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Highlights

  • The outlook for stocks this year
  • Analyst forecasts for the S&P/TSX
  • Analyst forecasts for the S&P 500
  • The many market risks ahead
  • And then there’s bitcoin

Riding the stock market in 2018 may well be like trying to ride a mechanical bull: Bumpy and risky, and hopefully you don't fall flat on your butt.

Stocks have come a long way in the 10 years since the financial crisis, setting record after record in 2017. And though the question on everyone's mind is how long this long rally can run, analysts still see the bull market continuing in 2018, with at least modest gains in Canada.

  • Part 2, Tuesday: Loonie (lame), interest rates (pain)
  • Part 3, Wednesday: Crucible: Housing, mortgages and banks
  • Part 4, Thursday: Eroding wealth, frightful finances
  • Part 5, Friday: The economy, oil and NAFTA

"By rights, the current market cycle should be shuffling into retirement, putting its feet up and taking things easy," said Jeff Hussey, global chief investment officer at Russell Investments.

"It is, after all, nearly nine years old, the second-longest bull market on record and positively geriatric by the standard of these things," he added in Russell's 2018 outlook.

"But this cycle belongs to the baby boomer generation, and like them, refuses to succumb to dotage. It's having a vigorous later life while frittering away the next generation's inheritance."

All of which raises the key question of "how to make the most of late-cycle returns while preparing for the inevitable downswing," as Mr. Hussey sees it.

"Late cycle can be the most challenging phase," he said.

"Valuations are stretched, central banks are taking away the punch bowl and fundamentals look long in the tooth. But markets may surge as investors, buoyed by their recent success, become overconfident and start believing (again) that this time is different."

Thus, strategy is crucial particularly for those who, like the market, are late in the cycle. Investors should diversify, and have a "robust dynamic asset-allocation process" at hand.

"Without a solid process, there is the very real risk of being drawn into euphoria at the market peak and capitulating with despondency at the cycle bottom," Mr. Hussey warned.

Here's what analysts expect at this point:

Canadian stocks

Risks may abound – there are housing bubbles, NAFTA uncertainties and the resumption of Bank of Canada rate hikes to keep in mind – but market observers expect gains nonetheless.

"While we expect a fair bit of volatility in 2018 after a 2017 lull, recession risks entering 2018 are low and should allow for modest positive returns for Canadian equities," the Russell report said, adding "we expect a fair bit of uncertainty around our central forecast for the Canadian market."

That central forecast would put the S&P/TSX composite index at 16,900 by the end of the year.

Laurentian Bank Securities, in turn, is calling for the TSX to close out 2018 at 18,000.

"We remain globally neutral with an underweight on U.S. equity and overweight positions in Canada, other developed markets and emerging markets," Laurentian's chief strategist Luc Vallée and senior economist Eric Corbeil said in their lookahead.

Buoying the TSX, they forecast, will be stronger commodities, with West Texas intermediate oil at $67 (U.S.) a barrel by late 2018, providing the production cap agreement among OPEC and other countries holds.

"This should contribute to the outperformance of Canadian equities and the Canadian dollar," they said.

Brian Belski's "base case" for the TSX puts the index at 17,600. The chief investment strategist at BMO Capital Markets has a bull case for 19,000 and a bear scenario for 14,500.

"If we were going to choose a word to explain the Canadian stock market environment heading into 2018, that word would be 'mundane,'" Mr. Belski said in his outlook.

"Mundane works, in our view," he added.

"Admittedly, the term is far from exciting. However, in a marketplace (Canada) that feeds on negativity, starves for total return and considers it a failure unless gold is at $2,000 and WTI is at $80 and going up – increasingly consistent broader equity market performance could prove to be an alternative to other regions in the world."

Mr. Belski listed financial, material and industrial stocks as overweight, and energy at market weight.

Laurentian's Mr. Vallée and Mr. Corbeil are "neutral" on gold, expect a recovery in forestry and agriculture stocks, forecast outperformance in financials and consumer staples, and consider REITs "excellent hedges against inflation, and their yield is expected to remain higher than that of long-term government bonds."

U.S. stocks

First, note what David Rosenberg has to say about breadth.

By late December, when the Dow Jones industrial average was up 25 per cent on the year and reaching for the 25,000 mark, the chief economist at Gluskin Sheff + Associates pointed out the 2017 rally was "very narrowly based," with just the top 10 stocks driving 80 per cent of the rise.

"If it had been left to the other 20 stocks to do all the heavy lifting, the Dow would be sitting at 21,620," Mr. Rosenberg said on Dec. 20. "Not bad, but nowhere near 25,000."

A broad market is a strong one, and a narrow market weaker, Mr. Rosenberg noted.

"Sorry to be such a party pooper."

And on that note, the calls among analysts may differ, but the idea's the same.

Mr. Belski's base case for the S&P 500 is 2,950. His bull case is 3,250, and his bear scenario is 2,200.

"The resiliency of U.S. companies has proven itself time and time again throughout this bull market, and investors desperately need perspective and discipline, in our view," Mr. Belski said.

"As such, we believe there is no reason to expect that a dramatic reversal in longer-term fundamentals is imminent," he added.

"Rather, the slope of our long-standing secular bull market call remains positive. In fact, we believe U.S. stocks are transitioning toward a renewed era of transparent investing, one defined by high-quality assets and fundamental bottoms-up stock picking."

JPMorgan Chase, envisioning a "Goldilocks scenario," puts the S&P 500 at 3,000 by the end of the year. So does Credit Suisse, citing stronger earnings and economic growth, as well as lower tax rates. Laurentian forecasts 2,800.

Capital Economics and Russell don't expect a barn-burner of a year, the latter saying "we forecast lacklustre U.S. equity market returns in 2018 and view end-of-cycle risks as becoming elevated thereafter."

As Capital Economics sees it, a strong economy won't necessarily translate to the markets.

"Equities look overvalued and, at this late stage of the economic cycle, we would expect gains in nominal GDP to accumulate to workers in the form of higher incomes rather than to firms as higher profits," said Paul Ashworth, the group's chief U.S. economist.

"The dollar's rebound will also hit the value of overseas profits and financial sector profits will be restrained by a flatter yield curve. The upshot is that we expect equity markets to do no better than trend sideways in 2018."

The risks

Let me count the ways: NAFTA, President Donald Trump, Canada's housing market, the Bank of Canada, the Federal Reserve, geopolitics, and trade and military wars. (And if bitcoin's your thing, then there's that.)

The big risk for Canada is the fate of the North American free-trade agreement, with talks toward a new pact already troubled amid Mr. Trump's demand for a fair deal and his broader trade agenda.

"We believe the market is not currently contemplating a significant negative outcome, in part because a NAFTA rescission may result in Canadian-U.S. trade being subject to the Free Trade Agreement (FTA) of 1987," Credit Suisse said in its outlook.

"In any event, the near-term impacts of even that type of disruption would likely substantially impact the [Canadian dollar], capital flows and trade patterns amidst the uncertainty."

Then there's the state of the housing market, with new mortgage rules from the commercial bank regulator, among other things, how aggressively the Bank of Canada tightens, and how the Fed moves under a new chair.

"Late-cycle tailwinds should be conducive for domestic equities, while potential over-tightening by the BoC remains a critical watchpoint," the Russell report said.

We should not underestimate what Mr. Trump's trade policies could mean. Or, for that matter, the potential impact of other flash points.

"Global growth could falter if the U.S. enters trade wars with its principle trading partners, namely Canada, Mexico and China," said Laurentian's Mr. Vallée and Mr. Corbeil.

"These could cause real havoc on the markets if the domestic value of U.S. denominated debt held outside the U.S. swells to unsustainable levels as the [U.S. dollar] appreciates," they added.

"Second, political risks in the Middle East and Asia are numerous and tensions have reached new highs recently. These would cause flights to quality which would favour U.S. assets and the U.S. dollar."

And then there's bitcoin

You can't have a discussion like this one without talking about bitcoin, particularly if you want to look at risks.

"The introduction of bitcoin futures at the CBOE and CME propelled the cryptocurrency into the limelight of financial markets," said Matthias Bouquet of JPMorgan Chase.

"At a time when volatilities across asset classes have plummeted, this presents us with the oddity of an asset with extreme daily moves."

The rise of bitcoin and others like it have raised many questions about their future, and added to the pressure on regulators and monetary authorities who are scrambling to figure out what to do about them.

Consider the fact that, as Royal Bank of Canada documented, the value of cryptocurrencies surged in 2017 to hit almost $500-billion (U.S.) by mid-December, having started the year at about $18-billion.

Cryptocurrencies have "the potential to transform financial services," said RBC economist Mathias Hartpence.

"Can governments regulate the cryptocurrency and blockchain financial ecosystem and not stifle innovation?" Mr. Hartpence said in a report on five notable things in 2017.

"Recently, China curtailed cryptocurrency exchanges, whereas Japan recognized bitcoin as an official form of payment," he added.

"As the pre-financial crisis experience shows, 'bad innovation' is possible, however Canada risks losing out if it fails to nurture an ecosystem that evolves into a foundational aspect of the future economy."

Bitcoin ran up late in 2017, often striking ridiculous gains by the day, and at times by the hour, before "investors were introduced to the law of gravity" at one point and the value plunged 25 per cent in one day, noted Jasper Lawler, head of research at London Capital Group.

This happened after the founder of Lifecoin dumped his holdings, likely fuelling "insecurity" in cryptocurrencies.

"Long-term holders will be used to this level of volatility but newer crypto traders could be permanently put off," Mr. Lawler said.

"The exponential price rise seen recently needs new investors to sustain it," he added at the time.

"In a bubble market it's known as the 'bigger fool' theory; you can buy high as long as there is a fool willing to buy it off you even higher. Previous price pullbacks have only strengthened the conviction of bitcoin traders when the price rebounded."

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