Where next now Brexit dust has settled?

Do British investors face their very own "Goldilocks period"? The economy is not cooling down rapidly, as some warned would happen after a Brexit vote, yet the Bank of England is renewing monetary stimulus to ward off any risk.

Significantly, it has ruled out negative interest rates for now (after the deputy governor's early August guidance towards zero rates by end-2016) which reduces fears for banks' profitability and emphasises quantitative easing (QE) as the main policy lever.

So, unless evidence from the real economy worsens (instead of confidence surveys) it's a benign mix of an economy not too hot to generate significant inflation, nor too cold with demand falling, with the authorities in pump-priming mode. As we've seen in the US in recent years, such a period has seen equities attain high valuations.

The chief risk with such a view is it being a snapshot, while Britain faces a long hard road to negotiate a satisfactory compromise on terms to access the single European market while delivering on domestic promises to check immigration.

That three years of US/EU trade talks have failed on every single issue exemplifies the challenge ahead. With London-listed equities already pretty fully valued (if lagging the rich price/earnings (PE) multiples of New York), they are exposed if companies start to warn in due course.

But, if they continue to manage through various headwinds it will need some unexpected macro event to genuinely unsettle markets. The authorities' actions so far reinforce a sense to buy any dips, out of desperation for yield.

Equities becoming a proxy asset for bonds

Buy-to-let property has been a popular trade for income and capital growth, now harder under new lending rules and higher stamp duty on extra homes. More conservatively, bonds were the logical option for relatively secure income/capital in a smaller outlay, but nowadays higher prices and lower yields tend to apply.

This helps explain the demand for equities, for example the recent rebound in house-building stocks during July, with the sector offering 6% yields. The risk is relying on monetary policy to manage through the challenges, while debt continues to soar, in a sense that "it's different this time".

Equities benefit from the expectation the chancellor will declare a fiscal stimulus programmeCentral banks will say they averted economic disaster in 2009 with QE, but argue about how easy monetary policy has subtle invidious effect. In the US, Professor Robert Schiller has warned of economic inequality becoming "a nightmare in the year ahead and Byron Wiel, a veteran Wall Street investor and Blackstone strategist, contended in a Barrons article:

"Much of the strength of the financial markets since the end of the recession in 2009 has been related to monetary expansion...the balance sheet of the Federal Reserve has expanded from $1 trillion  (£765 billion) in 2008 to $4.5 trillion today, and in my opinion, three-quarters of that increase has gone into financial assets, keeping interest rates low and expanding equity valuations." It would appear Britain is following a similar route.

Equities are also benefiting from an expectation the new chancellor will declare a fiscal stimulus programme, to include infrastructure spending, with his autumn statement come early November - hence construction and support services stocks rising in anticipation. The sense is a break with austerity economics of the Osborne years.

How solid are corporate earnings?

But how safe is it to trust in monetary policy averting any "reversion to mean" equity values in the medium term? The dilemma is well-illustrated by marketing services, which are a good forward indicator of business activity and confidence. Media giant WPP, a global leader, has declared first half of 2016 billings up 9.3% or 6.3% in constant currency, with July ahead of expectations.

You might wonder what those expectations were, given chief executive Martin Sorrell was a prominent "remainer" projecting doom in a Brexit scenario. WPP's outlook statement cites all regions and virtually all sectors performing positively - encouraging for equities because it implies low risk of profit warnings.

Mind how US productivity is weakening back to historically low levelsThe snag is WPP trades on a forward PE in the mid teens, priced around most broker targets, so the story needs to remain positive - likewise at other firms.

Third-quarter US corporate earnings are likely also to affect sentiment. The US stockmarket entertains record highs partly in a sense of optimism that first-quarter 2016 was a trough and earnings have been improving since.

Mind how US productivity is weakening back to historically low levels; some would say it's due to the increased regulation of the Obama years - if surprising that technology advances have not had a more positive offsetting effect.

So there is quite a moment of truth ahead for expectations, probably more important than the August fixation on whether the Fed might raise interest rates another 0.25% in September or December. Low interest rates have supported earnings-enhancement with acquisitions and buybacks, but revenues and the outlook are all-important.

US dollar exposure continues to look wise

Sterling has recovered some poise, but it looks wise to maintain an element of US dollar exposure e.g. via multinationals' equities. US leading economic indicators continue to edge higher compared to their peaking one to two years ahead of recessions in 2001 and 2008-09.

Meanwhile, high-yield bonds have seen their yields ease a couple of percentage points, i.e. reflecting better confidence in economic prospects.

The US election could be this year's "wild card" element, more important than rate rise rumoursWith the Fed super-tanker turning gradually from QE and ultra-low interest rates, in an aim to gradually normalise monetary policy, all this looks medium-term supportive for the US dollar. Sterling, meanwhile, has to contend with uncertainties in the British economy and public finances as the tricky process of exiting the EU begins.

The "wild card" element is the US election, where the established view is voters weighing which candidate can best stimulate growth and jobs. But, as with the EU referendum, anti-establishment voting could help tip the balance.

Trump's property development career has been a high-wire debt balancing act, so if he does win then investors look likely to anticipate a "borrow and spend" administration - such fiscal stimulus likely good for business and equities. Liberals may anguish but Wall Street will more likely rub its hands. It's another net positive for the dollar.

China: a political, rather than economic, black swan?

The inexorable rise in Chinese debt and doubts over GDP figures and their sustainability - depending as they have on infrastructure investment - have been central to the bearish case.

Yet the communist authorities seem to manage through, with nominal GDP increasing at a 7.3% annual rate in the second quarter and rising global commodity prices indicating China as a resilient source of global demand. Possibly the real risk is military conflict over territorial issues in the South China Sea, a vital trade juncture for the global economy.

An escalation in China's territorial squabbles would move markets more than UK developmentsAn international tribunal in The Hague has rebuked China's building artificial islands and cited no legal basis to its claim to sovereignty over the waters. The case was "brought by the Philippines", albeit headed by a US law firm - hence it invites a sense of wider legality and primacy in Asia.

The fuse-wire is a 1951 treaty obligation for the US to defend the Philippines, meanwhile the bombastic Filipino president - quite the Donald Trump of the Pacific - has kept up fiery rhetoric against China. Washington has publicly warned China against claiming land but its navy chief declared they will continue construction work on disputed territory.

Mind that as the US election nears, China could reason the US will be pre-occupied with its own issues to respond aggressively to further action in the Pacific. It's probably an off-chance that events will seriously escalate, but the elements are in place and conflict would be far more influential on markets than a British Goldilocks story.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.