National Bank Financial is recommending investors underweight Canadian stocks and shift their assets to cash.

Earlier this month, NBF cut its year end prediction for the S&P/TSX composite index to 8,600 from 9,500. The firm has also dropped its target for the S&P 500 target to 1,150 from 1,225.

In a new research report, the firm said: “The two basic reasons for our counsel of prudence: we now expect that Fed tightening will be much more aggressive than the consensus currently anticipates and that earnings growth will be revised down on both sides of the border.”

“Also, commodity prices are vulnerable to a shift of sentiment on the U.S. dollar.”

NBF is now advising investors to underweight Canadian stocks. Its model portfolio has 20% in Canadian stocks, compared to a benchmark weighting of 25%.

It previously overweighted this asset segment, recommending a 30% allocation. With little else appealing in this market, NBF is boosting its recommended cash position to 20% from 10%.

On a sector basis, the brokerage firm now recommends overweighting of defensive sectors such as consumer staples, and underweighting resources, “due to our expectation that increased Fed hawkishness will limit the downside risk on the greenback and induce many hedge funds to take profits on some currencies and commodities (bullion, oil, nickel, etc.).”

“Though our long-term story on China remains bullish, at least for now, any slowdown of U.S. consumption due to more-aggressive Fed rate hikes will affect China’s economic growth in 2006, since exports account for 38% of its GDP,” it adds.

“We now recommend underweighting financials as well. If the past is a guide, a restored risk premium will create a hostile environment for capital markets, which are an important source of bank earnings,” NBF concludes.