The Big Picture: Will the equities party last?

Onwards and upwards, or is there a reality check ahead?

Stocks remain buoyant, especially in the US, where the S&P 500 index has risen 6% since the presidential election, and UK economic growth is currently faster than expected, a check to Brexit fears.

Takeover bids show that industry is willing to take a more sanguine view than the market, helped by weaker sterling empowering foreign acquirers.

What a contrast to the deflationary fears that dominated early 2016!

Rotation from bonds to equities

A chief reason equities are trading higher is that fund managers are rebalancing portfolios as expectations gel and the US Federal Reserve finally tightens monetary policy - recently enhanced by the prospect the Trump presidency will be inflationary.

There is an inverse relationship between interest rates and bond prices, and Deutsche Bank estimates $3 trillion (£2.5 trillion) has shifted from bonds to equities since his election.

Trump's inheritance is better than Obama's when he became President in early 2009It's somewhat ironic after it was loose monetary policy that boosted share prices from 2009, while the prospect of Fed tightening was seen as bearish and stocks had already risen to rich earnings multiples. For now, investors are taking a benign view that rate rises reflect a healthy US economy, thereby stocks are an ideal asset.

The Fed will also be the first mover as other central banks continue stimulus - the world isn't moving to net tightening yet.

With US consumer spending robust and unemployment low, its economy is expected to return to a growth trend level of around 2.2% next year versus an overall 1.6% in 2016. Trump's inheritance is therefore hugely better than Obama's when he became President in early 2009.

Trade protectionism

Equities are also rising amid a casual assumption the Republican-dominated Congress will support Trump's pro-business measures and clip any daft policy kites he flew during the election.

But regarding trade protection, Congress has ceded powers over a very long period of time - during the First World War the President regulated all international trade and financial flows, for example. This is most unlikely to be reversed as a two-thirds' Congress majority would be required in both the House and the Senate.

A chief uncertainty for 2017 is how China will take Trump's snubbing of the 'one-China' policyTrump has said will rip up international deals such as the North American Free Trade Agreement, withdraw from the World Trade Organisation and raise tariffs on imports from China and Mexico.

While that may sound bluster, he has appointed Peter Navarro - a China hawk who authored The Coming China Wars and Death by China - to head a new national trade body. Navarro's approach to restoring US manufacturing involves protectionism, so some degree of it looks likely.

A chief uncertainty for 2017 is therefore how China will respond now Trump has already (effectively) brushed aside the "one-China" policy since 1979, where diplomatic recognition avoids Taiwan.

Markets relaxed about debt

In the summer of 2011, stockmarkets were in a tailspin over the US debt ceiling and smouldering issues within the eurozone. Yet debt-to-GDP ratios have continued to rise with US government debt currently about 82% of GDP.

Three Harvard economists, including Professor Ken Rogoff, have identified 90% as the threshold at which a nation's economic growth stalls as a higher risk of government default causes interest rates to rise. That's the theory, but in practice rates haven't jumped in Japan despite its 230% debt-to-GDP ratio.

The get-out is where independent central banks can issue debt in domestic currency and keep interest rates low; just like how the Bank of England has managed with UK government debt around 84% of GDP.

Bad loan issues for Italian banks look set to rumble on during 2017, adding to Brexit uncertaintiesHelped by rising equity valuations, such macro-management appears to have quelled sensitivity to debt, which is why Wall Street seems relaxed about Trump's plans.

This is another reason for bullish sentiment to continue into early 2017, barring any major upset. Federal spending won't improve stagnant US productivity though, and there's a challenging demographic context for the economy; retirees on entitlements are growing and the young are on low wages.

So while the consensus reckons on dollar strength continuing with rises in the Fed funds' rate rises, mind such risks and uncertainties in the US economic story.

Bad loan issues for Italian banks look set to rumble on during 2017, adding to Brexit uncertainties to maintain pressure on the euro; although not even the €6.6 billion (£5.7 billion) rescue of Italy's third biggest lender, Monte dei Paschi, caused stockmarkets to flinch.

Likewise Chinese debt continues to smoulder, but the extent of command economy meant it and GDP have been managed through challenges. Debt remains a key aspect of the big picture but unless it seriously hurts business activity, investors are nowadays less concerned.

Brexit risks major opportunity

UK economic data has held up well in the second half of 2016, albeit aided by the Bank of England's post-referendum stimulus measures.

Consumer confidence remains firm and Christmas/New Year trading statements may benefit from people buying wish-list items before prices (finally) rise on imported goods. Profit warnings have been pretty selective and aren't indicating any wider slowdown.

Meanwhile, the media jabs at this confidence - with the story of how EU officials can't let Britain leave the EU better off, otherwise the entire "European project" will fragment as separatists take encouragement more widely.

The IMF forecasts GDP growth slipping to 1.1% in 2017 from 1.8% this year. The upshot of Brexit is also sketchy when 44% of exports are sent "to the EU", but this figure includes goods passing through Rotterdam, destined elsewhere.

Also, 80% of UK GDP derives from services where EU arrangements such as passporting are influential; and although this strictly affects financial services, others such as law, IT and media derive business from financial institutions located in London.

So the real effect is difficult to gauge; so are Brexiteers' claims that leaving the single market will free Britain to strike many more beneficial trade deals.

It's ironic how ministers are already heralding a bright new future of such deals while Britain currently is in the EU, but a separation seems underway despite the lack of Article 50 divorce proceedings.

The IMF forecasts that uncertainty over trade, immigration and foreign investment means a near-term loss of UK momentum, by way of GDP growth slipping to 1.1% in 2017 after 1.8% this last year. Maybe so, but how reliable has the IMF been?

Mind the respectable estate agency view that property values are set to rise 3% in 2017Potentially, the property market is at the early stage of a slowdown as expectations grow that mortgage rates will rise. Higher rents are also a check on consumer spending.

Mind the respectable estate agency view that property values are set to rise 3% in 2017; such annual forecasts can appear ahead of a market fall. But lenders have been more selective about borrowers, so there is less risk of bad debts aggravating any downturn.

Liquidity to remain a backstop for equities

The economic context therefore looks net positive for equities unless bullish sentiment gets overblown, setting up a reversal where company fundamentals can't meet the hopes priced in. Key issues I've identified for 2017 manifest risks it will be vital to watch.

At some point there is likely to me a moment of truth, but even then the sheer extent of global liquidity - approaching $110 trillion (£90 trillion) - will take advantage of any major drop, with so much capital (extended by QE) now in pursuit of return. Excess liquidity and computer-driven trading also guarantee bouts of volatility.

So it's a challenging prospect for 2017 with markets at record highs, if potentially rewarding.

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.