Prepped for an Upside Surprise?

Pessimism is ruling the day. Any debate questions whether the glass is half empty or perhaps all empty. The major stock markets ended August with a loss, as investors shied away from risk and fled into the usual safe-haven assets: gold and US Treasuries.

The tide ebbed, and, as they say, all the boats sank.

It all sounds pretty crummy, and we ask how much worse can it get? Well, look at it this way: the yield curve hasn’t inverted, so at least that’s not flashing a recession warning. Mind you, that signal is unlikely to be much help. With two year rates effectively at zero and ten year rates falling below 2.00% at a point in trading last week, it is hard to imagine thirty year rates inverting.

You might find some solace from history. Market aficionados tell us that a lousy August often presages a strong year-end rally. And this time they may be right, although I am not hanging my hat on the historical significance related to market trends.

And if you buy into that story, you might want to look at a couple of Canadian financial issues that maybe – just maybe –have become a tad oversold in the past month or two.

Financial services conglomerate Power Financial Corp. (TSX: PWF), which is the holding company for a number of large mutual fund and insurance subsidiaries, has dropped from a 52-week high of $31.98 to a recent $26, and 18.7% decline since the spring. The company just reported a 20% increase in quarterly profit. Good, but not quite what analysts had hoped for. But share price appears to bouncing along a bottom now, and even the slightest bit of good news is likely to boost this economically sensitive stock.

Canada’s other big non-bank financial services company is also in the doghouse, having suffered at the hands of investors who haven’t forgotten what happened to it during the 2008-2009 bear market. But Manulife Financial Corp. (TSX: MFC) is a different animal these days, having hedged about two thirds of its stock portfolio at the end of June, with a target hedge of 75% by 2014. In addition, the company reported second-quarter earnings of $0.26 per share, topping consensus estimates of $0.19. The company is far better positioned now to weather an economic crisis than it was in 2008. Shares have been trading just at or below book value.

Aggressive options traders who are willing to bet on a market rally in the closing months of the year – one that lifts all boats, but especially those that seem to have become oversold – might consider establishing bullish positions in both Power Financial and Manulife. With PWF, you might look at buying the January 26 calls at $1.30, while for MFC, the January 13 calls at 70 cents look interesting.

The upside reward could fill the glass to overflowing.