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The Canadian Income Trust Conundrum

06/21/05 07:52:15 AM
by Koos van der Merwe

Income trusts are popular in Canada, especially in this low interest rate environment.

Security:   SPTSX
Position:   Hold

An income trust is a product that holds an underlying asset or group of assets. Most of the income these assets generate is distributed to unitholders. In contrast, publicly listed companies usually retain and reinvest their earnings, and sometimes pay out a small portion of earnings to their shareholders as dividends.

An income trust structure is formed when, instead of offering its securities directly to the public, an operating entity creates a trust. The trust offers units to the public and uses the proceeds to purchase the common shares and high-yield debt of the operating entity. The combination of the trust's equity and debt holdings allows the income to flow through to unitholders essentially tax-free. In other words, the unitholder pays the tax at their individual marginal tax rate, rather than the corporation paying the tax.

Income trusts in Canada have recently been granted limited liability and as such can now become part of the TSX index. This, and the fact that large pension funds can now own them, have cued their prices to rise astronomically, with new highs being reached almost every other day. In the week just past, Aeroplan offered an income trust initial public offering (IPO), and was oversubscribed almost as the ink on the offering dried.

Perhaps I am being too sensitive, but I must ask when-- when-- will this trust bubble burst?

Figure 1: Has the Canadian income trust market started to peak?
Graphic provided by: AdvancedGET.
Figure 1 is a five-wave Elliott wave count of the S&P/TSX income trust index. With the chart I have shown Fibonacci ratios, suggesting possible targets that the index could reach in the future; the exact turning point could be any of them. With income trusts soon becoming part of the S&P/TSX index, the top could be sooner rather than later.

What is also a concern are the falling bottoms in the relative strength index (RSI). This is a sign that the index is weakening and could turn once a new high is made, probably around 152.357, the 50% level. Wave 5s tend to be equal to wave 1, which means that the index should rise to the 168 level before falling, but with this enthusiastic market, anything can happen.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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Vancouver, BC
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