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With TSX Shaky, Canadian Fund Managers Play Defense

With China's massive economy slowing and fresh signs of trouble in Europe, many Canadian fund managers are now favoring defensive stocks over growth-driven sectors such as mining and energy.

TORONTO -- With China's massive economy slowing and fresh signs of trouble in Europe, many Canadian fund managers are now favoring defensive stocks over growth-driven sectors such as mining and energy.

So-called safe-haven sectors of the Toronto Stock Exchange's benchmark index such as the small health care and consumer staples groups are among the best performers so far in 2012. Investors say the stable earnings they offer during times of turbulence make them hard to resist.

"You don't have the strong economic growth or inflation that would underpin a big move in the materials (sector), and you're not going to have (the level of) growth offshore in China that would also tend to underpin a big move in commodity prices," said Robert Gorman, chief portfolio strategist at TD Waterhouse.

"It's going to be the companies with steady, modest growth in sales, earnings, cash flow, dividends that are, at the end of the day, going to have your highest total return."

Gorman pointed to blue chip stocks such as Royal Bank of Canada, the country's biggest lender, Power Corp , Shoppers Drug Mart Corp and dominant coffee-and-doughnuts chain Tim Hortons Inc.

The TSX's S&P/TSX composite index has struggled to make gains in 2012 and has lagged the Standard & Poor's 500 Index significantly for a second straight year.

The hefty weighting of resources on the composite is squarely to blame. The materials and energy groups, which together make up nearly half of the index, are the worst performing sectors this year. Both have been hurt by the impact of global growth fears on commodity prices.

In this environment, Jennifer Dowty, a portfolio manager at Manulife Asset Management, said she expects the so-called safer sectors to outperform, though she favors a strategy that includes a mix of defensive and cyclical stocks.

In the health care group, she said stocks such as Medical Facilities Corp should fare well due to expectations of modest growth, strong free cash flow generation, an attractive yield and stable operations.

But she also likes some cyclical names including Caterpillar equipment dealer Finning International Inc. As well, she thinks specialty channel and radio station owner Corus Entertainment Inc, a consumer discretionary play, offers modest growth with limited downside risk.

"I would favor a bar-bell strategy, one where you have a portfolio that has both some aggressive, some cyclical stocks, combined with defensive stocks," Dowty said.

"The global economies are going to stabilize and recover. You have to take advantage of those dips."

Stephen Lingard, a portfolio manager at Franklin Templeton, said he expects global market uncertainty to largely keep investors on the defensive until at least the second half of the year.

Franklin's Bissett Canadian Equity Fund has favored companies that traditionally pay dividends and increase them over the long term, with much of the portfolio in more stable financial and consumer discretionary names.

Top holdings include Bank of Nova Scotia and Brookfield Asset Management.

"They typically have been avoiding some of the resource areas of the economy and that's served them very well," he said.

The S&P/TSX composite index gained 3.7 percent in the first quarter, helped by positive economic data and efforts by some central banks to boost growth.

But most of those gains recently vanished as investors dumped stocks on fears of waning growth, spurred by news of a sharp slowdown in U.S. job gains and unexpectedly weak Chinese growth data.

China's economic performance is widely seen as a proxy for global commodity demand and the strength of international trade.


Still, many Canadian managers expect that at some point this year there will be a sector rotation back into cyclicals. This could coincide with "more aggressive reflation and monetary easing in emerging markets, specifically China," said Franklin's Lingard. "That's a second half story," he said.

Analysts polled by Reuters last month said they expected the S&P/TSX composite, which sank as low as 11,868.97 last week, to climb to 13,275 by year-end, and that resource stocks could lead the charge.

For that reason Greg Nott, chief investment officer at Russell Investments Canada, favors cyclicals now.

"If you do have the view that global growth is going to improve, then those cyclical sectors tend to do better and are the place you want to be," Nott said.

"I don't think you'll see a major shift with the level of uncertainty you're seeing now in the markets. But I do think you're seeing a shift starting in terms of where managers are positioning, and certainly where we're positioned."

(Editing by Jeffrey Hodgson and Peter Galloway)

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