Canadian equity fund managers are not predicting economic growth until later in the year, but they are already shifting assets into domestic growth stocks that will perform better when the economy does turn around.
Case in point: Michelle Horne, president of Bissett Investment Management<\/b> in Calgary, a division of Toronto-based Franklin Templeton Investments Corp., <\/b> says the slow shift toward equities has already started. As the manager of Bissett Canadian Balanced Fund, she has moved 2% more of the fund\u2019s assets under management into equities from fixed-income.
Horne has been cherry-picking, using Bissett\u2019s familiar \u201cgrowth at a reasonable price\u201d style. That has led the fund into more economically sensitive sectors, including the financial services and resources sectors.
\u201cYou\u2019re looking not merely at the defensives,\u201d concurs Gavin Graham, director of investments with BMO Asset Management Inc. <\/b>in Toronto. \u201cYou are looking at things that are likely to be beneficiaries of a more optimistic outlook on the world economy.\u201d
Even Richard Nield, a portfolio manager with Invesco AIM<\/b> in Austin, Tex., is looking at growth sectors, even though he isn\u2019t expecting the recovery to start until 2010.
But there is by no means unanimity about the timing of the impending recovery. Christine Hughes, senior vice president with AGF Funds Inc. <\/b>in Toronto and lead manager of AGF Canadian Balanced Fund, says the deleveraging isn\u2019t over yet and the global economy is in for a deeper, sustained recession than most fear.
And even if the economy does pick up sooner than Hughes expects, she believes there\u2019s a good chance it could be in lockstep with double-digit inflation. So, she recommends resources assets, such as gold, as the best way for clients to insulate themselves.
\u201cI\u2019d rather be wrong,\u201d she adds, \u201cbecause the way I see it, it\u2019s not going to be pretty in 2009.\u201d
Inflation could pick up, other money managers agree, but they don\u2019t expect double-digit rates. \u201cIt\u2019s not a high probability,\u201d Horne says. \u201cBut it\u2019s something we\u2019re keeping an eye on.\u201d
Another major downside risk is the raising of protectionist trade barriers by global economies such as the U.S., China and India that would produce a deep, sustained worldwide depression. If that happens, a rotation back into the economically defensive stocks will prevail, although, Graham says, this wouldn\u2019t help much.
Then, there\u2019s the Canadian dollar. Some increase in the loonie\u2019s value relative to the U.S. dollar is expected. This partly reflects the ultra-low interest rates in the U.S., which, combined with high US$ supply, will drag the greenback down. (See story on page B4.)
Another factor affecting an increase in the C$ will be the expectations of rising commodities prices in anticipation of a global recovery. Shauna Sexsmith, senior portfolio manager with MFC Global Investment Management, a subsidiary of Manulife Financial Corp. <\/b>in Toronto, says the long-term secular growth story for urban expansion in China and India still applies. That bodes well for Canada, whose industries can supply materials. (See story, page B14.)
Most forecasts are for the C$ to be in the US80\u00a2-US87\u00a2 range by the end of 2009, moving somewhat higher in 2010. That should be manageable for Canadian companies. But if the C$ goes back above par with the US$, the impact on Canadian exporters or firms that compete against imports could be very negative.
But assuming none of these risks emerge, the stage is set for the economy and stock markets to rally. The question is when.
Nield believes that a key indicator will be when the majority of companies start meeting or only narrowly missing analysts\u2019 earnings estimates. For that to happen, sell-side analysts need to revise to their earnings expectations downward. He expects this to happen in the first and second quarters of 2009 \u2014 as was the case in the previous bear market of 2002-03.
Hughes says investors would do well to watch bonds for cues on whether the market is about to rally. The key indicator will be when the yield on a two-year U.S. Treasury bond starts to rise again and when the spread drops between high-yield corporate bonds and U.S. Treasuries. (See page B18.) Corporate bonds usually trade with an average yield premium of about 400 basis points over government bonds, but they are at a much higher premium right now. \u201cWhen that normalizes,\u201d Hughes says, \u201cequities are ready to rise again.\u201d
@page_break@Here\u2019s a closer look at the companies that money managers like in the various sectors \u2014 excluding energy and materials, and financial services, which are covered in other stories in this report. (See pages B14 and B9, respectively.)
> Industrials. <\/b>Money managers are tending to overweight this sector, mostly with holdings in the two big railway companies, Calgary-based Canadian Pacific Railway Ltd. <\/b>and Montreal-based Canadian National Railway Co. <\/b> CN is particularly well run; it turned in a decent fourth quarter and, says Horne, it\u2019s a logical pick for an economic turnaround.
As for CP, Graham adds: \u201cCP is down in line with the index, and that\u2019s because it\u2019s seen as being a Western Canadian commodities-based play. But if you think commodities are likely to recover somewhat, and if people get over their panic about Chinese growth slowing to zero, which is not going to happen, then CP is a good story.\u201d
Sexsmith likes Montreal-based Bombardier Inc., <\/b>noting that it just won a contract to build subway trains for Deutsche Bahn AG, Germany\u2019s national railway company. Looking ahead, Bombardier will benefit as jet orders turn upward along with economic growth.
SNC-Lavalin Group Inc., <\/b> also of Montreal, is another of Sexsmith\u2019s picks. She describes it as the \u201cultimate\u201d infrastructure play. Infrastructure spending features large in the fiscal stimulus packages that governments around the world are putting in place.
> Consumer Discretionary. <\/b>Many money managers are also overweighting this sector, although it isn\u2019t considered a strong growth sector in Canada. The sector is loaded with companies such as Toronto-based Canadian Tire Corp. Ltd., <\/b> which, Graham says, isn\u2019t a top-end shopping destination.
That said, Graham does like Canadian Tire, noting: \u201cIt is a relative outperformer today, with a 12% earnings forecast for this coming year. It\u2019s been running efficiently.\u201d
The same logic applies to Mon-treal-based Gildan Activewear Inc. <\/b>, the shirt and sports apparelmaker whose stock was hit hard after it missed its earnings\u2019 target in the fourth quarter, due in part to bad cotton price hedging. In December, Gildan had been trading at a 40% discount to its 2008 high. \u201cIt has good market share,\u201d Horne says. \u201cIt\u2019s a low-cost producer and it\u2019s almost debt-free.\u201d
Montreal-based Astral Media Inc., Calgary-based Shaw Com-munications Inc. <\/b>and Toronto-based Corus Entertainment Inc. <\/b>are cable- and specialty-TV companies that provide some defensive insulation with potential for upside once advertising spending returns \u2014 particularly from the automobile sector as it emerges from restructuring, several money managers note.
> Consumer Staples. <\/b>Nield says Toronto-based Invesco Trimark Ltd.\u2019 <\/b>s Canadian fund managers tend to stay overweighted in this small sector regardless of the business cycle because of a couple of the names in the sector. For instance, Toronto-based Shoppers Drug Mart Corp. <\/b>is cheaply valued today, considering its steady earnings growth performance.
Sexsmith agrees about Shoppers, but warns that grocers Loblaw Cos. Ltd. <\/b>of Brampton, Ont., and Montreal-based Metro Inc. <\/b>are overvalued because they\u2019ve been in favour.
Graham still likes Laval, Que.-based Alimentation Couche-Tard Inc. <\/b>because of the better margins on gasoline in the U.S.
> Information Technology. <\/b>Managers who are overweighting this sector believe that the economy will turn around soon. However, managers are split on the outlook for the sector\u2019s behemoth, Waterloo, Ont.-based Research in Motion Inc. <\/b>
Some say RIM\u2019s earnings outlook for 2009 is obscure and margins are lower as it jumps into the consumer 3G smartphone market against some tough competitors, including Cupertino, Calif.-based Apple Inc. <\/b>
Others note that RIM is trading at less than half its price of a year ago and that the smartphone industry is still relatively new.
Nield likes Montreal-based CGI Group Inc., <\/b> the IT consultancy and business-process outsourcing firm, because a large percentage of its revenue is from governments that have promised to spend and also because it has upside in the event of a turnaround when corporate IT budgets rise again.
> Telecommunication Services. <\/b>Toronto-based Rogers Communications Inc., <\/b> like the aforementioned cable companies, has been a defensive play in the past six months, And its growth outlook is also strong as it is the only distributor in Canada for Apple\u2019s popular iPhone. Moreover, Rogers\u2019 monthly 3G network service fees have held up in today\u2019s environment and will presumably pick up as employment starts to grow later in the year or in 2010.
\u201cIt [has] been a very steady earner,\u201d says Sexsmith, \u201cgenerating some [positive] earning surprises.\u201d
> Utilities. <\/b>Managers say this is a defensive sector that has probably run its course.
> Real Estate. <\/b>The glut of commercial real estate supply leaves money managers uninterested in this subsector for 2009.\tIE<\/b>
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