Market will triumph over sub-prime: CIBC’s Rubin

By Mark Noble | September 6, 2007 | Last updated on September 6, 2007
3 min read

For months CIBC World Markets has been touting the fundamental strength of the Canadian market — and a little sub-prime trouble won’t change that outlook, according to the firm’s latest report.

“The sub-prime mortgage meltdown in the U.S. is a temporary and non-lethal shock to the bull market in Canadian stocks,” says Jeff Rubin, chief economist and chief strategist 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 regained 50% of those losses as investors rapidly scooped up discounted stocks.”

Rubin predicts that the TSX will rebound quickly, regain its recent losses and then go on to hit a record 15,000 within the next six months. Rubin expects the index to hit 16,200 by the end of 2008.

“The blow-up in the U.S. sub-prime 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,” Rubin says.

Although the CIBC report notes that roughly $700 billion US in sub-prime mortgages will reset by the end of next year in the U.S. housing market, Rubin believes the market has already discounted the worst of the sub-prime fallout, and in some cases created opportunities for bargain hunters.

“While delinquency rates are already at 15% — and up to 20% of outstanding sub-prime 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 says.

Rubin expects that the sub-prime mortgage fallout will be further softened by public policy. He predicts that the U.S. Federal Reserve will announce two quarter-point cuts in its key lending rate over the next quarter. He also points out that U.S. President George W. Bush is already indicating that the Federal Housing Administration will insure some sub-prime mortgages that are in arrears, encouraging financial institutions to continue to lend to the U.S. sub-prime market. This will lower financing costs on refinanced mortgages.

The report notes that the Canadian economy has outperformed Bank of Canada expectations over the first half of the year, so CIBC World Markets does not expect the Bank to match the U.S. Fed rate cuts and undo its July rate hike. At the same time, he doesn’t expect the Bank to tighten rates, due to the recent liquidity problems in the asset-backed commercial paper market.

The report says this will allow the Canadian dollar to regain momentum and reach parity against the U.S. dollar by the end of the year.

Tougher credit markets will put a long-term damper on leveraged buyouts, Rubin says, so CIBC 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 buyouts by private equity has fallen off a cliff,” Rubin says. “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.”

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Mark Noble