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Accelerating global growth and another year of solid corporate earnings could give equity markets room to rally in 2018. But there are risks: the U.S. Federal Reserve could pull the interest-rate trigger multiple times this year and inflation may awaken from its long slumber.

In the U.S., the Standard & Poor’s (S&P) 500 is poised to enter the ninth year of the bull market that emerged from the depths of the 2008 financial crisis. Can this long uptrend continue? Only time will tell, but U.S. consumer confidence is rising, economic fundamentals seem solid, and tax reform and deregulation could potentially add to economic growth.

As a result, we expect U.S. equities to grind higher in 2018, although we don’t expect a repeat of last year’s exceptional gains.

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However, with the U.S. economy firing on all cylinders, we could see inflation slowly begin to creep up. We believe the Fed is already poised to raise interest rates in the months ahead, and if inflation suddenly increases, it will have even more reason to do so. Historically, steadily rising interest rates have triggered higher volatility and slower growth.

In Europe, the economy has been hurt by the emergence of far right, anti-European Union political candidates and the U.K.’s decision to leave the EU. In the end, voters sided with pro-European parties, and negotiations surrounding Britain’s exit have been largely uneventful.

As political risk continues to fade, the eurozone economy has improved, with unemployment steadily falling while consumer confidence rises. We don’t expect the European Central Bank to raise interest rates in 2018, and with equity valuations lower than they are in the U.S., we could see European equities move modestly higher this year.

Emerging markets started to rally early last year when it became apparent that President Trump would not carry through with the draconian trade policies he had promised. We likely won’t see an almost 30% return in emerging markets like we witnessed in 2017. But equity valuations remain attractive and growth remains strong versus developed markets and we expect emerging market stocks to move higher again this year.

Still, there are clouds on the horizon. If rising interest rates in the U.S. help drive the greenback higher, it will hurt emerging markets that are heavily dependent on imported commodities. And China is always the elephant in the room. If its economy falters, the broader emerging-market economy could also be hurt.

Canada’s economy seems destined for a troubling year. Growth has been driven by a soaring housing market and consumers who have gone into debt at a record-breaking pace. The housing market appears to have topped out and may have started to decline, and cash-strapped consumers likely do not have the spending power needed to keep the economy humming. Throw in the fact that NAFTA could be terminated, and it is hard to be bullish on Canada.

It is unlikely that the Canadian economy will get a boost from a surge in oil prices, which we believe will be range-bound between US$50 and US$65 a barrel. And given the overall economic picture in Canada, the S&P TSX Composite Index could decline this year.

MARKET RISKS

On the geopolitical side, the ongoing standoff over North Korea’s nuclear buildup will likely continue. As we enter the New Year, that issue appears to have calmed somewhat but the risk remains.

In the U.S., controversy surrounding President Trump will likely remain. But we expect markets to continue to key off of economic fundamentals, not the fate of the president.

On the economic side, strong economic growth could lead to a cyclical uptick in inflation just as a growing number of central banks are striving to normalize monetary policy, which could produce a surge in market volatility.

FIXED INCOME

In 2018, the fixed income market appears to be shaping up as a contrast between the Fed and the Bank of Canada. The Fed, as we noted, could raise interest rates multiple times this year, while the BoC, faced with a number of economic challenges, remains on hold until late in the year.

As a result, we expect the yield on Canadian bonds to remain largely unchanged. However, U.S. bond prices could head lower if the Fed raises interest rates a number of times.

And if the BoC stays on hold (while the U.S. dollar potentially rises in value as the Fed increases rates), it is difficult to see how the Canadian dollar can gain traction this year; in fact, it could drift lower.

TO SUM UP OUR OUTLOOK FOR 2018:

  • Overall, we are slightly bullish on equities
  • We are slightly bearish on bonds
  • Expect gains in foreign markets while the S&P/TSX Composite Index lags
  • Composite moves lower
  • Expect market volatility to pick up
  • Canadian dollar could head lower

Sadiq S. Adatia is Chief Investment Officer for Sun Life Global Investments (Canada) Inc. and a key member of its executive team. In this role, Mr. Adatia is accountable for bringing clients the best in asset management and innovative solutions from around the world. He will also leverage his investment expertise to provide investment commentary to clients and media. Mr. Adatia joined Sun Life Global Investments in July 2011, bringing with him over 15 years of experience in the investment industry. Prior to joining Sun Life Global Investments, he was Chief Investment Officer at Russell Investments, a position he held since 2008. Mr. Adatia was responsible for all domestic and foreign investment funds sold in Canada and was also the portfolio manager for the Canadian equity, dividend and small cap products, as well as balanced portfolios. Prior to that Mr. Adatia was the Business Leader for Investment Consulting for Central Canada at Mercer Investment Consulting. Mr. Adatia is a member of the annual Up the Down Market Event for Down Syndrome Foundation and the Education and Examination Committee for the Society of Actuaries. Mr. Adatia holds an Honours Bachelor of Mathematics degree in Actuarial Science & Statistics from the University of Waterloo. He is also a CFA Charterholder, a Fellow of the Society of Actuaries (Investment Specialty Track) as well as a Fellow of the Canadian Institute of Actuaries.
Originally published on Advisor.ca