Canadian economy likely to sidestep subprime woes and hit new highs, finds a new CIBC World Markets report
TSX to hit 16,200 by end of 2008 TORONTO, Sept. 6 /CNW/ - CIBC (CM: TSX; NYSE) - While there is plenty of bad news yet to come from U.S. credit markets, CIBC World Markets predicts the TSX will rebound from recent market turmoil to hit a record 15,000 within the next six months and climb to 16,200 by the end of 2008. "The subprime mortgage meltdown in the U.S. is a temporary and non-lethal shock to the bull market in Canadian stocks," says Jeff Rubin, Chief Strategist and Chief Economist at CIBC World Markets. "Even at worst, the sell- off in the TSX was no worse than last summer's correction and the index has already re-gained 50 per cent of those losses as investors rapidly scooped up discounted stocks. The blow-up in the U.S. subprime market, like the collapse of Long Term Capital Management in 1998, will give way to new highs for both the stock market and the economy." Although the report notes that some US$700 billion of painful resets in subprime mortgages will occur by the end of next year, Mr. Rubin believes the market has already priced in the worst of the subprime fallout. "While delinquency rates are already at 15 per cent - and up to 20 per cent of outstanding subprime mortgages could end in default - it is now likely that financial markets have implicitly assumed a far more draconian outcome, creating an opportunity for arbitrage down the road." He also expects the U.S. Federal Reserve Board to address credit fears in the market by bringing in two quarter-point cuts in the lending rate over the next quarter. "Concern over credit market liquidity, rather than stock market valuations, will be the true motivation for the cuts, but they will, nevertheless, go a long way in bolstering market confidence." With the U.S. President already indicating that the Federal Housing Administration will insure some subprime mortgages that are in arrears, financial institutions will be encouraged to continue to lend to the U.S. subprime market. This will also lower financing costs on refinanced mortgages by improving their credit quality. The report notes that the Federal Housing Administration initiative will likely be enhanced as political pressure grows on both the Bush Administration and Congress to bail out mortgage borrowers. With growth in the Canadian economy outperforming Bank of Canada expectations over the first half of the year, CIBC World Markets does not expect the Bank to match the U.S. Fed rate cuts and undo its July rate hike. However, liquidity concerns, particularly in the asset-backed commercial paper market, will see the Bank of Canada stay on the sidelines and shelve any further plans for tightening. With near-record oil prices and two Fed rate cuts, the Canadian dollar is likely to regain momentum and reach parity against the greenback by the end of the year. While there's some risk that the meltdown in the U.S. subprime mortgage market could bring North American economic growth down with it, Mr. Rubin sees little evidence of contagion effects to the U.S. consumer. "The transmission mechanism for contagion to the U.S. consumer is through a rising personal savings rate, which is currently languishing near record lows below one per cent. Should the saving rate rise only modestly to two to three per cent, consumer spending would tank and with it the American economy. But aside from some benchmark revisions, the personal savings rate hasn't budged since U.S. housing prices turned south. And until it starts rising, U.S. consumer spending is not at serious risk." The report notes that while there is scant evidence of contagion effect in the real economy, outside of the direct effects in home construction, there is plenty of evidence of contagion in credit markets, far flung from sinking U.S. real estate values. Asset-backed commercial paper is one such casualty as are interbank lending spreads. The credit shockwaves from the U.S. subprime mortgage market have also impacted corporate spreads which have widened considerably. The report notes that in effect, rising default rates in the subprime market have been a catalyst for a systemic repricing of risk in global markets. As a result of the recent market correction, the bank is fine-tuning its equity portfolio by moving a full percentage point of weighting out of telecoms and moving a half-point into the heavily-sold base metals sector and a half-point to non-bank financials. "Global financing for leveraged buy-outs by private equity has fallen off a cliff and its diminished role in financial markets going forward is likely to hurt sectors in the TSX like telecom and media that have heavily relied on these funds to support merger activity," adds Mr. Rubin. "At the same time, base metal stocks, thrashed some 25 per cent in the recent selloff, seem oversold. We are adding a half a percentage point of weighting to our position in metal stocks on the belief that global economic growth will remain robust." He also added half a percentage point of weighting to non-bank financials which he believes look increasingly attractive in today's marketplace. Mr. Rubin believes Canadian insurance companies, with their large overseas operations, should also benefit from strong global economic growth while REITs should enjoy the support of a strong commercial property market in Canada. The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/pssep07.pdf. CIBC World Markets is the wholesale and corporate banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.