Tech Stocks Revisited Ten Years After the Bubble

Remember tech stocks and the gigantic bubble of the year 2000 followed by the equally severe crash to the bottom in October 2002? How could we forget with the troubles that ensued from the subsequent demise of many companies, which persist to today, most notably with Canada's former tech leader Nortel. What has happened since 2000 and what lessons can be learned?

Tech Stocks have not yet recovered to the peak! - Ten years on, the value of tech shares as a whole are not even close to attaining the peak attained at the end of March 2000. An investor who had bought at the peak an ETF like the Technology Select Sector SPDR (symbol on Amex: XLK), which holds a broad array of tech companies, would be down about 60% as of April 20, 2010. This is much worse even than the overall market, as measured by the S&P 500 Index, which is still 20% below the March 2000 high water mark (see chart below from Google Finance)

Even when measured from much earlier in the bubble on January 1, 1999, before the last euphoric rise through 1999 and early 2000, tech stocks are still down. A small dividend yield, not reflected in the above price graphs (the effects were discussed recently in TSX Composite and S&P 500 Total Market Return) reduced the loss somewhat but since its inception December 18, 1998, XLK has produced total returns averaging minus 1.6% per year. Add in the loss of purchasing power from inflation and, for a Canadian investor, the rise of the Canadian dollar over the US dollar (it has gone up from $0.65 then to more or less par today) and the results can only be termed awful.

Lesson: Once a bubble bursts, it stays burst. A miraculous bounce back doesn't happen and recovery takes a long, long time.

Tech stocks now track the overall market - In the time since the tech crash bottom in 2002, XLK, blue line in the Yahoo Finance chart below, has followed the general pattern of the S&P 500 Index, the orange line, but with peaks and dips. Ironically, the most recent section of the line over the past year and a half has remained consistently above the S&P500 because tech stocks did not fall as much during the 2008 crash when financial stocks declined the most. Since the March 2009 bottom, XLK has paralleled the S&P 500 very closely. This should not be too surprising since the tech sector comprises the largest single sector of the S&P 500, constituting about a fifth of the asset weighting.


Lessons: Tech stocks have slowly become normalized after the 2000-2002 bubble and crash and now are a core part of the stock market, reflecting the fact that information technology and the Internet play a key role in the economy. The length of the tech stock recovery, noted above, is actually a good thing. The stocks are being treated more in line with the overall market.

Most tech stocks have been losers but some are big winners - While the average and the overall mass of tech stocks has been down, when we drill down into individual companies we find a big majority of losers (again, we note, in reference to the bubble years) while a few have powered ahead and have even far exceeded the former peak of 2000.

The difference between the winners and the losers is not due to the success or failure of the company. Nortel's surviving competitor, Cisco, though consistently profitable, has not done wonders for its shareholders. Company success has not equated to stock investor success.

Stock Losers:
Among the highly profitable tech companies, whose names are well known to most people, and which have survived and thrived through the bubble years and continue to do so nowadays, but whose stock has languished as shown on the chart below, are: Microsoft (symbol: MSFT), Cisco (CSCO), AT & T (T), Intel (INTC), Hewlett Packard (HPQ), Oracle (ORCL) and Yahoo (YHOO).


Stock Winners:
On the other hand there are companies which have provided returns ranging from the weakly positive like IBM (IBM), with a 23% gain in ten years, to the middling, such as Symantec (SYMC), right up to superstars such as Apple Computer (AAPL) with a 678% stock price appreciation, Google (GOOG), up 412%, and Canada's very own Research in Motion (RIMM), up 228%. However, as the chart below illustrates, there have been lengthy periods when the stock was in losing territory and other times of significant drops. How many investors could and did retain their faith in the future and actually achieve those gains, one wonders?


The big question - why have some successful companies' stock performed poorly while others have done well? The answer is as individual as the company as one or more possible reasons may come into play:

• Fads - The same mass psychology that caused the tech bubble and crash, has not disappeared and some companies may benefit, or suffer, from this factor
• Future growth prospects - Investors may bid prices up or down, justifiably or not (see fads above!) according to whether the company is in the right or wrong segment e.g. are Apple products, iPhones, iMacs, iPods, etc not the rage currently and in the sweet spot of public demand? Does Microsoft seem a bit passé?
• Employees get the profits, not the shareholder - Some tech companies seem to make a habit of issuing huge amounts of stock options to employees, diluting the share base, and then buying back shares with cash profits, which in effect is an indirect payment to employees.
  

Lessons - With the bubble and the crash long past, the only way to proceed vis-a-vis individual companies is to dive into the analysis of each company - its financial statements, its market position and products, its competition etc - the traditional disciplines of stock assessment. Failing that, owning tech stocks through a broad diversified fund - perhaps a tech ETF such as XLK, or a general market fund such as an S&P 500 or a Total Market fund - is the cautious way to go.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Canadian Equity Market Darlings and Dogs - the Tale of Two ETFs

Want a quick snapshot of those sectors and companies which are currently in or out of fashion with investors and to possibly get a clue to over- or under-valuation? A comparison of the two Canadian ETFs - iShares Large Cap 60 Index (XIU) and Claymore Canadian Fundamental Index (CRQ) - provides the means to do so.

XIU reflects market sentiment since it weights its holdings according to market capitalisation based on current market prices. CRQ reflects recent past actual accounting results since it weights its holdings according to a combination of four accounting (which Claymore calls Fundamental) factors - cash flow, dividends, sales and book equity value. XIU reflects expectations of the future, while CRQ reflects the past. The two are a pretty good match since XIU holds the 60 largest stocks by market cap while CRQ holds the 65 biggest by fundamentals. If a stock or industry sector in XIU has a bigger percentage of the ETF's total assets than CRQ does, it means the market has bid up prices on that stock or sector in the expectation that higher returns will occur there. In the table below, these are called the Market Darlings. The opposite is true for underweight holdings - the market thinks those stocks/sectors will do poorly in future. These are the Market Dogs.

Market Darlings

• Energy and Materials - big bets are on oil and mining companies, like Suncor (SU), Canadian Natural Resources (CNQ), Barrick (ABX), Potash Corp (POT), Goldcorp (G), Cenovus (CVE). That's where the gold is thought to lie, literally and figuratively.

Market Dogs

• Financials! - wow, the over 13% under-weighting difference is huge; the markets dislike banks and insurance companies - especially Manulife (MFC) and SunLife (SLF)
  
• Consumer Staples and Consumer Discretionary - no company in these sectors even appears in the top twenty holdings of XIU; companies like Magna (MG.A), Tim Hortons (THI), Shoppers Drug Mart (SC) and George Weston (WN) are definitely out of favour
• Utilities - as a group are virtually absent from XIU, with tiny holdings of companies like Fortis (FTS) and TransAlta (TA)
  

The Chart for Details The Darlings are Green while the Dogs are Red. Wikipedia's article on the S&P/TSX 60 Index shows all the 60 stocks with their sector.


The Big Question for the Investor: Are those stocks which are overweight in XIU overvalued, or those underweight possibly undervalued? In the former case, there may be short-selling opportunities while in the latter case, simply buying the stock would produce good returns.

The above observations in this post can only be a starting point for further investigation since it is quite possible also that the overweight stocks are not overvalued at all (or the reverse, for the underweight stocks).

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Five Tax Tips for Investor Couples and Families

Last week's post noted five ways any investor can use to legitimately minimize taxes. This week, let's look at strategies specific to couples and families.

All strategies involve income splitting - The objective is to equalize taxable income within a family to lower total taxes, since paying a combination of middle range tax rates means paying less tax than a low-rate or a nil-rate and a high-rate together. Canadian Tax Resource blog provides a short primer in What is Income Splitting?

1. Loan to Spouse/Child at CRA Prescribed Rate - When a high income (and thus high tax rate) earner loans his/her family member money to invest, the gains or income on the investments will get taxed in the hands, and at the lower rate of, the family member. Result: the couple overall will pay less taxes. CRA specifies here the Prescribed Rates on a quarterly basis that allow this to be legitimate. Use the rate labeled " taxable benefits for employees and shareholders from interest-free and low-interest loans". Income Splitting at TaxTips.ca describes more rules on how to do this properly and works through an example. The current rate of 1% is as low as it ever can be (since it must be a positive whole number). Now that talk is turning to when interest rates will rise, the absolute ideal time to implement the loan strategy may be soon. If interest rates rise there is a quarterly lag between when rates have risen and when CRA changes the Prescribed Rate e.g. the 1% rate in effect now is valid at least till June 30th. Meanwhile, the 1% rate is locked in for the life of the loan. That loan becomes increasingly attractive as rates rise and as income and tax savings received by the lower income person compound. The high earner reports as income on his/her tax return the 1% interest received while the low earner can claim the interest as a deduction. A final advantage of the minuscule 1% rate is that since the rules dictate that the interest must actually be paid, the amount will still be small even with a substantial loan (e.g. 1% of $100,000 is only $1,000 interest).

2. Contribute to Spouse's TFSA - The high income spouse, having used up his/her own $5000 annual contribution room, puts money into the TFSA of the low income person. There is no attribution of income back to the high income spouse and the amount grows tax-free.

3. Contribute to Spouse's RRSP - Using the high income earner's own contribution room, income from amounts put into the spouse's RRSP will not be taxed back in the high earner's hands if not withdrawn in the year of contribution or in the prior two years.

4. High Income Spouse Pays Bills (including even income tax payments) with non-deductible cash while the low income spouse invests to earn income that will be taxed at a a lower rate. A variation on this method is for the low income spouse to take out an investment loan from an arm's length third party, e.g. a bank, while the high income spouse pays the interest on the loan. The low income spouse still gets to deduct the interest as an investment expense while all the income is taxed in his/her hands and not in those of the high earner.

5. Transfer Very Low Income Spouse's Dividends to High Earner - If a person has such low income that there is no tax to pay, the dividend tax credit, which is only applicable against tax owing, may not be usable. Combined with the fact that any income (such as dividends) the low income spouse earns reduces the spousal credit amount dollar for dollar, it can be advantageous, and is permitted, for the high income taxpayer to report the dividends received by the low earner on his/her return. KPMG's book Tax Planning 2010 suggests doing the calculation both ways to see what gives off the lowest tax to pay. Should my spouse and I file our tax returns together or separately? on TaxTips.ca gives helpful explanation. Some of the tax preparation software packages automatically figure out the best way if both spousal returns are done with the same package.


Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above are food for thought and are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Some strategies are more complicated and will not work if not carried out precisely in keeping with the tax rules. Do your homework before making any decisions and consider consulting a professional advisor.

Five Tax Tips for Investors: Capital Gains, Foreign Investments and Charity

Structuring one's affairs to pay no more than the legal minimum amount of income tax is perfectly ok, as Canada's tax collector, the Canada Revenue Agency, states in the first point of the Taxpayer Bill of Rights in CRA's Making A Difference. To that end, here is a list of short and long-term tax reduction ideas for investors to consider and investigate:

1. Carry Back Capital Losses Against Previously Reported Gains - If you have losses that exceed current year capital gains (you must first use your losses against current year gains), you are able to offset previously reported gains for any of the prior three tax years and get a refund of taxes paid. TaxTips.ca explains in Capital Losses how to make the claim. The losses can also be carried forward indefinitely to offset future capital gains. Though all capital gains and losses must be reported on the tax return in the year incurred, it is worth considering past and future marginal rates - claiming the loss against gains saves most tax when marginal rates are high. If you neglected to report a capital loss thinking it did not matter at the time, it is still possible to file an adjusted return (using the T1-ADJ form) for past years and then to use the loss against gains today or in future.

2. Use Past Capital Losses Against Current Year Gains - Last year's Assessment Notice from the CRA will state the amount of any accumulated losses that can be used in the current tax return to offset gains.

3. Select A Favourable Exchange Rate for Reporting Income from Foreign Investments - The CRA allows a taxpayer to choose either the average rate for the year or the rate in effect on the day the income was received. The Bank of Canada publishes rates acceptable to CRA here. If the year average is much higher than the day income is received, the taxpayer ends up with more taxable income in Canadian dollars to declare, which means higher taxes. For instance, the 2009 average rate of Canadian dollars per US dollar was 1.141977 but the year-end rate was only 1.0510. If most of the foreign income came in with year-end distributions, using the year-end rate will produce less Canadian dollars to declare. One caveat is that the same method must be used for all investment income in a particular tax year.

4. Optimize Reporting of the Foreign Income Taxes Paid - When you receive foreign income in a taxable account, (e.g. dividends or interest from US investments), the foreign government deducts tax, usually 15% (the standard amount in international tax treaties). The 15% deducted can be claimed either as a Foreign Tax Credit or as a combination with a Line 232 "Other Deductions". Finding the exact best mix is a circular calculation only determined by trial and error but it can reduce Canadian tax you would need to pay. TaxTips.ca's Foreign non-business income tax and foreign tax credit explains how this works. CanadianFinancialDIY discovered last year that one of the tax preparation software packages TaxChopper performs this optimization calculation automatically.

5. Donate Securities In-Kind to Charity - If the securities have a capital gain, selling the securities and donating the cash to a charity will oblige you to pay a tax on the capital gain. Instead, transferring the securities in kind to the charity as a special tax rule exempts the gain from any tax, as noted in resolution 9 "Donations of Securities" of the May 2008 eMonthly newsletter from financial publisher CCH. The full market value of the donation is still eligible for the charitable tax credit. You can contact the charity to learn how to do this, or you can donate securities online through CanadaHelps.org.

Next week's post will outline special ways by which investor couples or families can minimize their taxes.

Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above are food for thought and are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Some strategies are more complicated and will not work if not carried out precisely in keeping with the tax rules. Do your homework before making any decisions and consider consulting a professional advisor.