There is less risk in stocks listed on the Toronto Stock Exchange than in U.S. markets says National Bank Financial’s Economic and Strategy Team.

In a new report, Clément Gignac, NBF’s chief economist and strategist, notes that both Wall Street and Bay Street sell-side analysts have been revising their earnings estimates upward for the longest period on record. “Many analysts in resource sectors have been taken by surprise by surging commodity prices that have countered the negative impact of the loonie rise,” he notes. “If the IMF is right in its latest forecast for world GDP growth – 4.6% in 2004 and 4.4% in 2005, the best two-year sequence in 27 years — commodity prices will stay high given supply constraints.”

Gignac predicts that the resulting earnings strength is likely to cause Canadian equities to outperform bonds in the coming environment of rising interest rates. NBF doesn’t see U.S. rates heading higher until after the November election, with Canadian rates steady until 2005. It is maintaining a year-end target of 1225 for the S&P 500; and, 9200 for the S&P/TSX index.

“Despite legitimate concerns about early Fed tightening, we continue to overweight resource stocks. We think the Chinese economy matters more than the U.S. economy and the secular bear market for the U.S. dollar is not over yet. However, if the 1994 episode of Fed tightening is a guide, some other cyclical sectors, such as homebuilding, building materials and autos and parts, should be underweighted,” Gignac says.

“In addition, the S& P/ TSX multiple is much lower and therefore less at risk of contraction than it was in early 1994,” he says, noting that given the economic story, “the strongest world growth in 25 years – these year-end targets could be called conservative. They factor in an interest-rate environment much more hostile than that of the last two years. Meanwhile, earnings visibility and quality have improved.”

GIgnac says that fixed income assets are poised to underperform stocks like they did ten years ago when the Fed was hiking rates aggressively. And, it warns that income trusts, the big winners of the past few years, could be hit too when rates start to rise. “The recent behaviour of the trust unit indexes suggests a close correlation with bonds,” it says. “Individual investors should keep in mind that the performance of the last three years was due to an environment of declining interest rates and was exceptional for income trusts. Many of these products are too new to have been through interest-rate or business cycles.” The best (or least vulnerable) performers in a Fed tightening could be energy income trusts, he says.

Gignac also admits that there are numerous risks to its generally bullish outlook, including: geopolitical tensions in the Middle East, a sharper than expected U.S. tightening in monetary policy, and the resilience of Chinese economic growth.

“The ride could be bumpy over the next three to four months, but very strong earnings growth is likely to result in attractive returns on equities,” he concludes.

In separate report, NBF senior economist Yanick Desnoyers says that the firm is cutting its forecast for the loonie on the expectation that the Bank of Canada will be slower in tightening monetary policy than the U.S. Federal Reserve. “The prospect of a phase lag in monetary policy leads us to revise our outlook for the loonie down to an average 75¢ in 2004 (from 78¢). For 2005, when cyclical effects will begin to fade, our target is an average value of 77¢,” he says.

NBF says that the Fed could raise rates right after the November elections, but that the Bank of Canada is unlikely to tighten in 2004. “By the time it starts to do so, the Fed may have already moved more than once. Thus there will be a phase lag in North American monetary policies over the coming quarters. With the U.S. central bank moving alone, Canada-U.S. spreads will narrow substantially and the loonie will lose some of its lift,” he says.

“All things considered, the Bank of Canada can afford to hang back. Inflation is quiescent, allowing it to promote investment in productivity without compromising its ultimate objective of inflation control.”