U.S. equity markets appear to be gaining strength and are up about 7% year-to-date (in U.S. dollar terms), despite rising interest rates and the spectre of high oil prices dampening consumer spending. And managers seem confident that the bullish trend will continue as valuations are attractive and opportunities abound.

“The market was lacklustre last year, but earnings have come in like gangbusters and continue to do so,” says Rory North, lead manager of North Growth U.S. Equity Fund and chief operating officer at Vancouver-based North Growth Management Ltd. “The result is a multiple contraction that has been going on since 2001. The health of corporate America continues to grow, valuations improve and we are table-pounding bulls on U.S. growth stocks.”

North notes the benchmark S&P 500 Index is trading at about 18 times earnings, compared with about 20 times a year ago. “Earnings growth,” he adds, “is outpacing stock price moves and could go on for a number of years. Balance sheets have never been better and valuations are at decade lows.”

Although the US$ has come under attack, and eroded returns for Canadian investors, North is convinced the deterioration relative to the Canadian dollar has come to an end. Indeed, he argues that currency hedging is no longer necessary and it is time to look south for share price gains. “Canadians are sitting on an over-valued dollar. But they are completely ignoring U.S. equities. That’s a big mistake.” The fund is not hedged against currency fluctuations.

A GARP investor and fully invested, North has made a strategic shift in the past few years. “We’re at the polar opposite of where we were in 2001. Today, we own 70% large caps, in contrast with the heavy small- and mid-cap weighting we had. And the largest of the large caps is where we see the best value.”

Among the top holdings in a 40-name fund is General Electric Co. (other large positions include Wal-Mart Stores Inc., Bank of America and Microsoft Corp.). Although many small companies that compete against some of GE’s divisions once traded at a discount to the conglomerate, “the inverse is now true,” says North. “We’ve been selling some of these small caps in favour of the broader exposure on a global basis that we get through GE.” Bought in February 2006, at about US$33.20, the stock has a P/E multiple of 19 and a 3% dividend yield. North has no stated price target but aims to keep the stock indefinitely.

Another favourite is Cisco Systems Inc. A leading manufacturer of computer routers, it was a market favourite in 2000 and traded as high as US$80. North began buying in 2002 when the stock collapsed to US$8-US$10 and bought more late last year at US$17.50. “There was a time when we recognized Cisco as a fantastic company, but never thought we would own it because it was too expensive,” says North. Today, the P/E multiple has dropped dramatically to 18, from a high of 143, “and earnings have soared. It is an exceptionally strong company and at the early stages of a powerful product cycle.” Shares are trading at about US$21.30.

Equally bullish is Noah Blackstein, manager of Dynamic Power American Growth Fund and vice president at Toronto-based Goodman & Co. Investment Counsel. Yet he is unconcerned about macro-economic trends or interest rate changes. “I just focus on companies and try to find the 20 best growth stocks, which have the opportunity to be significantly larger companies three to five years from now,” he says.

“You could have argued that high oil prices would have affected consumer stocks that we happen to own, but thus far they haven’t,” he says, adding that the U.S. market is unmatched by others in areas such as information technology. “They are chugging along nicely. If oil prices and interest rates have an impact on our stocks, we will move on to something else. But using a top-down methodology is, in my opinion, futile.”

Fully invested, Black has allocated about 50% of the fund (which comes in a hedged and an unhedged version) to information technology stocks, 20% to consumer discretionary, 12% to healthcare, 5% to financial services and smaller holdings in sectors such as industrials. He has also reduced the number of holdings to 20, from about 40 that he held several years ago. “When you look at the elite growth stocks, there are only a small number that generate significant revenue and earnings growth. I am trying to pick the best of breed and, when I find them, I like to own a large position.”

@page_break@The fund’s top holding is Apple Computer Inc., maker of the Macintosh computer and the ubiquitous iPod. “I am a big believer in the secular change in the way we consume media,” says Blackstein. “It’s gone from a ‘push’ system where music DJs decide what you listen to, to a ‘pull’ system where you choose what you listen to. Apple has changed the model of how music distributed.”

Through the creation of the iPod and iTunes Web site for digital music downloads, Apple has generated significant revenue and earnings growth, says Blackstein, adding that the resurgence in Macintosh sales has also benefited the company. Bought in 2004 at about US$32, Apple now trades at about US$72. Blackstein is reluctant to disclose his share price target.

Google Inc., the Internet search engine, is another large holding. He bought the stock not long after its initial public offering in 2004 and paid US$103. Today, its share price is US$420. “Like Apple, it’s also a story about consumers ‘pulling’ information off the Internet. Google has a very powerful business model and is exceptionally profitable. Most people seem to miss how profitable it is,” says Blackstein, adding the company should earn US$9 a share this year and significantly more next year. “I think we are still in the early stages of the company’s growth phase.”

Another favourite is Zumiez Inc., a small-cap California-based retailer of snowboarding and surfing gear and accessories. “It really plays on the West Coast lifestyle. But when you walk into a Zumiez store you get the feel of an independent board shop — it’s not a sanitized version of the West Coast lifestyle,” says Blackstein, adding the 200-store chain could potentially grow to about 1,000 stores within several years. Bought at about US$13 in late 2004, it now trades at US$30.

Valuations have moved to fair levels, says Rory Flynn, a portfolio manager at Dublin-based AGF International Advisors Co. Ltd. , who oversees AGF U.S. Value Class Fund. “Earnings growth is just coming through, although people are wondering when the recovery will end.”

Earnings, observes Flynn, are in the mid-teens, which is above historic trends of about 7%-9%. “And, as long as you can see them above that trend level, you can justify a higher-than-fair multiple.

“We have had a Goldilocks environment recently, with earnings above trend and interest rates still at tolerable levels,” says Flynn. Although long-dated bond yields have been inching up in response to an uptick in inflation and the potential fallout from China revaluing its currency are negative factors, he remains on balance bullish.

“There is a trade-off happening, but from a top-down perspective the market is in good condition.”

A bottom-up, value investor, Flynn is focusing on a mix of about 45 mid- and large-cap stocks. Significantly, he shuns index weightings and has allocated about 47% to financial service names, 8.6% consumer discretionary, 7% telecommunications, 5% to industrials and lesser weightings to sectors such as energy. “We go where the values are.”

One of his favourites is Cleveland-based KeyCorp., which has grown through acquisitions, yet maintained a low profile. “It’s mostly a retail bank, focusing on credit cards and consumer loans,” says Flynn, noting the bank has a market cap of about US$12 billion. “It’s not a very exciting story, yet the organization has an obvious presence in its market. The combination of a solid consumer business and reasonable valuation is attractive.” The stock is trading at 13 times earnings and a 3.7% dividend yield. The shares are about US$37, compared with roughly $24 when it was acquired four years ago.

Another large holding is Merck & Co. Inc., a global leader in the pharmaceuticals sector. “One of the recent themes has been the huge rally in small and mid-caps, and some of them had acquired premiums to the larger names,” says Flynn. “People were upset with the way the health care and pharmaceuticals sector had behaved — and some of the valuations had been pushed to extremes. There has been a bit of recovery in them.” Merck had traded down to 16 times earnings and a 4.4% dividend yield, so Flynn grabbed the opportunity and added to the position he established about three years ago. Bought originally around US$50, the stock is $34 today, and Flynn is maintaining a long-term, optimistic view that it will turn.

“Merck is beginning to have a new product pipeline coming through, but people had been worried about patent issues and litigation over Vioxx,” says Flynn. Litigation has been a big headline grabber, although experience with tobacco companies shows actual settlements have been rare and more modest than expected.

“At the end of the day, Merck generates huge amounts of cash. It has the ability to pay.” he says. IE