Small-cap stocks still look promising. Balance sheets are strong, interest rates are relatively low and trending lower, and earnings should show mid- to high single-digit returns in 2007, according to Martin Ferguson, a director at Mawer Investment Management Ltd. in Calgary and manager of Mawer New Canada Fund.

On the other hand, small-caps are no longer trading at a discount to large-caps. There may be downward pressure on small-cap share prices as we near the end of this economic cycle.

Small-cap managers are picking value in isolated pockets in the massive resources portion of this sector, as commodity prices swing and the income trust debacle unwinds.

Industrials are also favoured in today’s relatively low interest rate environment, an overweighted position for both Ferguson and Scott Carscallen, portfolio manager at Howson Tattersall Investment Counsel Ltd. in Toronto and a value stock-picker for Saxon Small Cap Fund.

Both favour Aecon Group Inc., the construction company; Canam Group Inc., a steel component supplier; and Russel Metals Inc.,
a steel services company — saying
all should do well in an environ-
ment in which the industrial and capital spending cycle has picked up. Carscallen also likes Magellan Aerospace Corp. and Vector Aerospace Corp., because defence spending continues to grow and commercial aerospace is recovering from a low ebb.

Some large-cap themes also apply to the small-cap sector —namely, overweighting financials, consumer staples, technology and telecommunications.

In technology and telecom, Roger Dent, vice president and associate portfolio manager at Toronto-based Mavrix Funds Ltd. and manager of Mavrix Small Companies Fund, likes Peer 1
Networks Enterprises Inc., a Vancouver-based Internet infrastructure services company; VendTek Systems Inc., which sells long-distance telephone cards; and Grey Island Systems International Inc., a maker of GPS-aided schedule management systems for buses and trains.

Sebastien Van Berkom, president of Montreal-based Van Berkom & Associates Inc. , owns small positions in each of the following technology companies as a hedge on the competitive digital broadcast industry: Evertz Technologies Ltd., Gennum Corp. and Miranda Technologies Inc.

Small-cap managers point to long-term demographics that will favour the health-care sector. Apart from the biotech companies, Dent’s largest position is in ORTHOsoft Inc., which uses technology for computer-assisted orthopedic surgery.

Van Berkom likes Winnipeg-based CanGene Corp., which manufactures bioterrorism vaccines and recently signed a contract with the U.S. government. He also likes Paladin Labs Inc., which specializes in urological drugs and has licensed the Plan B birth control pill.

Financials are also overweighted. Ferguson points to Home Capital Group Inc., Equitable Group Inc. and Grey Horse Capital Corp. as strong companies in their niches. Van Berkom has a long-time investment in Canadian Western Bank and also likes London, Ont.-based Pacific & Western Credit Corp.

The risk for small-caps is inflation. “If rates moved up because of inflation or a credit crunch, a correction would occur,” says Van Berkom.

— GAVIN ADAMSON