A rapidly deteriorating economic outlook for North America and other OECD countries will likely push the S&P/TSX composite index down to 7,000 before the massive U.S. fiscal stimulus and financial rescue package kicks in, finds a new report from CIBC World Markets.

As a result, the firm has slashed its targets for both 2009 and 2010. The report notes that second-quarter GDP in both the U.S. and Canada is to likely to show further substantial contractions in the economy, while the banking crisis in the U.S. is likely to continue to have spillover effects on Canadian financial stock valuations.

“Even with a second-half economic recovery, it is hard to see the TSX beyond 9,000 at year-end,” says Jeff Rubin, CIBC World Markets chief economist and chief strategist.

“Assuming a sustained recovery in 2010, we could see the index rise to 11,000 by the end of next year. But even so, that will still leave Canadian equity valuations almost 30% below their mid-2008 peak — a bleak testament to how much the world has changed.”

The report notes that while it was ahead of the consensus in projecting a steep earnings decline for the TSX Composite in 2009, CIBC World Markets’ target for a 15% drop looks optimistic in light of a now deeper slide in economic activity. As a result, the firm is now looking for a roughly 25% broadly based decline in index-adjusted earnings.

CIBC World Markets forecasts brighter earning prospects for 2010, noting that valuations will continue to look cheap to investors looking at 12-month forward P/Es that extend into that year for earnings. Economic recoveries typically generate sharp earnings rebounds, in part because sectors seeing severe setbacks have a low base for comparison. The report calls for increased earnings for both financials and resource sector companies in 2010, as they put the worst of credit provisions in the former, and recessionary prices for the latter, behind them. CIBC expects TSX earnings will see a 12% rebound in 2010.

IE