Defensive For Time Being (Alfred Lee)

Opportunity #1: Utilities

Utility stocks are the prototypical defensive stocks. Companies that provide services such as electricity, water, heating or hydro tend to have stable incomes and thus provide a steady dividend stream. Moreover, since the services these companies provide are essentials and not luxuries, their revenues tend to fluctuate less than those companies from sectors such as consumer discretionary.

This stability in earnings is reflected through the lower volatility in share prices of these companies. The BMO Equal Weight Utility Index ETF (ZUT) tracks the Dow Jones Equal Weight Utilities Index, a collection of 17 Canadian utility companies. This index has a dividend yield of 5.7%, compared to the 2.7% of
the broader market S&P/TSX Composite Index. Also, the utilities index has historically had a lower 30-day volatility than the broad market which makes it suitable for our near-term strategy of reducing volatility and increasing income.

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Opportunity #2: REITs

With many remaining income trusts converting to corporations by year end, there will be a lack of assets producing a sizable and relatively stable income, especially in this low interest rate environment. As a result, investors may look to real estate investment trusts (REITs) since they are largely exempt from the 2011 income trust taxation ruling. Considering the aging demographics in developed nations, pension plans especially could place buying pressure on this asset class as a move to look for income to fund their obligations to aging participants. Though REITs tend to be interest rate sensitive and we are in a rising interest rate environment, we don’t envision the Bank of Canada (BoC) announcing many more rate hikes in the near term. As the central bank has gone on record saying that it will consider the global economy along with its own when setting interest rates, at most, the BoC will likely have only one more move. With no signs of inflation, we doubt the bank will risk stunting the growth of the economy considering it’s not yet on solid footing.

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  1. You write: "While an increased allocation to bonds should provide capital preservation as we wait for the turbulence in the market to pass."

    I recommend that one have no allocation to bonds. I recommend gold, but for those who must be invested, I suggest they go short bonds and stocks both!

    The Stockcharts.com chart of emerging market bonds shows that these can experienced an abrupt and significant loss of value.

    I would like to present my view that holding debt of any kind, even high grade corporate debt, exposes one to the risk of loss of principle as interest rates go higher. I believe that interest rates were called higher by the markets on September 1, 2010, in response to the US Federal Chairman Ben Bernanke announcing intentions to buy mortgage backed securities on not only one occasion but on two occasions.

    High grade corporate debt, LQD, fell parabolically lower on September 1, 2010, with the purchase of the yen based carry trades, on September 1, 2010, which rallied stocks, ACWI; and turned the tide on bonds, BND, sending them lower, establishing August 31, 2010 as a high in bonds at 82.66, that is, ”establishing August 31, 2010 as peak credit” … bond deflation has been underway since September 1, 2010.

    High grade corporate debt, LQD, peaked on September 1, 2010 at 112.58. It has the same wave structure as BND; so any comments about bonds, BND, apply directly to LQD as well.

    Going over to MSN.com and sorting on the 3 year returns, LQD shows 7.57%, which is quite good; going all the way to the bottom are such things as Natural Gas and Financial Services, which is quite bad.

    I believe that LQD’s returns will be influenced by a flattening of the 30-10 US Sovereign Debt Curve, and by CDS.

    The interest rate on the 30 Year US Government bond, $TYX, rose strongly September 1, 2010.
    And the interest rate on the US 10 Year Note, $TNX, also rose strongly September 1, 2010.

    September 1, 2010 marks the transition from “the age of neo-liberal Milton Friedman based credit liquidity” to “the age of the end of credit”; this also means ”the end of entitlements” and “the beginning of world-wide austerity”.

    The 30-10 yield curve,$TYX:$TNX, began to flatten on August 11, 2010, reversing a trend that goes back to early 2000.

    This signals risk aversion to sovereign debt. The flattening of the yield curve came as a result of the Federal Reserve Chairman's announcement of August 10, 2010 of the purchase of mortgage-backed securities. Then on August 27, 2010, the Federal Reserve Chairman stated the possibility of an even larger purchase of debt.

    This caused the bond rally in US Treasuries, TLT, and Zeroes, ZROZ, HIgh Grade Corporate Bonds, LQD, that began April 6, 2010, to fail September 1, 2010, sending bond prices lower and interest rates higher.

    The safe haven rally in debt, and the low-interest rates available to corporations, that began with the onset of the European Sovereign Debt Crisis is over, repeat over and done, through and finished. Investors see Mr Bernanke’s plans as monetization of debt; and have gone short US Treasuries, especially the longer out ones such as ZROZ.

    I believe a sovereign debt, read TLT, crisis, is coming soon, as well as a global financial collapse, where there will be no liquidity to buy or sell paper assets; I want something liquid like gold of silver as an investment.

    Systemic risk is quite high. Liquidity evaporation could happen quite easily, either coming through a failed Treasury auction or a situation where there may not be enough buyers of investment securities to meet sellers demand.

    I believe that soon, out of a liquidity evaporation and a bond, BND, liquidity crisis, stemming from a fast fall in bond and/or stock values, that here in the US a Financial Regulator will be announced who will oversee lending and credit, as well as money market and brokerage accounts.

    He will be what I call a credit boss or credit seignior who funds economic operations with an emphasis on seeing that the strategic needs of the country are met and that monies for food stamps keeps flowing. I believe the government will become the first, last and only provider of liquidity and money.

    I believe the intensity of onset of the coming credit crunch will come with a great rush and that the corporate bond market, LQD, will shut down very quickly. Like I say, I believe a lending boss will be announced and pretty much only natural resource companies and defense contractors and food producers will have credit liquidity.

    Furthermore, I see a coming ”see-saw” exhaustion of fiat wealth with stocks, ACWI, and then bonds, BND, alternatively falling lower. There may be days when both fall lower. The chart of Bonds, BND, for September 7, 2010 shows three black crows, with a fall in value to a head and shoulders pattern at roughly 82.00 and then a rise to 82.44.

    The chart of world stocks, ACWI, as well as the S&P, SPY, as of September 7, 2010, shows that the world stocks enter an Elliott Wave 3 of 3 of 3 down having completed a three white soldiers pattern, and a one day down --- ACWI closed down 1.28% and SPY closed down 1.13% on September 7, 2010.

    As the value of stocks falls lower, so will the value of corporate bonds, as they will fall under the influence of a flattening 30-10 US Treasuries curve, $TYX:$TNX seen in Stockcharts.com chart.

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