Equities markets have rebounded sharply since early March, largely on hopes that the worst of the grim economic news is behind us and that the combination of fiscal stimuli and rock-bottom interest rates are starting to have a positive effect. Indeed, managers of U.S. equity funds are expressing cautious optimism that the rebound may be sustainable.

“Our view was that we were going through a very difficult period, and returns were negative. But when things were going to turn, they would turn very quickly — that certainly has been the case recently,” says Darrell Anderson, manager of Mawer U.S. Equity Fund and director with Calgary-based Mawer Investment Management Ltd. “We are starting to see signs that things are getting better. But I won’t say that we are off to the races. It’s going to take some time, and we’ll probably enter what I categorize as a stabilization period, as opposed to one of strong growth.”

Even if the stabilization phase takes several fiscal quarters, it will be a positive development, as the economy must purge the excesses of the past.

“Growth was fuelled to a large degree by leverage. We are going through an unwinding phase, which will take some time,” says Anderson. “We will very likely have a period with slower than normal growth, which is not bad. I’d rather see that, as opposed to peaks and valleys.”

Anderson observes that demand has been put on hold, with consumers delaying purchases and companies holding back on investments. “Inventories are running pretty low. There will be some inventory rebuilding, and that could be a shot in the arm in the near term,” he says. “We are getting close to that ‘pinch point’ [at which] we will see inventory restocking. But growth will be muted for a few quarters.”

Still, Anderson also expects that unemployment will creep a little higher, and high-profile bankruptcies will continue to occur: “We will see more headline risk. It will be challenging. But there are signs at the margin that things are settling down.”

Just as important, stock valuations appear to be reasonable, adds Anderson: “On average, our holdings are trading at a 25% discount to their fair value. Any time that we have a big move like this, the market is vulnerable to a pull-back. I’d regard that as an opportunity to add companies we like.”

A bottom-up, growth investor, Anderson focuses on companies that are noted for their high returns on capital and are what he describes as “wealth creators.” Lately, he has also acquired some new stocks. One example in the 31-name Mawer portfolio is Paychex Inc., a payroll services firm that focuses on the small and medium-sized business market.

“It provides a simple, basic service, but it’s a very highly added-value service for employers who don’t have the resources or expertise to handle payroll,” says Anderson.

The stock had dropped by about 30% when Anderson bought it recently, down from its 52-week high of US$37 a share in May 2008. “The more we looked, the more we liked it,” he says, noting that Paychex has about 600,000 customers. The stock is trading at about US$27 a share and pays a 4.5% dividend. Anderson has no stated target.

Another favourite is Western Union Co. A global leader in the money-transfer industry, the firm boasts a network of 365,000 agents in 200 countries.

“It is the best at what it does,” says Anderson, adding that Western Union has a 16% market share and boasts a 30% return on capital. “When you think about competitive advantage, it is very difficult to achieve this so-called ‘network effect.’ People know they can send money almost anywhere in the world because there are agents almost everywhere,” he adds, noting that he has added to the holding on its share price’s weakness.

The stock is trading around US$17.60 a share, compared with its 52-week high of US$28.60 last August.



Equally optimistic is Phil Sanders, co-manager of Mackenzie Uni-versal U.S. Growth Leaders Fund and senior vice president at Waddell & Reed Investment Management Co. in Overland Park, Kansas.

“It appears that the crisis phase of the economic meltdown is over,” says Sanders. “The market is responding in a meaningful way to signs of stabilization. The message we hear from management teams is that they are also a little more optimistic these days. Most of them describe it as: ‘Things are less bad than they were.’ But it’s too early to make a call that the economy is in a recovery phase.”

@page_break@Sanders also points out that consumer confidence levels are starting to climb again, after plummeting last fall. “They are still at depressed levels, but have recently moved up a notch,” says Sanders, who shares fund-management duties with Daniel Becker, another senior vice president at Waddell & Reed. “Investor expectations have also been ratcheted down so low that when companies report earnings, they are being greeted in a positive way.”

Sanders, who takes a longer-term view, believes that the market and economy should be in better shape in about a year. “Whether the market overshoots in the near term — that is entirely possible. Initially, it is responding to the fact that the worst-case scenario has not happened, not necessarily that there is a recovery underway. There are reasons to be optimistic if you look out 12 to 18 months.”

Bottom-up investors, Sanders and Becker focus on large-cap, growth companies that have dominant franchises and competitive advantages. They run a low-turnover, concentrated portfolio with about 45 names. (The top 25 account for about 80% of the fund.) Currently, the Mackenzie fund has about 31% of its assets under management in technology stocks, a neutral weighting based on the benchmark Russell 1000 growth index; a neutral 13% in consumer staples; a slightly overweighted 13.5% in health-care stocks; and an overweighted 13% in consumer discretionary issues; with smaller weightings in sectors such as financials.

One top holding is Gilead Sciences Inc. The biotechnology firm is the dominant provider of medication for HIV/AIDS patients and generates most of its revenue from its patented therapy, Atripla. “It gets about 80% of the new prescriptions,” says Sanders, noting that the HIV/AIDS market is growing at about 6% a year. “Its medication receives strong endorsement from the health-care community, and Atripla is considered the drug of choice,” he says, adding that Gilead has visible growth prospects because Atripla’s patent expires in 2017.

The stock is trading around US$44 a share, compared with its 52-week high of US$57 last August. Sanders, who has no stated target, has added to the holding.

Another top name is Monsanto Co. The global seedmaker has gained market share at the expense of competitors, says Sanders, because its corn, soybean and vegetable seeds allow farmers to improve their yields. “Its seeds are more resistant to pests, weeds and drought. It can charge a premium, which the farmers are willing to pay because the yield advantage more than makes up for the extra cost,” says Sanders, adding that the firm has enjoyed 20%-plus earnings per share growth for several years.

The stock is trading at US$86 a share, compared with its 52-week high of US$146 last June. “It got ahead of itself last year,” says Sanders, “when global economies were strong and there was all this talk of corn as a fuel.”



Tony Genua, manager of AGF American Growth Class and senior vice president at Toronto-based AGF Funds Inc., echoes the view that the current rally is based on the market’s belief that the worst of the economic decline is past.

“The U.S. has avoided a precipitous spiral downward, which was the main risk that existed early this year and why the market made its low in early March,” he says. “But now we have less systemic risk. It’s not zero, because the stress tests [conducted in May to measure the health of 19 leading U.S. banks] were done in a bad economic climate, but not the worst that one could imagine.”

Genua believes that corporate earnings expectations are bottoming out for 2009 and 2010. “We may still have some downward revisions,” he says, noting that two-thirds of the companies in the S&P 500 composite index have surpassed expectations. “Valuations are reasonable. On current estimates on 2009, stocks are at 15.8 times earnings. But we are in a ‘trough’ year, and that multiple could come down to around 12 to 13 times earnings.”

Moreover, he says, stocks should do well because liquidity is ample, given that there is about US$3.9 trillion in money market funds and cash sitting on the sidelines.

A bottom-up, growth investor, Genua looks for companies that are innovators and benefit from growth in their niches. Currently, he is favouring stocks in the technology sector, as they account for 28% of the AGF fund’s AUM, compared with 17% in the S&P 500. He also likes consumer discretionary stocks, at 12% of AUM (vs 9.2% in the index) and financials, at 17.9% (13.9%); but he is underweighting health care, at 7.8% (13.7%).

One long-time technology holding in the 30-name AGF fund is Apple Inc. The maker of iPods and iPhones “continues to show innovations and we are likely to see more product launches, including a lower-priced version of the iPhone. This would be consistent with what Apple did with the iPod,” says Genua, noting how the firm garnered market share by making lower-priced versions.

Moreover, he expects that Apple will inevitably push the iPhone in China, the largest handset market in the world. Apple’s shares trade around US$124.50 a share, compared with US$192.25 last May 2008. Genua has no stated target.

Another favourite in the consumer discretionary sector is Amazon.com., the dominant online book and music retailer. “It will continue to benefit from increased sales from e-commerce,” says Genua, noting that online sales account for 3% of total retail sales in the U.S. “Online continues to gain share as a percentage of retail sales.”

Genua believes that Amazon will expand its revenue through the recent introduction of the wireless reader known as Kindle DX, which costs US$489 and can store up to 3,500 books. A more modest version, Kindle Reader, costs US$359 and stores 1,500 books.

“Five universities have trials whereby students could bypass buying textbooks, which are expensive,” says Genua, adding that the DX’s 24.6-centimetre screen makes it easy to read books as well as newspapers. “People are underestimating the potential of this product.”

The stock trades around US$76.80 a share, compared with its 52-week high US$91.75 last August. IE