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Despite woes, U.S. gaining investor favour

But it's a tough sell for those fixated on Canada's markets

MUTUAL FUNDS REPORTER

Rising consumer debt, a real estate bubble, a weakening currency, a growing trade deficit and an increasingly unpopular -- and costly-- war in the Middle East. Despite some grim economics, there's increasing sentiment that the U.S. equity market is a good investment.

"It's a good time to look at the U.S. market," said Dan Hallett, an independent mutual fund analyst based in Windsor, Ont. "U.S. stocks are generally cheaper than Canadian stocks, so there's relatively more opportunities there."

It's a tough sell with many investors who remain largely fixated on Canada's equity markets and are chasing past performance.

"The knee-jerk reaction of a lot of clients is they have seen that the Canadian funds have done so well that they are selling their global equities, their U.S. funds, to buy more Canada," said Mark Kent, president of Calgary's Portfolio Strategies Corp.

Canadians investing in the United States would have been hit with a double whammy in recent years: stale market returns and the impact of a rising Canadian dollar. The Standard & Poor's 500 composite index posted a meagre 2.4-per-cent annual return for the five years ended Feb. 28; when converted into Canadian currency, results for the same period plunge to a loss of 3.6 per cent annually. In contrast, the S&P/TSX composite index returned an average of 9.6 per cent annually during the same period.

The U.S. market's five years of choppy returns mean many stocks trade at a discount to Canadian equities, yet offer comparable earnings potential. The 273 equities comprising the S&P/TSX composite trade at an average price-to-earnings (PE) ratio of 20.28 and have an average dividend yield of 1.96. In comparison, the companies that make up the S&P 500 trade at a cheaper average PE of 17.75 and offer a competitive yield of 1.80.

Early evidence indicates a turnaround is under way. Year to date, the S&P 500 and the Dow Jones industrial average are both up about 2 per cent. The S&P/TSX composite, meanwhile, is up 4.5 per cent but short-term trading trends suggest the worm may have turned. The Dow is flirting with its February high of 11,137.2 points; the S&P TSX, meanwhile, has spent much of the week in negative territory and remains about 300 points off its February high of 1,2080.53.

"Valuations are exceptionally low and the opportunity remains high," said Noah Blackstein, manager of the Dynamic Power America Growth Fund, in a recent conference call with advisers. The $129.4-million fund has bested the returns of its rivals via a mix of top-performing technology, health care and consumer stocks.

"If you look at Canada, it's basically metals, mining and the banks that finance them. For long-term capital appreciation, you need to focus on other sectors, including health care and technology," Mr. Blackstein said.

Indeed, U.S. market conditions favour growth-style managers, said Phil Sanders, senior vice-president of Waddell & Reed Investment Management Co. of Overland Park, Kan. This month, Mackenzie Financial Corp. launched currency-hedged classes of two U.S. equity funds co-managed by Mr. Sanders, the Mackenzie Universal U.S. Growth Leaders Fund and the Mackenzie Universal U.S. Growth Leaders Capital Class Fund.

A maturing U.S. earnings cycle means companies that can maintain strong sales and profit growth will have a "much better opportunity to stand out from among their peers," Mr. Sanders said.

There's little industry agreement, however, when it comes to choosing the best means to invest in the United States. There's little consensus on the issues of passive or active fund management and currency hedging.

"If you are driving down the freeway and there is a brick wall in front of you, you don't go through it, you want to go around it. If a manager sees a sector is getting creamed and the sentiment is totally negative, an active manager can underweight," said active management advocate Mr. Kent.

But Mr. Hallett argues its "very tough" for the bulk of U.S. fund managers to beat their benchmark index, noting there's a wide range of funds and products available that offer broad or niche U.S. exposure. Similarly, the fund analyst believes that currency hedging will make little difference to long-term investors who have modest U.S. exposure.

A non-hedging policy "wiped out" the U.S. market's post-2000 returns, said Gavin Graham, chief investment officer at Guardian Group of Funds Ltd. The Toronto fund company favours multinational U.S. companies in the pharmaceutical and consumer products that are "naturally hedged against a weak U.S. dollar," Mr. Graham said.

Looking south

The U.S. market's five years of choppy returns mean many stocks trade at a discount to Canadian equities yet offer comparable earnings potential. Now may be a good time to buy U.S. funds.

Top U.S. equity funds ranked by 1-year return (as of Feb. 28, 2006)

1-year3-year5-yearNet Assets
Fund Name return %return %return % ('000)
Dynamic Power American Growth Class24.48%20.66%2.16%83,211
Mavrix Enterprise24.26%20.35%-12.59%1,088
Dynamic Power American Growth23.10%19.89%1.44%128,912
Clarington Navellier U.S. AllCap ($U.S.)20.94%27.05%3.02%n/a
Dynamic American Value ($U.S.)20.02%26.17%6.97%n/a
Fidelity Amer Discip Equity-B ($U.S.)17.02%19.76%n/an/a
Fidelity Amer Discip Equity-A ($U.S.)16.73%19.61%n/an/a
QSA Select U.S . Value 5015.61%n/an/a60,214
SEI U.S. MidCap Synthetic-O15.60%24.96%9.98%74,350
AGF American Growth Class ($U.S.)15.51%15.60%-2.60%n/a

Index returns (as of Feb. 28, 2006)

S&P 500 Composite Total Return S&P 500 Composite Total Return ($Cdn)
1-yr.8.38%0.16%
3-yr.17.11%7.11%
5-yr.2.36%-3.55%

SOURCE: GLOBEFUND.COM

© 2007 The Globe and Mail. All rights reserved.

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