Despite an economy that is still struggling, and a stubbornly high 9% unemployment rate, U.S. equities markets have been steadily gaining ground. Indeed, fund managers see further reasons for optimism in the face of significant headwinds.

“The economic cycle drives the profit cycle, which ultimately drives the market cycle,” says Mark Chaput, vice president with I.G. Investment Management Ltd. in Montreal and manager of Investors U.S. Dividend Growth Fund. “It doesn’t necessarily all happen at the same time. Some market cycles lag and get distorted by high inflation or market bubbles. But over time, the market will follow profits.”

There are always issues that dog the economy. “The ones that exist today are significant. But overall, the economic cycle is recovering,” says Chaput, adding that cash-rich companies are expected to invest more on capital equipment. “In historical terms, perhaps the recovery off the bottom has been a little slower. But if I look at the 1990 and 2000 recoveries, this one is similar. It’s also a jobless recovery.”

Yet, Chaput believes the employment cycle is improving because companies are pushing productivity to the limit and must start hiring people. “Once you get the employment recovery, that will support consumption, which is very important for the U.S. economy,” Chaput says. “The past 22 months have been stimulus-driven. But we’re getting to the point at which the economy is self-sustaining. That’s what the Federal Reserve [Board] is waiting to see. Then, it will start pulling back.”

Rising consumption and a strong capital expenditures cycle will accelerate U.S. gross domestic product growth into 2012, he adds: “Everything I see right now points to positive economic developments, which ultimately drive profit growth and the stock market.”

A bottom-up investor, Chaput seeks companies that have a history of dividend increases and growth in earnings and cash flow. From a sector standpoint, about 19.7% of the Investors fund’s assets under management are in industrials, followed by 17.6% in financials and 14% in consumer discretionary, with smaller weightings in sectors such as energy and consumer staples. The fund’s currency exposure is not hedged.

One top holding in the 40-name portfolio is Mattel Inc., the toy maker that owns well-known brands such as Fisher-Price. “It trades at 12 times forward earnings and has US$1 billion in cash on its balance sheet,” says Chaput, adding that the stock has a 3.5% dividend yield. “It has grown its dividend at about 15% compounded over five years. And it’s buying back its shares.”

The stock is trading at about US$26.80 ($25.20) a share. Cha-put has no stated target.

Another favourite is railway company Norfolk Southern Corp. “When you buy a U.S. railway,” says Chaput, “you get to benefit from attractive commodity themes, such as export metallurgical coal, while investing in a more conservative type of company. I like that combination.”

Norfolk Southern stock is trading at about US$73.20 ($70.60) a share, or 13 times forward earnings. It has a 2.2% dividend yield and is expected to generate 15% earnings per share growth over the medium term.

Equally Bullish Is Noah Blackstein, vice president with Toronto-based Goodman & Co. Investment Counsel Ltd. and manager of Dynamic Power American Growth Fund, which is available in a U.S.-dollar version and both unhedged and hedged Canadian-dollar versions. “There are a lot of opportunities and a lot of secular growth in certain sectors that the U.S. dominates,” says Blackstein, a bottom-up growth manager who is generally reluctant to make market calls.

Running a concentrated portfolio of about 25 names, Blackstein favours two sectors: infotech and consumer discretionary. Together, they account for about 80% of the Dynamic fund’s AUM.

“In the technology space, we’re undergoing a tectonic shift,” says Blackstein. “We’re at a point at which, as we move to greater mobility and away from PCs, we are changing technology architecturally. That’s very disruptive. It’s also a huge opportunity for companies that are positioned properly and can take advantage of it.”

There are more stock-specific issues in the consumer discretionary sector, he adds: “I am fairly bullish on the sector, but it’s more to do with the consumer who sits in China, not the U.S. Whether it’s luxury goods or gaming, the Chinese are changing the face of global consumption.”@page_break@One of the Dynamic fund’s top holdings is Starbucks Corp., the global retail purveyor of coffee. “There is an opportunity for management to improve margins — and they are doing that in the U.S.,” says Blackstein. “[Starbucks is] also continuing to grow internationally. That area holds a lot of promise. Starbucks’ stores in China are actually more profitable than the U.S. stores.”

But the real growth story is the US$50-billion global instant coffee market, which Starbucks has yet to tap, he adds: “[It is] now aggressively pursuing that opportunity. It can increase its revenue, and do so at the margins that are 50%-60% higher than the retail business.”

Acquired in Q1 of 2011, Star-bucks stock is trading at about US$36.25 ($34.90). “When we do the math, we think the potential earnings power of the company is significantly above that,” says Blackstein, who has no stated target.

Another favourite is Apple Inc. “The move to smartphones and tablets is still in the early stages,” says Blackstein. “Ninety per cent of [Apple’s] revenue will come from mobile computing. That’s the big opportunity.”

Although the mobile field is getting crowded, Apple still demonstrates a leadership role, adds Blackstein. Moreover, he points out that the stock is very cheap: “When you are talking about a stock trading at a single-digit multiple and 20%-plus growth and a pristine balance sheet, it’s still attractive.”

Apple stock is trading at US$348 ($335.60).

There Is No Doubt That the corporate sector has led the way out of the recession, says Jim Young, vice president with Toronto-based Invesco Trimark Ltd. and manager of Trimark U.S. Companies Fund, which is available in hedged and unhedged versions. “There is a gradual pickup in the U.S. This cycle will probably see the consumers come to life more mid-cycle. Normally, they lead us out [of recession]; this time, they haven’t. The good news is that in a couple of years, consumers will be in better shape. At that point, the housing market will also be looking a lot better.”

As excess housing inventory is absorbed and affordability continues because of low interest rates, the housing market will improve. “That activity, combined with more corporate activity, will lead to more job formation,” says Young. “The signs are positive, although the recovery is generally still modest. It’s not a booming economy by any means. But there are opportunities around the world.”

Admittedly, there are some risks on the horizon, and these are mainly political. “We need to address the deficit and decide where limited dollars will be spent on social programs,” says Young. “With the Republicans in control in the House [of Congress], we’re starting to approach these issues in a more adult fashion. Over the course of the next year, they have to make some progress — and there’s no reason they cannot.”

Technology, Young says, is one of the key equities market drivers. He points to the growing use of smartphones, as well as the proliferation of so-called “cloud computing” and retooling of the global energy infrastructure.

A “growth at a reasonable price” investor running a 42-name fund, Young has invested about 30% of the Trimark fund’s AUM in technology, 14% in health care, 14% in financials, 12% in industrials, 12% in consumer discretionary and smaller weightings in energy and materials.

One of the largest technology holdings is KLA-Tencor Corp., a leading process-equipment supplier to the semiconductor industry. “If you are going to continue to advance manufacturing,” says Young, “you need very sophisticated tools to ensure the process stays on track. KLA tends to be at the leading edge all the time.”

A long-term holding, KLA stock is trading at about US$45 ($43.40) a share, or 10.5 times forward earnings. Young has a 12-month target of around US$55 ($52.90).

One large holding in the consumer discretionary space is Phillips-Van Heusen Corp, a dominant player in the men’s shirt and tie business and owner of brands such as Calvin Klein and Tommy Hilfiger. PVH shares are trading at about US$69 ($66.40) apiece, or 13.8 times current earnings. Young has a 12-month target of about US$85 ($81.90). IE