Almost every major market in the world is down at least 10 percent so far this year, some much more. And that’s on top of huge losses suffered in 2008.

The US is still leading the way lower, with nearly 25 percent declines in both the Dow Jones Industrial Average and the S&P 500 Index for 2009. But the leverage crisis and financial system meltdown that began on these shores has spread globally with a vengeance. In fact, losses elsewhere have been compounded for US investors, as the US dollar has soared.

Last fall, the markets seemed to succumb to mass selling waves day after day. No industry or investment class was spared save US Treasury securities, as the institutions controlling more than 80 percent of market float fully liquidated holdings en masse.

Now after a few months pause, the fire sales appear to have begun again. The same indiscriminate selling is once again driving valuations lower than they’ve been in decades, even for stocks of companies that continue to prove they’re weathering the recession as businesses.

Market history demonstrates quite clearly that the stock market always bottoms some months before the economy starts to recover. Markets always look ahead, never behind. Even if the economic news seems to still be getting worse in the headlines, investors will step in, provided there’s some indication that conditions are at least near a bottom.

Unfortunately, the key catalysts for the bear market and unfolding recession appear as far from resolution as ever. The US housing market is flat on its back, and its weakness is spreading to other types of property, as unemployment spurs foreclosures, retail store closings and retrenchment by businesses.

The US banking system that once was the envy of the world now looks like a bottomless pit of losses that will take years even for the federal government with its limitless resources to fill. And the budget submitted by the Obama administration has raised worries of creeping socialism in the US, along with economy-killing new taxes.

In short, the slowdown in the global economy has become a full-scale contraction with no real visibility on when it will subside. The US economy shrank at an annual rate of 6.2 percent in the fourth quarter. And that figure showed up as positively bullish compared to Japan’s 12.7 power dive. Russia and other once- surging resource producing economies are on the verge of collapse. Even China and India–hailed as the future engines of global growth–are seeing their economies stall.

We know conditions will eventually stabilize and turn up again. But we still don’t have the visibility of when that will happen. And until we do, stocks around the world are going to remain under selling pressure. In fact, it’s pointless to even talk about how low equity prices may go, at least based on any measure of business performance or even yield.

The market never recognizes a real turn until it’s well underway. And that’s almost certain to prove the case again this time around. In fact, the rebound is likely to unfold far more quickly than ever. The market today is basically dominated by professional money managers, who can’t afford to be left behind in a genuine rally.

The bad news is volatile, emotional markets like this one always go a lot further than anyone thinks possible. In fact, given the turmoil in the real economy, no one should be surprised to see the Dow Industrials and the S&P 500 under 6,000 and 600, respectively by early summer.

Canada’s Edge?

The question for owners of trusts and high yielding corporations is where does Canada stand in all this? We’ve certainly seen some severe carnage on the northern side of the border to date.

Energy and natural resources sectors have been the hardest hit, owing to the USD100-plus drop in oil prices and commensurate blows to other commodities. But even sectors like electric power generation that have shown themselves recession-resistant as businesses have been caught up in the selling. And of course there’s the Canadian dollar, which has dropped 20 percent against the US dollar since September, lopping roughly 20 percent off the value of Americans’ holdings of Canadian investments.

The Canadian dollar’s plunge is intimately related to the drop in the price of oil, which in turn is tied to the extreme pressures on the global economy. We’re getting to a level for the currency that’s well out of whack for purchasing power parity, particularly for a country that’s such a close trading partner of the US. But again, until the global economy finds a bottom, no one should expect a recovery in the loonie. In fact, we may well see a 70 US cents per Canadian dollar exchange rate before this is over.

If you’ve been invested in Canadian trusts and high-yielding corporations–including those in the Canadian Edge Portfolio–I don’t need to tell you we’ve suffered some big losses over the past 12 months. Focusing only on high quality and unloading weakening trusts has kept us out of bankruptcy situations and in businesses that are weathering the downturn.

In addition, our dividends have remained strong. But that hasn’t shielded us from the selling, and it won’t as long as the mood of the market is toward liquidation.

That raises a fundamental question: Are we still best off sticking with positions in well-run Canadian trusts and dividend-paying corporations? Are we close enough to a turn and are values truly compelling enough to weather further potential pain, or are we better off dumping everything as staying in cash until there’s a real sign of a turn?

I’ve always been an advocate of holding cash in portfolios, and I remain one. Also, throughout this downturn I’ve steadfastly advised against doubling up on trusts that have fallen. And that remains my advice today. One option for those who want to own interest-bearing securities in Canada is EverBank Financial.

On the other hand, I’ve demonstrated in the Portfolio article, Listen to the Numbers, that our Conservative Portfolio selections are holding their own as businesses. In fact, their dividends actually appear to be quite secure for 2009, despite the ongoing turmoil. Our Aggressive Holdings, meanwhile, are all are definitely prepared to weather further declines in commodity prices and are still in position to profit from a rebound.

As long as this remains the case, market history shows our selections can and will recover the horrific losses we’ve seen since last summer. The key question then is this: Can they keep posting strong numbers until the global economy bottoms and the buyers do return? Or, will the macro conditions get so bad that they falter as businesses, and turn the losses we’ve seen already into a complete wipeout?

Like virtually anything in the investment world, the answer isn’t black and white. Much depends on how conservative management has been with leverage and operating risk.

The good news is Canadian managers are generally among the most conservative in the world. Trusts have been operating under restricted access to capital for nearly two and a half years, due to the Tax Fairness Act of 2007’s restrictions on share issues and tight credit markets. They’ve literally had to live within their means.

As a result, they’re not over-leveraged or dependent on outside capital. In fact, even the strongest only use capital when there’s a clearly accretive opportunity to grow. And every decision management makes is taken with only one thing in mind: sustainability. Those that have made it thus far are likely to keep making it in 2009.

Equally, management’s ability to weather the crisis also depends heavily on the nature of the business it’s in. Simply, some are better structured to withstand a recession, and are therefore better able to weather this difficult market.

The Portfolio section focuses on the performance of the individual trusts recommended. Two that have shown unique ability to weather crises are featured in High Yield of the Month: Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF) in energy and Northern Property REIT (TSX: NPR-U, OTC: NPRUF) for high, safe income.

Below, I take a look at the other side of the equation: The prognosis for the sectors tracked in the Canadian trust and high-yield universe in How They Rate. For more on individual trusts not in the CE Portfolio, see How They Rate as well as the “Search” function in the Web site.

Banks: At the Root

The collapse of our country’s biggest financial institutions is at the root of the US economic problem. Odds are fixing them will wind up costing American taxpayers trillions more than we’ve already been spent, or else many trillions more in lost productivity and economic growth from a prolonged depression.

In contrast, Canada’s biggest banks are at the root of its relative economic strength as a nation. As I’ve pointed out in previous issues of CE, Canada’s banks never gave in to subprime fever. Rather, they continued to adhere to sound, time tested banking practices, even as their American counterparts were testing the limits.

One reason, of course, is Canadian banks are far more effectively regulated and were never allowed to shift around capital to riskier areas and endanger other parts of their business. That’s even more so the case today, as the country’s financial system has tried to firewall itself from the US collapse.

More important, however, the country’s bankers have proven themselves just innately more conservative, i.e. better bankers than their counterparts south of the border. In fact, they’re now being held up as a model of how the US financial system should be organized.

Canada’s banks, of course, have had their share of troubles during this crisis. The damage thus far, however, has been largely confined to exposure to the US, and particularly to the mortgage-backed securities that originated here.

In contrast, business in Canada remains generally sound. Default rates are still low. Deposits are sound and credit is being extended, a major plus for trusts and corporations. And bank balance sheets are generally healthy with strong capital ratios, limiting the need for direct government assistance that’s become so critical to the survival of so many in the US.

Fourth quarter sector earnings tell the tale in graphic relief. Profits were nicked at most Canadian banks, largely due to asset write downs. The headline numbers, however, trounced expectations on Bay Street and Wall Street. Dividends were mostly well covered, or else affirmed based on expectations for recovery in 2009.

If there was an issue with Canadian bank earnings, it concerned potential management plans–long rumored–to launch a buying spree for US assets. Those expectations were squelched by several managements, to the great relief of investors, though certain banks stated they were still eying opportunities if they came at the right price.

All in all, this is the picture of a healthy industry in good shape to weather further downside in the global economy and markets, as well as profit richly when conditions finally turn up. I’m only recommending a handful of trusts and high dividend-paying corporations in the group currently as buys, due to continuing risks to the global financial services industry. Former CE Portfolio member GMP Capital Trust (TSX: GMP-U, OTC: GMCPF), for example, completely eliminated its distribution and announced a sudden conversion to a corporation to save cash after announcing horrendous fourth quarter results.

One big Canadian bank that’s particularly attractive now, however, is Bank of Nova Scotia (TSX: BNG, NYSE: BNS). The giant topped expectations handily in the fourth quarter, recording a return on equity of 16.9 percent that would have been considerably higher were it not for write downs taken on securities. Buy Bank of Nova Scotia up to USD30.

Energy: Survival Mode

Survival is the name of the game for Canadian energy producer trusts and high-yielding corporations, as well as the energy services business. The graphs of oil and natural gas prices over the past year have all the information anyone needs to know about both groups’ recent poor performance.

Mainly, cash flow for producers depends on the level of energy prices, how much energy is produced and the cost of getting the oil and gas out of the ground. The second and third factors are largely within management’s control. The first is partly controllable by hedging or locking in prices for output in advance. But when there’s a drop of USD100 a barrel in oil, all bets are off.

Cash flows plunge and trusts are faced with the choice of halting development and production or cutting distributions. Energy services firms, meanwhile, suffer as producers cut back on output, reducing demand for equipment and services. That also forces a decision of whether to scale back capital spending and activity, borrow new funds or else just cut distributions.

Thus far in this downturn, every energy producer trust but four have cut distributions: Avenir Diversified Income Fund (TSX: AVF-U, OTC: AVNDF), Crescent Point Energy Trust (TSX: CPG-U, OTC: CPGCF), Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) and Zargon Energy Trust (TSX: ZAR-U, OTC: ZARFF). Meanwhile, in the energy services group, only Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXIF) has avoided a dividend cut to date. Meanwhile, the group’s largest player Precision Drilling (TSX: PD-U, NYSE: NYSE) has now completely eliminated its payout.

Looking ahead, every energy producer and energy services company–aside from those no longer paying a dividend–should be considered at risk to further cuts, should energy prices plunge further. Dividend safety, however, has never been the key for either group. Rather, it’s the ability to survive the ongoing slide in energy prices and remain positioned to profit when oil and gas return to the upside.

The single biggest positive for energy now is the immense supply destruction that’s occurred since summer 2008. Current prices are so far below reserve replacement and even production costs that new project activity has been dramatically rolled back. Even the Saudis are allegedly idling rigs and activity in non-conventional development such as oil sands and shale gas is grinding to a halt. A return to normal demand conditions therefore will come when supplies have dramatically tightened, sending prices soaring again.

The other major positive for producer trusts is all of them now trade at sharp discounts to the net asset value of their reserves, even assuming much lower oil and gas prices. Enerplus, for example, has a NAV of nearly USD30 per share, more than twice its current share price. Moreover, though dividends have been cut sharply, they’re still at lofty levels, as share prices have fallen even more, and they’re now well-covered by cash flow.

Low valuations mean energy producer and service trusts will soar when energy prices return to the upside. The key is surviving until we get there and the best bets are still my five core producer trusts: ARC Energy Trust (TSX: AET-U, OTC: AETUF), Enerplus, Penn West Energy Trust (TSX: PWT-U, NYSE: PWE), Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF) and Vermilion.

Note that Daylight Resources Trust (TSX: DAY-U, OTC: DAYFF) has also distinguished itself as a more leveraged bet on natural gas, posting solid fourth quarter 2008 and reserve numbers. Portfolio picks Trinidad Drilling (TSX: TDG, OTC: TDGCF) and Newalta Corp (TSX: NAL, OTC: NWLTF) are my favorite services outfits, due to less cash needs and well defined conservative growth strategies. And all of these energy companies are also attractive for another reason: takeover potential.

The only energy trusts I’d avoid now are those that pay no dividends, like Enterra Energy Trust (TSX: ENT-U, NYSE: ENT). I’m also not a big fan of Harvest Energy Trust (TSX: HTE, NYSE: HTE), due to its heavy leverage and generally weak fourth quarter earnings and reserve numbers. (See Dividend Watch List.)

Energy Infrastructure: Still Solid

Steady earnings at electric power producers, pipelines and energy infrastructure companies continued to stand out in the fourth quarter. The CE Portfolios feature many of these businesses, none of which has missed a beat during this economic crisis.

One reason is what they produce is absolutely essential to modern society. Even under the worst market conditions, for example, demand for electricity rarely falls more than a few percentage points.

Power trusts are further removed from risk, as they typically contract with government entities and major utilities rather than directly with consumers. Their market is guaranteed, particularly if they produce from government-favored renewable sources, such as wind and hydro.

Pipeline and energy infrastructure players, meanwhile, deal only with major energy producers, which include some of the strongest and most creditworthy companies in the world. Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF) is the exclusive energy transporter for the Syncrude partnership, which is run by none other than ExxonMobil (NYSE: XOM). And its contract is “take or pay,” meaning the deep pocketed oil giant is obligated to pay for the capacity no matter what it produces.

The only power trusts I’m not high on now are Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF) and Primary Energy Recycling (TSX: PRI-U, OTC: PYGYF). The former has shown itself less than shareholder friendly, while the latter is still plagued with operating problems. In the energy infrastructure group, only Westshore Terminals Income Fund (TSX: WTE-U, OTC: WTSHF) deserves caution, as its major customer is floundering mining giant Teck Cominco (TSX: TCK/B, NYSE: TCK). All three are holds.

Getting the Business

Before Finance Minister Jim Flaherty lowered the boom on their creation in late 2006, all types of businesses were organizing as trusts, including more than a few that were extremely ill-suited for the structure.

Today, most of the junk that was packaged together for tax avoidance has collapsed. What’s left is generally battle hardened and has proved it can operate under a flow-through format under the worst possible conditions, with virtually all income going to shareholders as distributions.

The only real exception in How They Rate coverage now is Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF), which has been burdened by a lengthy US Justice Dept (DoJ) investigation at the same time its business has faced rising costs and falling revenue. Arctic Glacier Income Fund still best avoided until the DoJ case is settled.

Also, Cinram International Income Fund (TSX: CRW-U, OTC: CRWFF) doesn’t pay a distribution, while Somerset Entertainment Income Fund (TSX: SOM-U, OTC: SOFIF) isn’t likely to for long given its declining business. Sell Arctic Glacier, Cinram and Somerset if you still own them.

Meanwhile, several business trusts are indeed proving their ability to weather bear markets, as well as navigate future trust taxation. Looking outside the Portfolio, Superior Plus Corp (TSX: SPB, OTC: SUUIF), managed to convert to a corporation without cutting its distribution last year, and it’s since proven it has the recession resistant earnings to back that up by posting strong fourth quarter results.

Also, Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF) turned in strong fourth quarter results, indicating that its business is far more recession-resistant than many expected. Distributable cash flow per unit soared 73.8 percent in the quarter, pushing the payout ratio down to 70 percent and opening the door to another dividend hike this year. Buy Superior Plus Corp up to USD12 and Cineplex Galaxy Income Fund up to USD18.

Prime Properties

Real estate values in the US have been a major casualty of this down cycle. In contrast, declines in property values have been fairly benign in Canada. In fact, prices have actually risen quite sharply in certain provinces, notably the more remote ones served by High Yield of the Month Northern Property REIT.

CIBC real estate analyst Rossa O’Reilly says the latest statistics on commercial real estate prices bode well for Canada. The Canadian Property Investment Index, which tracks a diversified investment portfolio of 2,569 properties in 34 property funds, had a 4.7 percent total return in 2008. By category, the ICREIM/IPD Index found office properties returned 7.6 percent, residential properties gained 6.4 percent and industrial eeked out a 2.3 percent gain. Retail, meanwhile, was basically flat, while “other” segments were off 0.3 percent.

Mr. O’Reilly said in Canada stronger occupancies and lower development activity along with a stronger economy supported the 3.7 percent return, which was broken down as 6.2 percent income balanced by a 2.3 percent decline in capital growth. By contrast, US properties lost 11.2 percent in 2008 and are losing more this year.

All that is borne out in the strong returns posted by the Canadian real estate investment trusts that have now reported fourth quarter and full year 2008 earnings. The challenge is where they’ll stand in 2009, when property values are likely to come down. Happily, as O’Reilly points out, Canadian markets never underwent a sharp escalation in property values, excessive development or highly levered investment activity. And banks never moved heavily into subprime. That, coupled with management’s inherent conservatism, has cushioned Canadian property markets well in the current downturn.

A handful of REITs have gotten into trouble, as aggressive expansion projects ran into tight credit conditions last year. One of these was H&R REIT (TSX: HR-U, OTC: HRREF), which was forced to cut its distribution in order to secure sufficient access to capital to complete an office building for energy giant Encana (TSX: ECA, NYSE: ECA). Even H&R, however, appears in good shape to weather any further market weakness. And it now has the cash to complete the Encana project.

At this point the only REIT in my coverage universe rated a sell is Huntingdon REIT (TSX: HNT-U, OTC: HURSF), which suspended its distribution indefinitely and still faces leverage problems. InStorage REIT (TSX: IS-U, OTC: INREF) is also a sell, but only because it’s in the process of being taken over in an all-cash deal for CAD4 a share and trades virtually at full value.

Note, however, that I’m only recommending a handful of REITs as buys. That’s largely because many in this group have still not filed fourth quarter earnings. But it’s also because the highest quality plays in the group are selling so cheaply. There’s no reason to buy anything else.

Natural Resources: Watching Asia

Canada’s gross domestic product contracted at an annual rate of 3.4 percent in the fourth quarter. That was its worst showing since 1991. In response to the announcement, the Bank of Canada has now cut its overnight lending rate to 0.5 percent, its lowest rate level ever. Commercial banks have cut their prime lending rates as well, and the ruling Conservative Party government is enacting massive fiscal stimulus as well to get the economy going.

When it comes to natural resources, however, the key economies to watch are those that receive Canadian exports, rather than the home country itself. For much of the country’s history, that’s been the US. And the crippling drop in the US economy has taken a deep toll on a wide range of industries. In fact, I remain very bearish on a wide range of trusts selling products into the US.

Fortunately, Canada’s resource sector has also adopted another customer that has demonstrated its ability to carry demand, even if the US economy stays in the doldrums. That’s emerging Asia, the world’s fastest-growing market for a wide range of resources. In fact, US share of Canada’s total exports has slipped from the mid-90 percent range to the low 70s at last count, largely because commodities are going to China and other emerging countries in record amounts.

The Asia/Canada relationship will only expand in the coming months and years. That’s particularly good news if China is able to grow at 8 percent as its government has forecasted. Meanwhile, far from the headlines, other nations in Asia are showing signs of life.

South Korea’s most recent trade numbers are widely watched because they’re released before those of other nations, and therefore provide an early window into foreign trade and manufacturing activity in other Asian economies. As expected, the country’s exports slipped in January from the prior year, but the rate of decline was much less than expected. Meanwhile, preliminary indications are exports rebounded sharply in February, a number that’s consistent with a nascent recovery in South Korea’s manufacturing Purchasing Managers Index (PMI).

As for China, its Purchasing Manager’s Index (The CLSA China PMI) actually increased from 42.1 in January to 45.1 in February. That’s the third month in a row that the PMI has risen after a record low of 40.9 in November. It’s still below the reading of 50 that indicates a contraction. But the figure nonetheless shows strong gains in both total new orders and export orders, pointing to stabilization in the Chinese economy.

Meanwhile, the output component of the index increased to 43.9 from 39.7 and is currently above the average level for the fourth quarter of 2008. That suggests China’s contraction is checking itself in the first quarter of 2009. And as China is the world’s largest consumer of commodities like zinc, nickel, copper and aluminum, that’s a major development for natural resource producers, including those in Canada.

At present, roughly half of the resource producers tracked in How They Rate are buys. The five sells are either too highly leveraged or tied to the US economy to be able to recover unless there’s a full blown economic upturn, and there’s no guarantee they’ll survive until then. Avoid all of them.

Phones, Food, Health and Transport

Information technology has proven itself to be an essential service than a cyclical business on both sides of the border during this downturn. That’s a fact that was again demonstrated with the sector’s blockbuster fourth quarter 2008 earnings, as the public demands ever greater and faster connectivity.

My favorite play the past several years for income has been Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF), largely because of its high, safe dividend. That’s still my top choice for yield. But any of the other phone giants are also suitable holdings, including newly liberated BCE (TSX: BCE, NYSE: BCE), which posted solid fourth quarter earnings and recently earned upgrades from all the major credit agencies. Buy BCE up to USD24.

In contrast, transportation has shown itself to be one of the most cyclical of all businesses during the downturn. All of the trusts tracked in the group are now rated “hold,” as fourth quarter revenues at each of them showed distinct signs of weakness to the downturn.

I’m still holding Transforce (TSX: TFI, OTC: TFIFF), pending its release of fourth quarter results on March 12. But this is one group to avoid for the most part, as the slowing economy is having a direct impact on revenue and cash flow, and ultimately will have on distributions if the downturn continues.

As for Food and Hospitality and Health Care, it’s very much a mixed bag. Some, like CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF), are definitely weathering the downturn in stride, thanks to secure markets and very conservative balance sheets. Others, like Extendicare REIT (TSX: EXE-U, OTC: EXMUF), appear headed for more dividend cuts.

The breakdown in the restaurant royalty business is particularly striking. Canadian consumers seem to be taking a much harder look at where and when they eat out. Some, like A&W Revenue Royalties Income Fund (TSX: AW-U, OTC: AWRRF), appear to be having no problem attracting new customers and opening new locations, boosting income. Others, like Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF), are clearly experiencing difficulties, as same store sales growth grinds to a halt.

I’ve never been a big fan of this group, mainly because I haven’t felt comfortable differentiating between potential winners and losers in a downturn. If there is a silver lining to this market/economic crackup, it’s that it is separating the good from the bad and ugly. And if winners like A&W and Colabor Income Fund (TSX: CLB-U, OTC: COLAF) continue to put up the kind of numbers they did in the fourth quarter of 2008, it won’t be long before I find a place for them in the CE Portfolio.

In the meantime, A&W Revenue Royalties and Colabor rate solid buys. Note that Colabor has already absorbed the SIFT tax that will be levied on trusts starting in 2011– without reducing its distribution.