Trouble Overseas: Take Shelter Or Speculate?

We are in the midst of a global financial crisis brought on by the many-layered disaster in Japan and the concurrent series of Middle Eastern crises that threaten the world’s oil supplies.

For investors, whether farmers thinking about putting some money into stocks or bonds or mutual funds or older people who want to be sure that their money will see them through many years of retirement, the present situation is filled with opportunity and risk.

Let’s look at the basics. There is a massive move around the world out of assets that are regarded as being at risk. That’s commodities first and foremost — even gold, then volatile stocks, especially technology companies that may not be able to get all the semiconductor chips they need from Japan and Japanese car makers whose plants have been idled, and Japanese retailers that may have trouble getting electricity to light their stores.

The bond market has gyrated with the crisis. Money moving out of stocks has gone into bonds, raising prices and lowering yields. But not all bonds have been treated equally. A great deal of money has moved into U.S. bonds and Canadian bonds, pushing up their prices and lowering their yields to maturity. Yields on 10-year U.S. Treasury bonds, a bellwether for the world’s bond markets, dropped to 3.19 per cent on March 16, the lowest this year. The yield on the 10-year Government of Canada bond, 3.17 per cent, marched right along. Most corporate bonds have held their value. Bank bonds have been steady. Bonds of regulated utilities have not changed much in value.

What appears to be happening is a rush away from assets at risk and toward relatively safe assets such as government bonds and large company stocks that have solid dividends and little direct exposure to the Japanese crisis.

The decline looks like a liquidity crisis where sellers can’t find bids. “Money is coming off the table, but whether this is an entry point or not is hard to say,” says Tony Warzel, CEO of hedge fund Rival Capital Management in Winnipeg. “My feeling is that the slump is not over. You can buy into a stock at $30 and then buy more at $25 and keep on going all the way down. That’s cost averaging, but it’s dangerous when there is no bottom. I would rather give up five per cent of gain than lose five per cent on a false hope that we’re at a bottom.”

For investors with RRSP money sitting in cash, there are a lot of buying opportunities. The decline of the market averages has left regulated utilities as relative bargains. They have steady dividends that are not going to be affected by whatever happens in Japan.

The news is bad, but the leading economic indicators in Canada and the U.S. are positive, so the shock from the Japanese tragedy should not drive North America into recession,” says Chris Kresic, co-lead manager of fixed income at Jarislowsky Fraser Ltd. in Toronto.

“Sentiment has been bearish toward government bonds and bullish toward stocks, but the Japanese disaster has softened the extremes,” Kresic says. “There is a lot of uncertainty in markets. Investors appear to believe that the fundamentals will outweigh geopolitics.”

In the long run, Kresic is right. Markets have overcome wars, terrorism, epidemics and wretched economic policy. As long as there are solid bonds that return their principal and companies keep on earning more money to drive their earnings and therefore their stocks, share prices will rise.

A good way to judge the chaos in markets and to tell if it is offers opportunities or traps is to ask the question “If I overpay, what will get me out of the hole?”

Given that the weeks of Middle Eastern and Japanese crisis are bullish for Canadian energy producers, oil sands producers, energy producers like Capital Power Corp. (used to be Alberta’s Epcor), Suncor Inc., an integrated oil with a large position it the oil sands, stocks with good earnings and strong dividends are candidates for purchase, says Jackee Pratt, vice president and portfolio manager at Matrix Funds in Toronto.

Then there are strategic opportunity stocks — companies that will gain as a result of Japan’s rebuilding process. They include global steel producers, coal producers, aluminum makers — except in Japan where electricity is going to be scarce and expensive for years to come — and companies that make other kinds of building materials.

The bottom line for investors is to judge whether the problems priced into stocks are overstated or may get worse. My bet is that the quakes are not over and that more tragedy lies ahead for Japan. The Middle East will settle down to its customary blend of strong-arm government and plutocracy. Environmental concerns will yield to economic necessity, giving Alberta’s oil sands a boost in confidence and price in world markets, much to the benefit of producers like Suncor Energy, up 45 per cent from its April, 2010 price.

None of these observations should be taken as advice to rush out and buy any stock, of course. Today’s market darling can be tomorrow’s mutt. You need only look at what has happened to uranium producer Cameco Corp., which has taken a swan dive from a 12-month high of $44.28 to its present level in the mid-$20 range. Until new reactors are built, indeed, if they are built at all, world demand for uranium is bound to decline, even though almost all uranium is sold on long term contracts that have been priced for years to come. The outlook for the industry is surely not helped by the Japanese disaster and the market price, which may take years to recover, reflects it.

There is not a great living to be had in bonds that pay little more than three per cent but not much to lose either. That is the bottom line of crisis investing when the stock market turns into a roulette wheel spun by news. In such markets, the brave may speculate. The cautious stay on the sidelines until the dust settles and fundamentals return to rule.

AndrewAllentuck’slatestbook,WhenCan IRetire?PlanningYourFinancialLifeAfter Work,waspublishedasapaperbackby PenguinCanadaearlierthisyear

About the author

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Andrew Allentuck’s book, “Cherished Fortune: Build Your Portfolio Like Your Own Business,” written with co-author Benoit Poliquin, was recently published by Dundurn Press.

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