The spectre of a U.S. economy hobbled by the subprime mortgage crisis and dampened consumer confidence is hanging over the securities markets. Although central banks in the U.S. and Canada have cut interest rates to stabilize their economies, managers of dividend funds are either very cautious or selectively looking for opportunities amid the market turmoil.

One of those in the former camp is Martin Anstee, manager of Stone Dividend Growth Class Canada and vice president of Toronto-based Stone Asset Management Ltd. “The U.S. economy has definitely slowed down. That debate is over and done with,” he says. “What matters now is: what kind of slowdown or recession will it be? How long will it last? How deep will it be? Will the Federal Reserve Board be successful and keep it short and shallow? Or will it get stuck in a liquidity trap, as Japan did back in the 1990s? Japan ended up in a stagflation environment.”

Although the Fed cut interest rates by 125 basis points in January, bringing overnight lending rates down to 3%, Anstee remains skeptical that step will do the trick and bolster the U.S. economy.

“There are a lot of contradictory signals coming out. We’re getting tossed around and need to get a handle on where the economy is going,” he says. “We’re watching key indicators, such as job losses in the U.S. If unemployment gets worse, then we have a problem. As it stands, we’re not out of the woods.”

If the recession is short and shallow, the market will bottom fairly soon, he says. That could happen if there are further interest rate cuts and an improvement in consumer confidence. “But if it is long-drawn and deep, the market has further to run on the downside,” says Anstee, who believes President George Bush’s US$150-billion stimulus package is strictly window dressing and may get mired in congressional politicking.

A manager who blends top-down and bottom-up investment styles, Anstee admits that this past year, he had a difficult time finding stocks that met his criteria of dividend growth and a total return of 10% or more. As a consequence, about 18% of the fund’s assets under management is in cash. “There was nothing in the market that took into account the prospects of a recession,” he says, adding that only the consumer products sector had discounted a slowdown.

“There was a disconnect between the deteriorating fundamentals and the stock market,” he says. “The market has caught up now — and it’s all the more severe because it should have happened a year ago.”

Running a 40-name portfolio, Anstee favours large-cap names such as Canadian Natural Resources Ltd., Goldcorp Inc., Teck Cominco Inc. and Brookfield Asset Management Inc. He is wary of financial services stocks; they account for about 16% in the fund, or half their weighting in the benchmark S&P/TSX composite index. Prominent financial services names in the fund include Power Financial Corp. and TD Bank Financial Group.

Starting last October, for the first time in five years, the Stone fund acquired some U.S. names. One new holding is IBM Corp. The global information-technology firm’s stock yields 1.5% and trades at 12.5 times earnings. “That multiple is very low for a company that is growing at 12% and has a return on equity of more than 30%,” says Anstee. “You’d think the price/earnings multiple would be 20.” He attributes the low multiple to the perception that the company is a hardware manufacturer.

“I like that kind of company,” he adds. “It has a clean balance sheet and is growing at that level of profitability.” The stock was recently trading at US$106.10 a share. Anstee’s 12-month target is US$130 a share.



Markets could remain choppy for a while, argues Domenic Monteferrante, co-manager of CIBC Dividend Fund and first vice president of Canadian equities at CIBC Global Asset Management Inc. in Montreal.

“There is lack of clarity going forward,” he says. “We didn’t expect a 75-bps rate cut [in mid-January]. That was a surprise. Many people believed that the Fed was behind the curve. Now, we need to see if it will try to get ahead of it. It’s a very fluid situation.”

Monteferrante, who works closely with Stephen Gerring, vice president of equities with CIBC GAM, believes economic conditions will get worse before they improve. Indeed, some observers say the rate cuts signal worse economic news and there may be more to come, he notes: “There are a lot of unknowns.”

@page_break@Still, interest rate cuts have been known to bolster markets. Monteferrante points to studies by Morgan Stanley Investment Management that show that over the past decade, the S&P 500 composite index returned 14% on average in the six months following a surprise rate cut by the Fed. “Once you start cutting aggressively, in due course equity markets start to discount the future,” he says. “Maybe in six months from now and in the summer of 2008, there could be some firming up of the market.”

In the meantime, Monteferrante says, “One strategy — to raise cash and sit on it — is acceptable. One has to be cautious and redeploy that cash in an opportunistic manner.”

The CIBC fund has about 13% of AUM in cash, and Monteferrante intends to take a so-called “rifle shot” approach and add to core holdings when he believes they are oversold.

Besides cash, there is 65% in equities, 15% in income trusts and about 5% in preferred shares. From a sector standpoint, there is an overweighted 34% in financial services stocks (vs 30% in the S&P/TSX composite index), a neutral 27% in energy (including pipelines), an overweighted 9% in consumer discretionary, an underweighted 9% in materials, and smaller holdings that include information technology.

Running a 60-name fund, Monteferrante aims to deliver a total dividend yield greater than the index’s, which is currently 2.4%.

One top holding is EnCana Corp., a leading oil and gas producer. “It’s a steady long-term performer and one of the quality names in the Canadian equity market,” says Monteferrante. He expects the firm will see low single-digit growth in production and earnings per share.

“We’re going through a recessionary period and there will be some softness in demand,” he says. “But we’re in the camp [that believes] supply will also be an issue.”

Growing demand from Asia should offset weakness at home, he adds. The stock, which recently traded at $65.90 a share, yields 2.4%. His 12-month target is $75 a share.

Another favourite name is TD. The bank has expanded into the U.S. by buying Banknorth Group and more recently Commerce Bancorp. The latter cost US$8.5 billion but doubled TD’s retail presence south of the border.

“It’s a question of integrating these different cultures — merging Banknorth with Commerce Bancorp. It has to decide on branding and many other issues. TD paid a fair price for Commerce Bancorp. But can TD execute?” he asks, noting that it took several years for the merger with Canada Trust to pay off. “Longer term, we like the management and think they will execute.”

The stock, which recently traded at $67.85 a share, yields 3.4%. The 12-month target is $78 a share.



On the other hand, Doug War-wick, co-manager of TD Dividend Growth Fund and managing director of Toronto-based TD Asset Management Inc. , maintains fundamentals are strong and should drive better returns going forward than they have for the past few months.

“The Canadian economy is among the best in the G-8,” says Warwick, who works with Michael Lough, vice president at TDAM. “The Canadian consumer is in a much better situation than the American consumer. Our banks are very dependent on the consumer, and that retail franchise is still very strong.”

Although some Canadian banks have been hurt by exposure to the battered U.S. subprime mortgage market, only CIBC has seen significant write-offs. That has resulted in a sale of its shares to investors in order to strengthen its balance sheet. “The banks have not been immune,” he says, “but the banks are largely in good shape in Canada.”

Still, the malaise in the U.S. financial services sector has dragged down the Canadian banks. Adding to that are worries about an economic slowdown and subsequent rising loan-loss provisions. “There is a lot of fear out there,” says Warwick. “With hindsight, we will know whether it is justified. I just look at these banks and see that the dividend yield for the group is higher than 10-year Government of Canada bond yields.”

Yields for what range from 3.6% at the low end to 5% at the top.

“I don’t believe the Canadian banks will cut their dividends,” he adds. Warwick’s goal for the fund is a total return of about 10%. “In fact, the dividends will probably continue to grow — but, perhaps, at a slower rate than they have for the past few years.”

From a strategic viewpoint, the TD fund is dominated by financial services, which have a 54% weighting. That is followed by energy with a 10.8% weighting, income trusts with 10.5%, telecommunications with 8%, and smaller weightings in media and consumer staples. There is also 4% in cash.

With considerable inflows into the fund, Warwick has added to core holdings, including Rogers Communications Inc. and Shoppers Drug Mart Inc. Warwick notes that Rogers has benefited from healthy cash flows and increased its dividend several times.

A long-time holding, the stock recently traded at $38.50 a share and yields 2.6%. Warwick has no stated share price target.

Another favourite is Manulife Financial Corp. A leading Canadian insurer with interests around the world, Manulife has grown steadily and consistently increased its dividend. “We’ve owned it since demutualization in 1999 [when mutual life insurers converted to public companies],” says Warwick, “and have gradually increased our position in the company.”

Manulife has expanded into the U.S. with the acquisition of John Hancock Life Insurance Co. and also into China through its majority ownership of Manulife-Sinochem Life Insurance Co. Ltd. “That’s a long-term project,” he says of the China operations. “Manulife is getting in on the ground level in China and will build a decent business over the next 20 years.”

The stock, which recently traded at $37.45 a share, yields about 2.6%. IE