Sustained selling pressure over the next six months will erase two years of gains on the Toronto Stock Exchange before the S&P/TSX composite index comes back to finish the year at the 13,000 mark, notes a new CIBC World Markets report.

In a research note published today, the firm says it is cutting equity exposure on expectations that markets have further to fall in the short term.

It warns that the TSX faces the prospect of, “sustained selling pressure over the next quarter and possibly as long as the next six months.”

CIBC World Markets predicts that the S&P/TSX index will see a mid-year low of 11,000, followed by a 2,000 point recovery over the second half of the year. It sees the index climbing back to the 13,000 mark by year-end.

“With the subprime mortgage issue largely behind markets in 2009, and still strong growth in overseas economies, an energy and resource-based TSX should be in position to rally further in 2009,” it adds.

In addition to these revised targets for the TSX, it is also revising its call for interest rates. “We are lowering our forecast of the federal funds rate by 100 bps to 2.5% by year-end, following today’s surprise 75 bps announcement. We expect to see a succession of 50 bps cuts over the next two meetings.” Additionally, it expects to see the Bank of Canada also cut rates aggressively with the overnight target rate expected to fall to 3%.

As a result of its changed outlook, the firm is also shifting nine percentage points of its asset allocation weighting from stocks to bonds. Prior to today’s announcement, it was nine points overweight in stocks at 65%, and five points underweight in bonds at 33%. Its new mix gives it a market weight to stocks, an overweight to bonds, and it remains underweight in cash.

“While our new index weighting in equities is still vulnerable to short-term corrections in North American stock markets, it reflects our longer-term optimism about both global energy and resource markets,” it says.