Industry pundits agree the recent recession could fundamentally alter the economy for years, and consumers will no longer live high on the hog. So it strikes Ralph Shive, lead manager of the Wasatch-1st Source Income Equity fund, as a bit odd that consumer spending is on the upswing again. With that, consumer discretionary stocks like casinos, restaurants and retailers have soared too.

"That's driven by consumers' not paying their mortgages and using that money to fund purchases," Shive says, dismissing the recent run-up. "People are not in a good financial situation." Shive's philosophy played well in the meltdown, and Income Equity sidestepped much of the carnage. But will it work during the recovery?

AFTER THE FALL

South Bend, Ind.-based Shive applies a Midwesterner's sensibility to stocks. He's against profligate spending, whether by consumers, the government or investment banks, another sector he avoids.

In late 2007, Shive raised his value fund's cash level to 18% of assets, fearing that too much debt would crush companies when financing became hard to come by. He was right.

But when it was clear that the government bailouts could bring the economy back from the brink, Shive dove back into stocks. He deployed almost all his cash in the second half of 2009.

Going forward, as the personal debt bubble continues to deflate, Shive sees an economy that will have a tough time expanding. He favors companies that thrive in a slow-growth world-sectors like commodities, technology and healthcare.

The strategy has worked in different market environments. Over the last three years, Income Equity is down just 0.9% annually through April 4, besting 96% of its peers in the large-value category, according to Morningstar. Over the last five years, the fund is up 5.8% annually, in the top 2% of similar funds.

A COMPLICATED SECTOR

As with other investors who escaped the worst of the bear market, Income Equity was light on financials, especially banks. Shive was concerned about banks' balance sheets as early as 2007. He and co-manager Michael Shinnick still avoid banks, despite some impressive earnings.

Insurance companies are a different matter. One name in the portfolio is property and casualty insurer Allstate. Like other financials, Allstate suffered through 2008 and 2009, as its book value took a hit due to its own investments. "Their investment portfolio improved during 2009, bringing book value back up," Shinnick explains.

At $33, the stock trades slightly above its reported book value of $30.84, which is sharply higher than the $23.47 in book value it logged in 2008. Allstate's stock is up 10.4% this year through April 9.

CONSUMER QUANDARY

This year, with financials and consumer discretionary stocks performing so well, Income Equity is struggling to keep pace with its peers. Through April 9, the fund returned just 6%, beaten by 85% of its large-value peers.

The industrial companies that Shive and Shinnick favor haven't kept pace. The duo has peppered the portfolio with transportation and steel businesses, which tend to benefit late in an economic recovery. They like them because they make "real" goods and services.

Twenty-one percent of the fund's assets are in the industrial sector. One firm, Potash Corp. of Saskatchewan, makes potash, nitrogen and phosphate fertilizers. Although Shive predicts slow growth stateside, he's more encouraged about Asian economies. Nitrogen and phosphate prices have improved, but potash prices are still weak after first spiking and then crashing in 2008. Potash sells at a P/E ratio of 15 times 2011 earnings. At $114 a share, the stock trades at five times book value.

"[The P/E] may seem a little high," Shive acknowledges. "But the company is cyclical in nature, so it's got some volatility on the earnings, and it's not as cheap now as it's been in the past."

Another holding is Syngenta, a Swiss pesticide manufacturer. Its business suffered as genetically modified seeds, which can be pest-resistant, became more popular. Syngenta has acquired two seed companies and started a small seed division. At $53.31 a share, the seed business isn't fully valued, Shive contends. The stock is down 4.7% in 2010.

ECLECTIC VALUE

P/Es in the double digits may not sound like they belong in a value portfolio, but that's how Shive designed it. He calls his style eclectic value; some stocks fall into the deep-value category, others are temporarily discounted names and some are fallen growth names selling at the right price.

Tech fits the last group. The formerly frothy industry has matured, prices have come down and many of the firms pay dividends. Case in point: Intel. "Two years ago, the combination of valuation and dividend yield caught my attention," Shive says. "And I'm not worried about their balance sheet."