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Bank of Canada Governor Mark CarneyAdrian Wyld

Central banks in Canada and the United States are likely to raise regulated rates from their emergency low levels of just above zero in the not too distant future, but that will not snuff out the bull market, strategists say.

The inevitable rise in interest rates will slow the stock market gains, "but are unlikely to deliver a knockout blow to equity markets," said Avery Shenfeld, chief economist with CIBC World Markets Inc. in a report to clients.

The Canadian bull market "History shows that the half-year in the lead-up to the first Bank of Canada rate hike tends to coincide with a very strong run for stocks and stocks still outperform bonds in the early months after the first tightening move," he said. Leading up to the rate hiking cycle the S&P/TSX composite index historically gained an average 21.7 per cent (dividends plus capital gains), although in the six months following the trough in interest rates the annual gain was 8.3 per cent, which is close to its long-run average.

Among the positive factors is that the balance sheets of Canadian corporations are strong. The debt-to-equity ratio for the non-financial sectors is 50 per cent - $1 of debt for every $2 of equity- compared with 100 per cent fifteen years ago.

The U.S. bull market Likewise, in the U.S., stock markets appear to be set to embark on the third leg of the bull market run, said Carmine Grigoli, chief investment strategist with Mizuho Securities USA Inc. The bullish factors include an improving economy, soaring profits, accelerating stock buybacks and a pickup in merger and acquisition activity, he said.

Corporate America is awash in cash. "The cash holdings of non-financial S&P 500 companies rose by 29 per cent, or $242-billion (U.S.) to $1.1-trillion [at the end of 2009]" Mr. Grigoli said. "The cash hoard is equal to 11.4 per cent of total assets, the highest level in over 50 years."

Of the 421 non-financial S&P 500 companies, 40 had cash holdings exceeding one-quarter of their assets and 80 had cash plus short-term investments that exceeded 25 per cent of their assets, according to Mizuho Securities.

Investors need to keep their eye in earnings and growth prospects, the strategists say.

"Fear is subsiding, confidence is growing and investors' risk appetite is increasing at an accelerating pace," said Mr. Grigoli. "In our opinion, the [U.S.]bull market is transitioning from a liquidity-driven [assets moving from money market funds to equities] asset re-pricing advance toward one driven by earnings gains and corporate stock purchases."

And the profit outlook is good. "Even in an anemic economic recovery, operating earnings for the S&P 500 could rise 18 per cent over the next four quarters," he said.

Where to go? In Canada, best sectors leading up to the trough in interest rates are banks, base metals and the transportation groups, whereas in the six months following the nadir in interest rates transportation, telecom, consumer durables and chemicals are the best performers, according to CIBC World Markets. While higher-dividend groups tend to be hurt by rising interest rates, the telecom sector is an exception, CIBC said.

The U.S. sectors most likely to see aggressive merger and acquisition activity are the information technology and biotech sectors, according to Mizuho Securities. Financials are a sector expected to see strong earnings growth over the next five years, it said.