Higher prices for food and energy will reverse the direction of interest rates in the next 12 months, and lift energy and materials stocks to new record highs, according to a CIBC World Markets report released today.

Markets will be “surprised” at how rapidly the Bank of Canada is compelled to take back recent cuts to interest rates, says Jeff Rubin, chief strategist and chief economist at CIBC World Markets in his monthly Canadian Portfolio Strategy Outlook report. “We expect to see at least 100 basis points of tightening” by the end of next year.

Because rising interest rates make bond yields less attractive, Rubin is paring back the bond weighting in his model portfolio to “neutral” from “overweight”. That frees up funds to take a slightly overweight stance in equities, with emphasis on energy and materials stocks.

Rubin’s increased weighting in energy stocks reflects supply struggles and surging demand that he predicts will push oil to US$130 a barrel and natural gas to US$13 per Mn BTUs in 2009.

Rubin’s “overweight” stance in materials is tied to the strength of emerging markets where infrastructure developments are driving demand for metals and other resources, and rising income levels and meat consumption are pushing up global agricultural prices.

While those sectors are winners, Rubin says companies that “rely heavily on grain, oil, or other commodities as inputs face increasing costs and thus weaker profits.” As a result, he has cut a half percentage point of weighting in the consumer staples group, which includes both food retailers and processors.

He has also shed weight in the utilities sectors where dividend yields are likely to prove less attractive in a rising interest rate environment.

Rubin’s end of 2009 forecast for the S&P/TSX composite index is 16,200 versus 1,475 for the S&P 500.

“We now expect TSX earnings to rise by an above-trend 16% this year. That should easily surpass the consensus estimate of a 10% rise in S&P 500 earnings, marking the fourth consecutive year of better earnings growth north of the border.

Financial sector earnings are expected to fall modestly for the first time since 2002. That compares with expectations just three months ago for a near-double-digit gain for the sector.

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/psmay08.pdf.