CIBC World Markets has slashed its recommended income trust exposure to a market weight of 5% from 8%.

“Following last month’s weighting cut, we are continuing to shift assets out of the income trust market,” the firm says in a new report, adding that the market has been rocked by the surprise announcement from Finance Minister Jim Flaherty that he will impose a tax on distributions.

“We have moved 2%-pts of assets from trusts into high dividend-yielding stocks which are now an increasingly attractive alternative to trusts in a soon-to-be declining rate environment,” it reports. “We have also moved another percentage point of weighting from trusts to the bond market, where long duration bonds are also likely to benefit from the flow of funds out of the trust market.”

“Notwithstanding those adjustments we still hold a market weight in trusts, based on the sector’s leverage to expected interest rate declines, and may add to that weighting in the future should the current sell-off leave attractive valuations in its wake,” it counsels. “Within the trust market we remain heavily overweight REITs, which have not only led market performance but which are largely exempt from the recent federal announcements.”

The report also suggests that “fears of potential contagion effects from a crumbling housing market should prompt as much as 75 basis points of Federal Reserve Board easing over the next 12 months.”

“We expect even greater reductions in Canadian interest rates, as further gains in energy prices will continue to put upward pressure on a Canadian dollar whose recent appreciation has already brought economic growth in central Canada to a standstill,” it says. “A 100 bps reduction in overnight rates should see long Canada yields fall to as low as 3.5%. Consequently, we are moving 2% of our portfolio that was in cash, to the bond market where we are long duration.”

“With two-thirds of market cap in either interest sensitive stocks or energy stocks, the TSX seems made to order for an environment of rising energy prices and falling interest rates,” it says. “Our 12-month target for the TSX of 13,500 implies a total return from stocks in the neighborhood of 12% next year, sufficient in our view to warrant an 8%-pt overweight of the asset class. We remain overweight energy and the dividend-rich financial and utility sectors of the TSX.”