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Harry Koza

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Un-American activity

Harry Koza


There is America, which at this day serves for little more than to amuse you with stories of savage men and uncouth manners, yet shall, before you taste of death, show itself equal to the whole of that commerce which now attracts the envy of the world.

— Edmund Burke (1729-1797): Speech on the Conciliation of America. Vol. ii. p. 115.

America makes prodigious mistakes, America has colossal faults, but one thing cannot be denied: America is always on the move. She may be going to Hell, of course, but at least she isn’t standing still.".

— E.E. (Edward Estlin) Cummings (1894-1962), U.S. poet. repr. In A Miscellany, ed. George J. Firmage (1958). "Why I Like America," Vanity Fair (New York, May 1927).

TORONTO (GlobeinvestorGOLD) — There’ve been entire forests of pulp wood cut to make the paper for all the pundits’ prognostications about what the U.S. markets will do after the November 2 election. Well, fire up the old McColloch and clear-cut another hectare, folks, because I’m going to weigh in on the subject, too.

What if Dubya wins? What if Senator Nuance wins? An old Street adage goes that stock markets always go up when a Republican/Democrat wins the presidency, depending on which party is in power when your broker calls you with an idea. Of course, they also say that markets go up whenever an NFC team wins the Super Bowl, or in September, or January, or when the moon is full, or in a leap year, or on whatever day of the week it happens to be when your broker has that idea.

On the one hand, Dubya’s fiscal policy is a mess, the U.S. greenback’s in the toilet, Iraq is costing a bundle, oil is through the roof, the balance of payments is in deficit. Consumers are tapped out, in debt up to their ears, have no savings, and the warm glow of their recent tax cuts has faded faster than a campaign promise after November 3. For Canada, problems with U.S. protectionism under the Bush administration, such as softwood lumber, beef, wheat and steel remain unresolved.

Under a Kerry administration, on the other hand, the U.S. would still be a fiscal basket-case, would still be dropping billions in Iraq, oil would still be through the roof, the balance of payments deficit would be still be burrowing down to the center of the earth, and the consumer would still be tapped out, but taxes would be higher. And Canada’s problems with Yankee protectionism could be even worse, given Senator Kerry’s rhetorical predilection for espousing mercantilist trade barriers. When he talks about all the outsourcing of American jobs, I can’t help but hear H. Ross Perot’s braying about the "giant sucking sound" of all those jobs going to Mexico under NAFTA. That was a campaign theme that didn’t work out so well for Mr. Perot, and I wonder how it will work out for Mr. Kerry.

The thing is, though, I don’t think it much matters who wins the U.S. election, from a strict investment point of view. Canada always somehow manages to muddle along regardless of which leader of which gang of troughers is ensconced at the big house on Sussex Drive, so in many respects our American cousins will manage to get by regardless of whether the White House is occupied by the Cowboy and the Machiavellian or by the Empty Suit and the Ambulance Chaser.

Whoever wins, I’m staying out of the U.S. market for a while, for a variety of reasons. First and foremost, there’s the Loonie: The Great Northern Diver is belying its name, and soaring like a hawk. I hesitate to say eagle, because the eagle is a U.S. symbol after all, and the U.S. dollar is displaying many of the same traits as the loon (the bird not the currency), especially the one about diving and staying underwater for a very long time.

It wasn’t that long ago that a forecast target (I believe National Bank’s Clement Gignac was the first) of 85 cents U.S. for the Canadian dollar over the next year or so drew, if not gasps, then at least more than a few raised eyebrows. And just the other day, the entertaining and erudite Don Coxe, Chief Strategist at BMO Harris, said he sees the Loonie going to par with the U.S. buck over the next 18 months, no problem.

Well, if Mr. Coxe is correct, and with the Canadian dollar currently above 80 cents U.S. for the first time since 1993, you were to buy a U.S. stock, planning to hold it for a year or so, it would have to go up about 20 per cent in price just so you can break even on the currency. Oh sure, you can hedge your currency risk with forward contracts, but for small investors who aren’t making six- or seven-figure trades, that’s not easy, and the forwards are not RRSP eligible, either.

The best way for the small investor to hedge his currency exposure is to pay in full for his Canadian stocks, and buy his U.S. stocks on margin. Do keep a close eye and a tight stop-loss on your purchases, however — margin is a useful tool, but it cuts both ways. By buying U.S. stocks on margin you are fully hedged on the currency: the Canadian dollar goes up, and you owe less for the stock. You still pay interest on the margin loan, but it is comparable to the costs you would have incurred if you were hedging with currency forwards.

You cannot use margin in your RRSP, however, another reason I personally won’t be buying any U.S. stocks.

Still. Unhedged, you’d need a 20-per-cent gain to break even on the exchange rate, and the Dow Jones industrial average, Nasdaq and S&P 500 are all down on the year. Buy U.S. stocks? You do the math.

I still like the oil and gas sector a lot with West Texas Intermediate crude holding its 70 per cent gain so far this year. Most of the Canadian integrated oils were coining it huge when WTI crude was trading with a three handle. At $52 (U.S.) and up, they are making even more obscene amounts of money, lots of which will get put into drilling thousands and thousands of new oil and gas wells, both here in Canada as well as south of the border and abroad. Though I am still long a ton of oil and gas related stuff, I’m thinking about broadening my exposure to the energy sector by buying a few oil drilling stocks. They should have all their rigs busy over the next few years. I’m sure there are some good U.S. drill service firms, but there are Canadian firms (Precision Drilling, Ensign Resource Service Group, among others) well-poised to capture a nice chunk of U.S. drilling business (I already own several income trusts in the oil and gas services industry).

Now, the other side of the coin, as it were, for the Loonie, is that if it does go to par with U.S. buck, the Bank of Canada will, by the time it gets there (or in order to try to stop it from getting there), have had to cut interest rates to — as we say in the bond trade — "seven-eighths/an eighth around zero." With the dollar at par, our export sector — one of the Bank of Canada’s key indicators these days — will be suffering. Except for exports of oil and gas, anyway.

In that scenario, bonds are a man’s best friend, especially longer-dated ones. Yields on 30-year Canada bonds closed at the end of October at just under 5 per cent. While the Bank is still making hawkish noises about further rate hikes, I think you can forget about that if the dollar is even with the U.S. buck. Five per cent long-bond yields are going to look darn attractive if the Loon goes to par.

I figure that the U.S. markets are going to keep lurching from crisis to crisis: once the election is over, there’ll be the Inauguration, Iraq, the Budget, Iraq, oil, hurricanes, blizzards, Iraq, the housing bubble, all the usual stuff — plus what Dismal Scientists like to call "exogenous events." Exogenous events are the market equivalent of you walking along a city street and suddenly a grand piano falls on your head from 10 stories up. This kind of stuff may be great for volatility traders, but is not so much fun for p.c. (Preservation of Capital) investors like me.

Frankly, while I am sure there may well be plenty of attractive investment opportunities in the U.S., I am still sticking close to home. I think that stock markets generally will be hard pressed to generate returns much better than 7 per cent to 8 per cent a year in 2005 and I think there may well be a major downward correction ahead — bullish market sentiment is way too high.

So I plan to keep milking my herd of energy trusts, and build a cash position to take advantage of bargains next year.

My sole U.S. exposure at the moment is a small piece of Royce Value Trust, a U.S. closed-end small cap fund specializing in Russell 2000 stocks. It is up about 7.3 per cent (as at Oct. 30) year-to-date, including dividends. Thinking about where the exchange rate was (70 cents U.S. maybe?) when I bought it, however, the thing is likely still underwater.

So, bottom line, rather than investing in the U.S. now, I’m saving my money for something that promises much bigger returns down the road: Cross-Border Shopping.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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