Resources/Weekly Insights

Volume 14, Edition 2 | January 19 - January 25, 2025

Food for Thought on Taking Gains

Doug Walters, CFA

With a new “mega-class” of companies creating large gains in portfolios we take a page out of history to look at the risks associated with not realizing those gains throughout your investing journey.

Contributed by Doug Walters, David Lemire, Max Berkovich

Over the years I have witnessed numerous clients grappling with the complexities of their portfolios. One recurring theme is what to do with individual stocks with low cost basis. Selling means realizing a capital gains tax bill. Not selling means potential concentration risk or missing better opportunities in the market. It is quite the conundrum! Each case is unique and a financial advisor can help identify the best course of action. Today, our goal is simply to provide some food for thought.

The GE Way

30 years ago, I began my professional career as an engineer at General Electric’s Aircraft Engine business. I was living the dream, working in the Rotating Parts Center of Excellence, designing components for cutting edge, supersonic military fighter aircraft. Around me I saw and benefited from a well-run business with world-class training in the company’s famed Crotonville facility. In the papers I read about GE, the bluest of blue chip stocks. Jack Welch was in Forbes magazine touting his success instituting Six Sigma across the firm (I was a green belt). The result was an infallible stock. In the decade from 1990 to 2000 the S&P 500 was up 450% while GE was up 1155%.

A Turn of Fortunes

It didn’t last. From its peak in 2000 to its 2009 low the shares fell nearly 90%. There’s risk in even the best of individual stocks. Remember Nokia – the leader in the mobile phone revolution? To this day, the shares are down by over 93% from their dotcom hay day. Kodak, Blackberry, Xerox, Sears… all industry leaders and seemingly invincible, yet each down 90-100% from their peak.

The Next Giant Killer

Today we have a new class of leaders. The so-called magnificent seven. Companies like Apple, Microsoft, Alphabet and Amazon. Each are leaders in their space. It won’t last forever. This isn’t a call of impending decline – that could be years or decades away. It is more to say that you never know. Blackberry was dominant until the iPhone came along… and it was game over. Perhaps something coming out of artificial intelligence (AI) will be a giant killer. I’m sure Google is eying OpenAI and its peers with more than a passing interest.

All of this is to say, there is a reason we made the switch to preferring exchange traded funds over individual stocks a few years back. There is also a reason we generally recommend prioritizing the pursuit of the best investment opportunities over concerns about taxes.

The ETF Revolution

Exchange traded funds have been around for decades but came of age a few years ago. Their growing varieties and improved liquidity give us the ability to pinpoint the areas of the market where we see opportunity while at the same time benefiting from diversification we could not get from individual stocks. In addition, they are generally tax efficient compared to their mutual fund peers.

Handcuffing Gains Limits

Limits on capital gains constrain a PM’s ability to take full advantage of market opportunities. In addition, they generally lead to concentration risk. If you are always selling the securities with the fewest gains and holding on to your biggest winners, concentration risk continuously builds. If that big winner falls out of favor, like GE, that risk can be realized. Whenever possible, we recommend taking gains consistently without restriction throughout your investing journey. Where big unrealized gains exist, talk to us, there may be options to hedge those risks.

The allure of holding low-basis individual stocks to avoid capital gains taxes is understandable. Yet the risk of significant losses cannot be overlooked. Diversification through ETFs is a better way. Equity risk will not be eliminated (nor would we want it to be), but company-specific risk can be minimized. The result is a portfolio that has a better chance of avoiding negative surprises and the permanent loss of capital that can come when a single company’s fortunes turn in dramatic fashion.

Estimated current US housing shortage

4.5 Million Units

Headline of the Week

4.5 Million

Heading off the beaten path a bit this week. Housing is a key component for our economy in a myriad of ways. Housing needs to complement our dynamic and flexible economy by enabling mobility. Mobility can take two forms. First, a normally functioning housing market allows people to move up or down market (think one bedroom to three bedrooms and vice versa). Second the housing market needs to facilitate geographic mobility, whether its young people moving freely to where the best job opportunities are or older folks ditching long cold winters for warmer climates.

Currently the housing market is far from helping on either front. Due to higher mortgage rates and a supply/demand imbalance, we continue to see record low mobility as measured by home sales. The mixed inflation signals have helped to keep interest rates higher and by extension mortgage rates which restricts the purchasing power of would-be home buyers. By one estimate, we are short over 4.5 million homes causing the supply side to be constrained. This supply issue in turn has helped push up prices on existing homes, pricing many out of the market. Many would-be sellers are sitting on highly appreciated homes with low mortgage rates, further exasperating supply issues. All the while demand remains strong. Hard to see what breaks this cycle, but something needs to give.

The Week Ahead

Everything but the kitchen sink kind of week in store. It will start slow, but by mid-week, we get a Federal Reserve rate decision, gross domestic product (GDP), an inflation report and earnings for four of the magnificent seven. With all that, the European Central Bank (ECB) rate decision and Europe’s GDP may be lost in the shuffle.

Lots of Interest

While it sounds exciting, this Federal Reserve meeting is not expected to yield a rate move.

At the last meeting, expectations for further rate cuts were pulled back, but since than an inflation report showed firmer inflation progress than previously expected and gave hope for more aggressive cut cycle, only to be whisked away by a blowout jobs report.
With only a few days of the new administration in the books by meeting time, it looks like the central bank has a good excuse to do nothing.
Without a cut, all the interest will shift to the press conference and statement from the committee.
President Trump demanded the central bank cut rates during his appearance at Davos, so expect some heat on Chairman Powell during the press conference relating to this.
On the other side of the ocean, expectations are that the ECB is going to trim rates once more.
Fear of tariffs and an already sluggish economy pave the way for this, but the more important question will be if the three further cuts expected this year are still on and how soon.

Growth Plan

4th Quarter GDP growth is expected to come in at 2.6% when it is reported on Thursday.

This would be a solid number, but below the 3.1% and 3% reported in the previous two quarters.
This is the initial number which will see a few revisions still, but it may get a pass from investors who are looking at the new administration to push those numbers higher.
The GDP from the European Union will look awful compared to the US. This has been the case for a while now.
The EU is expected to print a tiny quarter over quarter expansion and 1% expansion from the previous year.
The various countries in the Union will report as well, with Germany expecting to show a contraction.

Numbers Game

The Personal Consumption Expenditures (PCE) price index is the preferred inflation measure of the Federal Reserve. However, it will be unveiled after they hold the January rate setting meeting.

Expectations are that the monthly inflation will be 0.3%, with the Core-PCE, which excludes food and energy, similarly up 0.2%.
The December-to-December rate is expected to be 2.5%, with the Core-PCE up slightly more at 2.8% for the period.

How Magnificent?

Earnings season heats up with Microsoft, Meta & Tesla on Wednesday followed by Apple on Thursday.

The results from the majority of the magnificent seven will determine market direction.
Tesla’s earnings will most likely be of most interest, analysts expect 2.07 million units to be sold in 2025, a 15.9% annual increase.
Friday’s results from Exxon and Chevron could also be interesting with a new energy policy initiated.

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