed heavily toward risk now. It was this particular ongoing risk mitigation factor that led me to sell AFSS last Wednesday and would keep my from even buying 50 shares at the closing price today.

    I was a little slow on the uptake which is unusual and was due to a failure to look at one of my Yahoo Finance monitor lists for several days. I am supposed to look everyday.

    In one list, I have the stock symbols of every company where I view their bonds to have a noteworthy credit risk. I do not own, nor do I plan on owning the common stock. If I see some unusual downside price action in the stock, I will find out more about the negative news development, and its potential impact on my bond investment.

    When I opened that portfolio, I can news items relating to the stock symbols, and I noticed information about AFSI's accounting issues that had been first divulged in the 2/27/17 earnings press release a few days earlier. So that is one way to monitor potential danger signals that could impact the value of bonds

    AFSI has had in the past numerous criticisms of its accounting practices which management has dismissed, and consequently the company lacks credibility about the scope of the problem when it had to admit to errors. Efforts to minimize the impact in last nights press release had no discernible positive impact today since the cockroach theory is now in play.

    The Bond Ghouls will also signal credit concerns through pricing long before a rating agency downgrades the bond. So it helps to know generally the yields for similar rated maturities in order to know when one of your bonds is way of kilter with the average range of yields. When that happens, an alarm bell goes off here at HQ that requires some investigation as to whether or not the concerns are justified by publicly available information.

  5. South Gent,

    Thank you for the detailed reply.

    I used to subscribe to a model of 20-30 positions, but it became too volatile at my age. Over the years I have adopted many of your investing strategies, key among which is risk mitigation. "A mile wide and an inch deep" is very descriptive of my current portfolio as well.

    Continue on the topic of fixed income's role (to generate income and prepare for a correction)in the current market environment. I looked at the 1998-current charts of S&P and US Corporate AA Effective Yield side by side. I see that

    1. AA rated Corporates positively correlated with S&P between 2003 and 2008 as the economy was expanding and overall debt built up.
    2. After the Financial Crisis AA rated Corporates diverges from S&P (due to the Fed's ZIRP).

    Now that the Fed has ended ZIRP because of a stronger economy and good employment condition. Would S&P continue to rise with an expanding economy? Or, would S&P correct first due to stretched valuation and/or external factors? I think you have already assigned a higher probability to the latter.

    1. There is a chart in this January 2014 Forbes article that shows the rolling correlation between the five year treasury and U.S. stocks starting in December 1931.

      Most of time, the 5 year treasury is showing modest positive or negative correlation with stocks which simply means that high quality bonds can act as a portfolio stabilizer and diversifier.

      In the period starting near 1950 through 1965, the correlation was negative. Bonds were in a bear market while stocks were in a long term secular bull market. Inflation was subdued throughout that period and can not explain why bonds produced negative real rates of return. The reason was due in large part to the FED successfully pegging the ten year treasury at an abnormally low level, as I have explained earlier and is further discussed here:

      Normalization to market set rates caused yields to rise and bonds to go down in price. The return to normal rates set by a free market, rather than by the CB, started a 32 year bond bear market.

      The economy was then in a post-WWII consumer led recovery. Stocks were cheap coming out of the Great Depression period and inflation was low.

      Starting in 1966, positive correlation was the dominant trend through 2000, but you have two break that period into two segments.

      In the first segment, lasting from 1966 and into 1982, the correlation was positive because both markets were going down. If the chart had inflation adjusted total returns, the positive correlation would probably be more pronounced. From January 1966 through July 1982, the S & P had an annualized average total return loss of over 1.8% adjusted for inflation and with dividends reinvested. That period also experienced a horrific bear market for bonds. The primary cause for bear markets in both asset classes was problematic inflation.

      In the second segment, 1982-2000, the positive correlation was positive in a positive way. Both were going up in value. Bonds were coming out of a 32+ year bear market and stocks were exiting a 16+ year bear market. Yields were high. Stock values were low. Inflation and interest rates were coming down.

      There can be different reasons over time that rationally explain the correlation.

      It is a possibility now that the next 15 years will usher in a period where there is what I call negative positive correlation. Both asset classes are richly priced and have a large number of future assumptions embedded in their pricing which are not realistic. One of those assumptions is that inflation and interest rates will remain at abnormally low levels, and relatively stable, for the next 15 years. Growth is predicted at much higher levels than over the past 15 years based on assumptions that appear to me know as unrealistic.

      The current generation has not been through an extended period where both asset classes fail, and there is a reasonable possibility that we will soon enter such a period. If so, it will be roller coaster ride going up and down in fearsome movements that ends up going nowhere after 10+ years.

  6. If both asset classes (equities and bonds) are going into a long bear market, there will be no place to hide. Maybe we should start looking for a sector that pays good and growing dividend and has the pricing power to thrive in an inflationary environment?

  7. Y: I simply view conditions as favorable for a long period where both major asset classes fail to produce positive or meaningful total returns adjusted for inflation.

    We are already in that scenario with bond ETFs.

    For example, the iShares 7-10 Year Treasury Bond (IEF) had a 1 year total return of -2.38% through last Friday unadjusted for inflation.

    The annual increase in CPI through last February was 2.7%, which results in about a -05.08% real total return (dividends reinvested).

    The 5 annual average total return was 2.27%, close to the five year annual average CPI rate.

    The yield provides at best a minuscule cushion for a loss in value. The sponsor says that the 12 month trailing yield was 1.8% as of 3/16/17 with a weighted average maturity of 8.36 years.

    The duration is listed at 7.58 years. A one percent rise in interest rates would result in about a 7.58% loss or 4.21+ years of dividends payments at 1.8%. And, that is before an inflation adjustment.

    Given the abnormally low yields, a return to normal inflation and interest rates will smash the prices of bond funds, particularly those that borrow short term to buy more longer term bonds.

    The stock market is near historical highs using many valuation measures such as the Shiller P/E. There are no major adverse events baked into prices while major positive assumptions about the future are priced at certainty levels. While an external shock such as a trade war or recession could be the catalyst for a major decline, valuation corrections can start without anything concrete happening that you could point to as a cause. It is more like a thundering herd changing directions and trying to squeeze through a shrinking door at the same time as selling begets more selling as people see their unrealized gains start to evaporate and panic becomes the dominant market force. Possibly, that may start later in the year or next year when too many investors are confronted with the reality of the U.S. growth rather than the rosy assumptions being made now, more than for a year or two, but for over a decade.

    So bond funds have already started to fail and that IMO will get worse. The question then is when stocks will start their roller coaster rise, which is a trader's market. Some of the biggest up and down percentage moves are made in long term secular bear markets.

    As to what works, that requires an analysis in real time. Back in the 1970s, gold and silver, Japanese stocks and energy stocks worked. During a catastrophic phase of the 1966-1982 long term bull market, other stocks could be bought by long term investors willing and able to hold for years and by traders buying the dips and selling the rips. That is one hard market to navigate successfully.

    My first approach would be to keep my bond durations short and to use a ladder strategy. I might go out longer when and if I conclude that a recession is on the horizon but that could be nothing more than a trade. I will have to adapt to the then existing circumstances by identifying what can work.

    The really bad scenario where both asset classes fail is not common but it has and will happen. My formative years as an investor were during the last occurrence. Conditions are ripe now for a repeat given the abnormally low interest rates and the current valuations in the stock market.

    Looking at a DJIA chart since 1982 may give some pause now.

    This chart is inflation adjusted. To see nominal numbers, uncheck the "inflation adjusted" box:

    When looking at this long term chart, unadjusted for inflation, the 1966-1982 period is what I would call a flatlining period. Within that period, there was a lot of up and down movement which ultimately went nowhere on a price level after 16 years.

  8. South Gent,

    I was thinking about the growth of DJIA/S&P since 1982. As 1982 was about the time when PC started to be widely used it can be marked as the beginning of the digital revolution. Maybe all the digital things (IBM, MSFT, NFLX, TSLA, .....etc.) and internet of things (FB, LNKD, TWTR,....etc.) will account for the growth of DJIA/S&P since 1982. However, the sector ETFs did go back that far to prove the point and XLK is still below its March 2000 high. But if this wealth creation is real and still alive we shall see the indices go higher after the inevitable market corrections.

  9. Y: As with all long term stock bull markets, there are several strong forces that coalesce to drive the economy and market up.

    For the bull market that started in August 1982 and ended in 2000, the initial spark was a recognition by stock investors that problematic inflation was mostly in the rearview mirror. Neither stocks nor bonds will do well when there is problematic inflation and a perception that this unfavorable milieu will continue for the foreseeable future.

    The second force that initiated that bull market was a long period where stocks and bonds had failed as asset classes. The 30 year treasury went over a 15% yield in 1981, and blue chip stocks that paid dividends could be bought for single digit multiples and with 5% to 10% dividend yields.

    So the environment was primed for a long climb up. That is not the case now.

    The bull would have failed within a decade, however, unless other powerful secular forces contributed to the move. The primary force that emerged started in the early 1980s as well and involved the rapid increase in consumer debt. Consumers started to borrow and spend more money as is shown in this chart.

    In the 1983, debt to disposable income was around 64%, well within a narrow 20 year range. Starting that year debt started to accelerate until this ratio hit 132+% in the 2007 4th quarter. Spending borrowed money in ever increasing amounts fueled economic growth and sowed the seeds for the inevitable collapse. We were fortunate that a Second Great Depression was avoided by governments, corporations and individuals taking on over $60 trillion in new debt worldwide assumed since 2007 at abnormally low rates which will need to be financed and refinanced.

    McKinsey calculated that number as $57 trillion over two years ago:

    This does not make the world economy more stable but less stable and more susceptible to another catastrophic event which, in the future, may be beyond the control over governments and central banks other than to watch it unfold and slow it down some.

    The period of spending increasing amount of borrowed money ended in the Near Depression. The onset of the Age of Leverage also involved the U.S. and other governments spending more borrowed money. As a reminder, the U.S. debt was less than $1 trillion in 1979. Deficit spending went into overdrive starting with Reagan and continuing through today.

    The last force in order of importance was productivity gains caused in large part by the computer revolution. I doubt that this revolution which is now moving in a different direction created or will create more jobs than it destroys. Those new companies which you mention are not major employers. Amazon, for example, probably destroys far more jobs than it creates. Efficiencies and automation have that result.

    For now, there is nothing flashing red in the market internals. I would view a continued expansion of market multiples, already near historic highs, coupled with interest rates and inflation moving up, as increasing the risks of a catastrophic event rather than a permanent wealth creation event for buy and hold investors.

    I suspect that I will go out as an investor during something similar to the bear markets, possibly worse, that existed when I started to buy stocks in 1967 or 1968.

  10. NKTR (own 70 shares Lottery Ticket)

    Pre-Market 3/20/17
    Nektar Therapeutics (NKTR)
    $18.86 +$3.36 (+21.68%)
    Pre-Market: 8:44AM EDT

  11. I have published a new post: