Wednesdays market action contained enough set-up failures to move the leading stock portion of our risk model to a current reading of negative from neutral. An even more obvious clue of faltering leadership was F5 Networks price response to earnings announced after Wednesdays close; the stock traded down more than 20% in afterhours trading. The weakness in FFIV caused a spillover of selling in other leading names, specifically cloud computing and related stocks such as VMW, CRM, ARUN, AKAM, APKT, RDWR, RVBD, JNPR and NTAP; they were all down in extended trading.

Like many names that have led this market, F5 Networks had formed a number of price consolidations along the way during its price advance; the most recent was clearly late stage. As we have pointed out in recent weeks, many leading stocks have emerged from late stage bases. Although our risk model has not yet flashed a sell signal, its important to keep a close watch on leading stocks and the stocks in your own portfolio. Market and sector weakness will generally show up in individual names first.

We continue to see more and more evidence that the start of a market correction may be underway or near. At the very least, we see it becoming increasing more difficult to make money in the market over the near-term.

To reiterate our recent advice: take smaller than normal positions, tighten stops, and nail down profits when you have them. Most importantly, religiously cut your losses on the names that move against you in order to protect yourself.

Mark Minervini

As Ive discussed in recent market commentary, we see signs of a rotation into larger cap names and also into some of the laggard stocks. This is a clear indication of late stage market action. While we dont see an end of the bull market on the horizon over the near term, a 4-8% correction (give or take a few percent) is likely looming. We have recently added some short positions to the portfolio to partially offset risk from our long exposure. Additionally, we have shifted to a tighter than normal loss cutting policy, giving stocks in our portfolio little room to move against us.

The market may indeed keep crawling its way higher however, if the rally contains less and less participation, it will become increasing more difficult to make money. Therefore, our recommendation is to take smaller than normal positions, tighten stops, and nail down profits when you have them.

Mark Minervini

Back in October last year, I announced the purchase of Aqua America (WTR:US), a water and wastewater services company that has over 3 million customers across 14 states.  At the time, I was pretty pleased with my purchase. Why?

o Aqua America provides what everyone needs; clean, safe, reliable water.
o Theyve been a dividend payer since 1939.
o Theyve paid quarterly dividends consecutively for more than 60 years.
o Their five year average dividend growth rate is over 8%.

With a market cap of about $3 billion they are not a small company and they have lots of room to grow through both acquisitions and service diversification.

So why did I sell them with mostly upside to be had?

Although I consider Aqua America a good company with long-term growth prospects, I recently found out that Aqua America is not eligible for any dividend reinvestment plan with my discount brokerage institution. This is in contrast to what Aqua America offers with their transfer agent Computershare in the U.S. Here are some highlights from their website:

o Aqua America, Inc. has a Dividend Reinvestment and Direct Stock Purchase Plan (the “Plan”) that offers investors a convenient and economical way to purchase shares of the Company’s Common Stock.
o Computershare Shareholder Services, Incwill administer the Plan and act as Agent for the participants.
o As a shareholder, you can buy additional shares of our common stock at any time for as little as $50. You can pay by check or by a one-time online bank debit through the Buy Stock Direct option noted above, or have your payment automatically withdrawn from your U.S. bank account.

While DRIPping Aqua America through Computershare has its merits, I do not want to go through the hassle of setting up a U.S. bank account or always commit to a minimum $50 cheque to purchase more WTR:US shares. Unfortunately when I made my Aqua America purchase in October I assumed because they offered a full DRIP via their transfer agent they would offer a synthetic DRIP with my discount brokerage institution. This was not the case. This was alarmingly clear when dividends were paid to me in December in cash.  

My lesson learned?

Before I make another U.S. stock purchase, Ill check with my discount brokerage institution to ensure the stock is synthetically DRIP eligible. Not all U.S. companies who offer DRIPs with their transfer agents offer these plans synthetically with brokerages. Im not sure why WTR:US Board of Directors made this decision (maybe they want to keep more control over the companys shares?) but it was an annoying revelation for me.

Sure, I could have kept Aqua America shares and not had the dividends reinvested but I think that goes against my strategy as a dividend investor. For every stock I own, I want to have enough shares of any company to DRIP at least one full share every quarter. I can do that for almost every stock in my portfolio, except for a couple Canadian stocks. 

o My DRIPs will provide me with dollar-cost averaging.
o My DRIPs take the emotions out of my investing.
o My DRIPs will not cost me anything to buy more shares.
o My DRIPs will take advantage of the magic of compounding.
o My DRIPs help me set and forget part of my retirement plan.

 
What can I say? I made another investing mistake and Ill probably make more.  How about you? Any investing mistakes you care to share?

My Own Advisor

Tis the season for stock picking contests…

Mike from Money Smarts Blog is participating with a few other savvy DIY investors in a stock picking contest. You can read about that here.

HUZ Silver ETF
RIM Research in Motion
CVX Chevron
POT Potash

After visiting The Financial Blogger, I decided I would send in my selections for this year. He has encouraged folks to submit their 4 stock selections to compete against his and his peers offering a prize to the winner if you can beat our group of bloggers for the 2011 Best stock pick contest.
Here is what I picked:

Amongst other savvy DIY investors, click here to view Passive Income Earners selections.

Click here to see Beating The Index selections.

Click here to see Million Dollar Journey selections.

Again, go check out The Financial Blogger for your opportunity to speculate in 2011!

What do you think of my selections?
Who would you pick?

Cheers,
My Own Advisor

We note recent relative strength in some of the larger cap, relatively low RS stocks such as IBM, PCS, QCOM, F, CSX, VZ, DIS, etc. as evidence of rotation. While we currently own some of these larger cap names in an attempt to profit from the rotational nature of the market, we would prefer to see the original market leaders continue to lead, which to us, would be a better indication of overall market heath.

For the above stated reasons we are downgrading the Leading Stock portion of our risk model to neutral from positive. This does NOT yet put us on an outright sell signal or indicate that I think we’re starting a bear market; but rather, its a heads up as we point out rotation and the increased possibility of a market pullback. It certainly heightens our awareness to be on the lookout for additional signs of internal fragmenting among leading names and even more obvious signs of distribution in the major averages.

Of course, the market has moved up quite a bit and most market participants seem to be pretty bullish these days. A pullback in the market would be normal however, we treat every market pullback and signs of weakness as potentially threatening and always entertain the fact that every 10-15% decline starts as a 2-3% pullback, just as every 25-30% bear market begins as only a 10% decline. One never knows for sure how far the market will drop or rally. This is why we have stop losses and why we adhere to strategy.

If we should get additional strength in the market going forward in the coming days and weeks ahead, it makes sense to take that opportunity to nail down some profits in those stocks that are extended in price. Conversely, as always, cut your losses on those situations that move against you.

Mark Minervini

Mr. BHARARA said: “Todays truly historic settlement with the estate of Jeffry Picower is a game-changer for Madoffs victims. By returning every penny of the $7.2 billion her late husband received from BLMIS to help those who have suffered most, Barbara Picower has done the right thing. We will continue to work tirelessly with our partners from SIPC, the SIPA Trustee, the FBI, the IRS, and the U.S. Marshals Service to track down any and all proceeds of Madoffs Ponzi scheme and return them to victims.”

SIPC Chairman ORLAN JOHNSON said: “Since the discovery of the Madoff fraud, the United States Attorney, as well as the Trustee, Mr. Picard, his counsel, represented here by Mr. Sheehan, and SIPC personnel have worked relentlessly on the Madoff case. They have committed constant time, energy, and resources to benefit the victims of that fraud. The settlement announced today is an extraordinary achievement by all concerned. More than $7 billion dollars will be distributed to the victims. We will seek to distribute these proceeds as quickly as possible. This is by far the largest asset settlement in the 40 year history of SIPC. The result we see today shows that SIPC and the Securities Investor Protection Act can meet the challenges they face. Prior to today, SIPC had already advanced over $760 million to the Madoff victims. SIPC has also provided the financial wherewithal to conduct the research, investigation, and legal proceedings that led to this recovery, and, I am sure,
will lead to other recoveries in the future.”

SIPA Trustee IRVING PICARD said: “The importance of this settlement cannot be overstated, as it shows significant progress in our efforts to assemble the largest Customer Fund possible. Every penny of this $7.2 billion settlement will be distributed to BLMIS customers with valid claims.”

FBI Assistant Director-in-Charge JANICE K. FEDARCYK said: “Among the thousands of investors in the Bernard Madoff scheme were individuals so taken in by his confidence game that they invested the bulk of their net worth with him. The unprecedented settlement announced today means people who two years ago faced the devastating prospect of losing everything now stand to recover a significant portion of their investment.”

IRS Special Agent-in-Charge CHARLES R. PINE said: “IRS Criminal Investigation has a unique role in Ponzi scheme related investigations. Our Special Agents come to the table with specialized talent and the ability to pour through transactional records, such as bank and brokerage account statements, and trace illegally earned income to other assets, such as cars, real estate, jewelry, and other highly valued items. IRS Criminal Investigators and its law enforcement partners will continue to work diligently in recovering assets to their rightful owners in illegal financial schemes.”

According to the Stipulation and Order of Settlement, and accompanying civil forfeiture Complaint, filed in Manhattan federal court today:

The investment advisory business of BLMIS was operated as a massive Ponzi scheme from at least as early as the 1980s, defrauding investors of billions of dollars. Rather than use client funds to invest in securities, as promised, BLMIS diverted those funds to (a) pay other clients redemption requests; (b) fund transactions to disguise BLMISs fraud; and (c) enrich Madoff, his family, and his associates. In order to support the lie that BLMIS was operating a legitimate investment advisory business, BLMIS created and disseminated fictitious account statements that, among other things, showed trades that never actually took place. During the course of the fraud, MADOFFs clients lost approximately $20 billion in funds they invested with BLMIS.

Since at least the late 1970s, JEFFRY M. PICOWER was an investor in BLMIS, holding an account in his own name and controlling accounts held by various individuals and entities. Over the course of his 30-plus year relationship with BLMIS, PICOWER withdrew a net total of $7,206,157,717 in profits from BLMIS. When MADOFF was arrested in December 2008 and his fraud was revealed, it became clear that PICOWER – like all of BLMISs investors who withdrew more money than they invested – had profited at the expense of more recent BLMIS investors.

PICOWER died in October 2009. In his will, PICOWER sought to establish a charitable foundation, which was to receive the overwhelming majority of his fortune, and continue his lifelong dedication to philanthropy and to funding medical research. In order to resolve potential civil claims by the Government against PICOWERs estate, and to enable the creation of the foundation called for in PICOWERs will, the estate, through PICOWERs widow BARBARA PICOWER, has agreed to give up the entire net total of any and all funds that PICOWER or any related entity received from BLMIS. The Settlement contains no finding or admission of fault against PICOWER, and his estate has claimed that neither PICOWER nor any of the related entities participating in the settlement had any involvement in, or knowledge of, MADOFFs fraud.

The United States Attorneys Office will use funds forfeited in the settlement announced today to compensate victims of MADOFFs fraud. Last week, in connection with a $625 million settlement involving the Office, the SIPA Trustee, and CARL SHAPIRO and his family, MR. BHARARA announced that the Department of Justice had appointed IRVING H. PICARD as Special Master to oversee the process of remission or mitigation under the forfeiture laws. PICARD is already serving as the court-appointed trustee for BLMIS under SIPA. Under the terms of todays settlement, and a related settlement submitted to the United States Bankruptcy Court for the Southern District of New York, PICARD will administer $5.0 billion of the funds being returned to Madoffs victims by the PICOWER estate through the SIPA liquidation proceedings. He also will administer the remaining approximately $2,206,157,717 through the Department of Justices remission or mitigation process.

Mr. BHARARA praised the work of SIPC and the SIPA Trustee. He also thanked the Federal Bureau of Investigation, the Internal Revenue Service, Criminal Investigation Division, the Securities and Exchange Commission, and the United States Marshals Service. Mr. BHARARA also thanked the U.S. Department of Labors Employee Benefits Security Administration and Office of the Inspector General for their work in this matter. Finally, he thanked the Department of Justices Asset Forfeiture and Money Laundering Section for their assistance.

This case was brought in coordination with President BARACK OBAMAs Financial Fraud Enforcement Task Force, on which Mr. BHARARA serves as a Co-Chair of the Securities and Commodities Fraud Working Group. President OBAMA established the interagency Financial Fraud Enforcement Task Force to wage an aggressive, coordinated, and proactive effort to investigate and prosecute financial crimes. The task force includes representatives from a broad range of federal agencies, regulatory authorities, inspectors general, and state and local law enforcement who, working together, bring to bear a powerful array of criminal and civil enforcement resources. The task force is working to improve efforts across the federal executive branch, and with state and local partners, to investigate and prosecute significant financial crimes, ensure just and effective punishment for those who perpetrate financial crimes, combat discrimination in the lending and financial markets, and recover proceeds for
victims of financial crimes.

Assistant United States Attorneys LISA A. BARONI, JULIAN J. MOORE, BARBARA A. WARD, and MATTHEW L. SCHWARTZ are in charge of the case.

With the recent turn of events in the global economy since late 2008, a number of investors who have relied on stock trading to make their fortunes have now turned to the precious metals market as a hedge against inflation and to help secure their financial portfolios. Investors have long been aware of the fact that gold and silver can be excellent investment vehicles, especially when stock trading markets become as unstable and volatile as they have in the past couple of years.

How Gold and Silver has Reached an All-time High Value in Recent Years

In the past couple of years since the U.S. stock market suffered during the 4th quarter of 2008, the price of both gold and silver has increased dramatically. The performance of gold and silver as investment vehicles can often be compared to stock trading because of their fundamental differences. However, to understand the effect of how investing in precious metals affects the stock markets, you have to understand how a stock market crash affects the price of the metals. Typically, the fears that are generated by a major market decline affect the price of gold and silver in a positive fashion.

You have to remember that the price of gold and silver is driven by supply and demand as well as pure speculation like most stock trading commodities. Conversely, and unlike other commodities, the disposal or hoarding of precious metals plays more of a significant role in how the price decreases or increases than what the actual consumption of them does. Most of the mined gold that is still available is found in the form of either bullion or jewellery.

By the end of 2004, about 19% of the worlds global reserves of gold were being held by the central banks and other official organisations. Additionally, there are other factors that come into play where the price of gold and silver are concerned. In the past, political tensions and the trade deficit have devalued certain currencies, especially the U.S. dollar. When this happens, people will shift their investments to precious metals to give them an advantage over what the economy and the stock markets are doing.

Gold Investment Options

Where gold and silver are concerned, there are a number of investment vehicles that an individual can consider. The primary ones are bars, coins and ETFs or Exchange Traded Funds. The most traditional form of purchasing gold is in the form of bars. These are easily purchased at the major banks and typically carry a lower premium than gold coins, hence their popularity. On the other hand, gold coins are the most common way of owning gold.

These are priced according to what is referred to as their fine weight. They are influenced by supply and demand factors as well. Gold ETFs are investment products that are traded much like stocks but with considerably less investment risk attached to them. ETF shares can be sold by the investor to other investors or the investor can sell the shares or units back to the ETF.

Several interesting narratives are included, such as the incident where Goldman Sachs (GS) admitted to trading against its clients. The smoking gun email from a Goldman senior executive appears at the end of the chapter. Augen explains in simple terms how volatility works and how stock options can be utilized to increase profits and reduce risk. One of the interesting techniques that he provides is buying the iPath S&P 500 VIX Short Term Futures ETN (VXX) and writing one month at-the-money calls against it. The downside is limited because the volatility will never go away. Plenty of other strategies such as this appear throughout the book.

Option collars are explained very clearly and is what he considers the most conservative of trades. One technique he shows on pages 203 and 204 demonstrates how an investor can own Apple (AAPL) for free in 72 weeks. Synthetic stock is another technique that he covers, in order to reduce the cost of a trade.

For traders who have never or rarely delved into option trading strategies, I recommend that you read Trading Realities.

Investors hear plenty about asset allocation and asset diversification but in my opinion not so much about asset location. Why is that? Is it often overlooked? I know I used to, but no longer, and here’s why…

Asset location refers to the type of account(s) you use to hold your stocks, bonds, ETFs, GICs, real estate investment trusts, cash or other investment products in.

In a post this summer, I wrote about asset allocation and diversification; I said everyone needs to have AAAD! I think asset location is equally important because owning all the right investments in the world does little good if youre always taxed on them. Taxes, bad. Keeping your money in tax-advantaged locations, good!

Heres a very brief overview of what I earn (and what you might too) from some investments:

Interest Income - from bond funds, bond ETFs, GICs and money market funds. I own bond ETFs. If you own any of these, in unregistered accounts you are taxed at your marginal tax rate. You probably dont want that. I know I dont.

Dividends - from eligible Canadian stocks. I own Canadian dividend-paying stocks. If you own Canadian stocks like me, you might receive some tidy dividend tax credits for doing so. This can be a very good thing. Why? In Ontario, for example, its possible for an individual to earn over $40,000 per year in dividends without forking any of that income over to federal or provincial tax. Wow eh? Honest.

Foreign dividends from U.S. stocks, for example, are taxed at your marginal tax rate. I own U.S. dividend-paying stocks. I don’t own any other stocks, outside the U.S. (yet). With my U.S. holdings, I don’t have to sit back and get taxed at my marginal rate: U.S. stocks held inside my RRSP and LIRA - I don’t pay withholding taxes.

This is much better because:
U.S. stocks held inside any RESP or TFSA – you pay 15% withholding taxes.
U.S. stocks held in unregistered accounts – you pay 15% withholding taxes PLUS tax at your full marginal rate (ouch).

Capital gains from selling a stock or security for more than you paid for it you made a profit. We sold our condo last year but I dont intend to sell my stocks, ever. You need to report 50% of your capital gains as income and pay tax on that amount.

Other Income from Real Estate Investment Trusts (REITs) or income trusts. I own REITs. These investments (sometimes) pay healthy distributions. Be mindful that “tax friendliness” varies from REIT to REIT since these companies distribute Return of Capital (good) and Income (bad). A former blogger, Think Dividends, who knows this stuff very well reminded me about this important point – so I’m passing it along! (Thanks). If kept unregistered, income received from REITs and trusts are taxed at your marginal tax rate. I don’t keep my RioCan or H&R unregistered…

The above mentioned, you might be asking yourself (or not), what does Financial Cents do with this information?

I certainly dont advocate you follow my lead, Im no personal finance or tax expert, but I know I dont like paying tax any more than I have to. This leads me to my asset location general rules:

Rule # 1 For now, I keep all my Canadian dividend-paying stocks unregistered. I want that dividend tax credit, I want the favourable tax treatment. Over time, I will probably put a few Canadian dividend-payers in my TFSA, just not right now. My 20-year goal is to make some good income from dividend income. Im on that journey, one dividend payment at a time…

Rule # 2 - I keep all my U.S. dividend-paying stocks in my RRSP or LIRA. I dont want to lose any dividends paid to me. I want to reinvest all dividends received. Besides, my U.S. dividend-paying stocks dont get the same (great) tax treatment as my Canadian dividend-paying stocks do.

Rule # 3 I keep Canadian bond ETFs (like XBB) in my RRSP and TFSA. Interest income, just like employment income, is taxed in a big way. I use these registered accounts to defer or eliminate tax respectively.

Rule # 4 I keep Canadian equity ETFs (like XIU) in my RRSP. Outside of a few U.S. dividend-paying stocks, I like to use passive investing in my RRSP. I dont have to think about the markets and besides, XIU amongst other great equity ETFs pay solid distributions that get reinvested.

Rule # 5 I keep Canadian REITs (Iike RioCan) in my RRSP and TFSA. RioCan pays nice distributions, which is exactly why this income should be tax-sheltered.

As always, buyer beware, do your own research, other investing disclaimers apply. When in doubt, ask questions from knowledgeable people. Nobody learns about asset location or AAAD in a vacuum. I didn’t. I learned from books. I learned from trial and error and some investing mistakes. I learned from bloggers, some pretty smart ones like Canadian Capitalist, Larry MacDonald, Canadian Couch Potato, Money Energy, Ending the Rat Race and Million Dollar Journey, just to name a few. I know I haven’t covered all the “rules” of tax-advantaged investing but I’ve described what I’ve learned that applies to me so hopefully it can help you too.

I became a better investor in recent years thanks in part to better asset location. I hope to become more knowledgeable over time, as I mature as an investor and learn more. Death and taxes will never go away. At least for the latter, you can do something about it.

Got other ideas about the best locations to hold investments, and why?
Do my rules go against yours?

Cheers!
Financial Cents

Long time readers of Stockerblog know that I am a big fan of stocks with high dividends and a bigger fan of stocks with no debt. So I guess it is no surprise that the list of stocks I wrote about in January 2009 called ‘Four High-Yield, Debt-Free Stocks‘ was the highest performing list, up an amazing 67% versus the benchmark of only 28.5%.

Many of the other stocks I have written about, including debt free and high yield stocks, can be found in an Excel list form at WallStreetNewsNetwork.com.