The U.S. markets have been resilient despite the slowing U.S. economy. The Dow Jones industrial average finally cracked the 13,000-point barrier and was up 7.2% year-to-date as of mid-May. Given relatively strong corporate earnings and the possibility interest rates may decline later this year, some fund managers are upbeat.

“The U.S. market has held its own,” says Dom Grestoni, manager of Investors U.S. Large-Cap Value Fund and senior vice president and head of North American equities at I.G. Investment Management Ltd. in Winnipeg. Valuations are reasonable, he adds, and stocks are trading at about 16 times earnings, vs about 20 times four years ago.

Ironically, the U.S. market has been out of favour globally for some years, says Grestoni, and investors seem overly concerned about its economic growth. After four robust years, gross domestic product growth is slowing to about 2.5% a year. That pessimism is exacerbated by concerns that the ailing housing market will further slow the economy.

Meanwhile, in recent weeks, companies such as Apple Inc. and IBM Corp. have been beating earnings expectations. “The tide of earnings has gone from being very, very negative to being somewhat more positive,” says Grestoni. “Valuations are not stretched, either. In many sectors, they are better than other developed markets.”

As a result, global investors will return to the U.S. because earnings are not as low as expected, he says.

A value-oriented investor, Grestoni took over management of the IG fund from Terry Wong last fall and runs it in the same manner. The unhedged fund has only 26 names and they meet strict value conditions. “We look at stocks for their intrinsic value. There is no particular sector bias and we don’t pay attention to indices,” says Grestoni. He uses a variety of databases to screen for prospects, which he tends to hold for a long time.

Merrill Lynch & Co. Inc., one of the largest brokerage and corporate finance firms in the world, is among the IG fund’s top holdings. The fund bought shares in Merrill Lynch about two years ago at US$51 a share; they recently traded at US$91. “There were lots of concerns over the past few years about the quality of the franchise,” says Grestoni. “Competition from discount brokers was also an issue. But the company restructured and got out of asset management and focused on the core franchise.”

Looking six to 12 months ahead, he predicts a Merrill Lynch share could be trading at US$105-US$110.

Another favourite is McDonald’s Corp., the world’s largest fast-food franchise. In 2005, the stock languished around US$32-US$35 a share, largely because of concerns about its eroding market share. The fund manager took a position and, in 2006, began to see a turnaround. The stock recently traded at US$49 a share.

“Profitability is up and it has spun off some of the underperforming businesses and refocused the company. Its dividend yield has doubled to slightly more than 2% from 1%,” says Grestoni. “We think there is more to come on that front.” His target over the next 12 months is US$55-US$60 a share.



The U.S. market has been on “a huge run” since 2003, says Rory Flynn, portfolio manager at Dublin-based AGF International Advisors Co. Ltd. , who oversees AGF U.S. Value Class Fund.

“It was partly that the market compensated after declining in 2001-02,” he says. “Once the recovery set in, there was a lot of earnings growth.”

Flynn notes that recent concerns about the slowing housing industry and the subprime mortgage crisis were a cloud over the market. But those worries have subsided. “Earnings growth is slowing and worrying, but overall things are OK,” he says. “ The good news and bad news are in balance, so it’s OK for the market to continue to make progress.”

Valuations are fair, Flynn says, echoing Grestoni: “The market is trading at a level it’s only occasionally been at.” The dividend yield is 1.7%, and the last time the market reached present levels was in late 1995. “For a lot of people, this is as cheap as the market has ever been,” Flynn says.

He concedes that earnings growth in 2007 will drop to about 6% from 16% in 2006. “It’s slower than [the historical] trend, which is about 8%,” he says. “But it is earnings growth, so it’s not bad news. Unless you believe that the U.S. will slip into recession, you can believe there’ll be a year of modest growth, and maybe we’ll get more respectable growth again later on.”

@page_break@A value investor, Flynn is running an unhedged fund with 36 names, somewhat fewer than the 45 he had a year ago. “We don’t have a market-cap bias,” he says, “we just go where the value is. At the moment, a lot of really big companies are a lot cheaper than the smaller ones.”

One of the largest holdings is Bank of America Corp., which has been in the AGF fund since its inception in 2001. Flynn has recently added to the holding. The bank is in the news because it may acquire Chicago-based LaSalle Bank Corp. as part of a possible takeover of ABN-AMRO by Barclays PLC. But this is merely a coincidence, says Flynn: “I like attractively valued stocks, and this bank is definitely attractive. It’s trading at 10.9 times historical earnings.”

Although Bank of America is not exposed to the subprime market meltdown, it is being tarred with the same brush as banks that are exposed. “This is the argument, which I don’t believe is true,” Flynn says. “But share prices have been struggling.” A share recently traded at about US$50.80. Flynn does not have a specific target but believes the stock could trade closer to the market multiple.

Another long-time favourite is Eastman Kodak Co. The company has seen its traditional film business decline drastically, but it is making a comeback in other areas.

“It’s doing two things effectively: a commercial digital-printing business and consumer imaging,” says Flynn, noting the company is under new senior management. The latter business involves home printers and kiosk-style labs that cater to digital photography. “Kodak doesn’t care whether you print the photos at home or at a kiosk,” Flynn says. “Once you print them, you’ll be a Kodak customer.”

The stock recently traded at US$24.50 a share, down from its high of US$41 four years ago. Yet Flynn is hanging on: “It is in a better position than a few years ago.”



Equally bullish is Ray Ma-whinney, manager of RBC U.S. Equity Fund and senior vice president Toronto-based RBC Asset Management Inc. “Our view is still constructive on the market,” he says. “There is still an opportunity to make decent returns.”

Mawhinney says the U.S. Federal Reserve Board is on hold with rates while the economy is going through a mid-cycle slowdown. This will impact earnings growth rates, which Mawhinney expects to be in the 7%-9% range.

“This will allow the Fed to begin reducing short-term rates, probably late in 2007 and into 2008,” says Mawhinney. “We don’t think the U.S. is going into recession, just a moderation in growth. But this is the opportunity going forward. As the Fed begins to ease, it’s good for the stock market.”

The weak U.S. dollar is a concern for U.S. importers, but it is a boon for exporters. “When you look at past history, when the US$ was weak, it can be good for stock markets. It makes U.S. products much more attractive,” he says.

Admittedly, falling interest rates could hurt the US$ even more, but, Mawhinney argues, most of the slump has occurred: “At some point, we will see stabilization of the US$. A lot of the damage has already been done.”

A bottom-up, growth-at-a-reasonable-price investor, Ma-whinney is running a 95-name fund that is partially hedged back into Ca-na-dian dollars. The portfolio is dominated by mega-cap stocks, including AT&T Inc., General Electric Corp. and Microsoft Corp.

Mawhinney has made a few strategic changes in the past few months, reflecting shifts in the economy. He has reduced the financial services weighting to 18%, vs 21.5% for the benchmark S&P 500 total return index. He has also reduced the consumer discretionary weighting to 8.5%, vs 10.3% in the benchmark. Conversely, he has raised the technology weighting to 17%, vs 15% for the benchmark. Meanwhile, he has maintained the 9.5% market weighting for energy stocks.

The reduction in financial serv-ices names is driven by pressure on the so-called “net interest margin” because spreads are so thin it’s difficult for banks to make money on loans. “As the Fed may begin to cut rates,” says Mawhinney, “we may move back into financials when we believe we are close to that point, in the latter half of the year.”

Meanwhile, he likes banks, especially Citigroup Inc. “The sum of the parts is worth more than what the stock is fetching,” he says. “It’s the world’s largest bank and has a very good brokerage arm, which is highly profitable.” The stock recently traded at US$53.20 a share, or about 11.5 times earnings. Ma-whinney sees 10%-15% upside in the next 12 to 18 months.

On the technology side, he likes Cisco Systems Inc., the leader in network equipment both for enterprise applications and communications carriers.“There is a network upgrade going on globally, and Cisco is a ‘complete solution’ type of company,” he says. “If you want a reliable brand name, Cisco is the one to get.”

Cisco stock recently traded at about 20 times earnings, but its 20% earnings growth rate is much faster than the market’s. Cisco’s recent share price of US$26.30 compares with US$18 about nine months ago when Mawhinney initially took his position. He expects upside potential of 15% in the next 12 to 18 months. IE