Canadian equities markets have rebounded strongly following their 33% decline in 2008. And although fund managers see continued upside in 2010, they maintain that stock-picking will be the key factor.

One of the biggest hurdles is that stocks are fairly valued, says Pierre Bernard, manager of IA Clarington Canadian Leaders Fund and vice president, Canadian stocks, with Montreal-based IA Investment Management Ltd. “Markets will go up and down around current levels,” says Bernard, noting that the S&P/TSX composite index is at roughly 11600 points. “Markets are telling you they are pretty confident that earnings [will go] back up in 2010.”

The big question is whether 2010 earnings will be higher than those seen in 2008, when markets last peaked.

“I don’t think so. It’s a bit too soon,” says Bernard. “The [index] will be pretty volatile [in 2010] but will go up and down around that 11000 level. People will keep saying, ‘We’re not sure that we’re back on track and that consumers have fixed their balance sheets yet. And we’re not sure about the U.S. banking system. And what about the next direction for interest rates?’ People will be worried.”

Indeed, this to-and-fro aspect reminds Bernard of the markets’ sideways movement between 1987 and 1993. “It took almost six years before the index could surpass the peak achieved in 1987,” Bernard observes, noting that the index was around 4100 points in June 1987. “People were worried, and asked, ‘Where are we going? This capital market can’t last forever. There’s too much debt in the system.’ We hear the same kind of thing today.”

Bernard remains bullish, largely because equities are more attractive than other asset classes and because fiscal and monetary policy responses are supportive. A growth manager who is convinced that stock-picking will beat his benchmark — the index — Bernard is also looking to reduce risk. As a consequence, he favours blue-chip, large-cap stocks in two sectors that have the lowest correlation: banks and gold stocks. Gold companies make up 15% of the IA fund’s assets under management, vs a 12% weighting in the index; banks account for 22%, vs 20.3% in the benchmark. Other weightings include 18.9% in energy (27% in the index), 17.2% in industrials (5.5%) and 9.1% in information technology (3.4%).

As Bernard’s mandate is to invest in leading, higher-quality companies, the IA fund has large positions in only three banks: Royal Bank of Canada, Toronto-Dominion Bank and Bank of Nova Scotia. “These three have been the best, as far as quality of management and track record are concerned,” says Bernard, adding that institutions such as Bank of Montreal and Canadian Imperial Bank of Commerce do not meet the tests of market leadership or other fundamental criteria.

Similarly, the IA fund owns only Barrick Gold Inc., Agnico-Eagle Mines Ltd. and Goldcorp Inc. in the gold sector.

Bernard intends to keep the bank and gold stock weightings as long as present market conditions prevail.

Otherwise, Bernard is investing in economically sensitive stocks such as Bombardier Inc. This diversified transportation firm has suffered because of its weak aerospace division. Its shares are around $4.50 each. But Bernard takes a contrarian view and believes the markets are overly pessimistic: “Look at [its order] backlog, and how much margins have improved. The potential is amazing. On top of that, with all these governments putting more money into the economy, the easiest way is to put money into transportation — including trains.” Bernard calculates Bombardier’s rail business alone is worth $7 a share.

“If you believe that aerospace will be the tail that wags the dog,” he adds, “you can add another $3-$4 potential. In about five years, it could reach $10.” Bernard’s target is $7 a share by the end of 2010.



Some of the easy money has already been made, says Garey Aitken, manager of Bissett Canadian Equity Fund and chief investment officer of Calgary-based Bissett Investment Management Ltd. “But from this juncture, there are still reasons to be optimistic,” he says. “Overall, I am constructive.”

Aitken prefers not to make market forecasts or predict how individual stocks may perform in the short term. Rather, he looks at valuations. “We do this on a stock-by-stock basis,” he says. “Decent returns can be had. It will be comparable with the historical experience in Canadian equities markets — which is high single digits, including dividends. That’s the most likely scenario over the next several years. In the interim, could we overshoot or undershoot? I suppose. Volatility is a fact of life. There are a lot of unknowns.”

Aitken maintains that the extremely low valuations and mispricing that occurred last winter and culminated in March have been rectified. “But there are still opportunities to be had,” says Aitken, a bottom-up, growth-at-a-reasonable price investor who concentrates on the underlying businesses relative to their prices. “There is an array of outcomes in front of us. The more likely scenario falls into the historical returns we’ve seen over the long term.”

From a strategic viewpoint, Aitken runs a 40-name, predominantly large-cap portfolio. Almost two-thirds of the Bissett fund is invested in two sectors: an overweighted 37% of AUM in financial services and an underweighted 26% in energy. There is also about 6.5% in technology, 6.4% consumer discretionary and smaller weightings in areas such as telecommunications.

Aitken has long favoured financial services stocks because they offer many high-quality, consistent growth stories. “We have a lot of confidence that the growth profile will continue in the future. That’s what we’re focusing on: quality and growth.”

Yet, rather than focus on the banks that have had a significant rebound, Aitken is favouring the so-called “non-banks,” whose stocks have been under pressure. One example is Power Financial Corp., which is best known for its controlling stakes in Great-West Lifeco Inc. and IGM Financial Inc. “We really like [Power Financial] because it is very well positioned,” says Aitken. “It is a good example of owning solid franchises and profitable businesses with bright futures. And it’s attractively priced; the business is worth more than the current price.”

A long-term holding, Power Financial stock is $27.80 a share, compared with $24 a share in November 2008. Aitken attributes the stock’s tepid performance to the pessimism surrounding life insurers and concerns about equity and credit risks. But he is staying the course: “There is no getting around the fact there are some near-term challenges. But we are still very comfortable about the longer-term outlook.” He has no stated target for the stock.

On the energy side, Aitken likes Canadian Natural Resources Ltd. This diversified firm has “an exceptional management team with a proven ability to deliver shareholder value,” says Aitken, adding that the firm’s management has been able to take advantage of the inherent cyclicality of its business.

A long-term holding, the stock is $71.60 a share, compared with its low of $35.80 a share last March.



The recovery has been faster than anticipated, argues Doug Stadelman, co-manager of PH&N Canadian Equity Fund and co-head, Canadian equity research, at Vancouver-based RBC Phillips Hager & North Investment Counsel Inc. “We recovered a lot of ground in less than a year,” he says. “But it’s been typical, in terms of the magnitude of the move and the sectors that have performed well. Other than its speed, I’d call it a typical economic recovery.”

Stadelman maintains that the earnings of economically sensitive firms should continue to rebound into 2010-11. “We believe it’s a stock-selection kind of environment,” says Stadelman, adding that commodities prices, which drive the resources-heavy Canadian equities markets, are in a normal range. (See story on page 21.) “We’re not sure if the sectors will be taken up, so it’s more important to focus on stock selection.”

As Stadelman believes that the economy is in the process of a cyclical recovery, he is focusing on economically sensitive firms that can take advantage of the rebound. At the same time, he has an eye on valuations and is also focused on insurance firms that have not seen the kind of recovery common to most banks. “They still look undervalued, relative to their long-term profitability metrics,” says Stadelman, a GARP investor who shares duties with Dale Harrison, co-head, Canadian equity research, at PH&N.

There are risks on the horizon, Stadelman admits. One concern is the stability of the global recovery, which is driving commodities prices. If the recovery turns out to be less robust than anticipated, he says, “The optimism surrounding the recovery will fade and stock prices will check back. My view, though, is that we’re still in the process of recovery. It will only take longer than anticipated. It’s more a question of timing.”

With a 43-name portfolio, the PH&N fund has a large position in Manulife Financial Corp. The insurance firm’s stock has come under considerable pressure in the past year, in the face of efforts to raise capital to bolster its balance sheet.

“The short-term concern is how many reserves Manulife has to build to cover equity guarantees and how long it will take. From our point of view, Manulife is a very strong insurer, even by North American standards,” says Stadelman. “If you look past the short-term noise, at the profitability of the franchise, the stock looks very undervalued relative to its long-term earnings potential.”

A long-term holding, the stock is $18.70 a share. Stadelman, who has added to the position on weakness, has no stated target.

Turning to economically sensitive stocks, Stadelman likes the country’s top railways, Canadian National Railway Co. and Canadian Pacific Railway Ltd. “They should enjoy rising earnings in a recovery,” he says, noting that both firms depend on transporting automobiles and lumber, whose volumes have been weak but are expected to pick up as the economy gathers steam. As the recession deepened last winter, Stadelman increased the exposure to the two names. “We’ll probably continue to hold them as the economy improves.”

The CN weighting is larger than that of CP (3.4% of AUM, vs. 2.8%), but Stadelman maintains that CN has been a better managed firm, with higher returns on capital. “CN has more visibility, in terms of the earnings recovery,” he says, adding that the railways are also gaining market share at the expense of other transportation modes, such as trucking. CN is trading at $56.40 a share, compared with its low of $38 last March; CP is $52.10 a share, vs $32.40 in March. IE