Weak economy, earnings pose near term challenges

    TORONTO, April 13 /CNW/ - CIBC (CM: TSX; NYSE) - The recent upswing in
North American equity markets looks vulnerable to being partially clawed back,
creating another buying opportunity ahead of a more sustained rally late this
year and into 2010, notes a new report from CIBC World Markets Inc.
    "Those still on the sidelines needn't fear that they missed their
opportunity to jump on board," says Avery Shenfeld, chief economist, in his
latest Canadian Portfolio Strategy report. "Markets appear to be in growing
danger of running ahead of the fundamentals."
    Mr. Shenfeld's caution on equities markets reflects many factors
including the "high potential" for more damaging economic news. "March's
horrible jobs numbers and onerous debt levels suggest U.S. consumers - a key
driver of past recoveries - continue to face powerful headwinds. Aggressive
fiscal stimulus will help in some countries, but that will take time."
    He also points to poor profit visibility in the near term with TSX
earnings likely to fall 25 per cent in 2009. "Year-on-year earnings growth for
both the TSX and S&P 500 is likely to remain deeply negative until at least
the fourth quarter."
    Additionally Mr. Shenfeld cautions there is no single strong driver that
could further propel the recent rally. "Tech stocks and oil shares spearheaded
the TSX's late-1990s and early twenty-first century rallies, accounting for
73% and 43% of the market's trough-to-peak climb respectively. The lack of an
obvious, heavy-duty market driver suggests the power of any upcoming rebound
may not match those two," he says.
    "Even if the TSX avoids a retest of March's low - as seems increasingly
likely - a slower climb back would limit the rewards from rushing back heavily
into stocks immediately, as opposed to waiting for at least some evidence that
the worst is over for earnings and that macro stabilization efforts are
starting to work."
    Recent news, particularly for employment, has led Mr. Shenfeld to pare
back a number of key estimates. Among them is Canadian real GDP which he
expects will decline by 2.7 per cent by year end, down from an earlier
estimate of a 2.1 percent drop. This compares to negative 2.9 per cent growth
stateside, and a 1.5 per cent fall for global GDP, both also weaker than
previously thought.
    A modestly paced economic recovery in 2010 could take the TSX to his
target of 10,500 by the end of next year, but the near term risks of a
correction have Mr. Shenfeld advising a somewhat conservative investment tilt
in his model portfolio.
    While remaining two percentage points underweight in equities, he has
trimmed his cash overweight position by a point and shifted those funds into
bonds. "Longer-run inflation expectations are likely too low, given growing
pressures on governments to finance runaway deficits via the printing press.
But in the next three to four months, reassurances from the Bank of Canada
that short term rates will stay low for an extended period should provide a
measure of temporary support for bonds. Spread product should also benefit
from a further, gradual reduction in risk aversion."
    Mr. Shenfeld is "waiting at least until the upcoming earnings season is
done before adding weight to equities as a whole." Similarly, he is only
neutral weighted in the energy sector this far ahead of a global economic
rebound. "Although the need to tap ever costlier supplies in the future make
us longer-run bulls on oil, prices have already enjoyed a fair relief rally,
given the recession's ongoing hit to demand. Inventory levels, moreover,
remain high," he says. OPEC production cuts could be reversed to meet the
first stages of demand growth in an economic recovery, he notes, keeping
wellhead prices from topping $70/bbl on a sustained basis before the end of
2010.
    Mr. Shenfeld has added two percentage points of exposure to the
technology sector, and has moved to a neutral stance in telecoms from a
previous underweight position. "Canadian firms appear relatively
well-positioned to benefit from the ongoing shift from expensive,
feature-laden personal computers, to smartphones and other smaller,
ultra-portable devices. Recent reports from some industry leaders also suggest
profit margins are bearing up well.
    "The support to revenues from strong demand for digital cable and other
new services, despite a difficult business environment, has also prompted us
to increase our weighting."
    Within the materials sector, Mr. Shenfeld has added weight to the
agricultural chemicals/fertilizer group at the expense of golds. "Although we
expect a tilt in market expectations, away from deflation to inflation to
support bullion prices and gold in the longer term, reduced market volatility
has dimmed gold's luster in the last month," says Mr. Shenfeld.
    He adds that "food demand is relatively unlevered to a weak economy and
we also expect Canadian fertilizer producers to benefit from important ongoing
changes in global food consumption patterns and efforts to boost crop yields.
That makes the sector a potentially good longer term investment."
    The complete CIBC World Markets report is available at:
    http://research.cibcwm.com/economic_public/download/psapr09.pdf

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