Equity Strategy February 12, 2008:

There appears to be a considerable amount of confusion in the markets and there isn’t any broad consensus regarding the potential going forward. I firmly believe we are in the beginning stages of a long drawn out bear market that will be with us for many months to come. So this is definitely not the time to be looking for bargains as what looks like value today will look expensive in a couple of months from now.

The best strategy over the next few months is to sell in to rallies and fade the selloffs, do not buy the dips as that will be an expensive strategy until the market finds a bottom.  Generally in a bear market two things happen, prices fall 35% to 50% from the high over a 12 to 30 month time frame depending on how much excess has to be washed out of the market and investors who have been trying to pick the bottom are either out of money or out of optimism or both. This is when the market will turn when nobody wants anything to do with investing and even the TV commentators are starting to sound depressed.

Investors should be planning for this period when there will be excellent opportunities and the risks have been lowered to very attractive levels. In preparation for the next bull market investors should be building up their cash holdings and looking for the most attractive sectors. One of the major changes after a bear market is leadership; the leaders in the previous bull are usually not the leaders of the next bull market. A good example of that is the technology sector since 2000, this sector was the only sector to own in the 5 year bull market leading up to the peak in March of 2000 and after that is was generally the worst performing sector to own over the next 7 years. Leadership changes can be quite radical, who would have thought that the commodity sector would be so strong coming out of the bear of 2000-2002, only those that believed the changes taking place in Asia were so powerful.

There is going to be a change in leadership this time as well so now is the time to be looking at other sectors in anticipation of a change. The financial services sector has consistently been a top performing sector in the Canadian market but is likely to underperform going forward due to global liquidity pressure. The commodity sectors such as base metal and energy will likely remain strong due to global growth but will not have the same leadership as over the past 4-5 years.

The agricultural commodity sector is in a very good position to be one of the leaders coming out of this bear market due to the rapid pace of wealth creation in Asia creating ongoing demand. The addition of increased ethanol demand created by political initiatives will maintain a strong demand in the US for grains over the next few years.

The alternative energy/green energy sector which includes bio-fuels such as ethanol, wind, solar, geothermal and hydro power generation will all be receiving a lot more interest in the coming years as the world tries to wean itself off of fossil fuels. In 2006 which is the most recent data available, petroleum was used to produce 40% of the power requirements in the US, natural gas and coal each accounted for 23%, nuclear 8% and renewable/green 7%. In the renewable segment power generated from biomass accounted for 48%, hydro 42%, geothermal 5%, wind 4% and solar 1%.

The 2006 data points out the huge opportunity that exists for alternate energy companies which account for a small fraction of the total energy consumed in the US. Due to several tax incentives created at both the federal and state levels there has been a surge in production by wind and solar for 2007. The completion of the Nevada Solar One Plant, which covers 400 acres in the Eldorado Valley near Las Vegas, has the capacity to produce 134 million kilowatt hours of electricity annually which is enough to meet the needs of approximately 15,000 households. The addition of 420 wind turbines in Texas at the 47,000 acre Horse Hollow Wind Energy Centre has made that facility the largest of its type in the world and moved Texas in to the number one spot for total power produced by wind generation moving ahead of California for the first time. Even with these major projects wind and solar power produce only a small fraction of the total required.

As this industry receives more interest and more investment there are going to be some major breakthroughs which could vault this sector forward much the same way added investment changed the internet and related sectors in the late 1990’s. To date there has not been a dominate technology in the green/alternative energy sector which is still in many ways only in its infancy. As the sectors profile is raised investors looking for the next big idea will be drawn to these technologies and during the next bull market leadership will be established, the world needs this to happen, the politicians love the idea and tax payers seem willing to fund some of the research required.

Most of the Canadian companies involved in the alternative/green energy sector are small and speculative in nature but there appears to be an opportunity developing in this sector. So in preparation for the next bull market it may be appropriate to look at companies such as Carmanah Technologies (CMH-T), Westport Innovations (WPT-T), Cleanfield Alternative Energy (AIR-V, $1.55) or Canadian Hydro Developers (KHD-T), all of which are developing  interesting green/alternative technologies which will become increasingly in demand over the next few years.