The firm issued an alert saying it is dropping its 12-month target from 9,500 to 8,600, and scaling down exposure stocks – particularly resource issues.

NBF says the key reasons to justify this move are: a looming liquidity squeeze; earnings expectations that are too high; and the future direction of the U.S. dollar and commodity prices.

“The just-released minutes from the last FOMC meeting show that the Fed is getting increasingly concerned by the fact that financial conditions in the U.S. remain too accommodative,” NBF says. The minutes from the Fed’s December meeting were released yesterday.

NBF says that the December 2005 futures indicate that market participants expect only an additional 125 basis points increase in the Fed funds target rate over the coming year (to 3.5%).

“In our view, this is too much complacency and far from a neutral monetary policy stance, particularly in light of the recent acceleration in core CPI inflation (which we see at around 3% at year-end),” NBF says.

It predicts the U.S. central bank will raise the Fed funds rate to 4.50% by the end 2005. NBF also says that the Bank of Canada, “… will probably stay on the sidelines this spring but will sooner or later be forced to raise rates again (3.75% year-end target) due to strong domestic demand, particularly if we see the loonie under pressure due to emerging CAN-US negative spreads.”

Given the evolving interest rate scenario, NBF also believes that earnings expectations are too high. “We are also poised to see downward earnings revisions on both sides of the border since we perceive that the current 10% earnings growth expectations to be at risk (flat earnings expected in Canada and a maximum 5% expected on the S&P 500),” it says.

The other big issue is commodity prices and the U.S. dollar story. “Until today, our baseline scenario relied on a 10% further decline on the greenback in order to address the huge U.S. trade deficit. Now, we believe that the Fed will instead engineer a consumption slowdown in second half of 2005 and 2006 to do the job,” NBF says.

“Bottom line, even if a further weakness is not completely excluded, a more aggressive Fed tightening will limit the downside risk on the greenback (or the upside on the euro and the loonie) and induce many hedge funds to take their profits on some currencies and commodities prices (bullion, oil, nickel, etc).”

The “time is coming to scale down resources exposure to an underweight position,” NBF concludes. “Since the resource sector represents almost 35% of the S&P/TSX, we have decided to revise downward our 2005 year-end target from 9,500 to 8,600, and underweight Canadian stocks by raising our cash position from 10% to 20%.”