The Canadian stock market’s recent strength is so tied to high oil prices that oil price weakness could easily trim 1,200 points from the S&P/TSX Composite Index, suggests National Bank Financial.

“A run-up of almost 50% in energy stocks has led the Canadian benchmark index to a gain of 15% over the year to date, in striking contrast to the U.S. market,” NBF notes in a new report. The Canadian equity market now boasts a five-year return superior to that of the US market, for the first time in 20 years, it says.

This outperformance has occurred despite the fact that Canada’s productivity growth is well behind that of the U.S. “The main reason for the North American divergence, other than Canada’s much more expansionary monetary policy, is the weight of resources in the Canadian benchmark. Energy alone accounts for 25% of its total capitalization,” it notes.

“The $15 rise in the price of [crude oil] to above US$60, seen by many as a structural phenomenon resulting from China’s rapid industrialization, has raised analyst expectations for the price of oil in the medium term. The consensus for 2007 has risen to $42 from $25,” it reports.

“If, as we expect, both global and Chinese economies decelerate in 2006 and spot oil prices fall accordingly, analysts could lower their assumptions about the price of oil. That could easily deflate the energy-heavy S&P/TSX by 1,000 or 1,200 points,” it says.

“Though the year-end S&P/TSX target of 8,600 that we set in January — on an assumption of oil at an average $40 a barrel and a more aggressive North American monetary policy — seems unlikely to materialize, our new 12-month target of 9,600 reflects our discomfort with the current exuberance of the Canadian market,” NBF concludes.