A reality check on Trump’s tax reform agenda

Still etched in my brain was the great income trust debacle that took place on Halloween of 2005. The Canadian conservative government won re-election promising not to change the tax preferred treatment of income trusts. That promise was broken and Canadian investors lost billions of dollars overnight. The value of my income trust holdings fell by 40% instantaneously.

Needless to say, as an investor in U.S. stocks, failure to appeal and replace Obamacare (ACA) makes me very nervous. Trump’s promise of massive tax cuts and infrastructure spending will need support from the Freedom Caucus (tea  party) who want a border adjustment tax to offset some of the loss revenue.

There is also a complicated Senate rule that would prevent Democrats from blocking the tax bill. Under the rule, the bill cannot add to long-term budget deficits. That means every tax cut has to be offset by a similar tax increase or a spending cut.

‘‘Yes this does make tax reform more difficult,’’ said Ryan. ‘‘But it does not in any way make it impossible.’’

Nevertheless, Treasury Secretary Steven Mnuchin said Friday the administration plans to turn quickly to tax reform with the goal of getting an overhaul approved by Congress by August.

House Republicans have released a blueprint that outlines their goals for a tax overhaul. It would lower the top individual income tax rate from 39.6 percent to 33 percent, and reduce the number of tax brackets from seven to three. The House plan retains the mortgage interest deduction but repeals the deduction for state and local taxes.

However, nearly 34 million families claimed the mortgage interest deduction in 2016, reducing their tax bills by $65 billion. Also, more than 43 million families deducted their state and local income plus personal property taxes from their federal taxable income last year. The deduction reduced their federal tax bills by nearly $70 billion.

On the corporate side, the plan would repeal the 35 percent corporate income tax and replace it with a 20 percent tax on profits from selling imports and domestically produced goods and services consumed in the US. Exports would be exempt from the new tax. (border adjustment tax)

The general goal for Republicans is to lower income tax rates for individuals and corporations and make up the lost revenue by reducing exemptions, deductions and credits. Overhauling the tax code is actually hard because every tax break has a constituency and the biggest tax breaks are among the most popular.

Over the past week, some investors are starting to doubt that the tax cuts will get passed. The value of the U.S. dollar has weaken and ten year bond yields have fallen  from 2.62% to 2.4%. Eight of the ten sectors that make up the S&P 500 were negative for the week. The biggest losers were U.S. financials (-3.72%), energy (-1.78%) industrials (-1.75%) and materials (-1.3%).

There is a lot of money on the sidelines that missed the Trump rally and are waiting for a stock market correction. I took some profits before the Canadian federal budget that hinted at tax increases so I also have some money to re-invest. The Canadian conservative government taught me a valuable lesson back in 2005. What government promises to do and what they actually do can have a negative affect on your investments.

 

Still doing tax returns for my adult children & their spouses

Every year I ask myself, should I continue to offer to do tax returns for my adult children and their spouses? All of them have university degrees and are smart enough to file their own tax returns. My daughter was willing to do it one year using tax preparation software with only a little help from me.

Part of my problem is Canadians are not even aware of how much tax they pay. Plus we keep voting for governments that buy votes using our tax dollars. The average Canadian family will pay 42.9% of their income in taxes imposed by all three levels of government in 2016. (Federal, provincial and local) Tax freedom day was June 7, 2016 if Canadians paid their total tax bill up front. Our U.S. neighbours tax freedom day was April 24th and they will only pay 31% of their income in taxes.

There are a number of reasons why I continue to offer to do tax returns for the whole family. Having worked as a financial advisor, tax planning is a key element when putting a financial plan together. My tax knowledge and skill comes from working many years with accountants and tax lawyers ensuring that my whole family pays the least amount of tax.

Plus, the Canadian tax system is very complicated and is constantly changing with every federal and provincial budget. For example: many tax credits that were given by the Conservative government have been taken away completely by a new Liberal government.

For the 2015 tax year, the Liberals cancelled income splitting for families, a maximum tax credit of $2,000 for transferring up to $50,000 of income to a spouse with a lower income if they had a child under 18 years of age.

Some changes for 2017 include the elimination of the following credits:

  1. Education and textbooks credit
  2. Children’s fitness credit
  3. Children’s arts credit
  4. Public transit tax credit

Now, most retired Canadian seniors who don’t have a pension from their former employer are not even aware of a $2,000 pension credit. It requires opening a RRIF account, transferring $2,000 from their RRSP and then taking it out. They don’t have to wait until they reach the age of 71 in order to open a RRIF account. Plus, RRIF income can be split with your spouse if both of you are 65 years of age which could potentially add up to $4,000 of income tax free per year.

The Federal Liberal government will introduce a new budget on March 22 and there are rumors of more tax increases. Three things that Canadians should worry about;

  1. Higher capital gains inclusion rate from 50% to 75%
  2. Reducing the dividend tax credit
  3. Taxing your principal residency 

I will end this post with two well known proverbs. ” In this world nothing can be said to be certain, except death and taxes.” & “A penny saved is a penny earned.”

 

10 Reasons to be cautious on equity markets

Image result for david rosenberg

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

Here are my 10 reasons to be cautious on equity markets right now.

Valuations are stretched

Trailing and forward price-to-earnings multiples are now in the top quintiles historically and the most expensive in 15 years.

Only in 1929 and the “Dotcom” bubble has the cyclically-adjusted multiple (CAPE) been as high as the case today.

We are heading into the ninth year in the cycle and have logged an epic 250-per-cent surge in the process. As retail investors now plow in to this market in the late innings, one could legitimately ask what it is they could possibly know that corporate insiders do not, considering the latter have been selling their company’s stock this year at a pace not seen since the data began to be published in 1988.

Extended leverage

U.S. margin debt has surged at a 27-per-cent annual rate since immediately prior to the election to stand at $513-billion, the highest level on record (eclipsing the high from April 2015).

Retail inflows

After an eight-year hiatus ($200-billion of net outflows), private clients have thrown in the towel and plowed nearly $80-billion into mutual funds and ETFs since the November election.

Remember Bob Farrell’s Rule No. 5: “The public buys the most at the top and the least at the bottom”.

Narrowing leadership

For the past four sessions, we have seen more new 52-week lows than new highs (the longest streak since Nov. 4) — a technical sign of a toppy market.

Moreover, the Russell 2000 index is now flat for the year and off 4 per cent from the high — again, we know from history that the generals tend to follow the privates.

Tack on the fact that the S&P 500 recently traded as much as 10 per cent above the 200-day moving average, and we have a market ripe for a near-term correction.

Complacency abounds

From a VIX of 11.9 to nearly 60-per-cent Bulls in the Investors Intelligence poll — though this has begun to roll off its highs in a sign of the “smart money” beginning to take profits.

The S&P 500 has gone 57 days without so much as a 1-per-cent intraday swing, something we have not seen in at least 35 years. The proverbial calm before the storm.

The Fed is in play

The front-end Treasury yields are rising discernibly — the two-year T-note yield has gapped up to nearly 1.4 per cent and futures market is in the process of pricing in an extra two rate hikes after the likely March tightening (the overnight index swaps market currently has priced in 70 basis points of tightening by year end).

The Fed has met its twin objectives and the fed funds rate consistent with that is 3 per cent, not the 0.75 per cent currently.

By the time the Fed reaches that level, the yield curve will likely have inverted long before and that’s when the clouds will come rolling in.

This could be next year’s story, which means a forward-looking market begins to discount this prospect sometime later this year.

Inflation pickup

Cyclical price pressures are showing through, with the core PCE inflation rate at a 30-month high of 1.738 per cent year over year.

As was the case in 1990, 2000 or 2007, this likely is not sustainable, but is a classic late-game signpost nonetheless.

All one needs to see is the latest blow-off in the commodity complex, which is now on pause, to notice how late cycle we are. Remember what oil did, for example, in 2008?

Lofty expectations

The survey data are at extremely high levels at a time when actual economic growth is running barely above a 1% annual rate.

Gaps like this, once again, are classic near-end-of-cycle developments.

The prospect of there being huge disappointment over the pace of policy change in Washington is also very high.

Over-ownership

While households were not net buyers of equities until very recently, the near-quadrupling in the stock market has still boosted their exposure to a 21.1-per-cent share of total assets. Only five times in the past 16 years has the share been this high or higher — this is 42% above the norm.

Frothy credit markets

Bonds lead stocks, just know that. And the risk-premium on U.S. high-yield corporate bonds very recently approached lows for the cycle at a super-tight 335 basis points.

However, they now are widening again, and with the overall narrowing path of the Treasury curve, this is well worth monitoring for those equity investors who are still long this market.

Nobody ever lost money by booking a profit, especially for a cycle that is now heading into year number nine.

Do you think that David is right?

Being Canadian, I am worried about the Federal Budget scheduled for March 22 because there are rumours of an increase in the capital gains tax. I have been taking some profits in my taxable accounts and for investment club just in case. I do believe it is impossible to time the market so I am still fully invested in my tax sheltered accounts.

 

20 Seconds of fame on the National News from a blog post

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One of my blog posts that I wrote back in September of 2015, caught the attention of a T.V. producer at CBC News which is a division of the Canadian Broadcasting Corporation. On Feb 24th I received the following email:

Rico,
I`m a National TV News producer at the CBC and I just read your article “Why I quit being a financial Advisor” we are working on story about the trend away from “active investing” to more “passive investing” and think you might be a unique and interesting voice in our item. Can you give me a quick ring so we can have a chat?

I immediately gave him a call and answered some questions about my views on both active and passive investing. He asked if I was willing to be interviewed at my home which I agreed to but I wasn’t given a confirmed date.

To my surprise, I received a phone call while I was at an indoor golf driving range to do an interview. Not actually camera ready, but they were willing to send out a senior writer and cameraman to the driving range. They couldn’t wait because it was going to air the next day before the RRSP contribution deadline of March first. The producer was kind enough to send me a copy of the story. Click on the link below to view my 20 seconds of T.V. fame:

https://drive.google.com/file/d/0B62hJdYjW6psU3Iwam5JTzRKN0k/view?usp=sharing_eil&ts=58b6e6d5

 

Please reframe from making any comments on my golf swing! It has been three months since I swung a golf club.

 

Is joining an investment club a good idea?

Now, you can learn about investing in countless books, magazines and Web sites, but you may enjoy the learning process more by joining an investment club. After all, most of us are social creatures by nature, so we like being with other people.

A blogger that I follow “Bear With The Bull” belongs to a club that just shares investment ideas. He was kind enough to answer a few of my questions about his club.

How many members are in your club?

“We currently have 36 members on Meetup, not all are active. We use Meetup.com as our internet platform and we have a Facebook group page as well.  We have a 6 month activity clause. Basically we remove anybody who is inactive for 6 months.”

How often to you meet?

“We meet once a month at a local Denny’s. We try to keep the meeting short less than 2 hours. We usually have anywhere from 3 or 4 to a dozen or more show up for the monthly meetings.”

What are the experience levels of the membership, any newbies to investing?

“We have all different experience levels and investment styles. It was surprising to find out that we have pure Chartists, option traders (mostly selling), IBD folks, and people who followed other systems and sites. This past meetup we had 4 new members.  1 newbie, 2 experienced traders but new to IBD (Investor’s Business Daily), and a retired couple who had just consolidated their retirement portfolios into one.”

Is every member required to bring a stock pick or ETF to the meeting or do you take turns?

“A week before each meeting we send out an email asking for stocks and investment topics of interest. Basically this is a solicitation for topics and stocks to discuss and forms the basics of our agenda. We generally give each person the opportunity to talk about their suggestions during the meeting.”

Do you find the information useful and have you invested in any ideas that were presented?

“Generally I and others in the group find the information interesting and informative. Sometime members invest in others watch lists but for the most part I think people use it as a learning experience.”

Are recommendations review at the next meeting?

“We keep a list of all stock suggestions and track their performance. We do keep an informal tally of whose stocks are best or not.”

Thank you “Bear With The Bull” for sharing information about your investment club!

Now, do you lack the confidence or discipline to invest on your own? There are also investment clubs that you can join where members’ pool their money, study different investments and the group decides to buy or sell based on a majority vote. Most of these clubs require a small monthly investment anywhere from $50 to $100 a month.

Some Advantages:

  • Investment clubs can be fun.
  • It is a good way to get your feet wet.
  • Clubs provide an affordable way to invest. (Sharing the costs)
  • Investment clubs, by their very nature, tend to have a long-term focus. Members are interested in following investments over time, not buying and selling at a frantic pace.
  • You can find wisdom in a group

Some Disadvantages:

  • Unregulated – You have to have a high degree of trust. (Income & tax liability is calculated correctly)
  • Disagreements – Democracy is great but you could disagree with the direction of the club or with some of the investments choices.
  • Risk tolerance – Make sure that you’re comfortable with a club’s investment philosophy and the amount of investment risk.
  • Difficulty leaving – Make sure that the club has a reasonable exit time for members who want to leave.

Did you know that Warren Buffett’s wealth to acquire Berkshire Hathaway in 1965 was created primarily from his investment partnerships? The first of which was Buffett Associates, established out of his bedroom in May 1, 1956, at the age of 25. It started with $105,000 from seven partners, all of whom were close family and friends.

He was solely responsible for managing a significant amount of other people’s money with investors agreeing to pay a fee for strong investment performance. These investment partnerships eventually fell under the umbrella of Buffett Partnership, Ltd., which was the entity that bought a controlling stake in Berkshire Hathaway.

I would classify “Buffett Associates” as a legalized type of investment club.  

On a personal note: My investment club just celebrated it’s 15 year anniversary.

Gilead Sciences: A buy, Sell or Hold?

gild-2

Many money managers have made Gilead a top investment pick when interview on some popular business shows. I never buy a stock based solely on the recommendation of a media personality. However, I will put it on my watch list and do some fundamental research and study some chart patterns.

Back in November of 2014, I decided to dollar cost average some Gilead shares using a strangle option strategy. I ended up owning 200 shares at $102.00 and made some nice profits selling covered calls. Unfortunately, the share price has been in free fall since Aug of 2015. See the chart below:

gild

I managed to reduce my average cost down to $90.50 but Gilead tumbled to a record low on Feb 8th after the company provided guidance for fiscal 2017 revenue, which missed analysts’ expectations. See press release:

The research-based biopharmaceutical company said it expects fiscal 2017 net product sales of $22.5 billion – $24.5 billion, below the Capital IQ consensus estimate of $27.98 billion.

Gilead reported late Tuesday Q4 non-GAAP earnings of $2.70 per share, a dime better than the analyst consensus on Capital IQ. Revenue was $7.32 billion, vs. expectations of $7.16 billion.

HCV product sales, were $3.2 billion for the fourth quarter of 2016, compared to $4.9 billion for the same period in 2015.

Price: $65.93, Change: -$7.20, Percent Change: -9.85

Is Gilead turning into a value trap or a real value investment?

valuetrap-300x250

This stock is cheap with a PE ratio of 6.68 compared to the biotechnology industry average of 34.55. Gilead has a 3.13% dividend yield which is the highest within the industry. It has one of the highest ROEs of all companies in the biotechnology & drug industries. Although, EPS growth at Gilead is declining, it is still above the industry average.

The biggest problem with this stock is the biotech industry is experiencing positive revenue growth as a whole but Gilead has been unable to grow revenues and is losing market share. This negative trend has been continuing from the previous year when revenue growth at Gilead was -13.94% while the biotech industry was up some 202.65%.

I hate throwing good money after bad in the hopes of breaking even. So I am not big on averaging down on a losing position. I have been fighting a losing battle on this stock for quite a long time. However, I am anticipating a dead cat bounce off the bottom if some deep value or dividend investors decide to buy. I think that I should take a lost and buy something else. What do you think?

Do you own Gilead, are you going to average down, sell for a lost or are you going to continue to hold?

Gold as a hedge against Trump’s Border Tax

Talk of a “border adjustment tax” has gone from the sidelines to center stage in Washington, which has a lot of people asking: What is it exactly?

Currently, U.S. corporations are taxed on their worldwide profits at 35 percent. The House GOP plan would change that radically. The new tax formula would tax domestic revenue (minus domestic costs) at a much lower rate of 20 percent. The net effect would be one that favors exports over imports.

The change would convert the country’s tax system to a “territorial” system rather than a worldwide tax system. It’s meant to create incentives for domestic production because companies also would no longer be able to reduce their taxable income by deducting their overseas expenditures.

The plan would essentially subsidize exports and lead to a 20 percent tax on imports for corporations.

Retailers are very opposed to a border adjustment tax because a large percentage of the products they sell are imported. The end result is Americans will pay higher prices for consumer goods including imported fruits and vegetables.

Now economists who support the tax say the policy would lead to a sharp rise in the value of the dollar. As a result, retailers’ costs will go down so much that it will be a wash to consumers. However, many CEO’s worry whether the economists are right in that assessment.

In the past, gold and gold stocks have been used by money managers to hedge against inflation, currency risk and world chaos. For years, financial advisors recommend having 5% to 7% of your portfolio in gold or gold stocks.

Unfortunately, we have been living with deflation so gold as an investment has not performed very well over the past five years. The chart below compares three ETFs – gold bullion GLD, large cap gold miners GDX and junior gold miners GDXJ

gold

The border adjustment tax could change all that. It could cause mayhem in world trade, leading to higher inflation and extreme volatility in currency markets. The chart below illustrates the 2017 year to date price movements in the above mention ETF’s

gold-1

The biggest risk to owning gold or gold stocks is if the Fed’s interest rate policy changes and they are more aggressive in raising rates. This could cause the value of the U.S. dollar to increase which would be bad for gold.

Fed watchers believe that the June meeting would be the earliest date for an increase in interest rates. The stock market has only priced in two rate hikes for all of 2017. President Trump’s immigration ban and talk on renegotiating trade deals will be in the news for the next few months making investors nervous.

I am considering three short-term trades in gold

  1. Dollar cost average: Buy 300 shares of GDX  at 24.50, Sell 3 Apr 26 call options for $1.20 & Sell 3 April 24 put options for $1.50 (Total investment = $6540.00 U.S.) 
  2. Covered call: Buy 100 shares of GLD at $116.20, sell 1 April $118 call for $2.25 (Total investment $9,370.00 U.S)
  3. Call spread: Buy 5 GLD April $110 calls for $7.10 & Sell 5 GLD April $118 calls for $2.25  (Total investment =$2,425.00 U.S.)

 

The problem with using options in these trade choices is the VIX that measures volatility is quite low. Having to wait until the April 19 expiration date reduces the profit potential. That being said, I think that the first trade is less risky, if I am wrong on the direction of the price of gold. I would own 600 shares of GDX at an average price of $ 22.90 but could then sell more call options.

Do you own any investments in gold stocks or gold ETF’s?

 

Disclaimer: These are not recommendations, please do your own research before investing.