The global economy will struggle throughout 2009, before reviving in 2010, said Scotia Economics in a special report released Wednesday.

Scotia predicts that global growth is unlikely to exceed 1.5% in 2009. “The U.S. economy contracted in the third quarter and will likely continue losing ground through much of 2009 before embarking on a protracted period of convalescence extending through 2010,” it says. “The stabilization of the housing market and home valuations — an essential precursor to U.S. recovery — will be impeded by accelerating job losses and an overhang of unsold inventories equivalent to 10 months’ sales.

Ultimately, it concludes, “the U.S. road to recovery is likely to stretch beyond 2010, with plenty of volatility in currency and bond markets along the way.”

Scotia also expects output to contract 1.2% next year in Canada, with the weakness concentrated in Central Canada. “Overall, next year’s retrenchment is likely to be about half the setback recorded in the U.S., with the prospect of a slightly stronger recovery in 2010,” it says.

On the investment front, it says that, “From a risk-reward standpoint, we believe investors will have the opportunity to move up the risk curve in 2009 by adding to their equity exposure and reducing cash. Our recommended asset mix is biased towards equities as we expect greater returns from that asset class both in the short (1-year) and long (3-5 years) term.”

Indeed, Scotia says that the silver lining to all this financial turmoil has been the adoption of concerted monetary and fiscal stimulus measures. “In our opinion, the unprecedented amount of stimulus decisively raises the odds of witnessing an improvement in the U.S. economy by the end of 2009. If such is the case, equity markets will move higher,” it says.

“Although the timing of any pending rebound is debatable, we believe the longer-term risk-reward outlook has dramatically shifted in favor of equities. In addition, we believe the end of this cyclical bear market may coincide with the end of the decade-long secular bear market,” it adds. “In the short term, however, any bottoming process will remain fragile and investors should remember that retesting the lows is very common in bear markets.”

“Our recommended asset mix is still tilted towards above-average cash weighting, but we plan to reallocate cash into equities when data deterioration moderates and/or we get heightened bottom confirmation,” it says. “From a sector standpoint, our bias is to stick with the S&P 500 as our index of choice and focus on defensive and early cyclical sectors for now. We continue to prefer financials, discretionary, consumer staples, and utilities.” Telecoms, industrials and technology are rated market-weight; energy and materials should still be underweight, it says.

“We are likely to reduce our presence in staples, utilities and gold when the macroeconomic outlook clears up, raising our weighting in industrials, technology, and resources,” it concludes.

IE