Despite continued strong performance, high-quality U.S. equities are “probably the only game in town,” says Stephane Rochon, vice-president and managing director, BMO Nesbitt Burns.

While portfolios can still include bonds and cash, investors should know that after-inflation returns on cash and government bonds could be negative for the next few years.

Rochon says his call on equities is based in large part on where we are in the business cycle.

Read: U.S. stocks on fire, economy expanding

“Our analytical framework is driven by economic momentum, as distinguished from absolute growth numbers. Economic momentum focuses on the trajectory of economic growth, and this is what drives asset and sector returns,” he explains.

He says momentum is improving in the world’s three largest economic blocs—the U.S., Eurozone and China—and this is good news for equities.

He also notes both the TSX and S&P500 are trading at roughly 14x forward earnings.

“This is pretty good value in the context of very low interest rates,” he says.

Rochon prefers the U.S. market because it’s fundamentally more balanced. For example, energy and basic materials comprise about 50% of the TSX, but only 13% of the S&P500.

And unlike the Canadian market, the U.S. has a wide range of high-quality technology, consumer and industrial companies—three areas Rochon is very positive on.

Read: Plenty of gas left for U.S. equities

Dividend growth prospects in the U.S. are also “far superior,” he says, adding “it’s important to note that, as many academic studies have shown, dividend growth is what matters for stock performance over a long period of time, not an absolute high dividend yield.”

He also suggests the “commodities super-cycle” that has fueled the tremendous outperformance of the TSX over the last 10 years is winding down.

“This is not to say commodities are going to crash, especially given improving economic momentum in China and emerging market economies, which will support commodities over the next few quarters. But this super-cycle is very long in the tooth.”

A key reason for this is that over the next 10 years China “won’t be able to increase its demand for commodities such as copper, iron ore and oil to the same degree it has in the last 10 years.”

Investment themes and sector preferences

Rochon notes housing in the U.S. is recovering and suggests participating in the upswing through banks like JPMorgan, Wells Fargo, Bank of America and Citigroup, as well as companies in the auto sector, such as Magna.

The auto sector will benefit from the housing recovery because “when people’s net worth increases—especially as a result of real estate assets increasing in value—their propensity to spend increases. This is good news for the entire economy, but it’s especially true for autos. Add to this the recovering labour market, and the fact that the average age of cars in the U.S is at the historically high level of 11 years.”

He also likes commercial construction. It typically lags residential recoveries by three-to-four quarters, so from a historical perspective the timing is right.

Read: Despite problems, U.S. still strong

He also points to the Architecture Billings Index (ABI), which measures how much work American architects are getting. “It’s been trending upward over the last six months, and that tends to be a very good indicator that shovels will hit the ground in nine-to-12 months.”

Rochon also sees opportunities thanks to the re-industrialization of America.

“Large companies like GE and 3M are bringing factories back to the U.S. from China, or, in their new investment plans, directly building in the U.S. rather than going to emerging markets.”

The cost advantage of labour in China is not what it used to be, as wages there are rising much faster than in the U.S.

Rochon also notes these firms want to be closer to their customers, and are worried about protecting their intellectual property—China is notoriously problematic in this regard.

He suggests getting in on the commercial construction recovery though high-quality industrial companies like Emerson Electric, Rockwell Automation, and Nucor, which sends 60% of its steel production into commercial construction.

Particularly important for Canadians, Rochon says, is the risk of rising interest rates.

It’s not clear when they will go up, and by how much, but when they do “it will have significant repercussions for the value of portfolios. Long bonds will get hit very hard, and so will some of the more defensive equity sectors, like REITs, telecoms and utilities,” he says.

Life insurance companies are a good buy in a rising rate environment, as they are “one of the rare sub-sectors that benefit from higher rates,” he explains.

Read: Fixed-income investors should look abroad