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ECONOMY: CIBC predicts dollar parity with US greenback by end-2007. Not everyone agrees.

            (AlbertaIndex, June 4, Monday) --- As the loonie surged past US$0.943, its highest level in nearly 30 years, a major Canadian bank has bravely predicted the two currencies to be equals by end-2007.

            A rise in the Bank of Canada's interest rate, combined with stronger-than-expected economic growth will drive the Canadian dollar to parity with the US dollar by year-end, said CIBC World Markets’ latest Canadian Portfolio Strategy Outlook report.
           
“Between red-hot commodity and energy markets and huge capital inflows associated with an avalanche of M&A deals, the Canadian currency has plenty of octane left to take a concerted run toward parity against the greenback and hold it into at least the first quarter of 2008,” said Jeff Rubin, CIBC’s chief strategist and chief economist.
            “With the national jobless rate plumbing 30-year lows and core inflation now bobbing above the Bank of Canada’s target range, our earlier assumption of the Bank of Canada intervening against a further rise in the Canadian dollar with rate cuts, no longer seems tenable.”
            Mr Rubin said that not only is the bank unprepared to intervene against the currency, but he believes it will likely welcome a further rise in the Canadian dollar.
            “The bank has already indicated that it expects to raise interest rates shortly. How much rates will actually rise remains to be seen. With the Fed still likely to cut rates in Q4, we now expect the Canadian dollar to climb to parity with the US dollar by year-end and remain in that range over the first half of 2008.”
            But not everyone believes the loonie will reach parity. Some economists have argued that the currency has now peaked or is near peak, and will soon descend all the way back to US$0.80.
            Others have pointed to one of Mr Rubin’s previous bold call for the loonie to reach US$0.50 in 2001 and 2002 as it slid to a record low of US$0.61. Instead, the Canadian currency surged, and has generally been on an upward track against the greenback.
            In line with its prediction, CIBC World Markets is adjusting the asset mix in its Canadian Portfolio Strategy. It is moving three percentage points of weighting from bonds to cash. It expects returns from the Canadian fixed income market to be negligible this year and with the curve likely to remain inverted after a bank rate hike, cash yields are likely to exceed those from bonds over the next quarter.
            The bank said it remains 12 percentage points overweight equities. Last month’s 600-point rally in the TSX Composite has CIBC World Markets well positioned to hit its 15,000 TSX Composite target by year-end. This will yield an 18.5% total return in 2007.
            With resources accounting for 44% of the index’s market cap compared to a seven per cent share for secondary manufacturing, the TSX is much less vulnerable to the effects of a parity exchange rate than the Canadian economy, particularly when the loonie is being driven up by rising resource prices.
            All indications suggest that M&A activity will continue to run at a feverish pace this year, once again playing a key role in driving the TSX higher.
            Canadian merger deals, on average, have carried more generous buyout premiums than the global average, owing to the concentration of Canadian deals in the mining industry, said the CIBC report.
            Mining accounted for 27% of the merger deals involving TSX-listed firms last year, the most of any market group and remains the focus of merger activity with another C$43 billion of announced deals in the last month alone.
            The report notes that another factor that could boost merger premiums is the growing prevalence of hostile versus friendly offers. Hostile deals accounted for 28% of all Canadian merger activity in 2007, up from 11% last year. The premium on hostile deals has averaged 35% over the last 12 months compared to only 21% for friendly takeovers.
            The greater premiums found in hostile deals arises from the need to woo shareholders against the objections of present management.
            A stronger Canadian dollar and modestly higher interest rates has required a fine-tuning of CIBC World Markets equity portfolio. The bank is taking two percentage points of weighting out of financials, returning to a market weight for banks as well as insurance companies and REITs.
            It is adding to its underweighted position in consumer stocks, particularly in discretionaries. Canadian consumers seem to have ample spending power these days, with the unemployment rate sitting at three-decade lows.
            And while US housing prices are falling, Canadian average home prices are up nearly 10% compared to a year ago.
In recognition of a stronger Canadian consumer and a stronger Canadian dollar the bank is adding one-and-a-half percentage points of weighting to the consumer discretionary group and a half a percentage point of weighting to consumer staples.
            The soaring loonie is also a big plus for retailer margins, given the high import share of the sector's product mix.
            The portfolio continues to be overweight in energy and base metal stocks.
            Mr Rubin notes that with a gain of 26% so far this year, CIBC World Markets overweight of the base metals sector has paid a handsome return in recent months. A high ongoing level of resource-centric merger and acquisition activity and expectations that the global economy will nearly match last year’s torrid 5.4% growth rate, warrant a continued two-percentage-point overweight in the sector.
            Despite some erosion in recent weeks, base metal prices generally remain well above 2006 closing prices.
Copper usage, buoyed by exploding demand in China and other developing economies, is expected to rise another five per cent this year, again outstripping mine output growth.

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