The recent upswing in North American equity markets looks vulnerable to being partially clawed back, according to a new report from CIBC World Markets.

“Those still on the sidelines needn’t fear that they missed their opportunity to jump on board,” says Avery Shenfeld, chief economist, in his latest Canadian Portfolio Strategy report. “Markets appear to be in growing danger of running ahead of the fundamentals.”

Shenfeld’s caution on equities markets reflects many factors including the “high potential” for more damaging economic news. “March’s horrible jobs numbers and onerous debt levels suggest U.S. consumers — a key driver of past recoveries — continue to face powerful headwinds. Aggressive fiscal stimulus will help in some countries, but that will take time.”

He also points to poor profit visibility in the near term with TSX earnings likely to fall 25% in 2009.

Additionally Shenfeld cautions there is no single strong driver that could further propel the recent rally.

“Even if the TSX avoids a retest of March’s low — as seems increasingly likely — a slower climb back would limit the rewards from rushing back heavily into stocks immediately, as opposed to waiting for at least some evidence that the worst is over for earnings and that macro stabilization efforts are starting to work,” Shenfeld says

Recent news, particularly for employment, has led Shenfeld to pare back a number of key estimates. Among them is Canadian real GDP which he expects will decline by 2.7% by year end, down from an earlier estimate of a 2.1% drop. This compares to negative 2.9% growth stateside, and a 1.5% fall for global GDP, both also weaker than previously thought.

A modestly paced economic recovery in 2010 could take the S&P/TSX composite index to his target of 10,500 by the end of next year, but the near term risks of a correction have Shenfeld advising a somewhat conservative investment tilt in his model portfolio.

While remaining two percentage points underweight in equities, he has trimmed his cash overweight position by a point and shifted those funds into bonds.

Shenfeld is “waiting at least until the upcoming earnings season is done before adding weight to equities as a whole.” Similarly, he is only neutral weighted in the energy sector this far ahead of a global economic rebound. “Although the need to tap ever costlier supplies in the future make us longer-run bulls on oil, prices have already enjoyed a fair relief rally, given the recession’s ongoing hit to demand. Inventory levels, moreover, remain high,” he says.

Shenfeld has added two percentage points of exposure to the technology sector, and has moved to a neutral stance in telecoms from a previous underweight position. “Canadian firms appear relatively well-positioned to benefit from the ongoing shift from expensive, feature-laden personal computers, to smartphones and other smaller, ultra-portable devices. Recent reports from some industry leaders also suggest profit margins are bearing up well.”

Within the materials sector, Shenfeld has added weight to the agricultural chemicals/fertilizer group at the expense of golds. “Although we expect a tilt in market expectations, away from deflation to inflation to support bullion prices and gold in the longer term, reduced market volatility has dimmed gold’s luster in the last month,” says Shenfeld.

He adds that “food demand is relatively unlevered to a weak economy and we also expect Canadian fertilizer producers to benefit from important ongoing changes in global food consumption patterns and efforts to boost crop yields. That makes the sector a potentially good longer term investment.”

IE