At more than eight years old, this economic cycle is long in the tooth.

Read: We’re in a ‘classic late cycle,’ says economist

And its age is showing because of several characteristics, including low unemployment, synchronized global economic growth and elevated asset prices, notes a Richardson GMP report.

How will the cycle play out and, more specifically, how should portfolios be positioned this late in the game?

Watch for inflation

The Richardson GMP report offers insight. The firm’s base case scenario can be described as traditional: global growth continues and eventually translates into inflationary pressure and upward pressure on bond yields.

“Given [that] so much asset price inflation occurred over the past decade thanks to low yields, this asset price inflation partially reverses and causes a recession,” says the report.

Though not imminent, signs indicate a recession may be on the horizon within a year or two. For example, the economies of Germany and Japan are producing above potential, and the U.S. economy is following suit.

In addition, how and when U.S. rate hikes impact longer-term yields “will be critical and could begin multiple compression, not just in the equity markets but also in real estate cap rates,” says the report.

Read: Global REITs to deliver up to 10% in 2018: report

And if inflation creeps higher, “this would likely trigger a surprise reaction in the bond market, causing higher-than-expected yields. Some surprises are welcome, but this development would certainly be an unwelcome one,” says the report. “We will be watching inflation for a potential early warning signal that things may change.”

Read: Your guide to inflation-proofing clients’ lives

Capitalize on extended bull market

In a January 2018 market report, HSBC takes a look back to 2017 before making a forward-looking assessment, saying “90% of global equity performance in 2017 can be explained by better corporate fundamentals. The percentage is lower in emerging market equities, but corporate strength is still the main driver of returns.”

Further, the HSBC report says valuations of riskier assets at the beginning of 2017 were relatively attractive, which caused investors to bid up prices.

“Contrary to the worry of many analysts that recent performance has pushed all risk assets into overvaluation territory, we disagree,” says HSBC. “Our analysis suggests that much of 2017 performance and what has happened over the last five years in many asset classes can be directly linked to fundamentals and the policy environment.”

Read: U.S. tax changes and market valuations

As for inflation, interest rates are expected to rise, but they’ll be coming off historically low levels, and will be measured and well communicated in advance, says the report.

In 2018 the firm continues to favour equities over bonds.

“Within equities, we are modestly overweight consumer stocks and financials,” says the report. HSBC also says it continues to “trim positions and take profits where warranted.” Gold and utilities are its two biggest underweights.

Within fixed income, HSBC has a neutral position in high-yield bonds.

“We still prefer investment-grade corporate bonds,” says the report. “Many good-quality corporate bonds are supported by solid company balance sheets.”

Within the government sector, HSBC prefers provincial bonds “because of their higher return potential” relative to government of Canada bonds.

Strike a balance

In a market outlook report, GLC Asset Management sees continued global economic momentum, with inflation and financial conditions that will remain accommodative long enough. The firm favours equities over fixed income at this late stage—with a caveat.

“Within that outlook, we acknowledge the attractiveness of equities over bonds on a risk-adjusted basis has narrowed. In short, we are less optimistic about the return prospects for equities and, similarly, less pessimistic about fixed income today than we were six months or a year ago,” says the report.

It’s too soon for a neutral stance, but caution is warranted, says GLC. “We need to be nimble in our investment positioning.”

The firm suggests investors strike a balance: rebalance out of equities that are scaling to new heights and allocate to fixed income assets that appear less attractive.

Of course, that’s easier said than done.

Read: Save clients from emotional mistakes

Says GLC: “Fixed income remains a valuable risk-mitigating tool that increases in value the closer we get to the end of this business cycle phase. At this stage of the cycle, we believe it is prudent to reduce equity overweight positions and increase fixed income to less underweight positions.”

Originally published on Advisor.ca
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