The Canadian economy will grow between 1.7%-2.0% this year, with risks skewed to the downside amid concerns about the housing market and domestic crude oil-price fundamentals.

So says Russell Investments in its latest strategists’ outlook and barometer, which updates the firm’s annual outlook for 2013. The report analyzes key trends and indicators recognized by company’s global team of investment strategists.

“A slowing housing market creates a reverse wealth effect that could restrain household spending,” says Shailesh Kshatriya, associate director of client investment strategies at Russell Investments Canada. “As well, market volatility related to issues such as the recent banking crisis in Cyprus will continue to cause anxiety for conservative investors.”

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Kshatriya expects the weak domestic economy to stall the Bank of Canada from raising interest rates for the rest of the year. This means the central bank’s target interest rate will remain at 1% until 2014. Read: Interest rates won’t budge until 2015

On the other hand, Kshatriya says low rates and the slightly weaker Canadian dollar might encourage investment spending, which could boost the domestic manufacturing sector. He also says the ongoing U.S. economic recovery could be beneficial for Canada.

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According to the report, the outlook for the U.S. is positive despite continued market risks. Russell’s updated economic forecast for the U.S. includes:

  • Fiscal tightening is expected to equal about 2% of GDP, with the three main contributions coming from: tax increases on incomes of about $400,000, expiration of the temporary 2% payroll-tax holiday and spending sequestration.
  • The debt-to-GDP ratio sitting above 90% could impair growth, and the U.S. economy may not see nominal GDP growth of at least 4.5% on a rolling four-quarter basis until 2014.
  • Employment gains are expected to average 170,000 jobs per month.
  • 10-year U.S. Treasury yield likely will be at 2.25% at the end of 2013, assuming the economy neither overheats nor undershoots toward recession.

“Even with modest growth expectations for corporate earnings, current stock-price multiples are quite high compared to historical measures,” says Mike Dueker, chief economist for Russell Investments. “[However,] we do not expect U.S. growth to set any records.”

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While Russell’s team of global strategists find the overall 12-month view of the U.S. equities market is positive—with projections of between 2% and 2.5% GDP growth— gains are expected to be tempered by fluctuating environments and risk.

The strategists believe current optimism in the U.S. and global markets is being driven by the U.S. housing recovery, as well as by a cyclical rebound in China and Japan’s favorable policy initiatives.

In terms of emerging markets, Russell’s strategists say despite underperforming developed markets during the recent rally, emerging markets are undervalued and demonstrate potential for double-digit earnings per share growth in 2013.

They add that despite rumours of a great rotation back into equities in Q2 2013, investors are actually moving cash into both bonds and stocks. This confidence could be quickly undermined by disappointing economic news in the U.S. market, or by another fiscal crisis in Europe.

Read: Great rotation is great myth

In the report, Russell’s strategists also offer a look at 16 key asset class pairings to determine which classes in each pair signal better return prospects.

“The biggest change we saw in our asset-class pairings was between U.S. Large Cap and Asia ex-Japan Equities,” says Douglas Gordon, senior investment strategist, North America. “Despite a large swing in our momentum modeling for this pair favoring U.S. Large Cap, the signal oscillates around neutral. This is a case where a big change might not lead to a big move in positioning.”

He adds, “The most notable surprise involved the comparison of U.S. Large Cap and Continental European Equities, which showed a modest valuation advantage to U.S. equities. When we incorporate structural forward-growth concerns, as well as political and policy risk, we would hold a neutral position in this pair, preferring other non-U.S. developed markets from a relative basis.”

Read the complete report.