CIBC World Markets says that the stock market is overly optimistic about the second half of 2004, although the first half should be good enough to support the current rally.

CIBC chief economist Jeff Rubin comments in a new report that, “Strong first-half US economic growth should sustain the stock market rally, but the economic outlook for the second half is not nearly as good as the market believes.” As a result, it is only weighting stocks in line with the index (53% in stocks).

Within the index it favours energy stocks, “which will continue to benefit from US$30 plus crude prices and US$5 plus natural gas prices.”

Rubin predicts that a move by the Canadian dollar above 80¢ will force the Bank of Canada to cut interest rates 75 bps over the next six months, “leading us to be overweight bonds and underweight cash”. It weights bonds at 45% against an index weight of 38%, with cash at just 2%.

“We are probably somewhere in the 7th inning of a North American equity market rally. While there is no near-term threat to the North American expansion, neither is there any huge buy story for the latter half of 2004 or 2005,” CIBC says, predicting that U.S. growth will taper off below 3% during the second half of the year, “posing a potential disappointment to second half earnings.”

“Trading at 17 and nearly 19 times 2004 earnings, neither the TSX nor the S&P 500 look particularly cheap. Investors will increasingly discount strong US economic growth over the first half, recognizing that it is largely driven by pump-priming, which will end abruptly in the second half,” CIBC says. “We see the rally in the S&P 500 running out of steam by mid year, at a level roughly 10% above today’s valuations.”

“Strong energy and gold prices may lever more near-term gains on the TSX, but it too is likely to lose ground over the second half of the year,” it says.

At the same time, CIBC technical strategist, Larry Berman, believes the equity markets are in good shape and should continue to outperform bonds in the first quarter. “Despite near-term resistance for the TSX in the 8550 area, a move to 9200 is a reasonable technical objective,” he says. “We recommend above average cash due to the short-term risks we see in the bond market (closed the year at the lower end of the yield trading range we expect), the typical bearish seasonal patterns, and the improving global economies.”

Using its’ quantitative model, the firm finds that the model is currently suggesting stocks outperform bonds, which in turn outperform cash. “We therefore recommend overweighting stocks and underweighting cash,” it says. “Within the TSX sectors, Energy, Health Care, Materials, and Telecom Services sectors are expected to outperform in January 2004.”

http://research.cibcwm.com/economic_public/download/psjan04.pdf