An optimist and a pessimist meet for a coffee. “Things can’t possibly get any better,” the optimist says. The pessimist responds: “I think you’re right.”

That’s how David Rosenberg, chief economist at Gluskin Sheff and Associates, described the psychology of this “classic late cycle.” He was not the optimist in the scenario.

Speaking at an Empire Club of Canada event in Toronto Thursday, Rosenberg offered a bearish outlook for 2018—which he pointed out is the Year of the Dog in the Chinese zodiac. (The last Year of the Dog was 2006, he noted, the end of a cycle no one saw coming at the time.)

To survive the year ahead, the dog “needs some late-cycle training,” Rosenberg said.

After a banner 2017 for investors, Rosenberg expects returns for the coming year to look very different. The current market expansion is now 103 months old, the second-longest on record, compared to the post-war average of 60 months.

“When consumer confidence is at its peak, a recession is usually a year away,” he said.

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Advisors need to make clients aware of where we are in the current cycle—a point Rosenberg estimated to be around “the seventh-inning stretch.” Portfolios need to change with the cycle, he said.

That means choosing names with predictable earnings rather than volatile ones. It also means looking abroad, where many markets aren’t in the same phase of the cycle. He is most bullish on Japan, where increased female participation in the labour force and more liberal policy for work visas has offset the economic threat from an aging population, and where Rosenberg said the stock market is showing signs of breaking out.

“This is going to have legs that go beyond the Year of the Dog,” he said of the Japanese market.

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IIAC president and CEO Ian Russell identified other risks during his speech at the event, including sudden shocks to the financial system. The growth in ETFs means investors are increasingly “buying the market rather than individual companies,” he said, which makes them more vulnerable to asset price declines across the market, or to major geopolitical events.

“The potential is there for an unprecedented herd mentality, leaving market-makers with limited scope to absorb panic selling,” he said.

More regulatory cooperation needed

Regulatory fragmentation, with the U.S. going in the opposite direction from much of the world in deregulating financial markets, is another concern for Russell. Canada is making progress with the Cooperative Capital Markets Regulatory System, but Russell lamented the fact that only five provinces and one territory are signed on, and that the system won’t be operational for another year.

He also noted the Financial Consumer Agency of Canada’s (FCAC) MOU with IIROC to establish a framework for compliance, and the newly established Financial Services Regulatory Authority in Ontario, which will develop regulations for the insurance industry and other financial institutions.

“We need a careful approach to regulation, finding the appropriate and most cost-effective rules to guide financial advice and market dealing,” Russell said. “We have made good progress, but need to rely even more on evidence-based analysis, and more effective cost-benefit work.”

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He also recommended strengthening non-bank institutions operating in the financial sector, especially large asset managers, with “increased liquidity cushions” and “tighter leverage requirements.”