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Canadian banks have underperformed due to uncertainty about write-offs and low interest rates shrinking net interest margins, but their dividend yields are also attractive. One money manager likes Toronto-Dominion Bank stock because of its retail exposure and growth potential in the U.S.Fred Lum/the Globe and Mail

Hunting for bargains in the stock market during the tax-loss selling season can be rewarding, but every year has its quirks and opportunities.

Deals arise from selling pressure on stocks or exchange-traded funds (ETFs) as investors dump losers at year-end to offset capital-gains taxes, but this year’s COVID-19 pandemic and vaccine optimism can play havoc with usual strategies.

“There are bargains this year, but one needs to tread more carefully to avoid value traps or potentially financially troubled companies,” says Stephen Takacsy, president and chief investment officer at Lester Asset Management Inc.

“It’s not your normal recession or economic slowdown,” he says. “Some stocks may look like a bargain, but they may not rebound in a normal fashion next year because the pandemic is continuing. And there are businesses in travel, entertainment and leisure that are going to take a long time to recover.”

The tax-loss selling deadline is Dec. 29. Investors must also wait 30 days to repurchase the same securities or the Canada Revenue Agency (CRA) won’t count it. Unused capital losses can be carried back three years or forward indefinitely.

Although most of the selling typically occurs in late December, “you don’t want necessarily to wait until then to buy, or consider staggering your stock purchases,” Mr. Takacsy says. “You may have competition for some of them.”

Stocks hit hard by COVID-19 may rally on vaccine developments and a bet on economic recovery. That happened recently after U.S.-based Pfizer Inc., which has partnered with Germany-based BioNTech SE, and Moderna Inc. announced that early results indicate that their vaccines are more than 90 per cent effective. Still, the logistics of getting people vaccinated is still a long road, he says.

Some of the compelling bargains now are in energy infrastructure names such as Enbridge Inc. (ENB-T), Keyera Corp. (KEY-T), Pembina Pipeline Corp. (PPL-T) and Gibson Energy Inc. because they generate a lot of cash and have 7-to-9-per-cent dividend yields, Mr. Takacsy says.

This sector has been hurt by falling commodities prices, weakened oil and gas producers and fund flows to renewable energy stocks, he adds. As such, it’s difficult to build new pipelines now, so “those companies with the infrastructure are in a good spot despite the long-term trend of a declining use in fossil fuels.”

Meanwhile, Canadian banks have underperformed because of uncertainty about write-offs and low interest rates shrinking net interest margins, but their dividend yields are also attractive, Mr. Takacsy says.

“We have been nibbling at Toronto-Dominion Bank (TD-T) stock. We like its retail exposure and growth potential in the United States,” he says.

Shares of smaller-cap dividend payers, such as nursing home operators Sienna Senior Living Inc. (SIA-T) and Chartwell Retirement Residences (CSH.UN-T), “have been overly punished,” but their businesses are sound and dividends are safe, Mr. Takacsy says.

Tax-loss selling may hit real estate investment trusts (REITs), but apartment REITs, which have performed the best for a long time, have also been unduly hurt and offer opportunities, he says. Mr. Takascy says he started buying Canadian Apartment Properties REIT (CAR.UN-T) before its units surged recently after “phenomenal [third-quarter] earnings.”

Benjamin Gallander, co-founder and president of Contra the Heard investment newsletter, usually buys more than 80 per cent of his North American stocks in December, but it’s not a normal year.

“I did a little buying” after the COVID-induced March market crash, he says. “Right now, there are not as many bargains in the pool where I fish.”

He focuses on stocks that have at least 100 per cent upside potential and have traded at much higher levels historically, but also eyes companies’ debt load carefully. During the past 40 years, he has “had numerous buys from tax-loss season go up four or five times and the odd one 10 times,” but also companies that have gone bankrupt, he says.

Mr. Gallander is now sifting through oil and gas stocks that have plunged to below $5 a share from more than $20 but worries about their companies’ debt. This sector is far from dead because the transition to cleaner energy will take a long time, he says.

Mr. Gallander, who bought shares of U.S.-listed Banco Santander SA (SAN-N) in May for about US$2.05 a share, suggests that Spain’s largest bank could be a tax-loss selling candidate that could have potential upside similar to the U.S. banks he once bought after the 2008 global financial crisis.

Santander’s stock, which rebounded recently from diving to below US$2 a share, is off from more than US$4 at the start of 2020. Its shares suffered after the European Central Bank recommended that banks stop paying dividends to cope with the pandemic. The bank is seeking regulatory approval to resume paying dividends.

He also owns conglomerate General Electric Co. (GE-N) and security software provider Blackberry Ltd. (BB-T), which could be tax-loss selling candidates, too. He says he “might buy more GE” as a bet on its chief executive officer turning the company around.

Investors seeking to maintain exposure to a security they sold for tax-loss reasons can invest in an ETF holding that name or that focuses on the same sector, says Daniel Straus, director of ETFs and financial products research at National Bank Financial Inc.

That way, they could benefit from a near-term rally in those securities during the 30-day period, as some did recently with vaccine developments. After a month, investors can repurchase their original security or stick with the ETF, says Mr. Straus, who recently released a report on tax-loss strategies using ETFs.

For example, in the energy sector, Vermilion Energy Inc. (VET-T), Enerplus Corp. (ERF-T) and Crescent Point Energy Corp. (CPG-T) are off 60 to 80 per cent this year. Investors selling them for a capital loss might benefit from any potential near-term sector rebound by investing in an ETF such as iShares S&P/TSX Capped Energy ETF (XEG-T), he says.

However, investors who own and dump that iShares ETF for a capital loss should not cycle into Horizons S&P/TSX Capped Energy ETF (HXE-T) because they track the same market-cap weighted index and the CRA would consider it as buying the same security, Mr. Straus says. That’s not the case with BMO Equal Weight Oil & Gas ETF (ZEO-T), which tracks an equal-weighted index of the same stocks.

A proxy for beaten-up financials such as Manulife Financial Corp. (MFC-T) and Industrial Alliance Insurance and Financial Services Inc. (IAG-T) is iShares Equal Weight Banc & Lifeco ETF (CEW-T), he says. Both stocks each have a 10-per-cent weighting in the ETF.

Air Canada (AC-T)’s stock has been pummelled by the pandemic, which has restricted air travel, but investors can maintain exposure to the airline through BMO Equal Weight Industrial ETF (ZIN-T) or U.S.-listed U.S. Global Jets ETF (JETS-A).

This tax-loss strategy using ETFs is a phenomenon that has been evident in past years, Mr. Straus says. “That’s why we see quite a lot of inflows into poor-performing ETFs in December.”