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Yola Edwards

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Diversify before December

Yola Edwards

TORONTO (GlobeinvestorGOLD) — At an annual meeting of the Canadian Chamber of Commerce in Calgary on September 20, Bank of Canada Governor David Dodge said the economy is close to firing on all cylinders, but inflation is on his radar screen.

Inflation, which the Bank of Canada targets at 2 per cent next year, has been pushed higher by record oil and gasoline prices and the economy has been fired up by the unexpected strength in the export sector. In an August memo to Finance Minister Goodale, Mr. Dodge wrote that the chances of steady economic and job growth were the best in years.

This good news should help fuel the dollar and economists recently revised their targets upward to an 85-cent (U.S.) loonie. That premise is also supported from a technical point of view.

The technical chart below reveals that all of the significant averages have crossed over one another to the upside issuing a buy signal. In addition, the Moving Average Convergence/Divergence Oscillator (MACD), which is a technical study whereby two exponentially smoothed moving averages revolve around a zero line revealing a buy or sell trend signal, has issued a buy signal, since it has crossed above the zero line.

Then there is the double bottom that the Canadian Dollar index has traced out over the past 16-months, and even more recently it has formed a bullish inverse head-and-shoulders pattern. Over the next quarter the dollar should be able to complete the shorter-term pattern and rally to the pattern's technical target measurement of about 82 cents, while the longer-term double bottom pattern's target of an 86.25-cent loonie could be complete over the next 18 months.

At the Federal Open Market Committee (FOMC) meeting on September 21, the Fed issued a statement saying that "after moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labour market conditions have improved modestly."

Canadian dollar index

That served to underscore Fed chairman Alan Greenspan's optimism that the U.S. economy was gathering some steam and "on the whole, the expansion has regained some traction." A stronger economy means growing corporate revenues and should translate into strong stock markets.

In fact, a technical view of the Dow Jones industrial average reveals a very bullish market indeed.

Dow Jones Industrial Average index

After rallying virtually non-stop throughout 2003, the index has spent virtually all of 2004 in decline. But the decline is really a consolidation pattern. Once the index declined to the 200-week moving average (MA) support it was able to turn and rally above the 10-week MA and for the past three weeks its highs are peaking above the consolidation's upper downtrend line, suggesting higher prices are directly ahead. Also, although the recent rally did not reach the intra-weekly highs of the June-July peaks, the September 3 weekly close was higher than that of the June-July period, thus indicating a breakout. The previous intra-week high of the 10,500 level will pose as a bit of overhead resistance, but with the MACD flashing a preliminary buy signal and the Dow Jones average having developed into a bullish flag pattern the level should be easily surpassed. A close above the intra-week high of 10,795 will set the stage for the index to rally to the pattern's technical measurement of about 13,700 over the next 12 to 16 months.

With all of the good news facing them, how best can Canadian investors profit from diversifying into a foreign market without the currency risk? To take advantage of a potentially longer-term rising U.S. market you might wish to look at a mutual fund index fund, iUnit, or other derivative funds that track the index and at the same time limit currency exposure to some extent. These financial vehicles will fall under the RRSP section as they hold almost all of their assets in Treasury bills and other Canadian money market instruments, with the remainder invested in futures contracts on the foreign stock indexes or equities.

Pay attention though to the management expense ratio for the mutual fund you choose, as your return will be calculated to be the gain on the index less the MER. The MER is the fee charged to manage the mutual fund and all other expenses related to running the mutual fund before any returns are paid out to investors. An index fund usually provides maximum diversity with the lowest fees and is designed to be a long-term investment.

This type of vehicle becomes a natural hedge. You get the market performance of the futures contract, but you're not revaluing the underlying portfolio based on what the Canadian-U.S. currency exchange rate is doing.

An RRSP clone fund would do the job and you could purchase the fund in any type of investment account. To find one go to globefund.com, and under the "Profiles" menu found on the left hand margin of the site, select the "Fund Companies" That will take you to the "Select a Fund Company" drop down menu. Once you've selected your desired company, all of the its funds will appear. If you're looking at investing in the U.S. market, any RRSP U.S. Index or U.S. equity fund will give you market performance without the currency risk.

One choice could be the TD Asset Management TD U.S. RSP Index Fund-I at about $8.60, which has an MER of 0.86 per cent, reflects the S&P 500 index. A third party holds the securities and hence the higher MER. The fund is 100 per cent RRSP-eligible as it invests primarily in Canadian money market securities which are used as collateral "to invest in option futures and forward contracts on one or more of the U.S. equity market indices to approximate the performance of the U.S. market." At present the fund is fully invested in S&P 500 Index Futures, but always read the prospectus to make sure.

TD U.S. RSP

S&P 500 index

The TD U.S. RSP Index Fund chart reveals a pattern virtually identical to the S&P 500 index. Both charts reveal a broadening consolidation pattern and are similar to the Dow Jones industrial average flag pattern. There might be a little more downside to the fund price as the S&P 500 MACD has given a preliminary sell signal. With the S&P 500 having broken below the 200-Day MA it could fall to support found at 1,100 where we find the 50-day MA, thus the fund price could fall to about $8.50 before it settles down. Longer-term the fund's technical pattern's measurement suggests a 12-month target of about $11.40, while the S&P 500 should rally to about 1,475.

Yola Edwards is a contributing writer and technical analyst for Bell Globemedia Interactive, providing options and technical analysis research on a variety of North American equities.

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