Latest rally unsustainable: CIBC

The latest upturn in the stock markets is likely unsustainable in the near-term, as the global economy remains weak and corporate earnings have yet to recover, according to the latest investment strategy report from CIBC.

“March’s horrible jobs numbers and onerous debt levels suggest U.S. consumers — a key driver of past recoveries — continue to face powerful headwinds,” says Avery Shenfeld, who recently replaced Jeff Rubin as chief strategist. “Aggressive fiscal stimulus will help in some countries, but that will take time.

“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,” he added, suggesting that total earnings for TSX companies are likely to fall 25%.

The good news is that a slump may provide a buying opportunity for investors who missed the March rally.

“Those still on the sidelines needn’t fear that they missed their opportunity to jump on board. Markets appear to be in growing danger of running ahead of the fundamentals.”

The largely negative outlook has led Shenfeld to revisit his economic forecast. Previously, he had anticipated real GDP to decline 2.1% on the year. That has been revised to a decline of 2.7%.

Meanwhile, south of the border, the economy is expected to contract by 2.9%, while global GDP will decline by 1.5%.

“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.”

If that stabilization takes hold, there may be a modest recovery in 2010, which could drive the S&P/TSX back up to 10,500 by the end of that year. That would mark a 14% increase gain from today’s opening value of 9,187.

Shefeld’s investment advice remains conservative. The CIBC model portfolio remains underweighted in equities by two percentage points, while the cash position has been trimmed by one point, in favour of bonds.

“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,” he said. “Spread product should also benefit from a further, gradual reduction in risk aversion.”

He remains bullish on the long-term price of oil, but the rising cost of production, coupled with the recession-related decline in demand, leaves him wary of energy stocks. The price of crude is unlikely to break the $70 per barrel barrier before the end of 2010.

His outlook has improved for the technology and telecoms sectors, with an additional two percentage points allocated to the former, and an improved “neutral” outlook on the latter.

“Recent reports from some industry leaders also suggest profit margins are bearing up well,” he said. “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.”

On the materials side, exposure to gold has been trimmed in favour of agricultural inputs, as market volatility has taken some of the shine off of precious metals. He believes that the return of inflation will instead drive increased demand for food.

“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,” he said. “That makes the sector a potentially good longer term investment.”

(04/13/09)