2012:
Three years into the recovery

recoveryre.cov.er.y (noun): the return of something to a normal or improved state after a setback or loss.

Three years into the recovery, the chart (below) shows Canada and U.S. markets regaining their former altitude. Although the current pattern is choppy (a so-called sideways market), the trend is definitely up. Despite two reversals along the way, the market is back to about 90 per cent of its pre-recession peak.

In the first two months of 2012, stock markets continued to climb higher. U.S. economic data (employment, housing, and consumer spending) and lending conditions improved. Investor confidence grew, showing signs of faith that policymakers are capable of handling the restructuring challenges facing the euro zone.

Still, in the aftermath of the financial crisis, economic activity is forecast to remain weak-but-positive in 2012 and 2013, at about half the economy’s 4-5 per cent longer term potential. The recovery’s slow pace is expected to keep inflation in check and interest rates low.

The stock market is forward-looking, and should trend upward as the macro environment improves. Equities remain appealing relative to bonds at today’s pricing. Getting back to normal requires more time, and patience. Momentum could again break down on unfolding political developments, like a Middle East oil shock.

RESULTS at a glance

• The S&P/TSX Composite Index* advanced, closing up 5.8 per cent to finish at 12,644. The U.S. S&P 500* was 8.6 per cent higher at 1,365. The MSCI EAFE* rose 11.2 per cent, while MSCI Emerging Markets* outpaced, up 16.6 per cent.
• Bonds prices are down slightly across the yield curve. The yield on the 10-year Canada benchmark rose to 2.01 per cent while the yield on the U.S. 10-year benchmark closed at 2.02 per cent.
• The Canadian dollar strengthened 3.2 per cent against the U.S. dollar, closing at $1.01 USD. Weaker foreign currencies had a negative impact on returns in Canadian dollar terms.
• In the energy sector, crude oil rose $7.66 (+7.7%) to close at US $106.86/bbl. Gold bullion finished at US $1,699, up $134 (+8.5%).

TAX TIME– will you be ready on April 30?
Failing to report income can be costly

Given the proper information, most people are happy to meet their tax reporting obligations. But as investment vehicles have become more diverse, so too have the related tax slips needed to report investment income.

Many people hold several different types of investment vehicles – bonds, trust units, stocks, and exchange-traded funds – in a single trading account. And, to make matters more complicated, the investment income for a single year might be reported on a T5, T3 or T5013 slip, or some combination of them all!

Canada Revenue Agency has internal audit controls to ensure that income is reported accurately and completely. CRA computers crosscheck taxpayers’ reported income against tax slips received directly from the issuers – that is, banks, brokerage houses, mutual fund companies and other financial institutions.

CRA automatically reassesses your return to include income from a missed tax slip. As a first-time offender, you pay the additional taxes and arrears interest. But second-timers can face severe penalties, whether their omission was intentional or not.

If you failed to report an amount in a return and have had one of your tax returns reassessed for the same reason anytime in the previous three years, you are liable to be penalized. The federal and provincial penalties are each 10 per cent of the missed amount that must be included in the income you report for the year.

Example

When Jeff filed his 2009 return, he forgot to report $50 of interest income he received that year. CRA reassessed his 2009 return to include the unreported income. When he filed his 2010 tax return, he missed giving his accountant a T5 slip with $5,880 of investment income. Later that year when CRA reassessed his 2010 return to include the unreported investment income, he was charged a $1,176.00 penalty ($588.00 federal and $588.00 provincial) for repeated failure to report income. Along with the change to tax payable and the adjustment for arrears interest, his balance due totaled $2,877.00.

Tax Package Checklist

Before you file your tax return with CRA…

• Review last year’s tax return to list all the financial institutions from which you expect a tax slip this year. Check your incoming 2011 T5, T3 and T5013 tax slips against this list. If something is missing, find out what changed during the year.
• Check for a Pending Trust Unit Summary - 2011 with your T3 slip(s). The list identifies any trust unit holdings that had not yet reported at the time the slip was printed. You will receive an additional T3 slip(s) on subsequent run dates.
• Do not separate your T5, T3 and T5013 slips before submitting them to your tax preparer. Your accountants require the supporting documentation that accompanies these T slips.
• Provide all information forms to your accountant for preparing your return. If you are missing a slip or two, note it for your accountant’s attention and follow-up.
• When in doubt, just ask. If you’re not certain you have received all your tax slips, contact your portfolio manager.

PLEASE NOTE: The information presented here is of a general nature only. It is not intended to replace personal, professional tax advice.

ASK & ANSWER
Return Terms: Why does my Investment Summary Report show three "rates of return"?

ASK
I received my 2011 Investment Summary Report from WDS. I know what "annual return" means. But can you explain "compound annual return" and "cumulative total return" for me?

ANSWER
Annual return is the percentage rate earned on your portfolio in a single calendar year. It’s calculated by taking the dollar amount of profit or loss at the end of each year and dividing it by the market value of the portfolio at the beginning.

Of course, a portfolio might be up 17.60 per cent one year and down 8.7 per cent the next. Investors need a metric to compare rates of return generated over different time periods.

Compound annual return does exactly that. It shows how the changes in your portfolio would look if they had happened at a steady, even pace. It tells you how much you would have had to earn each year on your invested capital to arrive at the same market value in the end.

In the example below, $100 growing at a compound annual return of 6.12 per cent would be worth the same amount – $151.58 – at the end of seven years. This does not mean that the portfolio appreciated by 6.12 per cent during each of those seven years; it means that the S&P/TSX Composite’s pattern of growth – rising, falling and recovering from 2005 to 2011 – would equal a 6.12 per cent annualized return if smoothed out.

Cumulative total return is the portfolio’s actual, non-annualized performance over the entire holding period. In our $100-investment example, the cumulative total return is the total profit of $51.58 that was made over seven years, expressed in non-annualized terms. It measures the total percentage increase in the value of the portfolio over time.

Investors usually use both annual return and annualized rates of return for comparative purposes.

Example of Annual, Compound Annual, and Cumulative Total Rates of Return

*The table above uses the annual calendar-year returns of the S&P/TSX Composite Total Return Index and does not include any management fees. Total Return means that dividends are included in the calculations.

PLEASE NOTE: The figures and rates of return cited above are for illustration purposes only and are not indicative of any actual or future performance.

WDS READS – Book Review
FIXING THE GAME: Bubbles, Crashes, and What Capitalism Can Learn from the NFL

Roger L. Martin, Harvard Business Review Press, May 2011

In the wake of two 21st century market meltdowns, Martin asks whether the rules of the capitalism game are working for the financial system as a whole. His critical question: Is it possible that the very theory we’ve embraced to underpin our capital markets is actually producing these crises?

Martin traces the trouble to a seminal article published in the Journal of Financial Economics in 1976. In it, finance professor Michael Jensen and Dean William Meckling at the University of Rochester argued that the singular goal of a company should be to maximize the return to shareholders. To achieve that goal, they maintained that the bulk of executive compensation should be in the form of stock and stock options.

One problem emerged. The theory had the unfortunate side effect of tightly tying together two markets: the real market and the expectations market. In the business world, the expectations market is “The Stock Market”. Since the time the article was written, the stock market has been subject to a pattern of increasing volatility and decreasing investor return.

Martin employs the NFL metaphor to cleverly illustrate the serious danger of linking the real game and the expectations game, i.e. gambling. Martin’s antidote to fix U.S.-style capitalism is to get back to rewarding real growth, not expectations. Capitalism, he suggests, can avoid bubbles and crashes by emulating the NFL’s approach and preventing CEOs from being so heavily invested in the outcome of the stock market.

Place customer’s interests at the heart of the company’s goals, says Martin. The shift from maximizing shareholder value to delighting customers does not involve sacrifice for the shareholder, the organization or the economy. Getting it right for the customer means greater returns for shareholders in the long run.

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