There are encouraging signs that equity markets are nearing a bottom and that the final days of 2008 will pass without another meltdown, according to new report from CIBC World Markets.

“We are cautiously optimistic that we can ride out the balance of the year without any further systemic shocks,” says Jeff Rubin, CIBC World Markets chief economist and chief strategist, in a report released Tuesday.

The sources of Rubin’s optimism include the London interbank offered rate or Libor, the interest rate at which banks lend money to each other. Libor has been reversing from summer-end highs in response to central banks aggressively cutting interest rates and infusing billions of dollars in cash and guarantees. The result is that “interbank lending is once again showing encouraging signs of life” after recording no growth during the spring and summer, says Rubin.

Equally significant is China’s new fiscal stimulus package which “could add as much as 3% to that country’s growth over the next two years,” notes Rubin, adding that the “U.S. is about to follow suit” with another stimulus plan.

But while “there may now be a few more signs of easing financial strains to the discerning eye, the building blocks for a sustained equity rally are still not firmly in place,” warns Rubin. “With credit and liquidity fears abating somewhat, concern is rapidly shifting to one of the other key factors clouding prospects for a heavily resource weighted TSX, the troubled global economy.

“The jury may still be out on the extent of the downshift in growth in emerging markets like China. But there is little doubt in the wake of Q3’s GDP decline and bleak manufacturing and employment data that the U.S. has now joined the Eurozone, Japan and most other OECD economies in outright recession.”

But if equity markets have seen, or are near a bottom, history provides clues on how long it might take stocks to fully recover, notes Rubin. “Unfortunately, only once in the TSX’s nine peak-to-trough declines of more than 20% since 1956, did it take less than two years for the market to retest its previous peak. On average, it has taken the TSX about three years to fully recover from a bear market. But the 1973 and 2000 bear markets took at least three times as long to incur roughly the same magnitude of losses as those seen recently. That provides some hope that the coming recovery period could be shorter than average.

“Even so, our 12,000 end-of-2009 forecast for the TSX implies that the market will remain well below its recent highs, until sentiment towards the U.S. and other key economies improves. Our shorter term target of 9,500 for the end of the current year means, moreover, that the market could struggle to maintain its current level through year-end,” says Rubin.

As a result, he’s maintaining “market weight” exposure to Canadian equities in his model investment portfolio.

Meanwhile, Rubin has made two single point shifts in his portfolio. Firstly, he has moved one percentage point of weighting to cash from bonds. “Government bonds appear to have exhausted their room to rally,” notes Rubin.

Secondly, within his equity mix, he has added one point of weighting to the defensive consumer staples group. “This sector, dominated by pharmaceutical and food retailers, has been the TSX’s strongest sector in 2008.” The increase is funded by an equal cut from the energy group, specifically natural gas stocks.

Despite the cut to natural gas stocks, Rubin remains four points “overweight” in the energy sector. “Oil is still the best play on recovery, when temporary market fears of demand destruction should quickly morph into more lasting fears of supply destruction.

IE