2008 Holiday Investment Review/Preview

As the year winds down we find ourselves with a tremendous amount to comment on, but too little time and space – so we’re going to keep it brief and to the point.

We’ve divided the year’s last Residual Income Report into a number of theme areas that we believe will be significant going forward into 2009.  Unfortunately, we won’t be able to cover the entire spectrum of investments.  There will be opportunity to address other matters in the fullness of time.

First up: Preferreds

The Residual Income Report believes that preferred shares, particularly those of banks (and a few other selected sectors, to be discussed below) will be the choix du l’heure this year (that means you want them).  The U.S. Government has essentially guaranteed the survival of the remaining mega-cap financials, and that means no worries when it comes to their preferred shares.  Grab individual issues or just invest in any one of the ETFs or funds that are stocked with preferred issues – nearly all of them are heavily weighted with financials.

Next: Commodities

We see significant upside to commodities in the coming year and would recommend positions in energy- and copper- related issues in particular.  These two sub-sectors have taken a drubbing since the summer and will likely pull ahead in coming months once “recovery” becomes a buzzword again, and the overall market has already completed its first eye-popping upleg.

The best way to play these is with yield-producing instruments like preferreds or convertibles.  The Canadian market (TSX) offers a bevy of opportunities for high yielding oil related issues in particular.  We’ll discuss these more in coming weeks.

Third (though not in any particular order): High Yield

We have commented at length on the bond market over the last six months, on its out of proportion distortions and contortions, and the following is clear: high yield debt is not sanely priced (nor for that matter are treasuries).  The yields on these issues (now hovering in the 20% range) will come down something fierce when buzzwords “recovery” and “bull” start getting bandied about in the coming weeks and months.

The best way to play these is to avoid the single issues (unless you have a better source of credible information than I) and stick to the funds.  Let the funds do the legwork while you cash in on yields of between 12% and 22% – dedepending upon how much risk you want to take on.

Fourth: Homebuilders

We have stressed that the turnaround in homebuilding is here.  You don’t need to see an end to foreclosures and 0% mortgages on offer before these issues begin to sail.  It’s already happening. 

As real estate has taken the blame for the entire mess we now find ourselves in, it’s only fair to pause here and elaborate on this sector for a moment.

To begin, US Banks are having difficulty processing the latest month’s worth of mortgage applications.  After the Fed said it would buy mortgage bonds to help stabilize the market and rates subsequently fell – applications doubled.

The banks’ processing difficulty may be related to layoffs in the mortgage industry – but be sure: no mortgage will go unprocessed for lack of personnel.  Any necessary hiring will be carried out pronto, Tonto.

Also: it looks like a number of Sovereign Wealth Funds have been picking over the scraps in the residential real estate market in the last while (as we wrote would happen back in September).  And they’ve been doing so in a big way.  It appears that bulk purchases of distressed properties is what they’ve been seeking.  A number of Middle Eastern SWFs – the Saudis in particular – have been looking to acquire agricultural real estate, too – both American and Australian – in order to better weather what they see as a long term uptrend in the price of foodstuffs.

While it’s true that most SWFs stick to larger commercial real estate opportunities, there are those that are now specifically targeting the residential sector because there is less oversight there.  Purchasing hotels, offices and large apartment blocks generally can only occur with the approval of the political echelon.

While the banks are eager to dump their losing residential portfolios, the SWFs are equally keen to acquire solid assets at 50 cents to 70 cents on the dollar.

Fifth: Shippers and Other Transports

In keeping with the general theme that the last shall be first and the broken made whole, we must also mention the shippers.  The Baltic Dry Index chart is the most trotted out visual in the investment newsletter world these last few months as it depicts an industry (large, ocean-going container vessels) that went into freefall, losing nearly 100% of its worth in less than half a year.

Those companies with strength enough to weather the downturn will be making boatloads in the not too distant future.  See our special report on this group in coming weeks.  And keep an eye for a newly launched ETF that covers the group.  We’ll be highlighting it in that same report.

Sixth:  Interest Rates Will Climb

Note it well: you will lose significant amounts of money if you are long treasuries of any duration over a year.  Our view is that fixed income assets must be kept short.  Inflation may not turn up in the reckoning of the bond Marketeers for another three to six months, but when it does the goose will be greased.  There will be no catching it – or your breath, when you see how much money you’re losing.  Stay away.  You’ve been warned.

Seventh: Gold’s time to Shine

Gold will be the investment of the future, no question.  We just don’t believe the future is now.  It may not be far off; the playing field is dynamic and gold moves very quickly.  But we expect a brief and deep downturn before gold really dazzles.

Here’s to better, wealthier days.  They’re dangerously close.

Matt McAbby
Analyst, Residual Income Report