A slowing economy, energy-driven inflation and higher interest rates will challenge “large swaths of the stock market” through 2009, with the airline and auto sectors taking the hardest hits, notes a new report from CIBC World Markets.

Pointing to an “increasingly stagflationary” environment, particularly in the United States, CIBC World Markets Chief Economist and Chief Strategist Jeff Rubin has lowered his year-end forecast for the S&P/TSX composite index to 14,300 from 15,200. His 2009 target for the TSX has also been cut to 15,250 from 16,200.

Rising interest rates in the U.S., coupled with the soaring cost of gas and sliding house prices “will deal a lethal blow to the hopes for a fast bounceback in growth stateside,” says Rubin. “The U.S. economy will continue to walk the fine line between growth and recession for a fair bit longer. That will, in turn, take a toll north of the border.”

As a result, Rubin is reducing his overweight exposure to stocks in his model portfolio by shifting four percentage points to cash. Notwithstanding that reduction, favourable fundamentals make Canadian oil and gas producers a continuing good investment. Rubin has added a further half point of exposure to that sector.

Rubin has revised his oil price targets to an average of US$150 per barrel of West Texas Intermediate crude in 2009 and US$200 in 2010. “Prices could approach those levels sooner, if the present Gulf of Mexico hurricane season hits exposed production heavily,” he says.

He’s also revised his natural gas target to US$15/MnBtu for next year, up US$1.

The additional weighting in energy is funded in part by cuts to two oil-sensitive groupings: the TSX consumer discretionary (11% auto related) and the industrials which includes the airline industry.

“The auto component of consumer discretionaries looks particularly vulnerable, in light of the fact that we are likely to see new vehicle sales in the United States slump to as low as 11 million vehicles over the next two years,” says Rubin.

Rubin is also adding a half percentage point to his weighting in the agricultural chemical sub-sector of the materials group. “Soaring demand for higher protein diets in China and India is lifting agricultural prices around the world and sending world fertilizer demand through the roof,” he says.