Rubin predicts parity, trims bonds

The Canadian dollar is headed toward parity with its U.S. counterpart and the Bank of Canada will not step in to prevent it, according to one of Canada’s most outspoken bank economists.

“With the national jobless rate plumbing 30-year lows and core inflation now bobbing above the Bank of Canada’s target range, our earlier assumption of the Bank of Canada intervening against a further rise in the Canadian dollar with rate cuts no longer seems tenable,” says Jeff Rubin, chief strategist and chief economist at CIBC World Markets.

In the monthly update to the Canadian Portfolio Strategy Outlook, Rubin says the flood of capital flowing into Canada to fund mergers and acquisitions will drive the dollar toward parity by the end of this year, where it could remain for the first half of 2008.

Rubin’s prediction is even more bullish for the dollar than that of Clément Gignac, chief economist at National Bank of Canada, who recently predicted parity by the end of 2008.

“The Bank has already indicated that it expects to raise interest rates shortly. How much rates will actually rise remains to be seen,” Rubin says. “With the Fed still likely to cut rates in Q4, we now expect the Canadian dollar to climb to parity with the U.S. dollar by year-end and remain in that range over the first half of 2008.”

The loonie is already trading at 30-year highs, propped up not only by the recent flurry of M&A activity but by the global appetite for natural resources. Rubin points out that the soaring dollar represents a double-edged sword. Resources represent 44% of the S&P/TSX Composite Index market capitalization, so continued demand for commodities should drive the overall market higher.

As a result, Rubin and his team predict the TSX to climb to 15,000 by year-end, representing a total return of 18.5%.

But at the same time, the manufacturing sector will face an even steeper uphill battle as the dollar continues to rise. This sector makes up a far larger percentage of the overall economy, and its woes will drag on GDP growth.

To capitalize on the strengthening dollar, Rubin is altering the model portfolio’s allocation, shifting 3% of the portfolio out of bonds and into cash. With his bullish prediction for the stock market, he maintains his overweight position in equities, at 68% of the portfolio.

Within the equity portfolio, he recommends cutting the allocation to banks and insurance companies by one percentage point each, using the proceeds to add 1.5% of the portfolio to consumer discretionary stocks, and 0.5% to consumer staples. The portfolio is now market-weighted toward financials, while overweighted in materials and energy.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com