Where to find a foothold amid downward spiral

ROB CARRICK
January 19, 2008

Just for variety, the stock markets briefly stopped unravelling yesterday morning.

Then, it was back to the business of losing money for investors. After five consecutive great years for stocks, we're really getting hammered.

Close to 900 points were sheared off the S&P/TSX composite index this week, a decline that left the index about 13 per cent below its peak last July. Declines on the Standard & Poor's 500 stock index and Nasdaq this week left them down about 15 and 17 per cent, respectively, from their October peaks. A drop of more than 10 per cent is considered a correction, so we're well beyond that milestone already.

Some market strategists have predicted that stock prices will still sag early in 2008 and then recover later in the year. But it's worth asking yourself if your portfolio is ready to withstand the longer, more serious kind of downturn that constitutes a bear market. If not, here are some ways to bear-proof your portfolio.

The best time to buy ultrasafe government bonds was about three months ago, when yields were within sight of 4.5 per cent for both short and long-term bonds. Today, 10-year Government of Canada bonds yield about 3.7 per cent, and retail investors are going to get even less once they pay the marked-up prices charged by their brokers. The more you pay for a bond, the lower the yield you get.

If federal and provincial government bonds don't offer enough yield to satisfy you, then an option suggested by TD Securities rate strategist Eric Lascelles is corporate bonds. Corporates are riskier than government bonds, which is why they offer a yield premium that has recently been higher than usual. For example, one broker yesterday offered a three-year American Express Canada bond with a yield of 4.8 per cent.

These American Express bonds had a decent single-A (high) credit rating from DBRS Ltd., but they've still been affected by investor concerns about the extent to which the subprime lending mess in the United States has infected the financial system. Lately, concern about weakening economic growth and a possible U.S. recession has also weighed on corporate bonds.

Mr. Lascelles is something of an optimist on the economy and believes the bond market may be overstating the risks of an economic slowdown. If that's so, then corporate bonds would be a smart buy right now. "Even if the world isn't hugely bright, if growth simply isn't abysmal, that's scope for a pretty good corporate bond performance," he said.

Another alternative to government bonds are guaranteed investment certificates issued not by the major banks, but by smaller banks and credit unions that are fighting for customers by offering better rates. Five-year GICs rates are as high as 4.4 to 5 per cent at these institutions, which sell these products directly and through some brokerage firms and investment advisers. Any reputable GIC issuer will be a member of a deposit insurance program.

Cash

Keeping money in cash is attractive right now because you can get returns of up to 4 per cent with negligible risk through high-interest savings accounts. Lots of banks and credit unions offer these accounts, but so do a growing number of investment advisers and brokerage firms.

If you deal with an online broker, enquire whether there are any fees for buying and selling the High-Interest CashPerformer account from the mutual fund company Altamira Investment Services. The CashPerformer account currently pays 4 per cent and can be purchased just like a mutual fund.

It's a great alternative to a money market fund, providing your broker won't dig you with trading fees. Note that the online broker E*Trade Canada has a high-interest account paying 4.15 per cent.

Preferred shares

Preferred shares are supposed to be inert cousins of the more popular common shares that sit in your portfolio and do little more than pay quarterly dividends. Like corporate bonds, though, preferreds have been beaten up lately and now offer substantially higher yields than we've see in a while. Preferred shares also offer the benefit of the dividend tax credit in non-registered portfolios.

This week, Bank of Nova Scotia announced a preferred issue yielding 5.6 per cent. "Look at the yields on government of Canada bonds - everything except 20- and 30-year bonds is under 4 per cent, and that's before tax," said John Nagel, vice-president at Desjardins Securities.

Preferred shares have been falling in price since the summer and many of the retail investors who held them have bailed out because they expected a less stressful ownership experience. If you can stand some price volatility, though, top-rated preferreds like those issued by Scotiabank are attractive as a source of income that can offset declines elsewhere in your portfolio.

Mr. Nagel said the bank's preferred share credit rating from DBRS is pfd-1, which is equivalent to a very strong double-A bond rating. This means you can be confident of getting your quarterly dividends while you wait for the share price to recover from today's highly depressed levels.

Bear market ETFs

A growing family of exchange-traded funds from Horizons BetaPro allow investors to profit from downward moves in stocks, as well as a variety of commodities. These bear ETFs are designed to give investors two times the inverse move of the underlying index or commodity.

"If the S&P/TSX 60 were to go down 2 per cent - and it has done that or more a few days this week - then the S&P/TSX 60 Bear Plus ETF would give you a 4-per-cent move to the upside," said Howard Atkinson, president of BetaPro Management Inc.

Mr. Atkinson said there are two ways to use these ETFs, one of them being to profit from downward moves in the market. The other is as a hedge to offset losses in other Canadian market holdings.

Because of the way they're constructed, these ETFs may not give you exactly two times the inverse of the market if you hold them for a while. And watch out if you catch the market going up because a 2-per-cent rise would give you a 4-per-cent loss. That said, bear ETFs are doing brilliantly thus far in 2008. One of the most popular ETFs in Canada, the iShares CDN LargeCap 60 Index Fund, is down 7.5 per cent this year, while the HBP S&P/TSX 60 Bear Plus ETF is up 17.2 per cent. Defensive stocks

Investment dealer CIBC World Markets said yesterday that it's raising exposure to utility stocks in its model asset mix because of their high dividend yields, and because they're likely to appeal to investors who want something safe and are leery of bank stocks.

Utilities are a classic defensive choice and, in fact, these stocks have been the top-performing sector in the S&P/TSX composite over the first 12 trading days of the year with a decline of 2.5 per cent. Other sectors that have held up better than the broader market are health care and consumer staples.

Note how the current market decline has adjusted people's attitudes toward the grocery giant Loblaw Cos. and soft-drink producer Cott Corp., both of which have been exceedingly bad investments in the past few years. Cott is up 1.8 per cent this year, while Loblaw is up 0.1 per cent. In a down market, you look for shelter where you can.

Playing defence

Here are some ways to help firm up your portfolio so it can better withstand the kind of stock market downturn we've seen so far in 2008.
Bonds & GICs
Government bonds: Province of British Columbia,
maturing Jan. 9, 2012 and yielding 3.5%
Corporate bonds: American Express Canada,
maturing Nov. 12, 2010 and yielding 4.8%
GICs: Canadian Western Bank 3-Year GIC, yielding 4.4%
Cash - High-interest savings accounts
Altamira High-Interest CashPerformer
(sold through Altamira and brokers): 4%
Dundee Bank of Canada (through advisers): 4.05%
E*Trade Canada Cash Optimizer: 4.15%
MRS Trust (through advisers): 4%
Preferred shares
Great-West Lifeco (GWO.PR.H): yielding 5.4%
Bank of Montreal (BMO.PR.K): yielding 5.4%
Royal Bank of Canada (RY.PR.W): yielding 5.2%
Bear market ETFs
BetaPro S&P/TSX 60 Bear Plus ETF (HXD): up 17.2% in 2008
S&P/TSX 60 index: down 7.8% in 2008
Defensive stocks
Canadian Utilties (CU): up 6.7% in 2008
Emera Inc. (EMA): down 3.8%
CML Healthcare Income Fund (CLC.UN): down 2.7%
Cott Corp. (BCB): up 1.8%
Loblaw (L): up 0.1%
Rothmans (ROC): down 6.2%
SOURCES: RBC DIRECT INVESTING, CANNEX, DESJARDINS SECURITIES AND GLOBEINVESTOR.COM