Everyone takes a real pasting in the marketplace once in a while. In fact, sometimes it’s totally unavoidable. Take, for example, September 2008.

I’m sure there have been worse months in the history of Wall Street. But the implosion of the US mortgage market did a lot more than crush the life out of the financial services industry. Decisive action by the Federal Reserve and US Treasury—coupled with Federal deposit insurance—has likely prevented a repeat of 1929. But weakened banks make rotten lenders, and the result—at the very least—will be slower economic growth in North America into next year.

Investor panic that a new Great Depression had begun fueled the record 778 point decline in the Dow Industrials on Monday, Sept. 29. That’s the kind of extreme sentiment that tends to reverse rapidly, particularly in an environment in which dramatic events seem to occur daily.

The Monday selloff was triggered by the House of Representatives’ rejection of the US Treasury’s request for a $700 billion fund to buy now-wholly illiquid mortgage securities. But the very next day, reports that a new bill was being negotiated erased more than half that loss.

What’s potentially a lot longer lasting is the impact of this turmoil on the real economy. And here, we’re only going to know the effect on our holdings as we see earnings results in the coming months.

Over the past year, I’ve approached every reporting season with a great deal of trepidation that some Canadian Edge Portfolio recommendations would show weakening in the face of their stress tests: the weak US economy, rising operating and raw material costs and tight credit markets.

In the second quarter, two Portfolio holdings succumbed. One of them—Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF)—I sold outright. And as it turned out, taking that loss saved us an additional 80 percent-plus in downside as the trust suspended its distribution indefinitely last month.

The other, GMP Capital Trust (TSX: GMP-U, OTC: GMCPF), I elected to keep on the basis that the investment house trust’s franchise was still strong and its troubles were entirely due to reversible market conditions. That’s still my take on GMP now, though the shares slipped a bit further during the past month’s drop in the Canadian market. Insiders bought again last month, but no one should own this one who isn’t willing to tolerate more downside.

GMP has shown it will reward its investors as it does its traders in good times. But bad times are also shared by all. Buy GMP Capital Trust up to USD12, but only if you haven’t already.

Why am I so interested in earnings numbers? Simply because they’re the best and only guarantor that our picks will recover from the pasting they’ve taken the past couple months.

This crisis is all about the financials. But because availability of credit affects virtually every industry, their crisis has become everyone’s problem. Generators of electricity that sell their output under long-term contracts to governments, for example, will make their revenue no matter how many banks fail. They may, however, have some troubles getting needed credit in this extremely tight market, which could result in a financial squeeze nonetheless.

If that proves to be the case, there could be real trouble. We’re going to want to be out of them as quickly as possible. But the only way we’re going to know to get out is by looking at the numbers. Arctic Glacier, for example, had a seemingly recession-resistant business, until it posted second quarter earnings indicating clear cost pressures and weak sales.

On the other hand, this panic-driven market is treating virtually every Canadian trust as a potential Arctic Glacier. As I’ve said before, that means the bar for their success—what’s needed to drive their share prices higher again—is set very low.

The average CE recommendation is off 6 percent for the first nine months of 2008, not including a 7 percent drop in the Canadian dollar. That’s not exactly anything to write home about, though it did beat most alternatives. Much more important, however, despite a real shellacking in the third quarter and September in particular, we’re still in the game for a fourth quarter comeback.

The key is earnings. If our picks just post sufficiently good cash flows to hold dividends at current levels, they’ll prove to the market that they’re weathering the crisis. Bottom line: It’s still all about the numbers. If the underlying businesses of our recommended trusts and corporations stay healthy, their shares are going a lot higher from these levels. Despite the body blows of the past month, we want to keep them.

The really good news coming out of the second quarter was every trust and dividend-paying corporation in the CE Portfolio besides Arctic and GMP did deliver on the numbers. That even included several that had previously tested my patience, such as last issue’s High Yields of the Month AG Growth Fund (TSX: AFN-U, OTC: AGGRF) and Energy Savings Income Trust (TSX: SIF-U, OTC: ESIUF).

The good news helped several of my picks to bounce back from losses taken in July. Unfortunately, it was quickly forgotten as the US banking system started to come unglued. To be sure, the strong second quarter numbers have correctly forecasted our picks’ ability to keep paying dividends and access credit as the crisis has gotten worse and worse. But with the books now closed on the third quarter, we have a new set of numbers to anticipate:

Algonquin Power Income Fund (TSX: APF.UN, OTC: AGQNF) Nov. 6
AltaGas Income Fund (TSX: ALA.UN, OTC: ATGFF) Nov. 7
Artis REIT (TSX: AX.UN, OTC: ARESF) Nov. 12
Atlantic Power Corp (TSX: ATP.UN, OTC: ATPWF) Nov. 13
Bell Aliant Regional Communications Income Fund (TSX: BA.UN, OTC: BLIAF) Oct. 28
Canadian Apartment REIT (TSX: CAR.UN, OTC: CDPYF) Nov. 7
Consumers Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) Oct 28
Energy Savings Income Fund (TSX: SIF.UN, OTC: ESIUF) Nov. 7
Keyera Facilities Income Fund (TSX: KEY.UN, OTC: KEYUF) Nov. 6
Macquarie Power & Infrastructure Income Fund (TSX: MPT.UN, OTC: MCQPF) Nov. 7
Northern Property REIT (TSX: NPR.UN, OTC: NPRUF) Nov. 12
Pembina Pipeline Income Fund (TSX: PIF.UN, OTC: PMBIF) Oct. 31
RioCan REIT (TSX: REI.UN, OTC: RIOCF) Oct. 31
TransForce (TSX: TFI, OTC: TFIFF) Oct. 30
Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) Nov. 7

Aggressive Portfolio

Advantage Energy Income Fund (TSX: AVN.UN, NYSE: AAV) Nov. 13
Ag Growth Income Fund (TSX: AFN.UN, OTC: AGGRF) Nov. 14
ARC Energy Trust (TSX: AET.UN, OTC: AETUF) Nov. 7
Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF) Oct. 31
Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF) Nov. 7
Enerplus Resources (TSX: ERF.UN, NYSE: ERF) Nov. 7
GMP Capital Trust (TSX: GMP.UN, OTC: GMCPF) Nov. 6
Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) Nov. 7
Paramount Energy Trust (TSX: PMT.UN, OTC: PMGYF) Nov. 7
Penn West Energy Trust (TSX: PWT.UN, NYSE: PWE) Nov. 7
Peyto Energy Trust (TSX: PEY.UN, OTC: PEYUF) Nov. 5
Provident Energy Trust (TSX: PVE.UN, NYSE: PVX) Nov. 7
Trinidad Drilling (TSX: TDG, OTC: TDGCF) Nov. 7
Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) Nov. 5

As I’ve done in past earnings seasons, I will report on these numbers as they’re released. Readers can look for a handful in the November issue and most of the remaining plays in Flash Alerts the week following. The last will be filed on or about Nov. 14, as AG Growth makes its report. The December issue will have a full recap of what we’ve learned in the numbers and what they portend for the future.

As I noted in the Feature Article, the most likely candidates to take a third quarter earnings hit are the energy producer trusts. That’s definitely what the market is betting on, handing shares of my nine sector picks an average third quarter loss of close to 20 percent.

The silver lining is, despite that pounding, my nine producer trusts were still up an average of 17 percent for the year. They’re nearly certain to report worse numbers for the third quarter than the second, due mostly to lower realized selling prices. But with payout ratios so low in the second quarter, they should still have more than adequate payout coverage.

None of them acted as though the first half spike in oil and gas prices was a permanent state of affairs. The only distribution increases were either long overdue or temporary measures, such as ARC Energy Trust’s successive “top-up” increases. The bulk of funds were ploughed into new development and debt reduction, increasing the long-run sustainability of the business.

I’ll let the numbers tell me what to buy and what to bump. But, as I explain in the Feature Article, I fully expect all to remain resilient as businesses, paying generous distributions until credit conditions stabilize and energy prices return to the upside.

That goes even for the gas-focused plays such as Advantage Energy Income Fund, Daylight Resources Trust and Paramount Energy Trust, though again investors should expect volatility. Even the most conservative, however, can pick up shares of High Yield of the Month Peyto Energy Trust with confidence.

A month ago, I tried to call a bottom for the energy trusts. The extreme action of September has proven me premature. The good news is whether you followed me last month or even bought at the top in June, you’re going to wind up doing well holding a well-tended group of these trusts.

Outside the energy trusts, I have a high comfort level my picks will generate more than enough cash flow to maintain distributions at their current rate. That includes the trusts and companies most battered by the recent market pasting. But again, the third quarter numbers are going to be my guide going forward, just as they’ve been in prior periods.

Easily my worst performing sector this year has been electric power production. All four of my picks have absorbed a beating this year, dropping an average of 24 percent–not counting the 7 percent decline in the Canadian dollar versus the US dollar. The downturn accelerated in the third quarter as the credit crunch worsened, though underperformance has actually been ongoing since the beginning of the year.

Power trusts have historically been a sleepy sector. Cash flows from hydroelectric plants vary with precipitation and can therefore be volatile from quarter to quarter. And as Boralex Power Income Fund’s spring distribution cut showed, profits at other types of power plants can also be affected by external factors, such as the availability of wood waste.

For the most part, however, power trusts quietly operate their facilities under long-term sales contracts with government entities and giant utilities. Moreover, these contracts automatically pass through changes in fuel costs, meaning there’s little or no commodity price or economic risk to costs or revenue. All trusts literally have to do to earn their distributions is to run their asset portfolios well.

The stability of this setup has been consistently reflected in the results of my four power picks: Algonquin Power Income Fund, Atlantic Power Income Fund, Macquarie Power & Infrastructure Income Fund and even Boralex, despite its recent stumbles. And as I noted in the September issue, the second quarter of 2008 was no exception.

This week, Atlantic Power again demonstrated its skills generating cash from operations and raising it in credit markets to expand its portfolio of power projects. Specifically, the company acquired Auburndale Power Partners, owner and operator of a 155-megawatt (MW) natural gas-fired combined cycle cogeneration facility located in Polk County, Fla. The plant is the last of the projects in which Atlantic holds right of first refusal from its former owner, ArcLight Energy Partners.

The purchase price is approximately USD134.5 million and will be funded by cash on hand, a borrowing under the company’s credit facility and non-recourse acquisition debt, which is attached to the project itself rather than Atlantic. Closing is expected to take place in the fourth quarter, following federal regulatory approval, and is expected to be immediately accretive to distributable cash flow. Output is fully contracted to giant utility Progress Energy, and fuel costs are “substantially” hedged via a purchase contract with El Paso Corp.

The plant has an excellent operating history and is complimentary to Atlantic’s interests in three other Florida plants. And the deal can be completed without raising additional equity in the public markets.

The company also announced new natural gas price hedges for its Lake Project plant interest, covering the second half of 2009 when its current supply deal expires. These will support the projected cash flow from the plant in 2009 at the high end of the previously announced guidance range.

The ability to do these deals at this extremely troubled time in the capital markets is extremely bullish news, which should mollify anyone still worried about Atlantic’s financial position. And it means more cash in the future to apply to debt reduction, further expansion or even a dividend boost.

Algonquin Power issued similarly bullish news last month, when it added new revenue sources with a business combination with Highground Capital Corp. More than 50 percent of Canada’s infrastructure will reach the end of its serviceable life by 2027. And Macquarie Power & Infrastructure states it has CAD100 million in cash and facilities with which to make acquisitions to take advantage of the country’s replacement needs in renewable energy, power transmission and other cash generating assets vital to a functioning economy. Even Boralex Power Income Fund now appears sustainable, as a dividend cut earlier this year was sufficient to cover the shortfall from the trust’s biomass plants. (See the Dividend Watch List section of Tips on Trusts).

So why have power trusts been hit so hard this year? I suspect it’s been a combination of factors. For one thing, up until recently, Canadian inflation had been picking up this year, making yield vehicles less attractive to investors. Rising energy prices in the first half of the year also contributed, driving investors out of power and into oil and gas production trusts.

Stepped up selling in the third quarter was likely due to several perceived negatives. Power trusts have traditionally paid out a very high percentage of their operating cash flow after maintenance capital expenditures, mainly because those cash flows are so steady and predictable. But those high payout ratios and the sizeable debt associated with big, fixed power assets has also no doubt spooked some investors, particularly in light of Boralex’s distribution cut this spring.

Finally, there’s the natural tendency to sell what everyone else is unloading, the relatively small size and trading float of power trusts, the fact that few analysts cover them regularly, the collapse of a rumored takeover offer for Boralex Power last year and concerns about what distributions will look like in 2011.

The one thing all of these factors have in common is they’re quite ephemeral. In other words, they have little or nothing to do with power trusts’ actual business performance—or their ability to sustain what are now extraordinary dividend yields averaging more than 16 percent.

Admittedly, we may yet see some heretofore hidden vulnerability appear in third quarter results for one or more of them. Algonquin, for example, may wind up being negatively affected by its heavy presence in the US, though its water treatment facilities and power plants have been mostly recession proof to date.

Macquarie Power & Infrastructure’s parent, Macquarie Bank, remains a target of heavy criticism for its infrastructure-based growth plans, which could conceivably impact the trust’s growth despite the strict segregation of assets. And Boralex should always be considered a speculation, as long as its biomass plants are shut.

To date, we haven’t seen any evidence of real weakening at any of these trusts, other than their abysmal performance in the stock market. And in any case, these trusts haven’t depended on the capital market for some time, relying mostly on internal resources even for acquisitions.

Two other points on power trusts: In recent years, Bay Street opinion has been relentlessly negative on them. However, the negativity has definitely thawed over the past few months as prices have come down and trusts have shown their resiliency as businesses. Second, corporate insiders have been steady buyers of power trust shares this year.

Since this bear market began, the top-performing power trust by far has been the sector’s most conservative play: Great Lakes Hydro Income Fund (TSX: GLH-U, OTC: GLHIF). I have consistently rated it a buy over the years, though I’ve never added it to the portfolio.

In my view it remains a superb choice for conservative investors. But if my views on my four favorite power trusts are even half right, they’re going to be far better performers going forward, even as they pay dividends nearly three times that of Great Lakes Hydro.

If you want a trust that holds its own no matter what happens, Great Lakes is the better bet. If you’re willing to tolerate a little more volatility and downside, however, Algonquin Power Income Fund (buy up to USD7), Atlantic Power Corp (USD10), Boralex Power Income Fund (USD5) and Macquarie Power & Infrastructure (USD8) are still my favorite ways to play. Note I’ve reduced their buy targets to reflect the drop in the Canadian dollar exchange rate.

On Oct. 12, Canadians will go to the polls to choose a new parliament. At this point, the Conservatives appear headed for another plurality, but not a majority government. That outcome would ensure another election, very likely before 2011 trust taxation kicks in. And it would give new life for the opposition Liberals’ efforts to push their plan to cut the top trust tax rate to just 10 percent, presumably under more dynamic leadership.

Everything in politics is conjecture. That’s why I’ve consistently advised investors to act as though the current “Tax Fairness” plan is set in stone and that today’s trusts will have to get creative to keep paying big distributions as well as run good businesses.

Last issue, I focused the Feature Article on what trusts have done so far, and what they’re likely to do to get ready for 2011. As I pointed out, early conversions to corporations thus far have wound up unlocking value, as they’ve removed the specter of what will happen in 2011. That should make everyone feel a lot better about the future.

I also highlighted the strengths that Canadian Edge Portfolio trusts bring to the table when it comes to maximizing “tax efficiency,” as well as their stated plans for 2011. The results are presented again below in the table “Beyond 2011,” along with new information from several trusts I’ve heard from since last month.

One of these is Yellow Pages Income Fund, whose spokesman restated the trust’s intention to literally “outgrow” its future tax liability. Specifically, Yellow expects ongoing growth initiatives, combined with modest dividend increases, to bring down the payout ratio close to 70 percent by 2010. That would enable the trust to meet its objective of “maintaining the 2010 level of cash distributions to shareholders in 2011,” when it converts to a corporation.

That’s about as clear cut as it gets right now, as most trust managements continue to ponder their options and are loath to make firm commitments. It’s a big reason I continue to like Yellow Pages Income Fund up to my buy target of USD12, though my main attraction is its strong underlying business.

I also heard from very solid infrastructure trust AltaGas Income Fund. Here management was willing to commit to being a dividend-paying corporation, though only “at a level that would hold taxable Canadian holders of our shares on an after-tax basis indifferent.”

Taken literally, that would mean a dividend cut for US investors upon conversion. Management also stated that it “expects not to be taxable of any significance through 2012,” thanks to tax pools of CAD775 million as of the second quarter of 2008. And it was willing to forecast an effective tax rate in the mid-teens presumably thereafter. That would leave considerable cash reserves with which to invest in growth and pay high distributions, particularly considering the high quality of the trust’s assets.

Again, living up to this projection will depend on the trust running its assets well. But that’s something management has done consistently every quarter and shows every sign of continuing to do so. AltaGas Income Trust remains a buy up to USD25 for those who haven’t yet picked up shares.

Last but hardly least, Enerplus Resources has assured investors it will remain an income trust at least to 2011 and will “continue to distribute a significant portion of cash flow from oil and gas assets post-2010.” Those are similar to statements made by Advantage Energy Income Fund CEO Andy Mah in my conversation with him last month, as well as other energy trusts.

Again, willingness to pay big dividends is a great bonus for buying all of these trusts up to the target prices listed in the Portfolio table. The key, however, is the strength of the underlying business. All are strong in that regard but, again, we’ll let the numbers tell us if that remains true or if we need to move along to greener pastures. Buy the business.