CIBC World Markets is trimming exposure to bonds and income trusts in its model portfolio, and shifting into cash instead. However, its ardour for energy stocks hasn’t cooled.

In a report Monday, CIBC chief strategist Jeff Rubin notes that it has slightly trimmed its overweight in bonds and income trusts in favour of cash, “largely in deference to near-term Fed rate hikes”.

“Better prospects await both trusts and bonds in the second half, when the Fed is likely to head to the sidelines,” the report says. “A flattening yield curve together with widening negative Canada-US interest rate differentials should limit near-term damage to the trust market, while a second-half halt in Fed tightening should set the stage for 4% long Canada yields in 2006. With monthly distributions still growing, the trust market should be the major beneficiary of that yield drop, delivering a 15-20% total return this year that warrants our significant overweight.”

“An overly aggressive Fed has temporarily derailed the rally in financial leverage, but the threat of higher long-term interest rates should prove no more lasting than the similar threat posed by Fed tightenings last spring,” it says.

The firm raised its target for the federal funds rate to 3.5%, but says it expects long-term interest rates to continue to fall over the next 12 months.

Within the stock segment of its portfolio, CIBC remains heavily overweight the energy sector in the TSX. It predicts that sector earnings should rise by 30%-40%, supporting a target of 2600 for the oil and gas sector this year and 3000 next year. “Moreover, energy stocks continue to be undervalued relative to both earnings and cash flow, discounted by as much as 10%-15% by financial market skepticism over the sustainability of high crude prices,” it says.

“Far less spectacular gains are implied for the rest of the TSX by our index target of 10,000 by year-end. Telecommunications stocks still look promising, and down the road, financials may show another leg up, once rising energy prices and a cooler U.S. economy put the handcuffs on the Fed,” the report notes. “Conversely, we remain wary of the materials sector (gold and uranium excepted) as well as industrials, both of which carry downside risk on a weakening of nonenergy commodity markets and industrial activity.”