Wall St. thinks stocks will rise in 2017 - What could go wrong?

EghtesadOnline: Wall Street's rally could be derailed by renewed worries about President-elect Donald Trump's policies, a resurgent dollar or potential wild-card events like cyber attacks or a trade war, investors say as they look to 2017.

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31 December 2016

Stocks are at record highs on optimism Trump will boost the economy, and strategists in a recent Reuters poll expect more gains next year.

But, according to Reuters, they also worry about what could derail the market as a surprising 2016 wraps up and an uncertain 2017 awaits.

Here are some potential roadblocks to more gains:

TRUMP FALLS SHORT

Many strategists' top worry is that Trump's efforts to boost the U.S. economy will be diluted or delayed by a Republican-controlled Congress reluctant to widen the budget deficit.

Trump's promises to ease regulations, cut taxes and boost infrastructure spending have spurred sharp gains in shares of banks, health care and construction-related companies.

"As bold as people think these policy changes are going to be, maybe they get watered down," warned Bob Doll, chief equity strategist at Nuveen Asset Management in Princeton, New Jersey.

TRUMP AND TRADE

Underscoring investor worries about Trump's threats to renegotiate trade deals, retail shares fell 3.5 percent on Dec. 22 on reports he is considering import tariffs as high as 10 percent.

A day earlier, Trump named Peter Navarro, an economist who has urged a hard line on trade with China, to head a newly formed White House National Trade Council.

Tariffs on goods from countries like China and Mexico would bump up costs on imported goods for U.S. consumers.

THE DOLLAR CRIMPS EARNINGS

Further strength in the dollar, which has gained nearly 5 percent since the election, could hobble sales of U.S. multinationals.

"Companies are saying, 'You know, we've got this higher dollar that's making our business overseas a little more difficult," Doll said.

A year-long U.S. profit recession has just ended, but earnings growth needs to pick up or stocks will get too expensive. The S&P 500 is now trading at nearly 18 times forward earnings versus a long-term average of about 15, Thomson Reuters data shows.

THE FED GETS REALLY AGGRESSIVE

Stocks racked up big losses earlier in December after the Fed signaled three rate hikes are likely in 2017. While a stronger economy boosts stocks, higher rates can hit spending.

"One risk would be the Fed being a little overzealous and maybe bringing rates up quicker than what makes sense," said Daniel Morgan, portfolio manager at Synovus Trust in Atlanta, Georgia.

POPULISTS DEAL BODY-BLOW TO EU

Anti-establishment candidates are on strong footings ahead of spring elections in the Netherlands and France, and victories for them could strike a critical blow to a European Union already weakened by Britain's vote to leave.

Ahead of the Netherlands election in March, surveys point to strong gains for the euro-skeptic Freedom Party. In France, far-right National Front leader Marine Le Pen's popularity recently reached 27 percent ahead of a May election.

"There is still an overwhelming lack of recognition of the power of populist movements," said Brad McMillan, chief investment officer for Commonwealth Financial Network.

TOO HAPPY FOR THEIR OWN GOOD?

Stocks are closing the year amid some of the highest readings of bullish sentiment in nearly two years, and that can mean tough sledding ahead.

Citigroup's U.S. equity strategy team's Panic/Euphoria Model shows that when investors are euphoric, stock prices are lower 12 months later more than 70 percent of the time, with a median decline of 12.6 percent. Citi's model is not yet in euphoria territory, but it has shot much higher since the election.

Meanwhile, the American Association of Individual Investors' final weekly sentiment survey of 2016, which is a component of the Citi model, showed investor bullishness holding near its highest level since January 2015.

By contrast, about a year ago bearish sentiment was prevalent as commodity prices dived and China's market gyrations roiled investors around the world. U.S. stocks had their worst start to a year ever, but 12 months later the S&P has delivered a 12.5 percent total return.

EXCESSIVE LEVERAGE

U.S. stocks are owned with a near-record level of borrowed funds, often the quickest money to leave at the earliest signs of weakness.

Data from the New York Stock Exchange showed debt balances in margin accounts at the end of November stood at $500.4 billion, just 1.3 percent below the record level of $507.2 billion in April 2015. It has risen by nearly 15 percent from February's trough.

After each of the last three major peaks in margin debt balances - March 2000, July 2007 and April 2015 - the market was lower a year later.

CHINA'S CURRENCY KEEPS FALLING

Chinese policymakers are wrestling with growing debt and property bubbles, while the yuan currency is near eight-year lows. Last year, fears of crisis in China's financial markets sparked a global sell-off.

As well as threatening to impose tariffs on China, Trump could formally label Beijing a currency manipulator.

"There is a chance for politics and economics and finance to intersect in a potentially disruptive way," said Commonwealth Financial's McMillan.

CYBERATTACKS

Allegations of hacking by Russia ahead of the presidential election, along with breaches at Yahoo (YHOO.O), have heightened fears among investors of future, larger-scale attacks that could harm the economy.

"I haven't placed a trade with an actual broker in five years," said Jake Dollarhide, chief executive officer of Longbow Asset Management in Tulsa, Oklahoma. "Cyber-security and attacks on our way of life and our way of doing business are certainly something to keep in mind."