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So long bull market, it's time to live with the bear

Daily Buy-Sell Adviser
0 Comments|July 30, 2008

You could profit from the bear with short funds, but still hold on to solid Canadian equities.

The bull market is dead in the U.S., but it’s clinging to life in Canada, says this analyst, who has several strategies for an uncertain future.

It began in October 2002. Officially, it passed away at the end of June 2008. It was a great bull market, but now it’s gone.

It became official in the United States when the Dow Jones Industrial Average dropped 20% below its previous high last October. The S&P 500 Composite Index, made up of the largest publicly traded companies in the U.S., followed the Dow Jones into bear territory shortly thereafter.

It’s time to take stock of the situation, says Mr. Richard Croft in the latest issue of The MoneyLetter. There is still a difference between Canada and the United States. The S&P/TSX Composite hasn’t taken that 20% fall, although it is down a rather glum 3.5% so far this year.

That means you need different strategies for the two markets. Mr. Croft has some exchange-traded funds to recommend and a couple of commodities that he likes.

Hold the bear

As the bear takes possession of the American markets, “the exchange-traded funds that take bearish positions against the big U.S. indexes have been minting money,” says Mr. Croft.

He has recommended ProShares Ultrashort S&P 500 Bear Plus ETF (AMEX: SDS, Stock Forum) since last October. “Using leveraged techniques, the fund aims to achieve twice the inverse of the daily performance of the S&P 500 Composite Index,” he explains. It has gained over 40% since his recommendation.

Yesterday, of course, the U.S. markets got a reprieve with some negative reinforcement from the sliding price of crude. But it would seem unwise to contradict Mr. Croft’s contention that “there’s more downside to come in the U.S. markets.” He advises investors to hold this bear fund.

The Canadian story

In Canada, it’s a slightly different story. “The reason for Canadian stocks’ relative outperformance lies in a happy conjunction of a number of different fiscal, business, and macroeconomic elements.”

Fiscally, the country is in good shape, with budget surpluses the norm on Parliament Hill (a sharp contrast to the gaping deficit in the U.S.). On the macroeconomic front, the overall economy is not going to grow much this year, 1% to 1.5% at best, says the analyst. Manufacturing and export will take the brunt of the punishment.

Inflation is also creeping in, says Mr. Croft, “but probably won’t exceed 4% before being shut down by the Bank of Canada.” Canada’s housing market hasn’t experienced the same catastrophic collapse as in the U.S. thanks to higher lending standards, but some deterioration is inevitable.

The most uplifting element in this mixed bag of factors is the giant resources sector that “provides a huge cushion for the Canadian market, and is likely to continue doing so, even as the overall market slides south.”

All in all, says the analyst, Canada is in a better position than most to weather the storm. But the bear is still coming and you can’t ignore it.

Another bear to hold

Canadian bear funds are lagging behind their American counterparts – which is a good thing if you’re invested in the market as a whole, not so good if you’re heavily invested in the bear.  

Still, Mr. Croft recommended Horizons BetaPro S&P TSX Bear Plus ETF (TSX: T.HXD, Stock Forum) for speculative investors in February. The same heavy weighting in resources that has kept the index relatively buoyant has kept this bear fund fairly flat.

“Any deterioration in the Canadian index from this point, however, will work in its favor as it has for the U.S. ProShares fund,” he says. Hold the fund, he says.

Then there’s the one area that’s troublesome wherever you go in the world – finance.

Not cut off from the world

While resources have lifted the Canadian market, the financial sector has dragged it down. It was simply impossible for Canada to resist the credit crisis that spread from the U.S. across the globe.

There was some sentiment that part of the country (i.e., the west) would be “decoupled” from these financial woes. Uh-uh, says the analyst.

“If you think about it for more than a second or two,” he says, “the concept of ‘decoupling’ seems diametrically opposed to the notion of ‘world-is-flat’ globalization that has prevailed for nearly two decades.” A region would have to be completely cut off from the rest of the world and self-sufficient for 20 years to achieve that.

“And even North Korea and Myanmar (Burma) haven’t managed that little feat of autarky,” he quips.

But on the whole, Canadian financial institutions have not fallen as hard as many around the world, despite huge write-offs at Royal Bank of Canada (TSX: T.RY, Stock Forum) and the “near basket-case status” of CIBC (TSX: T.CM, Stock Forum). Comparatively speaking, the Canadian banks are pillars of conservative management and tight-fisted care of shareholders’ equity.

“So much so,” he adds, “that in a lightly reported move, the Bank of Canada recently closed an emergency fund it had set up to shield the financial sector against the sub-prime credit storm.”

With that in mind, the analyst believes that those who bought iShares CDN Financial Sector Index Fund (TSX: T.XFN, Stock Forum) on his recommendation should hold the shares. The fund tracks the S&P/TSX Capped Financials Index, covering the big banks, insurance companies, and mutual fund firms. The pain for financials isn’t over yet, but Canada’s financial sector will be one of the first to recover.

Finally, Mr. Croft updates his MoneyLetter readers on two commodity stocks that “have held up well.”

The shares of Proex Energy Ltd. (TSX: T.PXE, Stock Forum) have indeed held up well in a topsy-turvy market. A junior oil and gas producer with operations in northeastern B.C., it “continues its program of exploration and expansion, including the construction of new pipelines, and is on track for significant growth in the second half of the year.” That makes it a hold/buy.

Goldcorp (TSX: T.G, Stock Forum) has not held up quite as well since this issue went to press, as gold futures drift down from previous highs. But the analyst likes it as a “profitable, low-cost major gold miner.” And in these Jekyll-and-Hyde markets, who knows where gold will go? This is a hold/buy.

If we’re in for a less threatening bear market in Canada, it may be possible to have the best (or least bad) of both worlds. You could profit from the bear with short funds, but still hang on to solid Canadian equities that can ride out the storm. We’re Canadians, we can take it.

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