Blessed by the Potato

It’s been a rough, rough month on the market. When I figured we were at the bottom, or close enough for it to not really matter, back in the summer I put the last of the cash I could into the market. These huge drops in the market we’ve seen have been pretty tough to take and just sit by and do nothing. It was a lot easier to sit there and watch 80% of what I own go down knowing I could then invest the other 20% at a better value. Now that I’ve got nothing to do but sit and watch and worry it’s a bit harder. Especially since we’ve broken through the old lows now, so it’s hard to say when it will stop.

I’ve been wondering if I should maybe mix things up a bit. Almost everything, even the “safe” stuff, is way down. Whether it’s actually got an issue in these uncertain energy/credit markets, or if it’s just something that hasn’t been hit so it can be sold to settle a margin balance, it’s probably down.

Q9 and Teranet are both takeover candidates that have a fair bit of upside to them for the takeovers: Q9 is sitting at about a 6% potential return for holding it for another 3 months to the close; Teranet has a hostile bid at $11, pays a ~7% yield on top of that, and could get bid higher, possibly to the $11.50-12 range. They’re both down a little these last few days, but nothing like most other things, and I’m wondering if I should sell them to take my chances on something that’s not fairing as well. From the “safer” side of the street there are trusts like FCE.UN, which is down over 6% this week, and yielding 10%, which compares favourably to the upside on Q9. HR.UN has long been a stable and reliable part of my portfolio, but it’s just been hammered lately; this is probably because it’s rumoured to need to borrow more money in the near future, and with the current credit conditions, that might cost them. It actually raises a good point for trying to do active management in this environment: previously acceptable levels of debt might not be at the moment. Good unleveraged cash flow might be the key thing to look for; or at least have the debt be long-term without a renewal coming up, which is part of why I like FCE.UN.

Another option is to take a gamble on some Canadian banks now that they’re cheap again, and hope that they can avoid the worst of this credit crisis, hope that CMHC will protect them from the Canadian housing market, and hope that they continue their dividend payments. Of course, then I’d have to engage in some bottom-calling again, and while there’s certainly the blood in the streets this time around, moreso than in March with Bear Sterns, I’m a little hesitant to try that again.

As much as I can drive myself crazy thinking of what the best thing to do is, given the current instability I think I’m just going to sit on my hands for a few days. The market probably won’t do anything until the US congress decides what it’s next move will be, and that probably won’t be until Thursday from what I can see.

Fortunately, I can see around the blogosphere that I’m not alone. Mr Cheap at 4 Pillars is reminding us today that the adage is “buy low, sell high” — and baby right now, things are low. CC reminds us to keep faith in stocks for the long term. Eventually, they will turn around; if they don’t, that future will be a bleak and different place anyway. It’s like my dad says: you’re either investing in the stock market, or in a cabin, a gun, a dog, and canned goods. From the look of my parents’ cabin, my dad believes in diversification.

A big thanks to the Vampire Librarian for pointing me to this unique crime/mystery/steampunk/vampire movie “Perfect Creature“. It’s not a perfect movie; as with many vampire movies there are some strange plot holes, mythologies, and love triangles, but it’s certainly a fair bit better than many other vampire movies, and certainly the best steampunk vampire movie I’ve ever seen. Though there are “vampires”, and the “brothers” refer to themselves as such at one or two points in the film, it’s not really true to the theme of most vampire movies since there is no spreading plague of the undead — vampires are born that way, freaks of nature, and don’t turn anyone.

All that aside, it does explore some really neat ideas. First up, we’re presented with a brother gone bad, off feeding on humans like a real vampire, and the cover-up that ensues. In the film, vampires are the clergy of this alternate world, the immortal overseers of humanity, and it would be a devastating thing to have it be known that one of them went totally batshit fucking loco. So they handle the cover-up and the shaken confidence fairly well alongside the main story of hunting the bugger down.

It starts to get a little muddled towards the end when the action picks up and the sense goes down, but it’s still worth a watch, IMHO.

With an election underway, there’s bound to be a few more political posts here at BbtP as I think out loud on the issues coming up. I haven’t yet decided who I’m going to vote for: the Liberals certainly seem to be making the environment more of a priority, and Glen Pearson seems like a decent enough MP; OTOH, I might want to continue to throw the Greens or NDP a bone, especially since this is a pretty safe Liberal stronghold, so strategic voting doesn’t really come into play.

One thing I know is that I won’t be voting Conservative. They’ve been campaigning pretty much non-stop since the last election, with a non-stop series of attack ads. Negative campaigning usually turns me off in general: this isn’t the States with a 2-party lesser-of-two-evils choice, slamming one candidate/party still usually leaves us with two viable choices. Doubly so when they’re wasting energy campaigning outside of an election when they should be doing what they were elected to do. Despite my distaste for negative reasoning, I’m going to go on a bit of a rant here about why you shouldn’t vote for the Cons. I can’t really say if you should vote Liberal, NDP, or Green instead — that’s up to you to figure out based on the issues and the candidates who would represent you in your riding. Here though are just a few of the reasons why you shouldn’t vote Conservative this time:

-Income Trusts
-Hypocrisy in many forms: floor-crossers, accountability, senate election/cabinet minister, own election law.
-Not prime minesterial: thuggish, non-stop partisan attack ads on taxpayer dime (10%ers); Con MP will be just another Harper pawn, will not represent riding
-CNSC affair – dangerous precedent
-Corruption – Cadman, in-and-out election funds
-Bad policies – spending away surplus and lack of fiscal restraint; GST vs income tax; 40-year mortgages; child care; no green/global weirding plan to speak of
-Transparency and accountability: nonexistent
– Goes against grass roots of party locals (parachute candidates, etc), MPs accountable to Harper, not the riding (cf. Lunn’s “I serve at the pleasure of the PM”)
-“Ontario is the last place to invest” – which is just a complete WTF moment coming from the guy who set the very taxes he was complaining were too high just a few years previous.

A few days ago I hammered that point-form summary out, intending to flush out each of those bullet points for anyone that wasn’t familiar with the issues, but I think with the exception of the 10-percenters (I don’t think they’re bothering to send them to Toronto) everyone should be pretty familiar with what’s going on here, and I don’t really want to spend too much time rehashing idiocy and negativity that make my head spin. So, quickly: ten percenters are mailings that MPs are allowed to send to 10% of their riding, that are paid for by the government (via our taxes). They’re supposed to be information fliers: for instance, you pass a new law about car seats, and send information to the 10% of your riding with a high portion of new parents; you change pension rules and send one to an area with a high portion of seniors. On average, I got 1 a year from my previous MPs. The Cons figured out that they could send them not just to their riding, but any riding. So even though I have a Liberal MP, I’ve been getting non-stop fliers (6 so far this year) paid for by the government, outside of an election period, from Conservatives. They are not informational, and in fact look exactly like their billboard attack ads “Dion’s Tax on everything; Not a leader; Dion will take away your 2% GST rebate”. It’s disgusting, and not the least bit prime ministerial to have a mailing ostensibly from Stephen Harper himself that is paid for by the government to bomb my riding with very negative, very partisan ads that have nothing to do with anything in parliament — there isn’t an election, Dion isn’t in power, and hasn’t even said the things they say he said he’d do. It’s clearly a political ad, yet the government is paying for it as though it were an informational mailing. There’s something deeply wrong with that, but censure, if it comes at all, probably won’t come until after the election… (for an example of some Con 10-percenters, click here)

Instead of focusing any more on that, I’ll quote liberally from a recent post by John Scalzi, on his site Whatever. His post was about the US election going on now…

“It’s a campaign that will lie and continue to lie when called on its lies because as far as it can tell it’s being rewarded for doing so.
[…]
When there is no real-world penalty for lying, distorting and demonizing, then the only thing to stop you is your own moral compunctions. However, if McCain actually had any moral compunctions on this point, he wouldn’t be running the campaign he’s running now. And I would suggest that a man who shows no moral compunction in pursuit of power is not a man who will suddenly find those compunctions once he has power. An election is a job interview, people. If someone lies to you during a job interview, and says to you “yes, I’m lying, what of it?” when you catch them in the lie, and you hire them anyway, well. You shouldn’t be surprised at what comes next.”

So even better than an election campaign, we’ve had a minority government to test-drive Con governance. And what did we get? Extreme partisanship, pork-barreling, broken promises, stupid promises upheld even under shifting economic sands, hypocrisy, and single-minded arrogance (no coalition or compromise seeking in the minority government, instead just election threats and confidence measures). Indeed, this is a leader who thinks he’s above even his own laws. I shudder at what might happen if the Cons get a majority government and then find some part of the charter of rights and freedoms inconvenient. Then the election comes along, and we get, yes repeated lies (ok, Garth Turner isn’t exactly an unbiased source). We get fearmongering rather than a debate on the issues. To some extent the hyperbole and vilification is there in every election, but the Cons seem to have taken it to new lows, and it makes me afraid not of the Green Shift, but of what might happen if the Cons win…

Of course, there’s a small part of me that’s afraid of a deeper game here. What if Stephen Harper’s insanity is a sacrifice play? What if they knew that the subprime issues in the States, the blowback from globalization and oil consumption were going to come to a head near the end of this decade? What if they called this election just before an unavoidable and severe recession hits, and just happened to throw the election and let the Liberals into power? What if they then later blame said recession on the Liberals, and get to become the ruling party for the next two decades? Because sometimes, it just looks like they’re trying to make themselves unelectable (though damnit, too many people are afraid of this carbon tax thing to see the real danger). Of course, the polls say they’re ahead, but I don’t know if they’re only polling out in Alberta or what, because I don’t know anyone who’s pulling for the Cons.

The Liberals have made one of their election promises to reverse the damage Harper & Flaherty have done to income trusts, and set a new tax of 10% which should bring them back to something approaching fair (it might just swing back too far towards benefiting trusts with the rebate, but it’s a hell of a lot closer than 31.5% was). This has brought the whole issue back to the forefront for a surprisingly small amount of people — most people never knew what an income trust was to begin with, or have written the sector off for dead and couldn’t care less about a Liberal promise. From a political point of view, it’s a brilliant promise because it points out to burned trust investors that the Cons broke their promise (flagrantly) at the same time that it talks about what the Libs will do. It’s negative campaigning at it’s best, because the negative part is fairly subtle. “They’re bad, and we’re better than them and have a plan to fix things.” vs. the usual Con rhetoric of “They’re bad, and we’re not them” which just doesn’t motivate me.

Anyhow, I know most of my readers won’t care, and in fact probably don’t know what an income trust is. Being an income trust investor myself, I’m going to do a post on the matter.

So for starters, what is an income trust? Well, it’s a special kind of company, a corporate structure. Like public corporations, you have shares (units) traded on an exchange such as the Toronto Stock Exchange, that represent ownership of the company. Unlike a regular public corporation, the money the trust makes is not taxed by the government in the hands of the company — instead, the company distributes the money every month to its owners (you, the unit holders), and it’s taxed there. There are various rules about how much a trust is allowed to grow and whatnot, but that’s the basic idea. The first wrinkle comes in that some of the distributions are (often) not interest, or employment income or even dividends when they go to the unitholders to be taxed, but rather are (or can be — some parts can be interest, income, or dividends) “return of capital”. This means they’re not taxed right away when you get them, but can be deferred until you sell your units (it affects your adjusted cost base*), and then at half your marginal rate.

So far, it’s looking about the same from the investor’s point of view: they can make the same money from either capital gains on a corporation’s shares or an income trust, and only pay capital gains tax (at half their marginal rate) when they sell. Then you consider that there’s a time advantage to getting the money up front but deferring the tax, which the income trust investor can do, and on top of that that the corporation was taxed on its money that it reinvested in itself, whereas the income trust was not taxed on its money. Then things start to look pretty rosy for the income trust setup, even with the other rules. They’re fantastic for people like seniors and students: you can get some cash flow up front, to keep the pizza and coke fund afloat while you’re still working a little, then when you’re finally in school full time (or retired), you can sell your trusts, and not pay much (any) tax since you’re in a lower tax bracket. The restrictions on growth were easily met by mature companies, and indeed it’s a pretty optimal structure for a company that has plateaued in its growth and capital expenditure and is now just churning out cash.

Of course, the deal seemed a little too good to be true, and there were ever more companies deciding that they would convert. There were accusations of “tax leakage” — that less tax overall was being returned to the government with trusts than with corporations. It’s kind of a difficult thing to figure out: yes, there almost certainly was less tax being paid by trusts**, but how much? Some of it was being taxed in investors hands, and while regular corporations faced double-taxation, that was only on their profit whereas income trusts get taxed on their cash flow (in the hands of investors). Was it worth bothering with, especially given the other benefits trusts offered (when you’re not taxed “expensing” something has a different meaning — I haven’t conducted a thorough survey, but obscene salaries, perks, and bonuses are seemingly less common in income trusts; stability in returns; regular cash flow vs. having to regularly sell when you’re in say, retirement)?

When behemoths Bell and Telus decided to join in the fun it started to become clear that there might be a problem, that the trust structure was clearly more lucrative than was fair. (Though according to CAITI Bell and Telus hadn’t paid any corporate taxes anyway, so converting to a trust would increase government revenues — again that point about taxing net income vs cash flow).

To “fix” this problem, the Cons, Flaherty and Harper made a surprise announcement, apparently having done no research on the subject, imposing a punative 31.5% tax, to come into effect in 2011. Now the evidence is clearly showing that this tax is too much to be fair because there is a torrent of companies converting back into regular corporations. Indeed, it doesn’t look like the government will collect anything from it’s 31.5% tax, because there won’t be any profitable trusts left. When asked to prove how they got to their figures on tax leakage, they released 18 pages of blacked-out documents, which tells us that they probably were wrong and are just too bone-headed to admit it and fix their error, or, as they have done before, they ignored the advice of their experts and just did whatever the hell they felt like anyway.

This was a hugely bad move not just from the point of view of killing the whole trust sector, but it also put the government on a bad foot because they were rash and impulsive. This was an election promise that they flagrantly broke, with no evidence provided that it was necessary. Moreover, this was not introduced gradually, there was no study. They didn’t halt new conversions and invite testimony from the corporate world, they just leaped out of a dark corner and sprung this on the market, and let me tell you, the market fucking hates that shit. It’s very difficult to do business in an environment where the government is pulling the rug out from under you and changing the rules all the time. Not just trust investors, but everyone suddenly had to be on Harper/Flaherty watch: what if a golf buddy of his complained about the favourable tax treatment solar water heaters were getting, would he jump in on that “crisis” and start taxing the sun to level the playing field with natural gas? If someone in the grocery line complained that cheese didn’t have GST but Coke did, would he run off to “fix” that, and add a cheese surcharge and tank that industry? What if he suddenly started believing in global warming?! Oh, the damage he could do in a brash unresearched move***. I’m all for fairness, and an income trust tax was probably necessary. But if you’re going to do that to the market, you’ve got to show up with a binder the size of the Yellow Pages documenting how you came to that conclusion, and showing that your new tax would be fair but not punitive, and moreover, showing that you’re taking this move as part of a well-researched plan, and aren’t just jerking the business world around on a whim.

And, as has been pointed out numerous times, the surprise announcement lead to a sell-off, which foreign and private companies/pension funds took advantage of to snap up trusts, and hey: now the tax leakage just got way, way worse.

So the Liberals have promised to put the tax at 10%, which to me seems more like where fairness should be (though rebating that might swing the pendulum back a bit too far in favour of the trusts). It should remove any tremendous tax advantage from either side, and will let companies pick the structure that best suits their investors based on other factors — are they mature, more suited to spinning out cash in a predictable fashion? Or do they still have potential for growth? Are they majority owned by crotchety old seniors and pension funds who want stability and cash flow from their mature industries, or hot-shots with blackberries trying for a two-bagger? Should they take on incredible amounts of debt to become highly leveraged, or would they benefit from being more stable with modest debt levels? I’m a trust investor, and I like having options, so I think the trust structure should remain a viable option, but yes, it shouldn’t be a privileged one.

My idea is that if the big symptom of a problem, the indicator of a preferred tax setup, is that too many companies are trying to convert; but that it just takes too much studying to try to determine the tax leakage and a fair tax rate from the government’s side… then let the market determine the fair tax rate for trusts. Let one and only one company convert to trust status each year, and let them bid on the tax rate they’re willing to pay to make it worth their while. Whoever is willing to take on the most tax burden gets to switch, the others can try again next year/quarter/whatever.

*** – hell, he risked nuking Chalk River/Ottawa because those damned “Liberal” safety people wouldn’t turn the 50-year old reactor back on without, scoff, backups. Oh, but he had it on good authority that it wouldn’t blow up, but he couldn’t share his evidence… but that’s a rant for another day.

So, despite the fact that I don’t particularly care for the word “blog” (as a bastardized contraction of the no better “web log”), and generally refer to my blog as a “site” — how very Web 1.x — I really like blogs as a thing. There are a number that I check at least weekly, from humour to personal finance, through personal diaries, to other ones that defy categorization like Whatever. And most blogs have comments (ok, this one doesn’t because my readers are non-involved zombies, or I’m not nearly as controversial as I think, but the software does allow for it). A lot of the time, I do read the comments, especially when the comments number less than about 20 and are relatively intelligent. It’s this kind of “discussion/interaction everywhere” that I like about “Web 2.0”. It’s especially nice for fact-checking, particularly when you start talking numbers in the personal finance world. I’ve taken FT at MDJ to task before for missing something in an analysis, and it looks like another silly mistake has crept in in his recent post on whether it’s better to sell stock to pay down debt. His conclusion: if your marginal tax rate is 40%, it’s better to slowly pay down credit card debt at 18.5% than to sell your investments making 5% to pay it off right away.

Wait… what?!

I think almost anyone with some personal finance common sense would immediately say that of course you sell your investments to pay off credit card debt. No way are you going to make 18.5% on your money in the stock market to make it worth it (you might get lucky, but you can’t really expect to earn that much). But FT@MDJ had a spreadsheet, so how could he have gone wrong? This is a case where making sense is more important than making numbers. It was pointed out pretty quickly in the comments that he wasn’t taking the opportunity cost into consideration. Basically, the ~$600/mo to make the minimum payments on his hypothetical $20k credit card bill were just sort of materializing to pay that debt down if the stock investments were kept, but if the stocks were sold to pay the debt off immediately, the ~$600/mo was not being used to buy more to rebuild the stock account. Once that opportunity cost was factored in again, we got back to the common sense solution that of course it made sense to pay that kind of debt off quickly, even if if means you have to pay some capital gains taxes. So it was kind of neat to see proof of that old adage “the fastest way to get information on the internet is to post something wrong and wait for corrections.” It kind of justified reading comments on blogs, though usually the discussion is worthwhile on its own, and not just for corrections.

More interestingly, is that this also serves as a special case to the conventional wisdom. There are people out there, terrible as it sounds, who can’t save. I don’t know if they spent too much time in government offices where any budget funds not spent at the end of the year would not be offered again, or what. But for them that rolling of the opportunity cost, the money that would have gone to the credit card bill, back into the investment account that was liquidated to pay the debt off wouldn’t happen. For them, if they had $600/mo that wasn’t going to their credit card, they would just spend more until it was gone. They wouldn’t save it up, and in that case FT@MDJ’s calculation shows that it might be better to just hold on to the investment account and slowly, painfully pay off the credit card than to pay it off quickly and give up what savings they have managed to acquire. Heck, for those sorts of people the fact that their credit card is maxed out is probably the only thing that keeps them from putting more on it. Likewise, all those rent vs. buy calculations that I like to pull out to show it’s better to keep renting at the moment than to buy all depend on the hypothetical person saving (and investing at some mid-to-high single-digit % return) the difference between what it costs to rent over the costs to buy. If you are not one of those people (and Wayfare and I actually know some), then buying a house is a good thing to do because it’s a forced savings plan. It is, as I’ve said before, one of the worst ways to save, but if you’re to the point where it takes the threat of getting kicked out on your arse in the dead of winter to not spend money on hookers and blow (or cars and clothes, or wine and vacations, or whatever your vice might be), then at least it’s a method of saving. Kind of like universal life.

On another note, I’ve got something like 5 or 6 posts in draft status, which is pretty typical for me; when I go a few days without a new post idea, I tend to brush one off and post that up so that I keep up my posting frequency of 1-5 (aim for ~3) posts per week. Well, now most of my backlog is somewhat topical with the election on, and I’m also going to take some time off from posting for the next two weeks. So, apologies in advance, but there’s going to be a rash of nasty political posts over the next few days, and then, apologies again, a dearth of posting. Please try to remember that I haven’t died and haven’t lost interest in blogging, and will be back in mid-October, and hope you will be too; in the meantime try to make the next few last. I might suggest only reading one every third day, even if more than one come up per day coming up :) I could go find some posting scheduling add-ons so that my pre-written posts show up spread out at some more reasonable frequency, but that sounds too much like work for the one time in 3 years it’s actually been necessary.