In its latest Canadian Portfolio Strategy Outlook, CIBC World Markets is warning that the loonie could hit 80¢, which would hurt the economic recovery.

As a result, the CIBC recommends a portfolio that is heavily overweight in bonds.

CIBC says that with its latest 25 basis point cut, “the Fed has done nearly everything it can on overnight rates to stimulate the U.S. economy.”

“It’s up to the bond market now,” CIBC declares. “Long bond yields must fall again or face the prospect of direct Fed intervention up the curve. We remain heavily overweight fixed income (55%), positioning our portfolio to catch the plunge in long bond yields, which in Canada could fall to as low as 4%.” Stocks remain weighted at 43%, with 2% in cash.

The firm predicts that if the Bank of Canada decides not to cut interest rates at its July meeting, “the loonie [could] spike as high as 80¢, creating further woes for the Canadian economy and in particular, the industrial and manufacturing sectors.”

In preparation, it its model portfolio CIBC has shifted more of its equity portfolio into “high dividend yielding stocks (i.e. telecommunications, utilities and financials) that are highly levered to declining bond yields, yet are relatively insulated from the economic slowdown.”

The sector to get the biggest boost is financials, it as raised its exposure to 36.3%, up 3.5%, compared to a benchmark weight of 33.2%. CIBC’s financial sector analysts say, “We remain cautious on the insurers given persistently low interest rates and the strong [Canadian dollar]. Compared to the U.S. insurers, Canadian insurers appear to have a stronger capital position giving them the flexibility to repurchase shares and increase dividend payouts.”

It says that the next 12 months should see attractive risk-adjusted total returns of close to 10% on REITs (excluding hotel REITs), “with current income providing most of the returns as interest rates are expected to be flat to lower. We expect yield spreads with bonds to tighten. Hotel REITs carry greater-than-average risk right now.”

It notes that the Canadian banks moderately outperformed in June, with a total return of about 3.9% (vs. 2.1% for the S&P/TSX). “Consumer confidence appears to be softening as indicated by the U.S. Michigan Sentiment Index. Personal and commercial banking remains a stable performer while wholesale operations continue to be affected by weak capital markets. Retail credit is holding well and we are seeing improving corporate credit conditions,” it concludes.

The report notes that CIBC’s market technician expects a 920-1,050 range for the S&P 500 for the balance of the year, and a 6600/7400 range for the TSX for the same period. “High beta stocks continue to swing the market around. July is typically the strongest month of Q3,” it says.