Thus far 2009 shaping up as a banner year for the Canadian Edge Portfolio. On average, our Conservative Holdings are up 48.5 percent, while the Aggressive Holdings are up 47 percent. And disproving for once that they generally underperform, our two mutual fund recommendations are up 67.7 percent.

Aggressive Holdings’ cash flows, dividends and share prices are sensitive to changes in commodity prices. Those of Conservative Holdings, meanwhile, are not and are highly recession-resistant as well.

The fact that both are surging shows just how exceptionally broad-based this rally is.

Only one of 33 current CE Portfolio members is actually underwater for the year, Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF). And four have more than doubled our money, Ag Growth International (TSX: AFN, OTC: AGGZF), Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF), Just Energy Income Fund (TSX: JE-U, OTC: JUSTF) and TransForce (TSX: TFI, OTC: TFIFF).

The question is what lies beyond this rally? Can well-run trusts and high-dividend-paying corporations extend these gains, or are we headed for an inevitable relapse and retracement along the lines of late 2008?

The global stock market rally that began in early March is already one of the strongest and fastest in memory. And US investors have leveraged their Canada returns thanks to the surging Canadian dollar, which has followed oil prices higher.

Even in a best-case, the big gains we’ve seen to date argue for a pause. A growing number of investors, however, fear a “Big W” recession. That means, rather than representing an upswing in a V- a U- or even an L-shaped economy and environment, the rally has left us on the precipice of a second down-leg in a W, with devastating consequences for all.

Canadian stocks and trusts certainly weren’t spared the carnage of late 2008. In fact, the CE Portfolio was with by far its worst loss ever, a 38.8 percent pasting counting the more than 20 percent drop in the Canadian dollar’s exchange value. And even that was considerably better than the currency-adjusted 58 percent loss in the broad-based S&P/Toronto Stock Exchange Income Trust Index (SPRTCM).

Should we see a repeat of late 2008, Canadian securities would surely lose ground. There are, however, several crucial differences between then and now.

First, our picks have now proven their ability as businesses to weather both a potentially devastating credit crunch and a sharp recession.

That includes the energy producers, all of which are still solid despite a more than 75 percent drop in natural gas and 50 percent drop in oil prices over the past 12 months. That demonstrated staying power will shore up share prices in the next selloff.

Second, market history teaches that lightening never strikes twice in the same place. In other words, the same catalyst almost never produces back-to-back selloffs.

The great credit freeze of late 2008 was undeniably responsible for the economic and market crash that followed. And the needy are still having trouble borrowing. But credit markets are more open than ever to those with stronger balance sheets, who are locking in long-term money at the lowest cost in decades. Global monetary authorities have virtually inexhaustible liquidity and an unprecedented will to use it. And after more than a year using it, they know where the danger lies.

That means the chance of another liquidity crunch bringing down global markets is slim. Rather, wrecking this market will take a different catalyst. And, unlike in 2008, the bar of expectations is very low.

A selloff can certainly happen. But the catalyst is going to have to horrific in an unprecedented way to create the panic and devastation last year’s selloff did. And even then, our picks have proven their ability to weather the damage and recover lost ground, paying generous dividends all along the way.

Ironically, the biggest long-term risk to global markets now is what no one is looking for. That’s certainly not a relapse of recession, but inflation resulting from unprecedented monetary largesse to prevent the 2008 meltdown from triggering a depression. And it may actually be beneficial for US investors who buy Canada.

That’s because all Canadian investments are priced in and pay dividends in Canadian dollars. The loonie tracks energy prices, which will surge with any upturn in inflation. That essentially makes Canadian dollar dividends an easy inflation hedge for US income investors, whether the underlying businesses are involved with energy or not.

My point is even the worst-case scenarios being thrown around in the investment media are no reason to sell good Canadian companies. The best stocks and trusts still have plenty of long-term upside, and they’ve already handled the worst the market can throw at them.

And trusts are almost universally exceeding expectations when it comes to dividends after converting to corporations. That suggests the rest have a real 2011 windfall coming, as the extremely negative expectations that followed Halloween 2006 are wiped away.

One final note: If you’re still struggling with the changes made to the Canadian Edge website, please feel free to drop us a line at CanadianEdge@kci-com.com.

Portfolio Action

I’m making one change to the Portfolio this month, upgrading Conservative Holding Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF) back to a buy.

Yellow Pages is one of the October High Yield of the Month recommendations.

There were also several profitable developments last month involving Portfolio companies that portend good numbers ahead. I recap them here and provide a list of expected dates for third quarter earnings releases.

I’ll be reporting on these–always the key to whether to buy, hold or sell–in the November issue and in Flash Alerts that will be e-mailed directly to you.

Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) is now the only hold in the Portfolio, pending the release of its earnings numbers on or about October 27.

Also, note that while not yet reflected in our live quote feed, Colabor Group (TSX: GCL, OTC: COLFF) will pay its first scheduled quarterly distribution as a corporation on Jan. 15, 2010, to shareholders of record December 31.

High Yield of the Month

Both October High Yield of the Month selections are rare breeds in the Canadian Edge Portfolio: trusts that have trimmed distributions in this year.

Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) announced a 37.1 percent reduction in its monthly payout last month to a rate of 5.5 cents Canadian as part of a major strategic shift designed to position it for trust taxation in 2011. Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF), meanwhile, made its cut a month earlier by a similar amount.

What separates both trusts from other dividend cutters is that their core operations and balance sheets are still healthy. These cuts were made to bring payout ratios in line with what they’ll have to be to ensure healthy and growing operations and hold down debt after these trusts convert to corporations and begin absorbing corporate taxes.

The lower payouts are more than sustainable, even under very conservative assumptions, and the yields are still quite high. That’s a great combination that not only ensures high income but also solid capital gains in coming years. Both Macquarie Power & Infrastructure Income Fund and Yellow Pages Income Fund are long-term holdings as well as strong buys for those who don’t already own them.

How They Rate

How They Rate lists trusts and high-yielding corporations by the following sectors:

• Oil and Gas–All producer trusts are included here.
• Electric Power–Power generators.
• Gas/Propane–A mixture of distributors, from propane to packaged ice.
• Business Trusts–A range of businesses involved principally with consumers.
• REITs–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. See How They Rate for other changes in buy targets. Price and yield information is updated every 15 minutes in both tables. Use this service as a reality check when errors occur with US quotes-based services.

Note that it sometimes takes several days for a dividend cut to be updated in the live feed. All dividend cuts in our coverage universe are analyzed in detail in Dividend Watch List.

Column four of the table shows dividend frequency. Note that dividend dates shown are approximate and can vary within two to three days of listed date. This column also shows how each trust and corporation can reduce its tax burden in 2011.

“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.

I’ve added Emera (TSX: EMA, OTC: EMRMF) to coverage under Electric Power. This first-rate energy company owns a portfolio of cash-cow regulated utility properties as well as stakes in power technology companies such as Ireland-based Open Hydro. The payout ratio is low even after last month’s 7.9 percent dividend increase. Buy Emera up to USD22.

ActivEnergy Income Fund (TSX: AEU-U, OTC: ATVYF)–Buy @ 9 to Hold. This closed-end fund has largely failed to cash in on the surge in Canadian securities since March, a worrisome sign.

Bank of Montreal (TSX: BMO, NYSE: BMO–Hold to Buy @ 50. Like many big Canadian banks, this one has proven its worth in bad conditions and is gearing up to profit as global growth picks up.

Baytex Energy Trust (TSX: BTE-U, NYSE: BTE)–Buy @ 17 to Hold. This oil-based trust’s only flaw is that its share price has run up sharply over the past month and is likely due for a breather.

BCE (TSX: BCE, NYSE: BCE)–Buy @ 24 to Hold. This phone company is steady and the dividend isn’t in danger, but there are much better bets for yield and stability among trusts.

Brompton Stable Income Fund (TSX: VIP-U, OTC: BVPIF)–Hold to Buy @ 8. Solid performance and steady management (dividends stable since before October 2006) are good reasons to stick with this stalwart performer.

Brookfield Asset Management (TSX: BAM-A, NYSE: BAM)–Buy @ 20 to Hold. Fundamentally, things are turning around for this asset company, but the shares have run up even faster.

Canadian Hydro Developers (TSX: KHD, NSDQ: CHDV)–Buy @ 5 to Hold. The company has agreed to a friendly takeover by TransAlta Corp (TSX: TA, NYSE: TAC) for CAD5.25 per share, leaving little risk but no real room for upside.

Crombie REIT (TSX: CRR-U, none)–Hold to Buy @ 10. The REIT’s successful offering of convertible debt shows credit market is again open to it and shores up distribution.

Enterra Energy Trust (TSX: ENT-U, NYSE: ENT)–Sell to Hold. At its current steep discount to reserve value, the only real risk to unitholders is bankruptcy, which looks a lot less likely now given debt reduction and expanding production in Oklahoma. On the other hand, there’s still no dividend, so it’s hard to see any attraction here.

First Quantum Minerals (TSX: FM, OTC: FQVLF)–Buy @ 60 to Hold. The market for raw materials is slowly improving, but this stock seems to have outrun the progress made so far.

Interrent REIT (TSX: IIP-U, OTC: IIPZF)–Hold to Sell. Attempts to prevent management’s takeover defenses by outside unitholders appear to have failed.

PDM Royalties (TSX: PDM-U, OTC: PDMRF)–Hold to Sell. The merger to form Imvescor is now pretty much a done deal. US investors can avoid the hassle of conversion by simply selling now.

Pengrowth Energy Trust (TSX: PGF-U, NYSE: PGH)–Hold to Buy @ 10. The trust has at last taken its medicine, launching a strategic shift to cut costs and improve stability of cash flows while cutting its distribution by roughly 30 percent. Coupled with the switch to a corporation for US tax purposes, that essentially makes it a decent play on natural gas.

Progress Energy Resources (TSX: PRQ, OTC: PRQNF)–Buy @ 10 to Hold. Production is still growing for this gas-focused company but the share price has surged and the yield is paltry.

Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)–Hold to Buy @ 8. This trust is proving management’s assertions when it cut the distribution earlier that its business model was sustainable.

Feature Article

When the recession first started gripping North America in early 2007, many, if not most, economists and investors alike assumed the US would drag Canada down for the count.

As it turned out, the Canadian economy and markets were hit but didn’t crack and have since rallied strongly. One big reason is the growing importance of China to the Canadian economy and markets.

The US remains the most important market for Canadian products by far. But the entrance of China to the scene has provided a valuable alternative that’s had a major impact shoring up Canada’s fortunes in the past couple of years. Here I explore the Canada-China relationship and what it means for US investors who buy Canada.

Canadian Currents

We’ve seen significant changes in intergovernmental regimes of late, some symbolic, others more substantial. Recent events are simply the result of processes under way for many years. But there’s time to adjust your investment strategy accordingly.

CE Associate Editor David Dittman looks at what these changes mean for US-based investors and why it’s important to introduce some international exposure to your portfolio.

Tips on Trusts

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–How They Rate trusts, high-yielding corporations and mutual funds increasing distribution again outnumbered the cutters last month, by an 8-to-4 margin.

The four trusts to cut were Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF), InnVest REIT (TSX: INN-U, OTC: IVRVF), Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) and Pengrowth Energy Trust (TSX: PGF-U, NYSE: PGH). Macquarie is discussed in High Yield of the Month (cms:30556). Prospects for the rest are highlighted here.

The rest of the Dividend Watch List (excluding oil and gas producers) are: Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF), Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF), Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF), Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF), FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF), InnVest REIT (TSX: INN-U, OTC: IVRVF) and Primaris REIT (TSX: PMZ-U, OTC: PMZFF). DWL reviews the cutters. All are tracked in How They Rate.

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

Alberta’s Sovereign Wealth–Alberta Investment Management Corporation (AimCo) bears the hallmarks of a sovereign wealth fund (SWF): it has a lot of public money to put to work; it is a creation of the state run on commercial principles by outside managers; it is a means to diversify economic exposure as well as to generate wealth for future generations.

Loonie Levels–The Canadian currency reached a one-year high against the US dollar this week, for some legitimate and some specious reasons.

More Information

The following is a regular repeat from prior issues.

Use our live quote feed in How They Rate for intraday US dollar prices and yields for trusts and high-yielding corporations. 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 www.AdviceforInvestors.com, the website of our Canadian partner, Toronto-based MPL Communications (133 Richmond St. West, Toronto M5H 3M8). The site features price charts and access to press trust releases.

For questions and comments, drop us a line at CanadianEdge@kci-com.com.

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

The Web site www.Sedar.com is an online library of documents filed by trusts with the Canadian equivalent of the US 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 pre-eminent credit rater for trusts.

The Bank of Canada website 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 Income Trust Tax Guide has backup to file distributions as “qualified dividends.”