Months ago, man-agers began to rotate investments out of late cyclical sectors into defensive ones, anticipating slower economic growth in Canada and the U.S. Now, many caution, it will be even harder to find safe places to invest in Canada in 2007.

“Much of the mutual fund inflows have gone into balanced funds and dividend funds, so these very stable companies are trading at rich multiples,” says Richard Nield, manager of AIM Funds Management Inc. ’s AIM Canadian Premier Fund in Austin, Tex.

Several other managers echo this concern. “The obvious things you should be buying — such as utilities and pipelines — are a little dear,” says Fred Pynn, chief investment officer at Bissett Investment Management Ltd. in Calgary. “We’re finding it difficult to find fresh investment ideas at prices we consider attractive.”

Indeed, Canada is so expensive that John Poulter, chief invest-ment officer at Cumberland Private Wealth Management Corp. in Toronto, is maximizing the firm’s permitted U.S. weightings in Canadian equity funds. His “underweighting Canada” theme especially applies to health care, even if it is typically a defensive sector. “If I’m going after biotech companies, Biovail Inc. isn’t the best one on the planet,” he says. “Why not look at the 15 companies in the U.S.?”

At Toronto-based Mackenzie Financial Corp. , maximum Canadian weightings in several portfolios are being reduced to 51% from 70%. “As a strategist, I believe Canadians should be seeking ways to diversify their portfolios out of Canada,” says chief investment officer Fred Sturm.

The Canadian manufacturing sector has been struggling for months, hurt by the high Canadian dollar and slowing U.S. growth. And now that oil prices have slipped, Alberta can no longer be expected to prop up the country’s gross domestic product. The Canadian economy grew at an annualized 1.7% pace in the third quarter, its weakest performance in three years. TD Bank Financial Group expects Alberta growth to be about 3%-4% in 2007, down from an estimated 6.8% in 2006.

The general outlook for 2007 is for continued slowing. “Unless commodity prices go right off a cliff, we’re probably looking at on-going growth — but at a lower rate again,” says Pynn. And that means slower earnings growth. “Maybe high single digits next year is a reasonable scenario,” says Nield.

The sectors to be overweighted in this environment are the natural defensives: financial services companies, because of their stable income; telecommunications and utilities, for their consistent yields; and consumer staples, because people have to keep buying them.

There are two risks to the outlook, however. One is a precipitous drop in commodity prices; the other is higher interest rates, should inflation rise. Neither is expected but, should either materialize, investors may find Canada even riskier and defensive sectors even more expensive.

Here’s a look at the key sectors of the Toronto Stock Exchange, other than resources and financials (see stories on pages B6 and B7).

> Consumer Staples. Shoppers Drug Mart Corp. is the poster child for this typically defensive sector. Managers roundly agree it’s a well-managed, dominant company that is maintaining earnings and dividend growth. “We can argue about valuation,” says Sturm, but notes that, in terms of being good at what you do, there are legitimate reasons to keep investing in Shoppers.

Compared with Shoppers, Alimentation Couche-Tard Inc.’s stock is relatively inexpensive. The company has potential in the U.S., where business is growing organically and there are acquisition opportunities. “I don’t need the economy to go up to make Couche-Tard work,” says Doug Stadelman, portfolio manager at Cypress Capital Management Ltd. in Vancouver.

He also suggests Montreal-based cheesemaker Saputo Inc., which has sales in South America and the U.S., for further earnings stability.

> Consumer Discretionary. This sector is loaded with companies that don’t really fit their billing, and some managers are overweighted in what would theoretically be a late cyclical sector to avoid. For example, Canadian Tire Corp. doesn’t depend as much as one might think on building supplies and will also continue to benefit from the better margins it gets from cheaper Chinese suppliers.

Several managers point to Gildan Activewear Inc., the low-cost T-shirt maker that, says Pynn, “keeps doing everything right.” He does, however, consider the stock pricey. He also notes that Tim Hortons Inc., whose relatively new U.S. operations will probably make a profit in 2007, isn’t likely to suffer much if the economy slows.

@page_break@> Technology. Fund managers tend to be at least at market weight in technology because the sector is a beneficiary of lower interest rates; some are overweighted. “From a tactical standpoint, we’re favourable to technology and telecommunications,” says Poulter. “The prices are still 40% below their peak in 2000.”

Celestica Inc., the electronics designer, is just emerging from an extended restructuring phase. “We’re starting to see some margin expansion while the revenue has been maintained,” says Poulter. “And the company has very little debt.”

Like other managers, Shaun Arnold, a quantitative portfolio manager and vice president of investments at London, Ont.-based Highstreet Asset Management Inc. , has a position in Research in Motion Inc. RIM delivered strong earnings growth last quarter from sales of its new “Pearl” handset and its outlook is strong. “That made it worthwhile for us to invest,” he says. He also points to software maker Cognos Inc. for earnings growth that is relatively cheap.

Stadelman likes MacDonald Dettwiler and Associates Ltd., which uses information technology for everything from evaluating property to managing mobile assets and workforces.

If you’re looking for other names to consider in this sector, Stadelman also favours Constellation Software Inc., a reasonably priced diversified software company.

> Telecommunications. Managers tend to be overweighted in telecommunications, with a preference for Telus Corp. and Rogers Communications Inc., which have greater wireless exposure than Manitoba Telecom Services Inc. and BCE Inc., which boast relatively lower wireless phone exposure.

“That’s where you’re getting the growth,” says Nield. “Cable is steady and visible, but it only grows with GDP.”

Poulter also suggests BCE for the value of its parts, should it ever be realized. “It’s in a good position to divest itself of some of the lines of businesses that it might not consider core,” he says.

> Industrials. This sector contains a number of contrarian picks. One is Magna International Inc., which, Poulter says, is a way to play the eventual recovery of the auto industry.

Another is Astral Media Inc.: for a media company vulnerable to lower ad budgets, it has good earnings visibility, says Nield. Astral’s specialty television assets continually gain subscribers and radio advertising is durable in Canada. “It has a great track record and balance sheet,” he says.

The railways, as well as SNC-Lavalin Group Inc., are coming off highs, says Poulter, noting that some of his firm’s portfolios contain no industrials at all.

That’s a common view, but not the only one. Pynn notes both Canadian Pacific Railway Ltd. and Canadian National Railway Co. are lean after years of restructuring, while Nield and Arnold see at least short-term earnings growth at both companies. “People have priced in an anticipated event that hasn’t actually come about,” says Arnold, referring to an economic slowdown. “As long as these firms continue to deliver, they’ll be attractive investments.”

Pynn also holds Finning Inter-national Inc., a supplier of equipment to the tar sands: “Finning is better managed as time goes on and seems to be turning around. And it’s a way to play resources but in a less cyclical way.”

> Real Estate. This sector has become expensive. That said, if you’re already invested, it is a good place to be, says Stadelman, citing Allied Properties and Northern Properties REIT among the handful of real estate holdings he has owned for some time. IE