Canadian markets chalked up another good year in 2006, despite an interest rate scare and Ottawa’s decision to remove tax advantages on income trusts. Yet managers of Canadian equity funds remain bullish, based on demand from the fast-growing developing markets of Asia. Indeed, they expect 2007 to deliver another double-digit performance.

“I’m bullish on Canada,” says Matthew Baillie, manager of Sceptre Canadian Equity Fund and managing director of Toronto-based Sceptre Investment Counsel Ltd. “We’re nicely positioned to profit from growth in Asia, which has been driving the global economy for five years, rather than the U.S., which is clearly slowing down.”

Canada will be hurt by the slowdown south of the border, he adds, but commodity prices are largely determined by Asian growth: “Our markets are a great play on Asian growth. Asia’s labour glut keeps our inflation low and helps our interest-sensitive stocks.”

The U.S. slowdown, which could turn into a recession, is a worry, he admits: “There are issues in the housing market. It depends on how deep the slowdown is. Clearly, that will also affect our dollar.”

But our weakened currency may still outperform the greenback.

On a positive note, there are no interest rate and inflation worries. “If anything, there would be a rate cut some time next year in Canada,” Baillie says, adding that in 2007 the market could provide low double-digit returns.

A “growth at a reasonable price” manager who blends top-down and bottom-up styles, Baillie runs a 45-name fund. As a rule, he looks for companies that are leveraged to growth in Asia or Western Canada, or that are active in niche growth markets such as telecommunications. He also strives to pick companies that are showing higher growth than the market, and trading below the market’s price-to-earnings multiple.

One representative top holding is Canadian National Railway Co. Since it went public a decade ago, says Baillie, “It has had superior performance and the top margins in the rail industry. It’s a nice play on Western Canada and global growth rather than U.S. growth.”

The firm is well exposed to global trade and the commodity story and, he adds, “has opportunities in Prince Rupert, B.C., where it’s building a port that could be a major gateway to China. And it has the best rail management in North America.”

Baillie notes CNR boasts a 19% return on equity. Bought over a five-year period at an average cost of $42 a share, the stock recently traded at $53.40, or 14 times 2007 earnings. “The P/E ratio is in line with the market, but it has faster growth. It’s a premium company,” he says.

The stock could rise about 15%-20% over the next 12 to 18 months.



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espite a slowdown in North America, other regions are still robust, says John Smolinski, lead manager of TD Canadian Equity Fund and managing director of Toronto-based TD Asset Management Inc.

“Yes, we are seeing a softening in the North American economy. And that makes us cautious,” he says. “But there is good strength in developing countries. When you put the whole picture together, 2007 will be a solid year for global economic growth.”

Smolinski expects markets to deliver 8%-10% total return in the coming year, including a 2%-2.5% dividend. “Our strategy is hopefully to do better than that,” he says. “We see lots of companies that can grow their earnings 10%-plus. So long as the P/E multiple doesn’t change, we can get performance that matches earnings growth for those companies.”

Although resources plays have been a key beneficiary of economic growth overseas, Smolinski is moderately cautious about exposure to that sector. In aggregate, the energy and base metals sectors account for about 41% of the fund, compared with 44% of the benchmark S&P/TSX composite index. There is 28.9% in financial services, vs 31.4% in the index.

Using a blend of top-down and bottom-up investment styles, Smolinksi is running a fairly concentrated fund, with the top 15 names accounting for almost 75% of the portfolio. Roughly speaking, the portfolio is broken into three “buckets” — dividend-paying stocks with the ability to increase their dividends, high-quality commodity plays and well-managed growth companies.

“The Canadian banks have 3% dividend yields. But, historically, they have grown their dividends by more than 10% a year,” he says. “The valuations are less than the overall market, as far as P/Es are concerned.”

@page_break@A top holding in the first bucket is Royal Bank of Canada, which boasts “one of the strongest retail franchises in the country,” Smolinski says. “It provides growth, high return on equity, stability and generates tons of excess capital.”

The bank has also increased its dividend fivefold since 1995. “You start with a 3% base, but in five to 10 years, there is a good chance that dividend will be lot higher. That’s one way to build wealth in good-quality franchises that have growth opportunities yet provide stability,” he says. A long-time holding, the stock was recently trading at $53.75 a share, or 13.5 times 2007 earnings. Based on Smolinski’s estimate of forward earnings, his 12-month target is about $60 a share.

The second bucket comprises natural resources players leveraged to rapidly growing countries such as China, India, Korea and Brazil. Typical of this is Teck-Cominco Ltd., a diversified base metals producer of copper, zinc and metallurgical coal. “The valuation is attractive,” says Smolinski, adding Teck recently traded at $86.50 a share, or about seven times 2007 earnings. The low valuation is attributable to market concerns that high commodity prices may not hold up at present levels, he says. But, based on continued high commodity prices and low zinc inventories, he says, the stock could be worth more than $100 a share in a year.

The third bucket consists of North American firms that can generate 10%-15% earnings growth a share even if North American economies slow. Shoppers Drug Mart Corp. is a holding in this bucket, as it still growing at about 10%-plus and has yet to penetrate markets in Quebec and Western Canada.



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qually bullish is Hugh Mc-Cauley, lead manager of Acuity Pooled Pure Canadian Equity Fund and managing director of Toronto-based Acuity Investment Management Inc. “We have a positive outlook for 2007. We see a mid-cycle slowdown in the U.S. but don’t see a recession,” he says.

He anticipates an “average” year for markets in 2007 and says returns could be in the vicinity of 10%-12%.

His confidence is based on the belief that inflation is under control, unemployment is at low levels, corporate balance sheets are in good shape and interest rates in the U.S. may trend downward. “All we see is a mid-cycle slowdown,” he reiterates, noting Canada, which is reliant on U.S. trade, will probably see a similar slowdown.

A GARP investor who heads a team of four other stock-pickers (including Warren Fenton and Martin Grosskopf), McCauley is focusing for the most part on large-cap stocks such as Royal Bank, Suncor Energy Inc. and CIBC. But he also has about 20%-25% of the fund in small- and mid-cap names, including Sierra Wireless Inc.

One large-cap holding in the 50-name fund is Nexen Inc. A global oil and gas player, it is active in Canada, the North Sea, Yemen and Gulf of Mexico. McCauley is particularly enthusiastic about the firm’s Buzzard oilfield in the North Sea, which will increase daily production to 300,000 barrels in 2007 from 220,000. Bought about two years ago at around $25 a share, Nexen stock recently traded at $62 a share. Although McCauley has no stated target, he notes Nexen could be trading at a higher multiple than its recent four times cash flow. If it returns to its historical multiple of six times, it could be worth significantly more.

Another favourite is Guyana Goldfields Inc., a junior gold explorer developing several sites in Guyana, including the Rory’s Knoll project. The firm has established it could produce four million to five million ounces of gold within two or three years. But, McCauley notes, recent findings indicate there could be reserves of as much as seven million or eight million ounces. Bought at the start of 2006 at $4 a share, the stock recently traded at $10.60. “It has significant upside,” McCauley says. It could be worth $14 a share if reserves are as large as exploration indicates. IE