Although third quarter corporate earnings for firms listed on the TSX surpassed its expectations, CIBC World Markets says it is increasingly worried about the durability of earnings.

In its latest Quarterly Earnings Report, CIBC says earnings surprised on the upside in the third quarter coming in at an estimated 27% above last year’s level, and nearly double its earlier expectations.

“Once again, energy stocks led the earnings parade, single-handedly accounting for half of the rise in index earnings, more than triple the sector’s weight in market capitalization. Over the first three quarters of the year, energy stocks continue to dominate index earnings, accounting for close to two thirds of the rise,” it says.

However, the firm warns that it is “increasingly concerned about the sustainability of earnings growth in light of the already 20% plus appreciation in the Canadian dollar and the likelihood of a further rise to 80¢ next year.” As a result, it has materially lowered its outlook for earnings momentum over the next three quarters.

It forecasts further declines in the materials and Industrials sectors extending into 2004 as margins get squeezed the exchange rate.

CIBC notes that Canadian firms continue to outperform U.S. earnings. “While third quarter S&P 500 earnings have come in much stronger than expected, the 21% third quarter rise will still trail the TSX number. For the first three quarters of the year as a whole, TSX earnings are up 41% over last year while S&P 500 earnings are up only 15% from same period,” it says.

“In currency-adjusted terms, the TSX has massively outperformed the S&P 500. The 20% appreciation of the Canadian dollar has offset the entire own-currency rise in New York, leaving year-to-date returns for the S&P 500 marginally negative in Canadian dollars.” Compared to the S&P, TSX earnings have been particularly strong for financials, but weaker in the materials and industrial stocks.

However, it expects TSX earnings to slow sharply in the first half of 2004, as the full impact of the higher loonie hits. It says the first two quarters should see negative year-on-year momentum before added Bank of Canada rate cuts succeed in reining in the currency and turning things around.

That should pave the way for a modest rebound in valuations and bottom line performance along with GDP growth in the second half. “Even with a pickup beyond mid-year, we expect TSX earnings next year to grow at only about a third of 2003’s forceful pace,” it says.

CIBC also notes that the TSX remains modestly expensive if valuations are judged by 4-quarter forward P/Es, with stocks valued at over 17 times leading 4-quarter earnings, compared with the historic average of around 16.5. “

It says that materials have now replaced Information technology stocks, as most expensive sector in the market, with valuations now trading at over 70 times the next four quarters’ earnings. It adds that infotech and industrial stocks aren’t much cheaper.