The strong loonie is the top risk for the economy, corporate earnings, and equities, according a new report from CIBC World Markets Economics and Strategy.

Operating earnings for firms in the S&P/TSX composite index remained buoyant in the third quarter, advancing 36% year-to-year, writes CIBC WM economist Peter Buchanan, in the report released yesterday. The TSX advance was led the resource-levered TSX materials and energy groups enjoying strong demand from China.

However, Buchanan warns that this may, “… mark the profit party’s peak, given growing bottom line strains from the Canadian dollar’s nearly 30% climb. The drag from weaker global growth on the TSX’s heavily-weighted resource cyclicals group will also help to slow earnings from this year’s 32% pace to 13% in 2005 and a below-trend 4% growth rate in 2006.”

“On the valuation side, forward PEs are not as cheap as they were prior to the late 1980s or decade-ago rallies, though they are below their late 1990s peaks,” he writes. “That and scaled back earnings growth points to weaker equity performance.”

CIBC WM continues to recommend underweighting the materials group, although the golds could benefit from an anticipated 5% or so further decline in the U.S. dollar. “We believe that the rally in Toronto energy stocks still has some life left even with the group’s impressive 25% run to date this year,” Buchanan writes.

Dividend payouts for TSX composite members rose by about 14% on average in the year to Q3, CIBC WM notes. “Dividend stocks have outperformed growth plays this year. We expect further dividend increases to provide some support for valuations even as earnings growth slows, given investors’ preference for a well-defined cash return. Ample free cash gives many firms room to further lift shareholder distributions,” Buchanan concludes.