Despite the threat of rising interest rates, National Bank Financial recommends investors remain overweight in stocks.

NBF notes that in anticipation of higher rates this summer the U.S. 10-year yield has risen nearly 1 point in four weeks, “the worst bond selloff in such a short period since 1987”. In turn, this has led to, “significant profit-taking in other asset classes such as equities and commodities in anticipation of slowing economic growth and permanent higher bond yields.”

NBF says that if history is any guide, the correction of close to 10% in the major North American stock indexes will be followed by a nice rebound, “since a strong world expansion and low unit labour costs are likely to deliver double-digit earnings growth in the foreseeable future. However, a reduction of Middle East tensions and a stabilization of the bond market are needed to sustain the rally.”

Still, NBF is sticking with year-end targets of 1,225 for the S&P 500 and 9200 for the TSX, and a recommended 60% weighting of equities (compared to 50% neutral). “A failure of bond yields to stabilize in the coming weeks or an acceleration of labour costs could prompt us to scale down our equity exposure,” the firm cautions.

As for asset allocation, NBF continues to overweight resource stocks. “We think China will manage a soft landing and the U.S. dollar will soon resume depreciating. However, taking the 1994 experience as a guide, we are staying underweight in cyclical sectors exposed to the U.S. economy such as homebuilding, construction materials and autos and parts.”

“Since the removal of U. S. monetary accommodation will not lead to a drastic deterioration in global demand for commodities or in the valuation of base metals stocks, we remain confident that Materials industries such as mining and aluminum should be overweighted,” NBF concludes.