Canadian stocks continued their recovery in 2010, in the face of challenges such as sovereign debt crises in Greece and Ireland, and concerns about slowing gross domestic product growth in China. And although it is uncertain if similar challenges lie ahead, managers of Canadian-focused equity funds remain upbeat about the prospects for 2011.

“There are a lot of challenges globally, there is no question,” says Ian Hardacre, vice president with Toronto-based Invesco Trimark Ltd. and lead manager of Trimark Canadian Fund. “The global picture is not fabulous. The world is interconnected, as we proved in 2008 and 2009. There are potentially a lot of negatives. But I am reasonably optimistic you can make decent returns, although it will require excellent stock-picking.”

Equities could see high single-digit or low double-digits returns in 2011, he adds. “There are many high-quality companies trading at reasonably low multiples that pay decent dividends,” says Hardacre, who shares duties with Jason Whiting, vice president, and Alan Mannik, portfolio manager. “The world is going to grow, and demand will come from the emerging markets.”

Admittedly, valuations are higher than the market bottom in March 2009. “The opportunities are not like they were over a year ago,” says Hardacre. “Stocks of a more cyclical nature have rebounded faster. Still, valuations are not stretched.”

The Trimark fund invests in about 45 names; 70% of its assets under management are in Canadian stocks, 20% in U.S. stocks and the remaining 10% in countries such as Britain and France. There is a partial currency hedge on the U.S. exposure.

One of the top Canadian names is diversified conglomerate Brookfield Asset Management Inc. The Trimark fund took a position in Brookfield in 2008, when its share price took a hit because of market concerns about similar firms. “We look at companies on three measures: business, management and valuation. Brookfield has businesses with steady, long-life assets,” says Hardacre, referring to the company’s hydroelectric dams and office towers that should generate revenue well into the future. “We also like the management; [the firm] owns a lot of stock. It is a very complicated company to analyze and you need faith in management that it will do the right thing.”

Brookfield’s stock is trading at about $30 a share. Hardacre has no stated target, but he believes the price should be significantly higher within several years.

Another favourite is U.S.-based Zimmer Holdings Inc., one of the world’s largest makers of orthopedic implants. “The demographics are in [its] favour,” says Hardacre. “As people get older, their incomes go up and they need new hips and knees.”

Acquired about two years ago, Zimmer’s stock is currently down because of the weak U.S. economy, says Hardacre: “That’s why it’s trading at 12 times earnings.”

The stock is trading at about US$50 a share vs US$70 two years ago. However, Hardacre is confident that it will rebound as the U.S. economy improves and revenue grows in emerging markets.



equally bullish is eric Bushell, vice president and chief investment officer of Signature Global Advisors, a unit of Toronto-based CI Investments Inc. , and lead manager of CI Signature Select Canadian Fund: “There will be some bumps. But, broadly speaking, the recovery will continue. There are several reasons to be positive.”

First, Bushell argues, growth in developing economies appears to be stable and robust.

Second, the Republicans’ majority in the U.S. House of Representatives will “unlock some decision-making for investments,” says Bushell. “What has been bottled up for a number of years — and there’s been a focus on fixing balance sheets — will change, and corporations will begin to reinvest in 2011. The private sector will get back on its feet.”

Third, Bushell says, there is little attraction in the bond market: “For equities investors, this means there is not much to compete with.”

Meanwhile, valuations in the Canadian equities market are generally reasonable, although Bushell maintains that some income trusts and banks have become pricey.

“If things keep progressing,” he says, “we will see low double-digit returns in 2011.” However, he adds, these types of returns are more achievable in the U.S. “Bank valuations are so low. They are trading at from one to 1.5 times tangible equity [book value less goodwill]” whereas many Canadian banks are trading at three times tangible equity.

The CI fund contains more than 100 names; Bushell has invested about 48% of its AUM in foreign content, including 28% in the U.S. This is largely because of the lack of breadth in the Canadian market, says Bushell, who has about half the fund’s foreign-currency exposure hedged back into Canadian dollars.@page_break@One of the top names in the CI fund is Bank of America. The fund acquired the stock in mid-2009, following the stress tests of the U.S. banking sector. “It’s a transformed company with the Merrill Lynch [& Co. Inc.] acquisition,” says Bushell. “And the bank is one of the dominant players, with double-digit market shares in all the business lines in the U.S. It’s a waiting game as it recognizes the losses on its consumer-loan portfolios. It’s our view those [losses] were peaking in 2009, and its credit card and mortgage portfolios would improve through 2010. That is what has happened.”

Bushell adds that Bank of America could earn $2 a share in 2012. The stock is trading at about US$11. Bushell’s 12-month target is US$14-US$15.

On the domestic side, Bushell likes Canadian Pacific Ltd., whose shares he began to accumulate last summer. “It’s a catch-up story on efficiency to close the gap with Canadian National Railway Co., which has been a better run railway,” says Bushell, noting that CP has hired away some senior CN managers to improve operations.

At the same time, he anticipates further growth in commodities shipping and a greater share of the market as customers move away from trucking. “[CP] can grow [its] earnings at a reasonable level, and hold [its] valuation,” says Bushell, noting that the stock is trading at 14 times forward earnings. CP stock is trading at about $66.40; Bushell’s 12-month target is in the low $70s.



James Cole, Lead Manager
of Manulife Canadian Focused Fund, is reluctant to make a market call over the short term. But Cole, senior vice president with Burlington, Ont.-based Portland Investment Counsel Inc. in Calgary, believes equities’ returns will be much higher than those of cash over the next three to five years.

“Yes, sovereign default risk is a real concern [in 2011],” says Cole. “There will be a terrible price to be paid when this comes to a head. However, I don’t know when it will happen, or where.”

He believes that because governments cannot afford the current level of indebtedness, they will debase their own currencies or even default on bonds issued in other currencies: “The environment is very reminiscent of [that in] the 1970s.”

Yet Cole welcomes continued market volatility as a buying opportunity: “When markets go straight up, that’s a difficult environment [in which] to find new investment ideas. I’m much happier with the kind of markets we saw in 2010. We had strong markets in the first quarter, and then they plunged in the second. They soared in the third quarter, and it was more difficult in the fourth. But I like volatility. Bring it on.”

Like his peers, Cole believes equities are reasonably priced, although non-Canadian stocks tend to be cheaper than those at home, he says: “If you look at this year’s earnings, the S&P/TSX [composite] index is trading at 18 times earnings, while the S&P 500 [composite] index is at 14 times. That is a very big differential, and why it’s easier to find more attractively priced equities outside Canada.”

A value-oriented investor, Cole has created a concentrated portfolio of 14 names for the Manulife fund. On a weighted basis, about 48% of the fund’s AUM is in foreign content, most of which is composed of U.S.-based firms. There is partial currency hedge on the U.S. exposure, in proportion to each investee company’s exposure to U.S. earnings.

One top name in the Manulife fund is Archer-Daniels-Midland Co. A global leader in oilseed and grain processing, about 46% of its US$62 billion in annual sales are outside the U.S. The fund began acquiring ADM shares last May, when global markets swooned. The stock price had dropped to US$29, then rebounded to US$33, but slipped back to US$29 in early December. Says Cole: “The rally got a little ahead of itself. The most recent decline was a response to disappointing earnings.”

But ADM’s stock remains very attractive, he points out, noting that it trades at 9.5 times 2011 earnings and has a 2.1% dividend yield. Cole believes the stock could be trading at US$51.50 within three to five years.

Meanwhile, long-time holding Toronto-Dominion Bank remains a favourite position. “I consider it the best bank in Canada,” says Cole. “Look at who blew up in the 2008 financial crisis. [Canadian Imperial Bank of Commerce] had its usual litany of disastrous charges, and Bank of Montreal had its exposure to special-purpose investment vehicles, and so on. TD is one of the banks that did not [blow up]. Ed Clark, the CEO, has done an excellent job and instilled the bank’s low-risk culture.”

Now trading at about $75 a share, TD stock has more than doubled in price from its low of $35 in 2009. “The valuation is reasonable,” says Cole, noting that the stock trades at 11.5 times 2011 earnings. Based on strong fundamentals and continued earnings growth, he adds, the stock could be trading around $107 within three to five years. IE