U.S. stocks have been punished since this past fall, largely by the double whammy of the credit crunch, which ensued from the subprime mortgage fiasco, and worries of recession. Yet the worst appears to be over, and fund managers are more bullish on their prospects.

“We continue to be constructive on markets for the balance of 2008,” says Dave Picton, lead manager of Synergy American Fund, as well as the Assumption/CI Synergy American C Fund versions, offered by CI Investments Inc.

“The Federal Reserve [Board] is clearly on our side,” says the president and chief investment officer of Toronto-based Picton Mahoney Asset Management, “and doing what it takes to protect the system in the short run. When the U.S. central bank goes from tightening to easing, that tends to be constructive for equity markets. Second, valuations are attractive on several bases, especially in relation to interest rates.”

Picton says the so-called “Fed model,” which compares the price/earnings ratio of the S&P 500 composite index to 10-year U.S. government treasuries, indicates that stocks are cheap: “They would have to rise about 10%-15% from here to return to a more normal environment.”

Similarly, investor sentiment in April hit the “oversold” mark by several measures. For instance, bearish levels recorded by the American Association of Individual Investors were reminiscent of those at the 2002 market bottom.

“Markets need to climb a wall of worry,” says Picton, a growth manager who seeks firms with improving fundamentals. “There are some very real issues, such as the housing and subprime mortgage markets. But they are largely factored into the market.”

Meanwhile, companies have large pools of cash they could deploy into the equity market. “After a pretty significant sell-off,” he adds, “the odds favour some sort of rally.”

Picton, who works with portfolio managers Michael Kimmel and Tim Shiu, has been investing the Synergy fund’s cash, which stands at around 4% of fund assets under management vs 12% last fall. “We’re sticking to proven leadership names,” Picton says, “companies that have been able to make their numbers in spite of the economic environment. It has led us to areas such as health care and staples. As the economy is taking hold, we’ve been adding to our weightings in energy and technology, which are showing signs of fundamental change.”

On a sector basis, there is an overweighted 12% in consumer discretionary stocks (vs 8.5% in the S&P 500 index), 15.5% in industrials (vs 12%) and 9% in materials (vs 4%). There is a neutral 13% weighting in energy; and an underweighted 12% in financial services (vs 17%) and 8% in consumer staples (vs 10.5%).

One of the latest acquisitions in a 85-name Synergy fund is VeriSign Inc. The former dot-com high-flier has been reinventing itself and shedding unwanted assets. “It has the elements of positive change that we’re looking for,” says Shiu, noting that new management is cleaning house. “This could be a transition year that will set the stage for positive momentum in 2009.”

VeriSign is transforming itself into a pure-play Internet infrastructure company and concentrating on two areas: Internet domain registration and secure socket layer certificate technology used for e-commerce applications. “Once it completes its divestitures, it will have the highest operating margins of any large-cap high-tech company,” says Shiu. VeriSign stock was recently trading at US$36 a share; the Picton team’s 12-month target is the high US$40s.

Another favourite is Transocean Inc., the world’s largest builder of floating deepwater rigs. It is in a rapidly growing niche, says Shiu, pointing out that by 2010, 9% of the world’s crude oil is expected to originate in deepwater areas, vs 5% in 2004. “[Transocean] has tremendous visibility because it has a US$33-billion backlog of orders,” says Shiu. “Between now and 2010, everything is spoken for.” The stock was recently trading at US$157; the target is US$200 within 12 months.



Equally bullish is Tony Genua, manager of AGF American Growth Class and senior vice president with Toronto-based AGF Funds Inc. “These dark storm clouds are still on the horizon, and may stay there most of the year,” he says, referring to subprime mortgages and the slowing U.S. economy. “The consumer is being squeezed, not only because home prices have dropped and they feel less affluent, but also because gasoline has become quite expensive.”

@page_break@The dramatic rise in energy prices, as well as those for some food and staples, is putting pressure on consumers who feel insecure about the economy.

“The question is: will we still be in a challenging environment a year from now?” says Genua. “I believe we will trough at the end of this year and start to recover.”

Genua argues that lower interest rates, fiscal stimulus and strong overseas economies should lead to a better U.S. economy later in the year. “Given that the market anticipates this, and that the average lead time is about five months, investors should increase their exposure to U.S. equities,” he says. “They should look beyond the valley of these challenges and see a recovery on the other side.”

Investors are currently gun-shy, he says: “People still remember the bad experience of the tech bubble bursting.” Still, Genua expects investors to return to equities as rates of return improve.

“The damage has already occurred. There could be other price declines, as the economy could be challenging,” he says. “But inves-tors should use setbacks to position themselves for the recovery.”

A growth manager, Genua seeks to invest in leaders in the economic cycle. From a sector standpoint, he is emphasizing information technology, as it accounts for 20.6% of the AGF fund (vs 16% of the S&P 500 index), financial services, which represents 21.1% (vs 17%) and 14% in consumer staples (vs 10%). Energy and health care are underweighted at 9.5% and 6.5%, respectively.

One of the largest holdings in the 30-name fund is Charles Schwab Corp. Best known as a discount broker, the Nasdaq-listed firm derives most of its revenue from asset management and investor services delivered through a network of 5,000 advisors. “When people open an account, they also get banking services. And if they have chequing accounts, they start using Charles Schwab for other services, including buying securities,” says Genua, adding that the firm has US$1.4 trillion of AUM.

“It has repositioned itself to be less dependent on trading and focused on value-added services, such as advice,” he adds. “When it comes to innovation in the sector, there is no better company than Charles Schwab.”

Over the past five years, Charles Schwab’s earnings per share have had a 29% compounded growth rate; the stock was recently trading at US$21.85 a share. Although Genua believes there is considerable upside, he has no stated target.

Another favourite is Corning Inc. The specialty glass and ceramics maker is one of the world’s largest suppliers of glass for flat-panel TVs that use liquid crystal display technology. “In the past few years, people are replacing their cathode-ray tube TVs with flat-panel models, “ says Genua, “and buying large-format televisions. It’s been a very healthy business for Corning, and will continue to be a great industry because flat-panel TV adoption should be going up.”

Americans are expected to buy 29 million flat-panel TVs in 2008, vs 23 million units in 2007.

Corning’s stock recently traded at US$26 a share.



David Fingold, manager of Dynamic American Value Fund and vice president with Toronto-based Goodman & Co. Investment Counsel, is also becoming upbeat: “When we look at franchise-type companies with high market shares, high margins and high stability, they are cheap relative to the market. They also benefit from global economic growth. People are down about the U.S. economy. I don’t care. We love global growth and are positive about what’s going on in the world. The U.S. is the best place to access it.”

A value manager, Fingold has been defensive since the summer of 2007, when his earnings estimates for financial services stocks had to be downgraded. Fingold then exited the sector, with the exception of one stock, Berkshire Hathaway Inc.

“We moved from the subprime being a blip on the radar screen to a broader issue in capital markets,” he says. “Across the sector, volumes and margins were looking to be down.” He raised the level of cash in the Dynamic fund to about 32% over the winter, but that has since dropped to 28%.

Berkshire, a top holding in the 31-name fund, controls a number of reinsurance firms and has been able to enter the bond insurance business. “As long as bad things happen to Ambac Financial Group Inc. [which provides financial guaranty insurance] and [bond insurer] MBIA Inc.,” says Fingold, “that is a new line of business that could be quite profitable for [Berkshire].”

As Berkshire’s insurance operations are AAA-rated, the company stands to benefit from the weakness of insurance players such as Ambac, whose operations have been downgraded. “More people are being forced to buy some coverage from Berkshire,” Fingold says, “which means it can charge higher premiums than the rest of the industry.”

Berkshire’s Class A shares were recently US$123,400 each. Fingold has no stated target.

Another favourite in the Dynamic fund, which is dominated by energy, health care and consumer staples, is Procter & Gamble Co. The multinational producer of household- and personal-care products is trading at 1.2 times the market multiple of 14. “It’s at the low end of fair value,” says Fingold. The stock usually trades at a premium because of its high margins and cash flows.

“It’s very exposed to the global economy because of its exports. It also has the benefit of reporting in a weak currency,” he says. “We think the earnings estimates are too low, just based on what’s happened to the currency and that most of its products are non-discretionary.” IE