Canada Is Looking Better and Better

07/20/2011 1:30 pm EST

Focus: GLOBAL

Roger Conrad

Founder and Chief Editor, Capitalist Times

While the US and European markets are moving on day-to-day data announcements, Canada continues to build strength, argues Roger Conrad of Canadian Edge.

Most Canadian stocks have lost ground since the market’s most recent peak in early May.

Why the pullback? Simply, the memory of 2008 is all too fresh. Since that crash, every dip in stocks has many investors asking the questions listed above—and no wonder. The financial media continue to trumpet every pullback as the potential beginning of a greater crash.

Market psychology was much the same in spring and early-summer 2010. Then, investors also worried about softer economic growth and global credit concerns as precursors to a steep drop for stocks.

Last year’s downturn eventually reversed by mid-summer, and stocks moved on to new post-crash highs by late April 2011. Rising prices calmed fears of a reprise of 2008, as investors again focused on growth and yield.

That’s pretty much what I expect to see this time around. For one thing, sovereign debt crises—whether in Greece or the US—don’t have the potential to sow panic the way the mass default of mortgage-backed securities did in late 2008.

With government bonds, everyone knows where exposure lies. A real US default would no doubt hurt the US economy, not to mention the country’s credibility. But there would be no surprises about where exposure lies.

That’s a very stark contrast with the mortgage-backed security crisis in late 2008, when bombs went off repeatedly in places suspected by few, if anyone at all.

As for economic growth, for all the sturm und drang in the financial media, it’s still running basically the way it has since mid-2009. That is, very lumpy and uneven with real pockets of weakness. But it’s growing nonetheless.

Meanwhile, 1970s-style inflation remains impossible, due to very slack employment conditions.

In 2010, many investors were convinced Chinese growth was on the verge of slowing rapidly, and prices for commodities, including oil, dropped in anticipation of lower demand. That didn’t last long, as the world’s most populous nation soon drew down inventories of key supplies and ramped up imports once again.

The current sell-off may go on for a while longer. But the bottom line is, credit, economic, and market conditions just aren’t anywhere close to as dire as they were in mid-2008, before the crash unfolded.

That means we’re likely to see a third leg of the post-crash bull market begin sometime this summer, and that means still higher prices for our favorites.

What I feel best about, however, is that if I’m wrong, my favorite Canadian companies are protected.

First, they have little if any refinancing risk, having basically cleared out all but a handful of obligations due to mature before the end of 2012. They’ve done this by using generation-low corporate borrowing rates to minimize interest costs. And should credit conditions tighten, they can simply delay bond offerings until things loosen up.

The Canadian economy as a whole is also far less leveraged than the US. The country’s federal budget is on track for balance in the next couple years.

Debt has risen at the household level. But 69% of Canadian homeowners have at least 20% equity in their homes. Those just aren’t the right conditions for a wholesale crash as happened in the US.

With few exceptions, the best Canadian companies operate in recession-resistant niches that proved their ability to generate consistent revenues during the 2008 crash and subsequent recession. And, mindful of the potential for a relapse, management has used the better economy of the past couple years to further cut risk by adding stable assets.

Even the Canadian dollar is no longer acting like the commodity-price proxy of yesteryear. Despite a sharp drop in oil prices last month, as well as worries about slowing growth, the loonie held above parity versus the US dollar.

Of course there are circumstances where stocks of even the strongest companies will drop sharply. And some companies—such as Yellow Media (Toronto: YLO, OTC: YLWPF)—have weakened in the current slow-growth environment.

However, 2008 proved that so long as a company remains solid on the inside, its stock will eventually recover any decline solely through market factors. So as long as stocks measure up on the numbers, we’re going to continue holding on.

This doesn’t mean doubling down as prices drop. That strategy has the potential to kill a portfolio under the wrong conditions. In fact, you should be ready to sell any position if it makes sense to, regardless of the gain or loss.

But it does mean letting bets ride in a balanced and diversified portfolio of well-chosen, dividend-paying stocks backed by healthy and growing businesses, even if the market is in severe turmoil.

Remember, this is a high-percentage strategy that worked in 2008. It will work again in 2011.

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