CIBC World Markets continues to recommend that investors overweight bonds, as it sees tough times ahead for the economy.

In its Canadian Portfolio Strategy Outlook released Tuesday, CIBC WM says that it expects the North American economy to struggle for the next two quarters, even with a successful conclusion to the war in Iraq.

“Flagging consumer spending in the U.S., and the brake from a rising Canadian dollar, will leave both the TSX and the S&P with disappointments on the earnings and economic fronts,” it says.

CIBC WM predicts that TSX operating earnings will see a front-loaded 25% increase this year, but by the fourth quarter, year-over-year gains will have decelerated to a mere 8%.

CIBC WM also forecasts further cuts of 50 basis points to U.S. interest rates over the next quarter to stimulate post-war economic activity.

“In view of that action, we expect the Bank of Canada to defer further rate hikes until 2004, providing significant rally room for bonds. Hence, we are overweight fixed income relative to a total Canadian benchmark and underweight equities and cash.” It calls for a mix of 40% stocks, 55% bonds and 5% cash.

CIBC WM is leaning on defensive stocks to counteract the weaker growth and earnings numbers. It favours overweight positions in consumer staples, energy and utilities and underweight positions in industrials, consumer discretionary and infotech.”

The firm says that its corporate debt research group sees further volatility in credit spreads in a sluggish economy, but maintains a market weight on corporate bonds.