Hot Off the Web– May 31, 2010

Personal Finance and Investments

In the Globe and Mail’s “How to avoid tax on U.S. dividend stocks”, John Heinzl answers questions relating to Canadian taxation of dividends on U.S. equities. The answer is dependent on the ‘location’ of the assets i.e. the type of account that the equity investments are held in. In a taxable account there is first a 15% withholding tax at and then dividends are treated as regular interest income, though “the 15-per-cent withholding tax would qualify for a foreign tax credit on your Canadian return”. In an RRSP there is no in-year tax implication (tax is deferred until the moneys are removed from the RRSP) and there no withholding tax on U.S. equities, because RRSPs qualify as a pension vehicle under US-Canada Tax Treaty. However TFSAs and RESPs don’t, so withholding tax applies. So he suggests that you might want to hold such securities in an RRSP.

Tim Cestnick in the Globe and Mail’s “Selling the keys to the family cottage”looks at succession planning as it pertains to the selling of the family cottage. He explores various options, but in all cases “Whether the sale takes place during your lifetime or upon death, start by making sure you’ve calculated the correct adjusted cost base (ACB) and keep those records handy. The higher the cost amount of your property, the less the taxable capital gain will be. Make sure you’ve included in your ACB the cost of all capital improvements to the cottage (whether or not you have receipts”. (This is essential, since the heirs will have no clue on the current ACB and will end up paying more tax than necessary.)

Real Estate

The March 2010 U.S. Case-Shiller housing index was released this past week The First Quarter of 2010 Indicates Some Weakening in Home Prices According to the S&P/Case-Shiller Home Price Indices. “The U.S. National Home Price Index fell 3.2% in the first quarter of 2010, but remains above its year-earlier level….Housing prices rebounded from crisis lows, but recently have seen renewed weakness as tax incentives are ending and foreclosures are climbing.” “13 of the 20 metro areas showed a decline in March compared to February.” The Florida cities in the composite, Miami and Tampa, are off 48% and 43% from the 2006 peak, respectively.

In Canada the March 2010 Teranet- National Bank Composite House Price Index  shows an 11.6% increase from very low March 2009 level. The composite is up 12% from the April 2009 trough and up 0.3% from February 2010 level. Toronto is up 15.5% on the year, 16.3 from the trough, but it showed no change from the previous month’s level. “Month-over-month increases have recently decelerated considerably….the broad slowing of monthly gains is consistent with a general loosening of the resale market conditions across the country. For some months now, homes have been coming on the market much faster than they have been selling.”

Other interesting articles on the Canadian housing market are the Globe and Mail pieces by Steve Ladurantaye’s “Nearly 20% of homes overvalued: report” and Boyd Erman’s  “Foreclosure wave deemed unlikely”, whose titles speak for themselves.

Pensions

CARP’s article Bill C-501 discusses how Canada’s federal government is using procedural blocks to prevent progress of this critical bill; “realities of parliamentary practice suggest that a lack of political will to confer preferred creditor status on employees caught in a bankruptcy proceeding- rather than a scrupulous regard for parliamentary procedure- may be the real force behind the stoppage of bill c-501”. Fortunately the bill was moved to committee with the support of all members of the opposition parties and 12 Conservative members; unfortunately only 12 Conservative members were willing to stand up for the key principle of priority of pension underfunding in case of sponsoring company bankruptcy. So the Bill C-501 and its supporters live to fight another day. To have an impact on Nortel pensioners the bill needs to be retroactive to January 13, 2009 and it must cover cases where even though the sponsor technically only entered bankruptcy ‘protection’ for purpose of reorganization (CCAA), but for all practical purposes (like Nortel) has gone into liquidation rather than ‘reorganization’ under the bankruptcy protection proceedings.

Things to Ponder

Eleanor Laise in the WSJ’s “Danger: Falling ETFs” discusses the complexity (and risk if not handled with care) that come with ETFs, which otherwise should be the picture of transparency, liquidity and simplicity. So while on May 6^th over about 20 minute interval when the Dow fell almost 10%, some ETFs dropped by 50% or more (some even to pennies), though the exchanges cancelled “any trades executed at prices 60% or more away from pre-crash levels”. “Many ETFs didn’t behave like broadly diversified baskets of stocks—they performed like single stocks subject to the whims of panicked traders. For some ETFs, the “net asset value,” or the value of underlying holdings, fell only 8% or so even as the market prices of the ETFs plunged 60% or more.“ Investors who placed stop loss orders (which are in effect market orders once the trigger price is hit) on their ETFs ended up selling some of their holdings at 50% or even less than the pre-crash prices. Laise then weighs in with some rules that ETF investors should consider such as: (minimize or) don’t trade on very volatile days, use limit rather than market orders, consider trading costs resulting from wide bid-ask spreads in your choice of ETFs (try to limit yourself to very broad market and highest liquidity ETFs), and look at underlying market value of the ETF before trading. In a related article Jason Zweig looks at a eerily similar plunge in “Back to the future: Lessons from the ‘Flash crash’ of 1962”; both events resulted from sudden evaporation of liquidity when key market participants (‘specialists’ in 1962 and ‘high frequency traders’ in 2010) withdrew from the market in the face of ‘rapid’ price drops. In the Financial Times article “’Flash Crash’ delivers clear messages” Duncan Niederauer argues that the ‘flash crash’ was caused by “weaknesses in the structure and mechanics of our market system rather than any particular piece of economic news”. While he is encouraged that the SEC has quickly enacted single-stock ‘circuit breakers’, he feels that confidence in the system has been shaken and further steps are required like: increased transparency (30% of all stock transactions in the US do not occur on regulated exchanges”) and insufficient transparency in ‘price discovery’.

In the Globe and Mail’s “Greece could set off bigger debt bomb” Eric Reguly looks at the potential fallout from the Greek debt crisis: “The upshot is that some major countries face debt restructurings, debt defaults or both. High debt-to-GDP ratios alone can kill growth, as governments soak up private savings to pay interest charges and borrow more. …Here’s a guess: Governments will take the cowardly option and try to inflate their debts away. They won’t stop spending, and the currency printing presses will run flat out. But that strategy often backfires, and the threat of default grows ever larger. Gold and productive real estate, like wheat farms, may be the defensive investor’s only remaining assets of choice. (Thanks for link to Jurgen S.) By the way the sovereign debt crisis was prominently discussed by many speakers at the 2010 CFA Conference I just attended; I summarized the conference highlight at 2010 CFA Conference Highlights.

In the Financial Times’ “The grasshoppers and the ants- a modern fable” Martin Wolf describes the current European crisis in terms of a fable with the Germans (and the Chinese and Japanese) as the ants and the Greeks (and the Americans and British) as the grasshoppers. He reveals in his conclusion the interesting moral of the fable “If you want to accumulate enduring wealth, do not lend to grasshoppers”; hopefully the grasshoppers are paying attention and the ants are less so.

David Rosenberg, in his May 26 Breakfast with Dave, doesn’t rule out 20%+ correction after the recent 80%+ recovery within one year, by analogy with 100%+ one year gains in 1932 and 1933 which were followed by 30-40% corrections.

In the Financial Post’s “Cashing in your human capital” Jonathan Chevreau reminds readers that Total wealth= human capital (HC) + financial capital (FC). People start their working lives with 100% HC and 0% FC, spend their working lives converting HC into FC and finish off with close to 100% FC and 0% HC. Human capital should be factored into the overall asset allocation, normally considered only in the terms of financial capital. (If you are interested in the topic, you might want to read my couple of years old blog on the subject of Life-Cycle Investing)

Paul Vieira in the Financial Post’s “New national securities regulator unveiled” reports that “the federal government tabled legislation to create a national securities regulator…that can act swiftly…against sophisticated white collar crime”. Alberta and Quebec are still unhappy, but one Canadian regulator probably makes good sense. Of course having one Canadian regulator for Canadians’ pensions is even more urgent and it’s not clear that pensions are even included in this discussion.

In the Globe and Mail’s “Why Canada should worry about bloated family debts” Michael Babad writes that the recovery in Canada is strong but  “the OECD warned, however, that “the high rate of household indebtedness is a source of risk to the outlook.” (Canada’s household debt is $41,700 per person and current interest rates are at all time low but “the central bank is expected to soon begin changing course, possibly raising rates as early as next week” and “higher rates could still be a problem for consumers who took on more debt than they can juggle should rates rise rapidly.” And just out, “Canadian economy tops forecasts”with a Q1 growth at 6.1% (annual rate, I assume; and also likely a Bank of Canada interest rate rise tomorrow.)

Sandra Ward interviews Bridgewater’s Ray Dalio in Barron’s “Set aside fears of inflation- Just for now”. Dalio’s view is that “The depreciation of the major currencies and the printing of money will not cause a significant general level of inflation anytime soon….The printing of money will offset the deflation that is coming from the weak demand for goods and services due to weak credit growth. For example, in March of 1933 the U.S. printed a whole lot of money, and that had the effect of converting deflation into modest inflation, but not a high rate of inflation…. My point is, in developed countries there is too much of most things at the moment, and that’s creating a deflationary environment…That is why, contrary to almost everybody’s belief, I believe the bonds in countries that can print money will be good investments.”

And finally the golden story, starting with the WSJ’s Brett Arends’ look at the two sides of the gold story. First he argues that perhaps it’s not too late to buy even if gold is a bubble since “it may be about to go vertical” in “Is gold the next bubble?”; comparing gold to Nasdaq and S&P Homebuilding indexes, gold is less than half way to those peaks of which indexes increased 9-fold over a little over a decade. Gold’s momentum is also helped by the current loss of confidence in paper money, and on inflation adjusted basis at $1200 it is still far from the inflation adjusted $2300/oz 1980 peak or from $6300/oz required price for the gold held by the U.S. to cover 100% of the U.S. dollars in existence. A couple of days later in WSJ’s “Why I don’t trust gold” he proceeds to explain why “gold, as an investment, is absolutely ridiculous”. “Warren Buffett put it well. “Gold gets dug out of the ground in Africa, or someplace,” he said. “Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” And that’s not the half of it. Gold is volatile. It’s hard to value. It generates no income.” And he argues that the only reason that the price is rising is because there are more buyers (hoarders) than sellers. He concludes with the question: “What do you call an investment where current members’ returns depend entirely on new money brought in by new members? A Ponzi scheme.” (He has a third article that’s in the pipeline where he will “square this golden circle”. My take on gold might be considered an insurance against very high inflation, depreciation of the U.S. dollar and catastrophic loss of confidence in paper money; in this context I bought some “insurance” (at around $400/oz), and currently still hold about 3-4% of my investable portfolio is in gold. Richard Wiggins in this weekend’s Barron’s argues that this “soft, semi-useless metal with very few industrial applications…is just another fiat currency” in “Gold: The ultimate fiat .currency” .