Although doubts about the timing and strength of the economic recovery could see equities flat or in a further correction this summer, prospects for solid gains remain for the next 18 months, suggests a new report from CIBC World Markets Inc.

“Only the most nimble market timers should think about going underweight equities at this point in the cycle,” says Avery Shenfeld, CIBC’s chief economist, in his latest Canadian Portfolio Strategy report. “There’s enough upside over the 18-month horizon to stay benchmark-weighted, and anything more than a 10% further correction would represent a good opportunity to add weight.”

One positive Shenfeld sees for stocks is that Canadian households and businesses are flush with cash. The extra money held by individual Canadians is likely to find its way into equities, he says, while high liquidity levels for companies “reduces [their] sensitivity to recessionary financial strains” and will enable them to tap “capital markets to boost sales and profits in the future when the economy turns.”

Further supporting a renewed equity rally by yearend is the continuing determination of central banks to add liquidity, says Shenfeld. And historical sensitivities suggest further upside to stocks following the rapid growth in recent quarters of the M2 money supply, which measures cash outside banks as well as personal and other deposits. “Policy-makers haven’t exhausted the options available to provide additional stimulus if necessary and investors are rightly rejecting the worst case scenarios kicked around earlier this year.”

Another positive for equities is that corporate earnings may have seen their worst. “The good news south of the border is that the earnings picture is looking a bit less ugly,” says Shenfeld, pointing to more positive estimates for the upcoming quarter and present year, following a better-than-expected Q1 performance by S&P 500 members.

In Canada, Shenfeld says consensus earnings this year now appear “sufficiently conservative” so that “we should see some modest upside surprises in the second half.”

He notes the consensus sees TSX earnings falling 27% in 2009 — a “sobering number but less severe than the 80% drop incurred in the debilitating 1990-91 recession, when a runaway currency slammed exporters, a risk that looks less likely after the recent cooling off in the Canadian dollar.”

Shenfeld also notes that “while year-on-year earnings growth for the TSX composite index is unlikely to show a positive handle until Q4, matching the consensus call for a 33% drop off in Q2 would nonetheless represent an improvement over Q1’s 43% year-on-year decline, the probable low point for the current cycle.”

And more important, says Shenfeld, is that “longer term valuation metrics still show ample headroom for equities, even if the first year of expansion proves to be as tepid as we suspect.”

Elsewhere in the report, Shenfeld sees specific upside in telecommunications services stocks. “Multiples in the sector remain relatively affordable in historical terms and the four largest players all surprised to the upside in the latest earnings reporting quarter. Wireless data represents the largest area of growth. While that product line is not immune to the recession, the sharper than warranted decline in wireless valuations on such concerns has created a buying opportunity.”