The Bank of Canada (BoC) raised the target for its overnight rate 25 basis points to 1 percent Wednesday morning, the latest sign that the Great White North is experiencing quite a different economy than is its neighbor to the south. Canada is in a sweet spot relative to its developed peers, enjoying strong demand for its copious resources from emerging markets even as the fallout from long-term structural shifts hampers growth for its traditional trading partners.

The BoC’s monetary policy is flat-out traditional and, now, flexible; fiscal policymakers crafted a timely, effective stimulus and have made a credible case for a return to budget balance in the medium term; though still headed by a minority the federal government is stable, the country’s politics absolutely placid compared to the US circus; its banking system has been lauded yet again; and Canada is home to abundant commodities, including the oil sands, a resource that sets the country apart at a time when crude is becoming ever more dear.  

Right after the BoC released its rate decision the Canadian dollar spiked against the US dollar. Money is more expensive in Canada, and the gut reaction is that the relationship will move this way for the long term. The traders who bid the loonie up over USD0.96 today are right; the loonie has been on a flight toward parity with the buck since North American markets bottomed in early March 2009.

The full text of the BoC statement, described by some as “hawkish,” by others “dovish,” is available here. Hawks were pleased with the BoC’s repeat acknowledgement that “financial conditions in Canada have tightened modestly but remain exceptionally stimulative,” an indication that the current course of rate hikes won’t stop at the nice, round 1 percent. As today’s statement noted, the market has basically absorbed recent increases without much impact on real-world borrowing costs.

Doves, meanwhile, took comfort in the BoC’s conclusion that “any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook,” suggesting that a downward revision of its base-case growth scenario is a sign the central bank will hold off on any more borrowing-cost increases until the outlook is more certain.

Whatever the tea leaves suggest about what the BoC will do with its next rate-policy announcement on Oct. 19, the BoC has given itself more room to maneuver should deterioration south of the border proven worse than it now anticipates. And that is a good thing; the BoC can employ traditional monetary tools to stave off another downturn. The US is faced with the revival of quantitative easing and all the long-term inflationary pressure it seems to imply, not to mention the new spending measures and tax cuts soon to dominate fiscal policymakers’ agendas.

It’s unlikely the US Congress will get a new stimulus bill to President Obama for signature. It’ll be enough, however, if the two branches can hammer out a compromise on the so-called Bush tax cuts, set to expire at midnight Dec. 31, 2010. Movement on this issue has been positive in recent days, with Peter Orszag, who left his post as Director of the White House Office of Management and Budget for the cozier confines of the New York Times, arguing recently in favor of a flat two-year extension followed by a total repeal. President Obama said today he would like to see the cuts made permanent for the middle class.

Whether Orszag’s op-ed and Obama’s desire become the basis for final legislation is as murky a question as what the BoC will do next with its overnight rate target; however, it does indicate that there is a path to compromise on this issue and that some form of preferential treatment for investment income will persist. Make sure your voice is heard: Go to DefendMyDividend.org and sign the petition.

Taking yet another side-step, there’s still a dearth of empirical evidence in favor of the argument that the Bush tax cuts were ever priced in by the market. The advantaged rates, as written by Republicans in Congress and signed by President George W. Bush, were perhaps always seen as temporary. But the grappling over the cuts, as well as the tussle over more US fiscal stimulus spending, promises to be even more intense given the rapid approach of November midterm Congressional elections.

The market will overreact to news on the Bush tax cuts issue, in particular, whether Washington churns out a total repeal or a total extension. It’s important for US-based investors in high-yielding Canadian corporations and trusts to bear in mind that the biggest part of the shareholder bases for these particular equities are north of the border. Canadians won’t be affected by changes to US tax laws.

Setting aside still puzzling and infuriating but also rather anomalous decision to tax income and royalty trusts, Canada is unlikely to be swayed by the US example; in fact the trend is in the other direction as far as Canadian tax rates. Corporate rates are already the most favorable to business in the G-7 and will soon be among the lowest in the world.

Nor does it need to raise taxes: Canada put together a decade’s worth of budget surpluses and put a significant dent in its federal debt before enacting true countercyclical, Keynesian measures in response to the onset of the Great Recession. It has a credible record of fiscal discipline–at the provincial level and in Ottawa–and its deficit isn’t structural.

The global financial and economic crisis that began in 2007 and climaxed in 2009 is still playing out; the denouement is likely to include the revelation of interesting geopolitical dynamics and new power players. China and India are asserting themselves in the global economy; though the US will remain the world’s dominant force, the future of growth leadership lies in Asia.

Fortunately, Canada has a lot of stuff that these emerging giants need.

The Roundup

These are heady times if you own shares of Potash Corp of Saskatchewan (TSX: POT, NYSE: POT). “Maximize shareholder value” being the prime directive of management teams, it’s little surprise that Potash Corp CEO Bill Doyle predicted yesterday–on video (click through and scroll down)–that another bidder would emerge to take on BHP Billiton (NYSE: BHP) for control of the world’s largest producer of an increasingly critical agriculture input.

No doubt BHP’s USD38.6 billion bid has boosted capital flows into Canada, lifting Potash Corp shares, in particular, but providing an updraft for the loonie and boosting returns for US investors who are long Canadian assets, including high-yielding corporations and trusts, as well.

Clearly, Doyle prefers a bidding war.

He must be encouraged by the Chinese government’s endorsement of a possible bid by state-owned entity (SOE) Sinochem (Shanghai: 600500) and talk that the SOE has approached Singaporean sovereign wealth fund (SWF) Temasek Holdings about a combined effort. China Investment Corp (CIC), the most active and influential SWF in the world since the end of the Great Recession, is said to already be involved with Sinochem’s possible bid. The Chinese, who purchase 7 percent of their supply from Potash Corp, are concerned about what BHP’s ownership would mean for prices and access in the future.

Still, as of Wednesday afternoon Sept. 8, no competing bid has emerged. As we note in the September Canadian Edge:

BHP Billiton’s…all-cash offer of CAD130 per share for the company is now officially hostile, as Potash Corp’s management has rejected it outright. That’s set off a flurry of rumors that either BHP will up its bid to a “can’t refuse” level, or that a counterbid will emerge, which in turn has sent shares soaring roughly 50 percent above my recommended buy-in point.

Certainly, anything is possible, and Potash Corp is a valuable company, as solid second-quarter numbers attest. On the other hand, investors should remember BHP’s bid for arguably far more valuable Rio Tinto Plc (NYSE: RTP) a few years ago. Rio’s board, too, held out for a better deal and was eventually spurned, at one point losing more than 80 percent of its value. Potash Corp shares have been all over the map in recent years like most resource companies. Conservative investors should grab the blockbuster gain they’ve just been handed.

Sell Potash Corp of Saskatchewan.

Canada’s Office of the Superintendent of Financial Institutions (OSFI) said it’s close to removing the constraints on Canadian banks that had required them to hold excess capital. An official with Germany’s central bank had previously divulged that global regulators meeting in Basel, Switzerland, were ready to make concessions to banks on the timing of new capital ratio requirements.

Before the crisis hit, banks had to hold 4 percent of Tier 1 capital, but OSFI required 7 percent; the Big Five are now well into double-digit percentages on their own accord, ratios much higher than their foreign rivals’ and well above their historic norm of 10 percent. Bank executives signaled during fiscal third-quarter earnings conference calls that they expect to be able to implement the new Basel rules without disruption, and that dividend hikes at some of the banks could be declared once the new requirements are clear and OSFI gives the green light.

We have no Canadian banks in the CE Portfolio. We do have “buy” recommendations on four of the Big Five, which we cover in How They Rate under Financial Services. Our top pick is Bank of Nova Scotia (TSX: BNS, NYSE: BNS), Canada’s No. 3 bank in terms of assets.

Scotiabank’s net income for the fiscal third quarter ended July 31 rose 14 percent to CAD1.06 billion (CAD0.98 per share) from CAD931 million (CAD0.87 per share) in the third quarter of 2009. Cash earnings were CAD0.99 per share, which missed the consensus estimate by a penny.

Reduced writedowns partially offset surprisingly weak trading revenue. International banking–also a measure of global economic conditions–reported solid results. Foreign-exchange effects dragged, but here, too, provisions for credit writedowns declined and recent acquisitions contributed to the bottom line.

Domestic banking business again posted record results, earning CAD604 million, up from CAD500 million a year ago. Revenue at home was up 9 percent, driven by market-share gains in mortgages and mutual funds.

Provisions for bad loans declined by half to CAD276 million from CAD554 million, helping offset a 35 percent earnings drop at trading unit Scotia Capital to CAD305 million. Revenue for the unit was off by 37 percent to CAD697 million. Scotiabank is the most internationally diverse of Canada’s banks, with operations in 50 countries; earnings from abroad rose 2 percent to CAD317 million on a 9 percent revenue increase.

Scotiabank reported a Tier 1 capital ratio of 11.7 percent as at July 31. Management maintained its quarterly dividend at CAD0.49 per share. Bank of Nova Scotia is a buy up to USD50.

Along with Scotiabank, Bank of Montreal (TSX: BMO, NYSE: BMO), Royal Bank of Canada (TSX: RY, NYSE: RY) and Toronto-Dominion Bank (TSX: TD, NYSE: TD) missed consensus estimates. Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) was the only one of the Big Five to beat estimates.

Toronto-Dominion, Canada’s second-largest bank, earned CAD1.18 billion (CAD1.29 per share), up 29 percent from CAD912 million (CAD1.01 per share) a year ago. Adjusted profit was CAD1.43 a share, against a consensus estimate of CAD1.44 per share. Loan loss provisions fell to CAD339 million from CAD557 million.

TD’s Canadian retail banking profit rose 24 percent to CAD841 million. Income at Toronto-Dominion’s US outfit, TD Bank, rose 30 percent to USD276 million. Wholesale banking income fell 45 percent to CAD179 million, also following the trend of TD’s rivals, as trading and underwriting revenues were hurt by the European debt crisis. TD’s Tier 1 capital ratio rose to 12.5 percent from 11.1 percent. Buy Toronto-Dominion Bank up to USD65.

Bank of Montreal, Canada’s No. 4 bank in terms of assets and the only one of the Big Five not rated a buy in How They Rate, reported a 20 percent increase in net income to CAD669 million (CAD1.13 per share) from CAD557 million (CAD0.97 per share) a year ago. On a sequential basis earnings were down 10 percent from CAD745 million (CAD1.26 per share).

Cash earnings were CAD1.14 a share, up from CAD0.98 a year ago. Bank of Montreal’s CAD1.13 earnings per share number was below the consensus estimate of CAD1.21. Earnings from Canadian personal and commercial banking operations rose 18 percent to CAD426 million, while capital-markets net income plummeted 58 percent to CAD130 million, hurt by widening credit spreads, lower trading margins and fewer trading opportunities.

Loan-loss provisions dropped to CAD214 million from CAD357 million, while the bank’s Tier 1 capital ratio as at July 31 was 13.6 percent. Bank of Montreal is a hold.

Royal Bank of Canada’s net income fell 18 percent to CAD1.28 billion (CAD0.84 per share) from CAD1.56 billion (CAD1.05 per share) a year ago. Excluding one-time items, Canada’s largest bank by assets earned CAD0.87, well below a consensus estimate of CAD1.02.

Revenue fell 13 percent to CAD6.83 billion, dragged down by the bank’s capital-markets business. The sovereign debt panic that gripped Europe during the quarter overwhelmed otherwise solid results, particularly in the Canadian retail business.

Royal Bank’s loan-loss provisions fell to CAD432 million from CAD770 million a year earlier.

Net interest income–the amount it receives less what it pays out–fell 5 percent to CAD2.75 billion. Non-interest income sank 17 percent to CAD4.08 billion on trading losses. Earnings at RBC Capital fell 64 percent to CAD201 million from CAD562 million a year earlier. Earnings in Canadian banking rose 14 percent to CAD766 million on deposit growth, home-equity loans and higher mutual-fund fees.

The bank’s international unit, which includes North Carolina-based RBC Bank, posted its ninth consecutive quarterly loss but narrowed to CAD76 million from CAD95 million a year ago on lower loan-loss provisions. Management reported a Tier 1 capital ratio of 12.9 percent as at July 31. Royal Bank of Canada is a buy up to USD55.

Canadian Imperial Bank of Commerce was the only Big Five bank to beat its consensus third-quarter earnings estimate. CIBC reported net income of CAD640 million (CAD1.53 per share), up 47 percent from CAD434 million (CAD1.02 per share) a year ago.

As was the case with its Big Five peers, strong results in its domestic operations and a steep decline in loan-loss provisions drove results. CIBC, Canada’s No. 5 bank in terms of assets, reported cash earnings of CAD1.55 per share, up from CAD1.04 a year ago.

Retail operations, which includes personal banking, business banking and wealth management, generated earnings of CAD599 million, up from CAD416 million a year earlier. Investment banking contributed CAD25 million to earnings, down from CAD90 million.

Loan-loss provisions fell to CAD221 million from CAD547 million. CIBC’s Tier 1 capital ratio as at July 31 was 14.2 percent, up from 13.7 a year ago. Canadian Imperial Bank of Commerce is a buy up to USD70.

Scotiabank and Toronto-Dominion could be the first two banks to boost dividends because their respective payout ratios are within management’s target range. Both stocks–as well as those of the other three Big Five banks–have run up in recent days on speculation about impending Basel-driven dividend increases. Stick to buy targets until the matter is settled, likely sometime in late 2010 or early 2011. The flexibility to make such moves is one thing; whether a dividend hike is a prudent use of cash is another. Banks will want to see more clarity about global and North American economic conditions before risking hard-earned capital stability in recent quarters.

Here are tentative third-quarter earnings announcement dates for the Canadian Edge Portfolio.

Aggressive Holdings

• Ag Growth International (TSX: AFN, OTC: AGGZF)–Nov. 12
• ARC Energy Trust (TSX: AET-U, OTC: AETUF)–Nov. 1 (confirmed)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–Nov. 11
• Daylight Energy (TSX: DAY, OTC: DAYYF)–Nov. 4
• Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF)–Nov. 12
• Newalta Corp (TSX: NAL, OTC: NWLTF)–Nov. 5
• Parkland Income Fund (TSX: PKI-U, OTC: PKIUF)–Nov. 5
• Penn West Energy Trust (TSX: PWT-U, NYSE: PWE)–Nov. 5
• Perpetual Energy (TSX: PMT, OTC: PMGYF)–Nov. 9
• Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)–Nov. 11
• Provident Energy Trust (TSX: PVE-U, NYSE: PVX)–Nov. 10
• Trinidad Drilling (TSX: TDG, OTC: TDGCF)–Nov. 4
• Vermilion Energy Trust (TSX: VET-U, OTC: VETMF)–Nov. 5

Conservative Holdings

• AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF)–Oct. 28 (confirmed)
• Artis REIT (TSX: AX-U, OTC: ARESF)–Nov. 11
• Atlantic Power Corp (TSX: ATP, NYSE: AT)–Nov. 10
• Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF)–Nov. 10
• Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF)–Nov. 9
• Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF)–Nov. 3
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)–Nov. 12
• Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF)–Nov. 10
• CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF)–Nov. 11
• Colabor Group (TSX: GCL, OTC: COLFF)–Oct. 7
• Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF)–Nov. 2
• IBI Income Fund (TSX: IBG-U, OTC: IBIBF)–Nov. 4
• Innergex Renewable Energy (TSX: INE, OTC: INGXF)–Nov. 12
• Just Energy Income Fund (TSX: JE-U, OTC: JUSTF)–Nov. 5
• Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF)–Nov. 2 (confirmed)
• Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF)–Nov. 3 (confirmed)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–Nov. 12
• Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF)–Oct. 28
• RioCan REIT (TSX: REI-U, OTC: RIOCF)–Oct. 26
• TransForce (TSX: TFI, OTC: TFIFF)–Oct. 29 (confirmed)
• Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)–Nov. 4