Equity Strategy November 2, 2007:

Canadians are starting to see the positive impact on purchasing power that a strong currency offers. The recent surge in the loonie to near record valuation relative to the US dollar is allowing Canadian consumers and investors an opportunity to purchase real bargains in other countries. The price of consumer goods and investments in the US has not looked this attractive in decades. The last time the loonie was at these levels was in the late 1880’s. The purchasing power of the Canadian dollar has moved up to the point where virtually everything in the US looks relatively cheap.

Over the past couple of years I have been cautioning investors to avoid the US markets due to the potential losses due to changes in exchange rates. If you have been investing in the US market you will know what I mean the Dow Jones Industrial Average is up approximately 16.5% so far this year while the Canadian dollar has risen by approximately 23% this year. The currency change has turned a strong bull market move in the Dow into a 6.5% loss for Canadian investors.

The risk of further currency erosion from here appears to be limited, the Canadian dollar is somewhat over bought and valuation is stretched. There is a very good potential for the loonie to fall back to the 99 cent level and this would still leave the bull market intact. I would not be surprised to see a correction back to this area and then a longer term consolidation with the Canadian dollar trading in a range between $1.00 and $1.06 as the US dollar struggles to find a bottom.

The Federal Reserve has indicated that it is on a trend to lower rates even though the potential for increased inflation remains high with crude oil making new highs, heating oil and gasoline are moving higher as well, the core CPI is likely to move up. It appears that the focus of the Fed is on maintaining the integrity of the financial markets which are still not operating as efficiently as they should.

Lower interest rates in the US will continue to pressure the US dollar but how much more over valued the Canadian dollar can become is really the question investors should be asking. If the loonie is at or near a peak valuation then investing outside of Canada could be a very rewarding exercise. If over the next 12 to 18 months the loonie falls back to a more reasonable valuation of closer to 90 cents then investments in the US markets would increase by approximately 14% just on the decline in the currency, a nice change from the last year or two.

Diversifying in to the US market at this time is prudent as the potential for slower than forecast economic growth in Canada just became a lot higher with the recent announcement by the Government of Alberta regarding increased royalty rates for the energy sector. These increased costs will slow the investment in new infrastructure and that will reduce the economic activity in the Province. Economic growth in Canada has been driven largely by the huge infrastructure expansion taking place in the energy sector, as that slows it will impact growth in the rest of Canadian economy.

In the US markets I would still avoid any financial institutions due to the risk of further negative surprises from the subprime mortgage sector and the Asset Backed Corporate Paper (ACBP) market. The US housing sector is still falling and it looks like there is still a long way to go before the real estate sector stabilizes. The rate of mortgage foreclosures and defaults is rising and until that stabilizes the chances of a recovery in the real estate activity is very low.

It will be some time before the home builders and building supply companies are attractive the over hanging inventory of homes for sale will take months if not years to fully work off. There are going to be a number of failures in this sector and it is still too early to tell which companies will not be able to survive the down turn.

Drug companies may look attractive in the short term but they are likely to stay under pressure until after the US Presidential election next November. All of the Democratic candidates are talking about drastic changes to health care in the US and a lot of those changes have been targeted at the drug companies creating an environment of uncertainty in this sector.

The technology sector appears to be building a bit of positive momentum and has been able to avoid being tainted by the subprime and real estate problems and should continue to lead the markets over the short to medium term. Not all technology companies are attractive but some of the industry leaders are trading at reasonable valuations.

Chip maker Intel (INTC-Q) remains an industry leader and continues to innovate and bring new products to the market. The chip market is basically a commodity market and the only way to add substantial value is to continuously create new chips. Intel has a long term track record of successfully creating new products.

Global software powerhouse Microsoft (MSFT-Q) has been diversifying in to a number of segments. The company is adding features to compete with rival Google in the search and advertising markets.  The company recently reported excellent earnings growth and appears to be on track for continued growth over the medium term.