Equity Strategy November 26, 2007:

There has been so much volatility over the past few months that some investors have decided to opt out of the markets completely and if history is any guide that would be an expensive decision. There are always opportunities for investors it is just that sometimes they are not very easy to act on. These hard decisions are commonly the most rewarding because not many investors are making them due to the overriding uncertainty in the markets at the time.

I believe the first step is identifying the sectors of the market that should be avoided. At this time it would appear that the financial services sector still has a lot of potential down side to come. There has not been a clear indication as to just how big the industries exposure is to the frozen Asset Backed Corporate Paper or the subprime mortgage sectors. Virtually all of the major financial institutions have started to recognize the losses but none of these companies has fully declared their exposure and really how can anyone know the final value of these derivative investments when a viable and active market does not exist. I would expect this sector will be struggling to account for their exposure for many quarters and the losses will be much larger and more wide spread than anyone can forecast at this time.

The retail sector will be under substantial pressure going forward as consumers demand prices that are closer to those available on the same product in the US. Consumers have been frustrated by the slow move by retailers to lower prices as the Canadian dollar rises. Canadian consumers in larger and larger numbers have been making the decision to shop in the US rather than pay higher prices at home. Retailers will either have to lower prices or accept considerably lower volumes until the loonie stabilizes. I am a bit surprised that the retail sector didn’t see this coming and try to get ahead of the currency impact rather than hope that consumers would continue their shopping habits regardless of price changes.

The auto sector is being hit much more directly by the strong currency than most of the rest of the Canadian economy.  When the loonie was at 65 cents US the Canadian auto industry had a considerable cost advantage over other manufacturers, the steady rise to par has increased costs to the point where Canada is now one of the high cost producers even when Government funded health care is taken in to account. The auto parts manufacturers are not likely to see any relief until the loonie falls back some and that doesn’t appear to be in the cards in the near future. The combination of a slower US economy, possibly heading in to recession, and a high dollar are going to be very damaging to the potential profitability of this sector.

The commodity producers still appear to have upside potential but it will be limited relative to the past few years. The higher Canadian dollar and higher energy prices are starting to bite in to profits. Base metal prices appear to have settled in to a wide trading range that is likely to be maintained over the next few quarters as the global economy slows slightly along with the US economy. The energy sector looks very attractive over the next few quarters as crude oil appears to be on the way to $100.00 a barrel and demand is not likely to fall dramatically even if the US economy goes into recession, the slack will be picked up in Asia.

Investors looking to invest in the energy sector should consider the ishares S&P/TSX Energy Index ETF (XEG-T) the unit is diversified holding a total of 64 energy companies with representation from all segments of the Canadian industry. The top five holdings include EnCana, Suncor, Canadian Natural Resources, Petro Canada and Talisman. The units are a low cost alternate to a Mutual Fund with an MER of only 0.55%.

The strong Canadian dollar has created an opportunity for Canadian investors to diversify globally this may be the best opportunity in the past three decades. Until recently the potential currency risk attached to offshore investing was too high to justify anything other than limited exposure to special situations. Since the Canadian dollar moved up to the all time high of $1.10 the risk has been substantially reduced. The economic growth in Asia continues to be the most robust globally led by the double digit GDP growth in China and followed India with high single digit growth.

The Chinese equity market appears to be extremely over valued at this point and I would not recommend investing directly on China. I would instead look at investing in the region which is benefiting from the economic growth in China. The entire Asian region is seeing robust economic growth driven by the expansion of the middle class in the region a trend that is only just beginning and has the potential to continue for decades.

There are a number of ETFs that offer exposure to this area. ishares offer a number of region specific ETFs such as the MSCI Australian Index Fund (EWA-N) which holds a total of 87 Australian based companies the top five companies in the fund are, BHP Billiton, Commonwealth Bank of Australia, National Bank of Australia, WestPac Banking Corp and Aus & NZ Banking Group.

The S&P/TOPIX 150 Index Fund (ITF-N) offers broad based exposure to the 150 largest companies in Japan. The top five holdings are Toyota, Mitsubishi Financial, Canon Inc, Nintendo, Sumitomo Inc.

The newly launched (November 13, 2007) ishares S&P Asia 50 index Fund (AIA-N) holds 50 of the largest companies in the region including Chinese shares. This new ETF will potentially be more volatile than broader based funds that are not invested in the over valued and volatile Chinese stock market. That being said, for those investors who are willing to accept the increased volatility and are looking for a diversified position covering the entire region this may be the right option. The top five holdings are China Mobile, Samsung Electronics, Taiwan Semiconductor, POSCO and China Life.

All of these ETF’s trade actively on the New York stock exchange and are priced in US dollars offering Canadian investors an excellent opportunity to utilize their increased purchasing power to diversify their portfolio into a rapidly expanding region.