The rising Canadian dollar has CIBC World Markets overweight both stocks and bonds, but sanguine on stocks for the medium-term.

“Momentum is building in North American equity markets just as a runaway Canadian dollar exchange rate makes the outlook for 2005 earnings increasingly problematic,” say the firm’s economists in the Canadian Portfolio Strategy Outlook for December. “We are now likely to hit next year’s TSX target of 9,300 as early as the first quarter, hence we remain overweight equities in the near term.”

“At the same time, however, there is little to compel us to raise our target for next year. From tech to forestry stocks, a close to 85-cent Canadian dollar exchange rate is taking a big bite out of next year’s earnings growth,” it notes.

Also, CIBC WM economists say, “the soaring Canadian dollar is breathing new life into the Canadian bond market, as it is about to send a chastened Bank of Canada to the sidelines”. CIBC WM predicts that the Bank of Canada will forgo a rate hike at its next rate announcement. “Moreover, the long-anticipated march to monetary neutrality is on hold indefinitely, opening up more rally room at the long end of the Canadian yield curve.”

“With rate hikes about to become a thing of the past, ten-year Canada yields are heading towards 4% next year, the lowest setting since the 1950s, while long Canada yields should fall as low as 4.5%. With those targets still ahead of us, we remain overweight bonds at the expense of cash, as is our quantitative analyst,” the report says.

“Energy stocks continue to anchor our equity portfolio, with a 4%-pt overweight in the oil and gas sector. Valuations still have a nearly 20% upside in 2005 as they continue to play catch-up with cash flow,” it reports.

However, the firm has cut its overweight position on financials, “in light of growing currency translation effects on overseas insurance earnings.” And, it has lessened its underweight in materials “in light of still reasonably bullish prospects for gold”.

“We remain underweight industrials and consumer discretionaries. High-dividend stocks have outperformed low-dividend stocks throughout 2004, and with long bond yields continuing to fall next year, further outperformance is expected,” the report concludes. “We are overweight the dividend-rich telecommunications sector as well as relatively defensive sectors such as health and consumer staples.”