Will Santa Claus visit Canada this year? To be sure, the second half of 2008 has thus far been pretty much a lump of coal for investors, just as it’s been in virtually every other market on the planet. But there are some reasons to hope for a better December.

Global credit pressures are still the most severe they’ve been in decades. But there are distinct signs of improvement, as the world’s central banks continue to try anything and everything to unfreeze lending. A coordinated fiscal spending boom that would make John Maynard Keynes proud is also in the works, centered on major infrastructure projects.

It may be some time before economic growth revives. But the progress we’ve seen combined with the world’s resolve to do whatever it takes has calmed the markets in recent weeks. Energy prices have stabilized along with the Canadian dollar, which is now tracking oil prices closely.

Perhaps most important, from their current washed out state the country’s trusts and high-dividend-paying corporations are historically cheap. Many are trading at or below book value, and energy producing trusts are selling at the same prices they did when oil was under USD20 a barrel. Most astounding is the large number of trusts yielding 10, 15 and even 20 percent-plus that have actually increased distributions this year and feature recession-resistant underlying businesses.

Clearly the expectations bar has been set very low. Consequently, it won’t take much to send share prices markedly higher, even if the Canadian economy should weaken more into 2009.

For investors who are now deep in the red, the possibility of recovery from here may seem farfetched. In fact, more than a few readers I’ve talked to don’t believe they’ll live to see the day. Such is the nature of market emotion, and the overwhelming feelings since early September have been fear, panic and even hopelessness.

The important thing to remember, however, is market emotions can swing just as wildly to the upside as they have this fall to the downside. This past summer, for example, the psychology on energy was as manically bullish as it is bearish now.

The world is still facing the same supply and demand questions that sparked the extreme rally to USD150 oil. In fact, they’ve intensified over the past several months, as the previous halting steps toward permanent conservation, alternatives and new supplies have dramatically reversed. Again, it may take a while for the global economy to truly revive. But once the fear level drops for the overall market, the world’s energy problems will surface again, and market emotion will shift back to bullish just as surely.

As I’ve pointed out since this bear market began in mid-2007, the key for Canadian trusts and high-dividend-paying corporations is to survive the underlying stress tests while they last. These have intensified in recent months, particularly tighter credit conditions and the slowing US economy.

The biggest takeaway from recently reported third quarter earnings, however, is companies and trusts that had been doing well continued to do well. Conversely, conditions worsened for businesses that were already struggling.

As the Dividend Watch List points out, dividend cuts picked up steam in November. The energy patch was the epicenter, due to the now more than two-thirds drop in oil and gas prices since mid-summer. Cuts outside energy were primarily due to either exposure to the weakening US housing market or debt concerns. Companies and trusts that had been weathering the storm, however, continued to show their mettle by posting strong cash flows and even increasing distributions during the turmoil.

Even shares of the strongest have taken on water the past few months, hardly a surprise with both the Toronto market and the Canadian dollar tumbling. And a loss is a loss, whether it’s caused by business weakness or not. But as market history has shown again and again, the cause of losses is absolutely critical when it comes to recovery. Good businesses bounce back. And in this case, they’ll continue to pay us extremely high and surprisingly secure yields while we wait.

Since inception in mid-2004, every issue of Canadian Edge has been focused on underlying business strength. It’s a strategy that’s served us well during both good times and bad, as we’ve generally kept the high dividends flowing.

Bottom- or top-ticking a market is always more a matter of luck than skill. Calling a major turn for the now washed-out Canadian trust market is no different as we look ahead to the holiday season and into 2009.

What we do know is sooner or later it will happen. And when it does, trusts and high yielding corporations that held it together during the turmoil will lead the recovery. That’s where we want to be now.

December is my favorite month for housecleaning. This time around, I’m sticking with most positions going into 2009. I am, however, replacing three of the current 32.

To the Conservative Portfolio, I’m adding Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF), CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF) and Innergex Power Income Fund (TSX: IEF-U, OTC: INGRF). All three have proven their businesses to be highly recession-resistant, and they yield more than 10 percent on average.

To make room for them, I’m selling Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF), GMP Capital Trust (TSX: GMP-U, OTC: GMCPF) and closed-end mutual fund EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF). I still believe this trio will survive the current turmoil with their underlying businesses in good shape. All have been beaten down to levels that in a normal market would be compelling values, and I may revisit them as buys in the future. All three do have problems in the current environment, however, that could carry them lower, and at a minimum mean their ultimate recovery will take time. That makes them good candidates for tax-loss selling and replacement with heartier fare.

Note Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF) was sold last month.

Both December High Yield of the Month picks are new additions to the Conservative Portfolio. Bird Construction Income Fund is a rock-solid play on Canada’s ongoing infrastructure spending boom, which is likely to accelerate in coming months. The other is CML Healthcare, a play on the recession-resistant healthcare industry with a valuable niche in medical imaging and laboratory testing that it’s grown dramatically under Canada’s national health system for more than three decades.

Note the third addition to the Portfolio, Innergex Power Income Fund, is highlighted in the Feature Article.

How They Rate

Note that How They Rate now features the following trust groups:

Oil and Gas–All producer trusts are included here.

Electric Power–Power generators.

Gas/Propane–A mixture of distributors, from propane to package ice.

Business Trusts–A range of businesses involved principally with consumers.

Real Estate Trusts–All qualified real estate investment trusts.

Trust Mutual Funds–Closed-end funds holding portfolios of individual trusts.

Natural Resources–Trusts and corporations that produce resources and raw materials other than oil and gas.

Energy Services–Trusts and corporations whose main business is providing drilling, environmental or other services to energy producers.

Energy Infrastructure–Trusts and corporations that own primarily pipelines, processing facilities and other fee-generating assets.

Information Technology–Trusts and corporations that provide communications, newspaper, directory and other information services.

Financial Services–Canada’s banks, investment houses and other trusts and corporations feeding that business.

Food and Hospitality–Trusts and corporations that franchise restaurants, own and operate hotels and manufacture and distribute food and beverages.

Health Care–Trusts and corporations involved in the medical care and/or supply business.

Transports–Trusts and corporations that ship freight and move passengers by bus, truck, rail or air.

Here are advice changes. Note I’ve changed buy prices on a number of trusts this month to reflect the disaster hitting the credit markets and the likelihood of slower economic growth in North America.

See the How They Rate Table for changes in buy targets. Price and yield information is updated every 15 minutes in the How They Rate as well as the Portfolio tables. Use this service as a reality check when errors occur with US-based quote services.

Column four of the table shows dividend frequency and the most likely way each trust will minimize 2011 taxation. “Foreign” indicates non-Canadian income, which is not taxed. “Pools” indicate tax pools used primarily by energy producers, which shield income dollar for dollar. “Depreciation” indicates businesses with large non-cash expenses that can be used to shelter cash flow. “None” indicates no visible method of avoiding 2011 taxes, though some trusts have stated their intention to simply outgrow their future liability and maintain distributions.

Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF)–Sell to Hold. Third quarter earnings unmasked another reason why management cut distributions last month, as higher costs and a weakening US economy took a toll. But the new distribution level is well supported.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–Buy @ 4 to Sell. The assets are solid, but wood waste supply problems will keep the payout ratio uncomfortably high until the Canadian timber industry bounces back, which in turn depends on the US housing market. That’s enough ifs to make the trust a tax-loss sale candidate.

Colabor Income Fund (TSX: CLB-U, OTC: COLAF)–Hold to Buy @ 8. This trust has proven its ability to stand up to stress tests, as well as 2011 taxation as it’s been paying the trust tax since 2007.

EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF)–Buy @ 5 to Sell. This fund should make it, but its near-term leverage challenges make it a good swap out in tax-selling season.

GMP Capital Trust (TSX: GMP-U, OTC: GMCPF)–Hold to Sell. The trust will make it and continues to maintain market share. But recovery won’t happen until the Toronto market picks up, and that may take time.

HR REIT (TSX: HR-U, OTC: HRREF)–Hold to Buy @ 5. The selling is way overdone considering the high-quality portfolio, even though high capital spending is a threat to dividends.

Provident Energy Trust (TSX: PVE-U, NYSE: PVX)–Hold to Buy @ 10. Third quarter earnings were decent, and the lower distribution rate should hold barring a drop in oil to less than USD40 a barrel or gas to under USD5.

TimberWest Forest Corp (TSX: TWF-U, OTC: TWTUF)–Hold to Buy @ 3. The trust doesn’t pay a dividend anymore, and it faces credit challenges as its timber market weakens. But there are enough valuable timber and real estate assets selling at a fraction of book value to make it a worthy speculation again.

Canadian trusts and high-dividend-paying corporations have generally avoided the worst of the credit strife. Several have been considerably less fortunate, however, dealing with the weakening North American economy. And with growth likely to taper off further in coming months, that puts a premium on trusts’ ability to resist a recession.

In this article, I focus on trusts inside and outside the CE Portfolio with the best credentials on that score, including new Portfolio addition Innergex and several other recommendations that are equally suitable bets for conservative and aggressive investors alike.

The Canadian economy has managed to weather the worst of the financial and now economic crisis to date. But it’s absolutely essential to keep tabs on the stresses and strains that are occurring, as well as what sectors remain in robust shape. Two key areas are real estate and the banking system, both of which are far healthier than their US counterparts, but which nonetheless do have their pitfalls. This article is a macro-view counterpart to the Feature Article.

This section features short bits on a wide range of topics. For more evergreen and tutorial items, see the Subscribers Guide “Subscriber Tips” section.

Dividend Watch List—Distribution cuts again accelerated in November, the consequence of falling energy prices, slowing growth and still-tight credit conditions. Surprisingly, energy patch cuts were primarily confined to companies making strategic moves or trying to shepherd cash for development.

Most were also relatively minor: Bonterra Oil & Gas (TSX: BNE, OTC: BNEFF), Progress Energy Trust (TSX: PGX-U, OTC: PGXFF) and Provident Energy Trust (TSX: PVE-U, NYSE: PVX).

Outside the energy patch, the biggest cuts were due to debt woes are exposure to the US economy. These included Home Equity Income Trust (TSX: HEQ-U, OTC: HEITF), InnVest REIT (TSX: INN-U, OTC: IVRVF), TimberWest Forest Corp (TSX: TWF-U, OTC: TWTUF) and Tree Island Wire Income Fund (TSX: TIL-U, OTC: TWIRF).

Other trusts facing likely cuts are Calloway REIT (TSX: CWT-U, CWYUF), FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF), Harvest Energy Trust (TSX: HTE, NYSE: HTE), HR REIT (TSX: HR-U, OTC: HRREF) and Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF).

Bay Street Beat–How the Canadian analyst community views trusts, including our favorites.

Tax-Selling Tumult–The end of 2008 is a high time for tax selling. Canada’s tax law includes a three-year loss carryback allowance for Canada-based/Canada-filing investors. That could contribute to volatility in late December. 

Use our live quote feed on the How They Rate Table for US dollar prices of trusts intraday.

For other information, go directly to a trust’s Web site by clicking on its name in the table. Clicking on the Toronto symbol (suffix “.UN”) will take you to the Web site of our Canadian partner, Toronto-based MPL Communications (133 Richmond St. West, Toronto M5H 3M8), http://www.adviceforinvestors.com/, which has price charts and access to press trust releases.

Check out the Toronto Stock Exchange Web site for a range of information on income and royalty trusts.

The Web site http://www.sedar.com/ is an online library of documents filed by trusts with the Canadian equivalent of our Securities and Exchange Commission.

The Toronto Globe & Mail features the “Globe Investor” section with all the latest news on trusts.

Dominion Bond Rating Service is the preeminent credit rater for trusts.

The Bank of Canada Web site features a handy currency converter for Canadian dollars and US dollars into 50 other currencies around the world, and it’s a great source of free information on the Canadian economy.

Note the NAFTA challenge to the Government of Canada’s “Tax Fairness Plan” is heating up. Interested investors should contact: http://www.naftatrustclaims.com/.

Also, for late filers, the Income Trust Tax Guide has all the backup you need to file distributions as qualified dividends.

Roger Conrad
Editor, Canadian Edge