Trader’s Narrative

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The Canadian government introduced a really smart new way for its citizens to save for their future by introducing Tax Free Savings Accounts (TFSA).

These are special accounts that allow your assets to grow sheltered from taxes. You can contribute up to $5000 a year (the limit for 2009) with this limit rising with inflation in $500 increments. As well, any unused contribution limits can be carried forward. So let’s say that you don’t contribute for 5 years and then receive an inheritance of $25,000. You would be able to put that lump sum and have it grow tax free. But any contribution over the $5000 a year limit gets a 1% a month penalty (similar to Registered Retirement Savings Plans).

Unlike RRSPs, you don’t need to have any income to make contributions to a TFSA account. But neither will you receive any tax benefit for simply making such a contribution.

The really amazing thing is that you can also withdraw the money at any time with no tax consequences! So unlike a RESP or RRSP your money is not locked in. And since contribution limits are carried forward, when you make a withdrawal, you have increased the contribution amount for future years by the same amount.

But the real flexibility of this new account is that it can hold bonds, GICs, mutual funds, equities and equity options. So if you combine it with a brokerage account that would allow you to trade the account, you have the best of both worlds: a trading account which grows tax free!

Although I still like and recommend Interactive Brokers to active traders and even lackadaisical long term investors, for some reason, they refuse to offer registered plans (RRSPs, RESPs, or TFSAs).

Knowing Interactive Brokers’ penchant for thrift, it probably has to do with the cost and human labor involved with setting up and administering such accounts. So with Interactive Brokers out of the picture, Canadians who want to open up a TFSA are left with the usual options of the big banks as well as a few independent brokers.

I’ve looked at all the options out there, and for Canadians, the best option for a TFSA is Questrade.

If you are an IB client like me, something else that you may not have realized is that buried within the agreement you signed with Interactive Brokers, is a clause that says you must have another brokerage or trading account. So if you don’t already have a ‘back up’ account, this is a great way to set one up. Not only will you be earning tax free capital gains, dividends, interest, etc. but you will also be saving money by paying the lowest commission rate in Canada (second to IB).

Questrade Commissions
For equities, Questrade charges 1 cent a share, with a minimum of $4.95 and a maximum of $9.95 per trade. As well, with a regular Questrade account you can trade options, futures, forex, mutual funds and physical gold.

And on top of all that, as a reader of Trader’s Narrative, if you sign up using the link in the banner, you get $50 in free commissions! What else can you ask for?

With Questrade’s low commission structure and no annual fee, you can quickly transform your tax-free savings account into a tax-free trading account. Just imagine, within a few years of contributions, you can have $25,000+ growing tax free.

Disadvantages
Of course, the only disadvantage is that if you have losses in this account, you can’t use them to offset your taxes. So depending on how confident you are in your ability to be profitable in this account, you might want to use this as more of an investment account for high dividend paying stocks, REITs or bonds. But remember, since this is a registered account, you can trade and hold any asset in your Questrade TFSA account except forex and futures. And for the same reason, you can’t use margin - this is a cash account.

Since capital gains are already 50% tax-free, you might want to only include bonds or bond ETFs which would otherwise be taxed at the full amount. Another option is to take advantage of the bear market and buy a leveraged equity ETF to ride the recovery. Whatever your strategy, take the time to learn about this new option or speak with an advisor to find out how it can benefit you.

It never ceases to amaze me just how horribly wrong regular people are as a group when it comes to timing the market. There is a whole cottage industry around trying to gauge their sentiment so it can be faded.

Being a contrarian isn’t as easy as simply doing the opposite of what the non-professional investors are doing though. The key is to pick your moment. You want to do the opposite of what they are doing only at extreme inflection points.

Escape to Cash
Take for example the current state of Canadian investors. In spite of seeing the market recover, they are so traumatized that cash holdings in Canadian households has climbed 15%. According to the investment banking arm of CIBC, this is the fastest pace since… c’mon now, this shouldn’t be difficult… 2002.

So Canadians are basically rocking back and forth in the fetal position. Just as they were at the bottom of a brutal bear market which cut the Nasdaq in half and decimated investment accounts everywhere.

They have cashed out $35 B of equity mutual funds in the past 6 months. And on a rolling 3 month basis, net sales of mutual funds is in negative territory (in other words, net redemptions). That is the worst state of the mutual fund industry since they have been keeping records.

Double Whammy
So on the one hand we have investors who don’t see the market correction coming, get excited and buy mutual funds. And when the market does correct, and they lose money, they are so shell shocked that they just sit there on a pile of cash while the market moves on.

The 1987 stock market crash lasted two months and panicked investors towards the safety of cash. The problem was that, according to the CIBC report, they stayed there for 16 months afterwards, missing out on an amazing run as the market recovered.

This is the sort of thing that drives regular people absolutely bonkers! The give up saying that the market is “rigged”. Truth is that money flows inevitably from weak hands to strong hands.

The good news in all of this is that with a bit of effort you can learn to zag when everyone else is zigging. This is not as simple as it sounds though. There is something innate within us that draws us to the safety of the crowd. So standing apart is excruciatingly difficult from a mental and emotional basis.

Caution, Caution, Caution
While this level of fear usually marks major market bottoms, it doesn’t mean that the stock market will go up without pause or retracement. In fact, from the percentage of TSX stocks trading above their 50 day moving average, it looks like this is just the right time to lighten up:

The fact that the market is now probably topping here does not negate the contrarian significance of the regular Canadian investor hording cash. Note that the market topped out in July 2007 and again in October 2007 without whipping the masses into a frenzy of stock buying. That is, they weren’t mortgaging their homes to buy stocks like the bubble years gone by.

And when the market bottomed in the summer of 2006 and 2007 it wasn’t enough to cause people to become shell shocked. For some reason it took the market correction in early 2008 for that. I have no idea why. Maybe it was the confluence of the housing market, the price of oil marching higher, the credit crunch, etc. All I know is that right now we have market sentiment so bearish it only appeared last in 2002.

On a related note, if you are interested in mutual fund cash levels and their significance for the stock market, check out Jason Goepfert’s award winning paper: “Mutual Fund Cash Reserves” located in the Charles H. Dow Awards folder of my free trading resource area.

After the close of the market on August 30th, right out of the blue Summit announced that it was being taken over by ING for their ING Industrial REIT Fund (Australia). The buyout offer is for an 18% premium to the market close which is quite respectable. ING is buying the whole thing but will only keep half and sell the other half to other institutional holders.

So what does this mean? For one, the real estate market (especially REITs) is becoming more and more global. Money flows to where the opportunities are regardless of national or geographic boundaries. Second, it means that Canadian REITs are in play since they are cheap. This is not really news to me since I considered the small and shallow nature of our REIT markets to be a handicap when it came to valuation. And lastly, it means that when there is a foreign buyer involved, people on the inside can actually manage to keep their yaps shut.

To see what I mean by the last point, check out the price action prior to the announcement (purple oval). There was no discernable pattern, either in price or volume, that there was a deal in the works. Summit was trading as it usually does - rather sluggishly. Tragically this is an all too rare occurance in Canada where almost everyone and their uncle know about a deal before it goes down.