Tilt portfolio toward Asia: CIBC

The current rally in the Canadian stock market is a sign that investors are looking ahead to an economic recovery that has yet to materialize, according to the latest Portfolio Strategy report from CIBC.

“The rally has turned what was a very cheap market into one that’s looking a tad expensive benchmarked against 2009 earnings, with the TSX sitting at roughly 16 times 2009 earnings,” says Avery Shenfeld, chief economist with CIBC.

That, he says, warrants a “neutral, rather than overweight, position in equities” as markets could correct over the summer months.

“There’s still plenty of upside when markets get comfortable pricing in a moderate-paced recovery in 2010, but we would like to see more confirmation that an economic recovery is at hand before overweighting stocks.”

That recovery is not likely to be fuelled by the developed world, according to the report. Call it “China rising, redux” as the emerging economic superpower drives prices for raw materials higher once again. Meanwhile, neighbouring Japan and South Korea are showing stronger industrial output.

“The global economy, led by some of its more resource intensive constituents, is getting closer to an inflection point,” Shenfeld says. “There are growing signs that the market’s worst fear — a 1929-style banking system collapse leading to a Great Depression reprise — has been averted.”

To capitalize on this recovery, the CIBC economics team is increasing the already overweight allocation to resources in its model portfolio. Base metals and the fertilizer/chemicals sub-sectors each received an additional 1% allocation, rising to 5% and 5.8% respectively. That puts the base metals allocation 2% above the benchmark, while the chemicals allocation is 1.5% above the benchmark.

Getting Canada’s resources to Asia is also identified as a money-making proposition, and the industrials sector — specifically railway stock — gets a 1% boost to 2.7% of the portfolio, still 2.5% below the benchmark.

But despite the promise of increased shipping, the portfolio remains only market-weighted in energy stocks, citing untapped capacity in OPEC member states.

So where is Shenfeld trimming exposure? The consumer discretionary sector is returning to a market-weight allocation in the portfolio at 2.8%, down 3%. Utilities are also trimmed to market-weight, with the allocation declining 1% to 1.5%.

The portfolio’s recommended cash position has been cut by 2%, in favour of bonds, which remain underweighted at 37%, compared to 39% of the portfolio’s benchmark. The recommended cash position is now 13%, compared to 11% in the benchmark.

The Canadian dollar is expected to remain in the 90 cent range over the coming year. This will translate to “a leaner decade” for manufacturers that rely on the U.S. export market, as the American economy will be slow to recover.

“The loonie has pulled so sharply out of its tailspin that a recent plus for earnings performance has now become a key concern,” the CIBC report says. “If, as we expect, it still averages near 87 cents [U.S.] over the balance of the year, that will be more of a challenge to the economy than to the mix of stocks that make up the TSX.”

(06/04/09)