june 5, 2008 executive summary strategyresearch.cibcwm.com/economic_public/download/psjun08.pdf ·...

Executive Summaryby Jeff Rubin

Canadian Portfolio Strategy outlook

Strategy

Jeffrey RubinEconomics & Strategy

(416) [email protected]

Peter BuchananEconomics & Strategy


Avery ShenfeldEconomics & Strategy


Quentin BroadCanadian Equity Research


CIBC World Markets Inc. • PO Box 500, 161 Bay Street, BCE Place, Toronto, Canada M5J 2S8 • Bloomberg @ WGEC1 • (416) 594-7000C I B C W o r l d M a r k e t s C o r p • 3 0 0 M a d i s o n A v e n u e , N e w Yo r k , N Y 1 0 0 1 7 • ( 2 1 2 ) 8 5 6 - 4 0 0 0 , ( 8 0 0 ) 9 9 9 - 6 7 2 6

http://research.cibcwm.com/res/Eco/EcoResearch.html

Strategy's Recommended Asset Mix & TSX GICS Sector Weights

vs. Current Benchmark

Thanks to an even stronger crude market than we had forecast, the TSX is through our target and poised to set further record highs later this year.

We are raising our year-end target from 14,500 to a still moderately cautious 15,200 while maintaining our earlier 16,200 target for the end of 2009. As a result, we are adding another 2 percentage points of weighting to our equity position at the expense of our fixed income weighting.

Our 7-percentage-point overweight in energy stocks remains the foundation of our portfolio strategy, and the major reason for our model equity portfolio’s 138-bp outperformance of the TSX benchmark so far this year. WTI has averaged US$107/bbl this year and should easily meet our US$115/bbl annual average target.

Neither speculation nor the value of the US dollar is material to the oil outlook. We estimate that accumulation of “paper” barrels of oil in the hands of speculators has been, at most, one-fifth of the increase in Chinese demand for actual barrels of oil over the last five years. And even if denominated in a trade-weighted basket of world currencies, the price of oil would still have risen to over US$100/bbl.

Prospects on the gas side of the energy equation are no less appealing than our long-run outlook for over-$200/bbl oil prices. LNG imports are failing to materialize leaving the US market critically dependant on Canadian supply. At the same time, outside of a few isolated places like Alberta,

there is no new coal generation being licensed in North America. Virtually all of the increase in power capacity over the next decade will be gas-fired, sending North American gas prices well into the teens over the next several years.

We are reducing our exposure to interest rates this month, both in terms of a cutback in fixed income weighting, as well as a point reduction in interest-sensitive utilities stocks. While the Bank of Canada still has one more rate cut left, we see a minimum 100 basis points of tightening next year as Canadian inflation rates double.

June 5, 2008

“We estimate that accumulation of “paper” barrels of oil in the hands of speculators has been, at most, one-fifth of the increase in Chinese demand for actual barrels of oil over the last five years.”

ASSET MIX (%)Bench-mark

StrategyRecom-mend.

vsBench-mark

chg vs

mon. ago*

Stocks 53 57 +4.0 +2.0Bonds 38 36 -2.0 -2.0Cash 9 7 -2.0 0.0GICS SECTORS (%)**Cons. Discretionary 3.9 1.4 -2.5 0.0Cons. Staples 2.2 2.2 0.0 0.0Energy 31.6 38.6 +7.0 0.0Financials 27.0 24.5 -2.5 0.0 -Banks 15.2 13.2 -2.0 0.0 -Insur., REITs, oth. 11.8 11.3 -0.5 0.0Health Care 0.4 0.4 0.0 0.0Industrials 5.4 3.4 -2.0 0.0Info Tech 5.1 5.1 0.0 +1.0Materials 18.2 20.7 +2.5 0.0 -Gold 7.1 8.1 +1.0 0.0 -Other Metals 5.3 6.3 +1.0 0.0 -Chemicals 5.5 6.0 +0.5 0.0Telecom 4.8 2.3 -2.5 0.0Utilities 1.5 1.5 0.0 -1.0

Note: Shading indicates recommended overweight.*chg in %-pt underweight/overweight from last month.

** Benchmark weights are for TSX Composite.

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CIBC World Markets InC. Canadian Portfolio Strategy Outlook—June 5, 2008

strategyStrong Resource Earnings Cushioning Drag From Financials—Jeff Rubin and Peter Buchanan

Table 2 - Economic Forecast

The TSX has outpaced the other G-8 bourses in 2008 en route to its recent record highs. Notwithstanding the potential for some more subprime-linked volatility in the next quarter or so, Canadian stocks, and more specifically resource stocks, should remain one of the better places for exposure over the next 12-18 months. Consistent with that assessment, we are raising our end-of-year target for the TSX Composite to 15,200 and adding a further two points to our modest existing equity overweight. Our projected end-of-2009 target for the benchmark remains at 16,200. Offsetting our added equity exposure, we have lopped two more points from bonds, keeping cash steady at 7%. The likelihood that central banks in both Canada and the US will soon have to shift gears, from supporting growth to fighting inflation, limits our enthusiasm for fixed income products.

Contributing to the TSX’s traction, analysts have been raising their earnings projections north of the border almost as vehemently as they have been wielding the axe stateside (Chart 1). By virtue of its stable of resource heavyweights, the TSX is much more levered to world growth than to North America. We expect gains in the oil and gas sector and the mining and chemical-levered materials group (Chart 2) to power TSX earnings growth of some 21% this year. That’s triple the long-term rate and more than double the pace expected by the consensus for the S&P 500.

The costs of the subprime crisis will weigh for some time, with housing weakness contributing to a decline in US GDP this quarter, and likely the coming quarter as well. What has lessened

Table 1 - Equity Projections

Chart 1 - Earnings Growth Expectations: Changing Places

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"Bottom Up" Consensus, Earnings Growth in 2008 (%)

Source: Thomson Reuters

2006 2007 2008 2009TSX Composite 14,715 (5/30) 12,908 13,833 15,200 16,200

% total return 7.5 YTD 17.3 9.8 12.5 9.0

TSX Operating Earnings - index adj 726 817 989 1,108

- yr/yr % chg 10.0 (08:Q2) 12.1 11.8 21.0 12.0

S&P 500 1,400 (5/30) 1,418 1,468 1,410 1,475

-% total return, YTD (3.8) 15.8 5.5 (1.7) 6.8

Year-end

Latest

08Q1 08Q2 08Q3 08Q4 2007 2008 2009Canada Real GDP Growth (AR) -0.3 0.7 1.2 3.2 2.7 1.1 2.3

Real Consumption Growth (AR) 3.2 2.1 2.6 3.0 4.5 4.0 2.8CPI - Headline (y/y) 1.8 2.1 2.8 3.3 2.2 2.5 3.1 - Core (y/y) ex taxes 1.4 1.5 1.6 2.3 2.1 1.7 2.1Unemployment Rate (%) 5.9 6.2 6.4 6.3 6.0 6.2 6.2

US Real GDP Growth (AR) 0.9 -0.6 -0.4 2.9 2.2 1.2 1.9Real Consumption Growth (AR) 1.0 -0.9 0.0 2.8 2.9 1.1 2.3CPI - Headline (y/y) 4.1 4.0 4.7 4.8 4.2 4.4 4.1 - Core (y/y) 2.4 2.3 2.2 2.3 2.3 2.3 2.8Unemployment Rate (%) 4.9 5.2 5.5 5.5 4.6 5.3 5.3

World Real GDP Growth (% chg) - - - - 4.9 4.3 4.3

3


however, thanks to 325 bps of US rate cuts and the injection of billions of dollars of liquidity worldwide, is the ability of writedowns and related stresses to spark the raw fear seen earlier. The CDX Investment Grade Index’s 100-bp decline is one of several signs that investors are no longer shunning risk as assiduously as they were two or three months ago (Chart 3).

As credit fears gradually relinquish center stage, those on another front, inflation, are coming to the fore. A two-decade era of exceptional tranquility on that score is coming to an end. Inflation stateside is now low only for those prepared to ignore what is staring them in the face—soaring food and energy costs. And even excluding those two pressure points, it’s running a bit above the Fed’s presumed target. The high loonie has helped to keep prices in check north of the border, but even there, the latest readings hint at trouble ahead.

Globalization Now Boosting Rather Than Taming Inflation

Threatening to amplify inflation concerns, ironically enough, is the force that once kept it on ice—globalization. The aspiration of third world consumers for first world levels of car ownership and meat consumption has helped to set prices for energy and agricultural products on fire.

In today’s world of triple-digit oil, distance increasingly costs money. The already visible impact of food and energy costs on headline inflation is going to get a further unwelcome boost as exploding transport costs remove what has been the single most important brake on inflation recently—wage arbitrage—with low cost emerging markets like China. The more than doubling in shipping costs from Asia to the US since 2000 is already penalizing low-value-per-ton imports like steel. A further doubling in those costs in the next five years as oil surpasses US$200/bbl will amplify the pricing power of domestic producers and labor, across a broadening swath of sectors (Chart 4).

Capping returns from bonds, investors will be surprised at just how abruptly monetary policy changes course when this happens. Although lingering economic concerns could see a final 25-bp cut, we expect rates in the US to rise by a full 200 bps and those in Canada by

strategyChart 2 - Strong Resource Profits Offsetting Financials Headwinds

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Chart 3 - Easing Credit Market Fears Buoy Cdn Stocks

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Chart 4 - Transport Costs Highly Sensitive to Oil Prices

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strategyas much as 100 bps over the course of 2009 (Chart 5), as banks withdraw recently extended stimulus.

REITs, banks and utilities stocks ordinarily underperform the broad market during periods of rising interest rates (Chart 6). In fact, REITs and bank issues have been even more sensitive to rate changes than longer maturity government bonds. We have consequently retained our underweight on those sectors while scaling back our exposure to the utilities group. Although utilities stocks posted decent results in the latest reporting period, the group faces growing headwinds, as noted below. Offsetting that move, we have taken off our previous underweight on info techs. That sector looks less expensive on a forward PE basis due to strong recent earnings growth. Reducing vulnerability to the high C$, demand for tech products is also not as price sensitive as demand for many traditional manufactures.

Rising yields would not normally be good news for stock valuations, but the threat from that quarter may not be as large as it might otherwise be. One reason is that stocks are very attractively priced relative to bonds, reflecting the fact that earnings growth in this rally, unlike the late 1990s’ tech bubble, has largely kept pace with valuations. More specifically, the gap between the TSX earnings yield and the yield on 10-year Government of Canadas at just over 300 bps is close to its highest level on record (Chart 7).

Table 3 — Valuations & Earnings Growth by Sector

Chart 5 - Canadian CPI & Interest Rates Set to Climb

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%Forecast

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Chart 6 - Equities Most Sensitive to Interest Rate Hit

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4-Qtr Fwd IndexEarnings Level Current Last Decade 2005 2006 2007 2008 (f)

Financials 133.1 1773 13.3 12.0 13.8 17.3 11.3 -4.7Energy 299.3 4002 13.4 12.0 45.4 8.5 7.9 59.4Industrials 73.1 1383 18.9 14.9 28.1 12.8 40.2 -24.8Health Care 24.9 364 14.6 22.0 5.3 29.2 -38.8 6.5Telecommunications 62.3 928 14.9 29.8 5.9 30.8 28.4 -10.6Consumer Discretionary 70.8 1071 15.1 15.7 2.3 18.2 12.5 -1.8Consumer Staples 99.1 1524 15.4 17.8 2.9 -1.2 -1.5 -1.0Utilities 127.6 1966 15.4 17.4 17.9 -1.6 52.7 4.2Materials 197.4 3513 17.8 28.9 40.7 81.0 -2.5 76.9Info Tech 16.3 452 27.8 44.5 -40.1 47.0 154.4 64.0TSX Composite 989.0 14715 14.9 16.1 31.2 12.1 11.8 21.0

Forward PE

Note: Indexes as of May 30th; 4-qtr fwd earnings are proj. 08:Q1 thru 08:Q4

TSX Op. Earnings (% ch)

5


strategyCommodity stock prices have lagged resource prices of late, with oil stocks up by 20% this year versus a 30% rise in oil itself. Mining stocks have also lagged metals prices in recent years. The belief that a good deal of the run-up in oil and other commodities is due to speculative froth and therefore unsustainable has contributed to this divergence, but how valid are such claims?

At nearly US$4 trillion per year, the global oil market’s sheer scale—about twenty times the value of global commodity index investment—is itself a barrier of some significance to market-moving speculation. One way of gauging the role of speculation is to look at the effective diversion of physical supply that would be needed to match the historic rise in speculators’ holdings. Non-commercials’ long positions for crude oil and oil products have risen by the equivalent of 848 million barrels in the last 5¼ years. Impressive as that number may sound, it works out to an increase in exposure of merely 500K barrels daily—a fifth of the rise in Chinese demand over the same period (Chart 8).

And those are only “paper” barrels of oil. If hoarding were raising prices, inventories should be rising but in fact they are not. Oil inventories remain within their longer-term range of 50-55 days of supply. And oil producers do not appear to be deliberately leaving crude in the ground, running instead close to capacity.

The claim that the rise in commodity prices is largely just the inverse of US$ weakness also seems dubious, since oil has risen strongly against other currencies. Indeed, we estimate that oil would still cost US$100—five times its 2002 level—even if the US dollar had not declined against a trade-weighted basket of other currencies (Chart 9).

Table 4 — Commodity Price Forecast

30-May 2005 2006 2007 2008 (f) 2009 (f)

Oil (WTI) $/bbl 127 57 66 72 115 130

Natural Gas (Henry) $/Mn Btu 11.45 8.89 6.73 6.97 12.50 14.00

Gold $/troy oz. 886 444 604 695 1000* 1100*

Copper $/lb 3.66 1.67 3.06 3.24 4.00 4.25

Aluminum $/lb 1.31 1.23 1.17 1.20 1.30 1.00

Nickel $/lb 9.98 6.71 10.98 16.86 11.00 9.50

Zinc $/lb 0.90 0.63 1.48 1.48 1.00 1.05

*Year-end

Average

*848 million bbl rise in speculator’s long crude & oil product exposure since 2003, converted to daily terms

Chart 8 - Role of Speculation in Oil Market Modest

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Source: CIBC WM, Masters Capital Management

Chart 7 - Earnings Yield vs 10-Year Bond Gap at Near-Record Level

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strategyLong Oil, Exporters Having Trouble Meeting Rising Thirst

Glancing at some key sectors, energy stocks are still being valued on a per barrel crude price of around US$90 per barrel, far below the prevailing spot price. That group consequently remains our top candidate for exposure with a recommended 7% overweight. Consumers will cut back on their oil consumption only in markets where they are exposed to price signals. Demand destruction in the US, Japan and Europe will consequently continue to be more than offset by growth not only from the BRIC countries, but highly subsidized consumers in many Middle Eastern countries. Delays by countries like China in aligning domestic with global prices also constitute a demand-boosting subsidy. Infrastructure demand from May’s earthquake will also boost the need for diesel power and oil demand there, potentially for the next several years.

The latest data, moreover, appear to add substance to our earlier fears that runaway domestic demand is cannibalizing production in the traditional oil-exporting countries, limiting their ability to meet the needs of an increasingly thirsty world. According to the US Department of Energy, shipments of petroleum products by the world’s top 15 oil exporters fell 2.5% in 2007 and the weakness appears to be carrying over into the present year.

Natural gas remains cheap relative to oil. Gas-fired power, moreover, is only about half as CO2-intensive as coal, and has much shorter lead times than nuclear, making it the logical candidate to fill the capacity gap left by canceled coal generation plans, as global warming concerns grow. Given support from these factors and gains in oil, we expect gas prices to average US$12.50/MnBtu this year and US$14/MnBtu on average in 2009. Demand in the Middle East itself for natural gas is also rising for both subsidized electricity generation and desalination, and the cap that places on the region’s LNG exports could also help to lift North American gas prices over the longer term.

Each dollar-per-barrel increase in the price of oil lifts earnings in the TSX oil and gas group by about 3%, giving the long-standing correlation between oil and natural gas prices. Our forecast for an average oil price of US$115/bbl

Table 5 - Fixed Income & Exchange Rate Projections

Chart 9 - US$ Weakness Accounts for Less Than One-Fifth of Oil’s Rise

*currencies & weights are the same as those used in the Fed’s broad US$ index

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Year-End

2007 2008 2009

B of C Overnight Target (%) 3.00 2.75 2.75 4.25 2.75 3.75

2-Year GOC 3.02 2.85 2.85 3.75 3.10 4.15

10 Year GOC 3.71 3.65 3.60 3.99 3.75 4.25

30-Year GOC 4.13 4.10 4.10 4.10 4.25 4.60

S&P TSX Cdn Bond Index (% YTD total return) 2.5 2.9 3.9 3.8 4.0 2.8

Fed Funds 2.00 2.00 1.75 4.25 1.75 3.75

10-Year US Note 4.06 3.90 3.80 4.03 3.95 4.60

C$ in US cents 100.7 101.5 104.7 100.2 105.0 101.5

US$/EUR 1.56 1.57 1.62 1.46 1.56 1.50

Yen/US$ 106 104 104 112 106 94

Jun 30/08

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7


this year and US$130/bbl next year consequently points to strong continued momentum in industry earnings.

Financial sector earnings slowed sharply in the quarter just ended, and we expect results for the year as a whole to be off 5%, the first drop since 2002. While subprime-related troubles are increasingly well factored into share prices, there are other reasons for caution on the outlook. We are consequently keeping our 2.5%-pt underweight recommendation on the sector. Banks’ loan loss provisions jumped 74% year-on-year in the most recent period (Chart 10). The historical evidence points to several more quarters of the same, as the softer economy affects credit quality. A flatter curve threatens to squeeze interest margin income. The financial sector has been one of the most susceptible to higher interest rates. Vacancy levels in commercial real estate, looking at another critical financial subgroup,

are at five-year lows. Healthy property markets are being offset, however, by difficult financing conditions for many firms due to recent credit troubles.

Agricultural Bull Still Has Life, Supporting Materials Outlook

We are also maintaining our overweight of the materials group, the TSX’s second best performer after energy this year. Led by fertilizer producers, the chemical sector has paced that group’s advance with a 30% return so far in 2008. Contributing to strong demand is the shift by consumers in China and India to a protein-rich diet. Potash spot prices have now breached US$1,000/ton and are likely to climb further, since any material rise in global capacity is at least 5 years off. Base metals prices have ceded some of the early-2009 steep run-up, but remain well above break-even costs. Fundamentals for copper look particularly solid. Real interest rates in China are negative, pointing to continued growth in a key market, and massive earthquake reconstruction should also help to lift metals demand.

Higher ocean freight costs, meanwhile, are helping North American producers of costly-to-ship products like steel. While acquisitions have reduced the number of TSX plays in that sector, the remaining handful have been strong performers so far in 2008. The recent correction in gold, meanwhile, could present a buying opportunity. Inflation is poised to rise on the back of costlier oil and food, and central banks are also likely to be reluctant to keep allocating so much capital to US assets.

Cutting Utilities on Climate Concerns, Rate Outlook

While energy and materials stocks remain preferred areas for emphasis, we are removing our percentage point overweight on the yield-sensitive utilities group. Although rising Western Canadian power prices bolstered earnings in the sector in Q1, moves to price carbon will raise costs, especially for producers with appreciable coal-based capacity. Power rates are also politically sensitive in many areas. Efforts to keep producers from fully passing along their rocketing fuel costs to retail consumers could also consequently limit earnings growth in some jurisdictions. At the same time, we have opted to remain underweight another dividend paying sector, the telecoms. Earnings in that sector are likely to decline in 2008, a dramatic turnaround from the near-30% gains of the last two years. Efforts to promote competition by reserving spectrum for new players could squeeze margins in that lucrative segment. High broadband saturation levels limit growth prospects on the internet side.

strategyChart 10 - Loan Loss Provisions Could Rise Further Given History & Softer Economy

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strategy

HISTORICAL PERFORMANCE: CIBC WM BENCHMARK AND ASSET CLASSES

(2) Market benchmark weight is the actual mix for stocks, bonds and cash held by the broad base of pension funds, segregated funds, mutual funds and insurance companies. This totals about $1 trillion of which pension and mutual funds are the biggest (45% & 37%) with life insurance and segregated funds at 11% & 7% respectively. The cash, stock and bond breakdown varies significantly among the 3 basic components such that the benchmark for any of the 4 categories may vary significantly from the published aggregate (eg. equities can vary from 10% for life companies to 75% for the other 3 categories). Data is Statistics Canada/Bank of Canada published data updated to current based on correlation analysis from the most recent partial actuals. The total return for the index will differ slightly from the summed weighted return for the sectors due to the weight shifts on a day-to-day basis.

(3) Equities by GICS sector benchmark weights are TSX data. Sector index levels are total returns.

All Asset Classes TSX Only

(1) Total return for the recommended portfolio is the index return multiplied by the individual asset mix or sector weight recommended by Economics & Strategy. Recommen ded portfolio weights for the current month appear in the front table.

PERFORMANCE OF STRATEGY PORTFOLIO VS BENCHMARK

Asset Classes 2007 2008 YTD Last 3 Mos.Stocks (TSX Composite Total Return Index) 9.83 7.51 9.07 -Strategy Equity Portfolio 9.09 8.89 9.39Bonds (Bloomberg Cda Bond Index) 3.84 2.54 0.14Cash (1-Month Bills) 4.07 1.16 0.60Total Market Benchmark(2) 7.22 5.00 0.36 -Total Strategy Portfolio 7.20 5.18 5.19TSX Stocks by Sector (Total Return) (3) 2007 2008 YTD Last 3 Mos.Consumer Discretionary 4.22 -16.25 -1.31Consumer Staples -5.34 -3.05 7.21Energy 8.23 21.93 20.02Financials -1.63 -3.05 4.39 -Banks -6.84 -1.15 3.75 -Insurance, REITS, others 5.20 -8.07 0.96Health Care -24.25 -3.24 2.20Industrials 10.51 11.08 9.88Info Tech 48.22 14.67 26.97Materials 30.26 13.33 -0.53 -Gold 5.73 9.23 -12.36 -Other Metals 16.51 10.62 1.30 -Chemicals 113.26 29.55 21.25Telecom 19.87 -5.36 5.61Utilities 11.89 0.88 3.84*as of May 30/08

Total Return (%)*

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equIty researCh

TSX SECTORAL VIEWS BY FUNDAMENTAL EQUITY RESEARCH ANALYSTS FOR JUNE 2008

Consumer Discretionary – B. BekCanadian media performance has been solid in H1/2008, but forward tone is more cautious, as US recessionary concerns have begun to creep into the Ontario economy. As expected, specialty TV remains strong as advertising dollars and subscription increases continued their fast pace. Newspapers continue to struggle, especially in Metro markets. Internet advertising remains a small piece of the overall advertising pie in Canada, but is growing materially. Conventional TV remains an issue, although conventional TV players in Québec are benefiting from the uncertainty surrounding TQS (Bek: Communications & Media – Market Weight).

Canada’s wireless penetration, at 62% (year-end 2007), still suggests that plenty of growth remains in the Canadian wireless market. While the new entrant risk is real, we believe that growth remaining in the Canadian wireless industry is significant and should be enough to absorb the emergence of new competitors (Bek: Telecommunication & Cable – Market Weight).

Consumer Staples – P. CaiccoSo far, 2008 looks like it could be the worst year for the Canadian consumer in over a decade. Our major trading partner is entering the early throes of a recession and our ability to sell to the Americans has been hampered anyway by the strong Canadian dollar. On top of that, Canadian retailers are facing fierce new U.S competitor-driven Supercenters, bringing a new level of price competitiveness to the market. Combine this with rising costs, and margins will be pressured (Caicco: Merchandising & Consumer Products – Market Weight).

Energy – R. Plexman, M.Bridges, B.Borggard, W.Lee & J. FetterlyWe believe that a powerful combination of fundamental and financial factors will keep oil prices high. We raised our WTI oil price forecasts for each of 2008 and 2009, as of April 27, from US$90.00/Bbl to US$105.00/Bbl. And with the turnaround in North American natural gas markets unfolding sooner than we had been expecting, we raised our AECO price forecasts from US$8.00/Mcf to US$9.00/Mcf and our Henry Hub price outlook from US$9.00/Mcf to US$10.00/Mcf for each of 2008 and 2009 (Plexman: Oil & Gas–Large Cap – Overweight).

While the recovery in natural gas prices in recent months is a positive sign, we believe improved pricing will need to continue for several more months (likely through the spring) before translating into increased capital spending from producers and improved activity levels for oilfield services companies (Fetterley: Energy Equipment Services – Market Weight).

With the group trading at an average 2008E EV/DACF multiple of 5.7x and a P/NAV premium of 30%, from a long-term perspective, we believe the sector is reasonably valued at current levels (Bridges, Borggard and Lee: Oil & Gas Junior E&P – Market Weight).

Financials – D. Mihelic, R. O’Reilly, A.AveryWe expect banks’ earnings growth to slow considerably relative to prior years due to higher loan loss provisions and weaker capital market-related earnings (Mihelic: Banks & Lifecos – Market Weight).

The weakness in Canadian REITs belies the healthy, strong fundamentals of the sector in Canada. Canadian economic growth is expected to remain positive in 2008. Vacancies are at record lows and new commercial space completions will be very low. Availability of debt financing, albeit reduced and confined

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to conventional mortgages, is still sufficient to provide for REITs’ and other conservative investors’ needs (O’Reilly, Avery: Real Estate – Overweight).

Health Care – M. ParisMore than 90% of the S&P/TSX Health Care Index is now driven by just three stocks, so company-specific news should continue to drive sector performance more so than broader macro trends. We maintain our Market Weight sector weighting, as we view the risk/reward profile for Canadian health care stocks as balanced (Paris: Health Care – Market Weight).

Industrials – M. Willemse, J. BoutNorth American vehicle sales have begun to show softness due to a variety of economic headwinds. Until US auto sales show signs that they have hit bottom, the US economy shows signs of a rebound, and the Canadian auto suppliers report favorable results with the high Canadian dollar, we believe investors may hold a cautious view on Canadian auto-related equities. Valuation multiple contractions are likely to occur prior to a recovery in the sector (Willemse: Automotive – Market Weight).

Our Market Weight rating reflects the strong fundamentals in the steel sector offset by the potential for economic headwinds and rich valuations on peak earnings. Our only concerns for the sector would be related to a stabilization in steel prices, which may cause some momentum players to exit the industry. Steel prices have increased significantly in 2008 due to raw material cost pressures and limited import activity (Willemse: Steel – Market Weight).

Even with a soft US economy, robust growth in Asia should continue to drive demand for commodities. Barring a global recession, the outlook for the heavy equipment sector in 2008 is modestly robust (Bout: Capital Equipment – Market Weight).

Our Market Weight rating on the Canadian rails reflects the mixed outlook for the global economy (more buoyant for international markets and muted for North America) (Bout: Railroads – Market Weight).

Information Technology – P. Lechem, T. CouplandConsolidation remains one of the foremost themes of the sector, with a high level of activity from strategic buyers (looking for incremental technology, customers, geographic reach or market share) and from private equity (eyeing the highly profitable and stable annual maintenance revenue streams) (Lechem: Technology-Software – Market Weight).

While fundamentals appear relatively stable, we believe that a continued commodity price pullback and US economic slowdown could serve to limit demand. To date, major engineering and construction firms have noted record backlogs and positive outlooks going into 2008. The one exception is a US construction firm which stated that they expect a near-term slowdown in public infrastructure spending as a result of the current economic downturn and the increasing budget challenges facing state and local governments. We expect that this type of outlook could become more common if the US economy continues to deteriorate (Lechem: Business and Professional Services – Market Weight).

The technology hardware sector has started to benefit from growth in certain emerging markets and resurgence in capital spending in networking, although there may be a short-term pause given current macroeconomic conditions (Coupland: Technology Hardware – Market Weight).

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Materials – J. Bout, H. Carreau, B. Cooper, D. Roberts, C. Hale-SandersWe are using our 2009 gold price forecast of US$1,200/oz. to set our price targets. With gold prices rising much faster than the cost curve, we expect earnings figures for most companies to improve dramatically in 2008 and 2009. We believe this margin expansion will set the stage for a new influx of investors who will see the earnings power of the industry take hold while at the same time provide some degree of safety from general market mayhem (Cooper: Mining, Precious Metals – Overweight).

Into the second quarter of 2008, metals and equity markets remained volatile, with daily swings instigated by the release of various economic indicators as the market seeks direction. Indicators continue to point to a deteriorating outlook for base metals demand in the Western World offset by strong emerging market demand (Hale-Sanders: Mining, Metals and Minerals – Market Weight).

Our Market Weight rating on the sector reflects the diversity of commodities in it. We believe that a slowing US economy will negatively impact styrenics and olefin/polyolefin demand. In fertilizers, pricing momentum for the three main nutrients (nitrogen, phosphate and potash) is due mainly to the tight grain market and declining inventories. Methanol prices seem to be stabilizing, with supply/demand relatively balanced (Bout: Chemicals & Fertilizers – Market Weight).

Most companies in the Canadian paper & forest products industry are implementing plans for “cash preservation”. A key variable for investors is how much of a company’s asset base will remain intact over the next 12 to 18 months. Given the strong Canadian dollar, we expect ongoing rationalization throughout the Canadian forest products sector (Carreau, Roberts: Paper & Forest Products – Underweight).

Utilities – A. PavaoWe have raised the weighting on the Canadian pipelines & utilities sector from Market Weight to Overweight. On the pipelines side, high commodity prices, strong demand growth and shifting supply sources are creating significant investment opportunities in North America that extend well into the next decade. In power, regional jurisdictions continue to focus on system reliability in addition to expanding generation and transmission capacity to keep up with demand growth. Dividend yields, adjusted for interest rates, are at peak historical levels and are bound to attract significant cash sitting on the sidelines as the worst of the credit crisis passes (Pavao: Pipeline, Utilities & Power – Overweight).

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*“We have compiled our analysts’ views in accordance with the TSX sectoral breakdowns. We would note, however, that an analyst’s coverage universe might not correspond exactly with the constituents of the TSX sectors noted above. As such, we refer readers to CIBC World Markets “Canadian Research Review and Common Stock Universe” publication where each analysts’ specific universe is broken out. Analyst weightings are based solely on the specific constituents of that analyst’s universe and might not correspond with the constituent in the TSX sector breakdowns.”

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