Investor fears unwarranted

    TORONTO, Aug. 2 /CNW/ - CIBC (CM: TSX; NYSE) - The recent losses on the
TSX were driven by unwarranted fears that the U.S. subprime meltdown would
seriously impact global growth, finds a new CIBC World Markets report.
    "Investors followed a circuitous route to link U.S. mortgages to Canadian
equities over the past month," says Avery Shenfeld, Senior Economist at CIBC
World Markets. "Losses on subprime mortgages put some hedge funds at risk,
which raised concerns about Wall Street's liquidity. This led to widening
spreads on high-yield bonds and loans, which left dealers stuck with loans on
leveraged buyout (LBO) deals in process. This added to the risks to lending
liquidity and pressured investment grade spreads, which raised concerns over
global growth. The last leg of this Rube-Goldberg path entailed a broad-based
drop in Canadian equities."
    Mr. Shenfeld notes that there is a missing link between the very evident
troubles in the U.S. mortgage market and credit quality in the corporate
world. He notes that global corporate defaults are low, as are debt burdens
outside the LBO world. Economic growth continues to surprise on the upside,
even in Canada, and TSX operating earnings are on track for a 16 per cent gain
this year and a double-digit gain in 2008. Only a small minority of the M&A
wave that supported Canadian stocks has been in LBO deals and the world's
resource giants have ample cash flow to finance further deals in Canada.
    "Buoyant global growth and the pick-up seen in Canada, underpin our
optimism on the equity outlook, driving earnings on both sides of the Canada-
US border to materially exceed the street's expectations in Q2," adds Mr.
Shenfeld. "But unfortunately, over the last month investors have been throwing
out babies with the U.S. mortgage bathwater."
    As a result of this, CIBC World Markets is sticking to its overweight
position in equities. Within the equity market, it is taking profits by
trimming its overweight in base metals based on the dwindling field of M&A
targets, and adding to energy. It has also added to its consumer staples
holdings, where heavily weighted retail importers will benefit from a stronger
Canadian dollar as it resumes its climb up the currency ladder on evidence of
healthy global growth.
    The bank has further cut its bond underweight by shifting an additional
two percentage points into cash. It expects that the recent rally in the bond
market will be short-lived as investors' flight to safety begins to melt away
and in anticipation of another Bank of Canada rate hike in September.
    The report forecasts that when the dust settles in the credit markets,
funding for private equity leverage buyouts is unlikely to return anywhere
near its previous terms and spreads. However, CIBC World Markets does not
expect a chill in LBO private equity buyouts to take the toll on global stock
markets that some claim, as there is little evidence that stocks were pricing
in a large across-the-board premium for such takeovers.
    The report notes that while private equity has been a significant, if not
dominant source of fuel for the M&A boom in the U.S., it has been less
critical elsewhere. Private equity accounted for 27 per cent of deal volume in
the U.S. over the last two years. In Europe, which now outpaces the U.S. in
deal volume, private equity has accounted for just 13 per cent of recent deal
activity, and in Asia only 6 per cent.
    Including some pending deals, buyout firms have been responsible for a
modest 17 per cent of takeovers of Canadian targets in the last two years.
Even that share is largely concentrated in telecom and media targets. Strip
out the high-profile telecom deals and private equity's M&A share has been
just seven per cent, a quarter of that stateside. Such LBOs have accounted for
less than one per cent of mining acquisitions and just five per cent of deal
volume in the energy patch.
    Corporate acquirers, typically other resource producers, have accounted
for about 95 per cent or more of the recent takeovers in Canada's resource
sector. Such activity is unlikely to be affected by a less favourable credit
environment given unprecedented cash flows and balance sheet strength and the
ability of many of these firms to partially fund acquisitions via asset sales.
Share buybacks, running at two to three times last year's pace, should also
support Canadian equities.
    The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/psaug07.pdf.

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