To say that equity markets have been volatile this year is an understatement.
With the Toronto Stock Exchange 300 Index losing more than 20 percent of its value since the beginning of the year, these turbulent markets not only provide investors with tax-loss selling opportunities, but may also provide an opportunity to pick up great value.
Tax-loss selling means converting paper losses in investments in stocks or mutual funds into cash losses that the Canada Customs and Revenue Agency considers capital losses.
The capital losses can then be used to offset capital gains generated from the sale of successful investments in stocks or mutual funds. This applies only to the non-registered investment part of a portfolio.
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Investors can carry capital losses back three years and forward indefinitely. This is an important consideration, given that capital gain inclusion rates changed to 66 percent from 75 percent on Feb. 28, 2000 and dropped to 50 percent on Oct. 18, 2000. By applying capital losses to transactions that generated capital gains at these inclusion rates, investors realize a higher refund by selling their dogs.
So far in 2001, 28 percent of small cap companies, those with market capitalization of $50 million to $900 million, and 16 percent of large cap companies had price declines of more than 25 percent, in line with last year at this time.
I’m not surprised that once again this year the industrial and consumer products segments represented the largest group of companies with price decreases in excess of 25 percent.
On the flip side of the coin, consumer products also represented the largest segment of companies with price appreciation greater than 25 percent.
While last year I attributed the price appreciation in the consumer products sector to the performance of biotechnology companies and the share price declines and weakness of the traditional old economy sectors, this year I have seen a complete reversal.
This is evident in the CIBC World Markets Small Cap Biotechnology Index, which has decreased 19 percent to the end of September.
The following are some examples of a few small and large cap companies trading on the TSE that have undergone price declines greater than 25 percent since Dec. 29, 2000. These stocks may be candidates for tax-loss selling.
Large cap companies:
Nortel Networks – The telecommunica-tions equipment company has seen its stock decline by about 70 percent as of Nov. 22.
While Nortel faces some choppy quarters ahead, I believe that through restructuring initiatives and a positive third quarter report, stabilization is likely and investor focus will now shift to the company’s growth prospects.
Bombardier – The transportation and recreational equipment manufacturer has had a tough road since the Sept. 11 tragedy. New regional aircraft orders have been hard to come by, leading to a share price decline of about 40 percent as of Nov. 22.
But its third quarter 2001 financials are in line, there are strong order backlogs in most of its divisions and it has recently won some contracts, so there is a positive overtone to the company.
However, the business environment is still uncertain enough that the company has not provided earnings forecasts and until it does the market is reluctant to bid up the share price.
Small cap companies:
Air Canada – Canada’s largest airline, now regarded as a small cap company, has depreciated about 60 percent as of Nov. 22. Business has dropped sharply since Sept. 11. Given the speed and magnitude of the drop in revenue, the company has laid off employees, restructured aircraft and cut capacity.
Although uncertainty remains a key factor in the market, investors may want to watch to see if tax-loss selling creates buying opportunities for stocks such as those just mentioned.
Once they have an idea of the investments they wish to sell, it is important to note that the settlement date, not the trade date, is the effective date for selling purposes. Because of the three-day settlement rule, Dec. 24 is regarded as the last day on Canadian exchanges to take advantage of tax-loss selling.
It is also important to know about “superficial losses,” which happen when investors, their spouses or corporations that they control buy investments that the investor sold less than 30 days earlier.
The Canada Customs and Revenue Agency doesn’t consider these to be eligible candidates for tax-loss selling.
Finally, investors should consider why they’re selling stocks and mutual funds. They should be certain that it’s not solely for the tax considerations.
Ian Morrison is a financial consultant with Wood Gundy Private Client Investments in Calgary and is licensed to sell insurance
products. His views do not necessarily reflect those of CIBC World Markets Inc. This article is for information only. Morrison can be reached at 800-332-1407 or by e-mail at ian.morrison@cibc.ca.
