U.S. equities markets have been on a roller-coaster ride, surging on positive domestic economic news, dipping on concerns about Greece’s fiscal crisis spreading to other European Union countries, then rallying when EU officials pulled off a complex rescue package. Through it all, equity fund managers have remained optimistic and maintain that the U.S. market still offers upside potential.

“The market has gone up by 70%, [from its lows in March 2009] although bull markets can go up anywhere from 75% to 150% through the full cycle,” says Ray Mawhinney, lead manager of RBC U.S. Equity Fund and senior vice president, U.S. and global equities, with RBC Asset Management Inc. in Toronto.

But the market was due for a mid-cycle correction — triggered either by rising interest rates or the risk of Greece defaulting on its sovereign debt — although this does not signal a proper bear market, he says: “These could affect the market on a short-term basis, but they won’t derail [the market rally] completely. We have gone a long way in a short time, but it’s not over.”

Still, Mawhinney expresses concerns that the recovery is on shaky ground, as the fiscal stimulus is about to run out. “We need to see the real economy become sustainable. That’s probably the biggest risk we see,” he says. “The key is [greater] confidence by corporations and continued improvement in consumer confidence. If there is any slippage, it could cause indigestion for stock markets. But we think there is further room to move upward.”

Mawhinney believes the U.S. market will remain in a broad trading range for some time and that the secular bear market that began in 2000 may continue to around 2018.

“We’ve seen this before,” he says. “It happened in the 1930s, and again from 1966-82. Markets may go up and down, but make no headway [overall]. In the interim, you can have some terrific bull markets and some difficult bear markets. There may be one or two [bear markets] left before we enter the secular bull. But we are more than halfway through [the current secular bear market], if not three-quarters.”

From a strategic viewpoint, Mawhinney and his five-person team tend to overweight attractive sectors in the benchmark S&P 500 index or, conversely, underweight those that lack attractive metrics. Currently, the team favours basic materials (10% of the RBC fund’s assets under management vs 3% in the index), industrials (14.1% vs 10.2%) and technology (19% vs 18.5%). The team has underweighted utilities (1.6% vs 3.4%) and consumer staples (7.6% vs 11%).

Although the RBC fund is aiming to capture the cyclical recovery, says Mawhinney, “There will be a point when we will have to make a shift away from cyclical sectors and back to more defensive names in health care, for instance. We’re not quite there yet.”

A growth-at-a-reasonable-price investor, Mawhinney runs a 100-name portfolio. A favourite holding is diesel engine maker Cummins Inc. “The company is a leader in its sector, and there is a recovery underway,” Mawhinney says, noting that the stock was added to the fund’s portfolio about a year ago. “There is also a product cycle of new engines in the trucking industry, so it’s an area we like.”

Cummins’ shares are trading at about US$72 each. Mawhinney believes there is 15%-20% upside in the next year.

On the basic materials side, Mawhinney likes Cliffs Natural Resources Inc. A major iron ore miner, it also has a coal division and stands to benefit from the economic rebound. “There is a global shortage of iron ore, and producers such as BHP Billiton Ltd. have gone to quarterly pricing,” says Mawhinney, adding that this move has resulted in iron ore prices rising in the past year to US$120 a tonne from US$50.

Cliffs’ stock is trading at roughly US$61 a share. Ma-whinney believes there is 15%-20% upside within about a year.



Although the past decade was extremely difficult, conditions could start to improve, argues Jim Young, manager of Trimark U.S. Companies Class fund and vice president of Toronto-based Invesco Trimark Ltd.

“The period between 2000 and 2008 was a case of stop and start. We had two wars, which made it difficult for equities to move ahead,” Young says. “Then, we had the final catharsis in 2008, and all the excesses got washed away. It was a great cleansing. That created an opportunity for those companies that were doing what they were supposed to do: build a business based on solid fundamentals.”

After the lost decade, Young argues that technology is the key to the market moving ahead: “In the last boom, 1999-2000, you had two drivers: Y2K and the emergence of the Internet. A lot of that stuff got washed away in the tech bust.”

Today, he says, there are five drivers in the technology sector: smartphones; Web 2.0 (more efficient distribution of Internet content such as movies); Windows 7 (which means PC infrastructure upgrades); so-called “cloud computing” (which turns computers into appliances and involves external data centres rather than hardware); and retooling the global energy infrastructure to utilize more natural gas and green electricity technology.

“There is more than 100 years of natural gas reserves in unconventional deposits,” Young says. “[The U.S.] has the solution to its energy problems, if it wants to embrace it. It has a domestic supply, and it’s cheap.”

Although the challenge is significant and will take decades to accomplish, Young maintains it is feasible: “We’re redoing the infrastructure in [the U.S.] and, ultimately, the world. The same way we rebuilt the telecommunications infrastructure, we will rebuild the electricity and appliance infrastructures.”

@page_break@Although tech stocks were overvalued in 1999-2000, the fundamentals are more solid and the valuations are more compelling now, he adds: “Herein lies the opportunity. The U.S. market is driven by valued-added activity, which is in turn driven by intellectual capital. We had a resources boom for the past 10 years, and it certainly benefited Canada. Now we have these drivers, and the U.S. will be much more interesting, based on that.”

Also a GARP investor, Young has invested about 40% of the 42-name Trimark fund’s AUM in technology companies, 13% in health care, 14% in financial services and smaller weightings in industrials, energy and consumer discretionary.

A favourite holding is Cisco Systems Inc. The maker of high-tech equipment, such as Internet routers, Cisco fits within two key thematic drivers: Web 2.0 and retooling the electricity infrastructure. “It keeps evolving the product line and can put more data through faster,” Young says, noting that the firm is increasing the capability to put through more high-definition video on the Internet.

“The Internet has to be retooled to accommodate that. It also applies to smartphones,” he adds. “Cisco is providing the fundamental underpinning that is necessary to allow this to occur.”

Cisco shares are trading at about US$26 each. A long-term investor, Young has a target of the mid-US$40s in about five years.

Another favourite is Wells Fargo & Co. The San Francisco-based financial services firm took advantage of the 2008 financial crisis when it acquired Charlotte, N.C.-based Wachovia Corp., for US$15 billion — and doubled in size. Says Young: “They are similar-sized companies and share a lot of ways in which they ran their businesses.”

Yet, before the takeover, Wachovia got into financial difficulty when it acquired Golden West Financial Corp., a mortgage firm that had some bad assets. “[Wachovia was] not in such bad shape as people thought. It’s a case of the good guys [Wells Fargo] gaining market share. That’s the thesis,” adds Young, who expects that Wells Fargo will able to expand its West Coast and southeastern U.S. businesses and earnings will bounce back in the next couple of years.

A long-term holding, the shares trade at about US$32.65. Young’s five-year target is US$60.

Value investor David Fingold, manager of Dynamic American Value Fund and vice president with Toronto-based Goodman & Co. Investment Counsel Ltd., focuses on the better stock-picking conditions available today.

“There are opportunities,” he says, “to build a concentrated portfolio of attractively valued companies that have growth prospects that are severely undervalued.”

Although Fingold was very cautious in 2008, he became bullish in the first half of 2009 and put the Dynamic fund’s 28% of AUM in cash to work. “We sold all the financials as the crisis was starting [in mid-2007] and re-entered the sector in the second quarter of 2009.”

Fingold adds that he then identified a number of attractive real estate players, such as Simon Properties Inc., that were trading at deep discounts.

Running a concentrated portfolio of 25 names, in which the top 10 account for 51% of the fund’s AUM, Fingold likes firms such as Apple Inc., which “was a high flyer in the bull market in 2007 and was driven down to US$80 [a share] in November 2008.” At about US$90 a share, its so-called free cash-flow yield was 11%, which is “extraordinary,” says Fingold. “We were very happy to get involved.”

Fingold has added to the Apple holding since. The cash-flow yield has declined to around 6%-7%, and the stock is trading at roughly US$255 a share, or around 18 times forward earnings. “The free cash-flow yield exceeds that of the market,” he says, “and the company continues to grow. It’s a cheap stock.”

Fingold has no stated target.

Another favourite is Schlum-berger Ltd. The major oil services firm has been under pressure because of its US$11 billion bid for Smith International Inc. “It’s the best-in-class global oil services company,” says Fingold. “It’s also very clear that, regardless where new oil is developed globally, the deposits are increasingly difficult to extract. The deep-water offshore area is one great example, so are the complex shale plays in the U.S. You need the best technology to discover and exploit energy resources. Schlumberger is the leader in the field and has one of the best track records of profitability and margins.”

Schlumberger stock is trading at about US$66.50 a share, about 21 times 2010 forward earnings. IE