The FTSE 100 reached record highs over the Christmas period, closing at previously unseen levels and has continued to trade at elevated levels at the start of trading in 2017.
However, experts FE Trustnet spoke with have cautioned against getting too carried away with the rally.
The blue chip index closed at 7,142.83 on Friday 30 December and continued to rise as the London Stock Exchange opened for the first time in 2017.
Led by the previously under loved banking and commodities sectors, the FTSE 100 ended the first trading day of the new year at 7,177.89.
This bounce was largely caused by the oil price, which hit $58.16 a barrel on Tuesday and ended 2016 45 per cent higher following a late rally. Iron ore and coal also ended the year strongly and even gold and silver finished 2016 with a minor flourish as they sought to rally from 10-11 month lows.
For banks, rising bond yields and the potential for higher interest rates this year have warmed investors to one of the least loved asset classes since the financial crisis in 2008.
Performance of index in 2016
Source: FE Analytics
It means the FTSE 100 ended a challenging year, which saw the UK vote for Brexit among a number of landmark political events, 19.07 per cent higher.
Russ Mould, investment director at AJ Bell, says the FTSE 100 performance is being driven largely by four sectors, banks, insurers, oil & gas and mining, which are expected to generate roughly half of the index’s total sales, profits and dividend payments in 2017.
“More potently still, this quartet is forecast to provide three-quarters of the forecast growth in earnings and half of the forecast growth in dividends,” he said.
“For the moment, these sectors are seen as a positive. Steepening yield curves are helping banks, rising bond yields are helping insurers and rising commodity prices are lifting the resources plays.”
While this has helped in the short-term, he notes that the long-term reflation trend has impacted the surge seen at the end of 2016. 
“The long-term trend was the reflation trade, which was accelerated by the election of Donald Trump in November but which had really begun back in the summer around the time of the UK’s Brexit vote,” he said.
“Politicians got the message that electorates are sick of austerity and out of concern for the people’s jobs – and their own – governments began to row back on talk of austerity and instead emphasise fiscal stimulus and fresh efforts to stoke both growth and inflation.”
“Markets welcomed the shift as they had spent most of the first half fretting about whether monetary policy was losing its power to boost the global economy after seven years of record-low (or even negative) interest rates and Quantitative Easing seemed to be producing diminishing returns.”
Architas investment director Adrian Lowcock agrees, adding that investors seemed to be in two camps at the end of 2016 – those that are investing despite nervousness over potential pitfalls and those that are optimistic for the future.
“This is the first rally where we’ve seen a swing in opinion and I think a lot of people are either on the one hand climbing the wall of fear while on the other hand I think it’s a hope rally based on a lot of optimism,” he said.
“People have been looking for change and markets have been looking for politicians and central bankers to do something different because we’ve absorbed as much QE as we possibly can, we’ve absorbed as much monetary stimulus as we can.”
“While that’s helped keep markets up and buoyant it hasn’t helped corporate earnings and it hasn’t helped demand growth.”
Both Lowcock and Mould agree that the ‘Trumpflation trade’ is key for the UK market, creating a stronger dollar and in turn boosting the FTSE 100’s overseas earners, who generate around two-thirds of the benchmark’s total earnings.
“So long as the Trump trade remains in favour, the FTSE 100 should continue to do well, especially as a yield of around 4 per cent could provide a bedrock of support from income hunters – and the higher oil and commodity prices go the better dividend cover becomes, as it is thinner than ideal at around 1.5 times,” Mould said.
Lowcock added: “What has driven this rally has effectively been triggered by Trump but the foothills or the groundwork was already being laid with the rhetoric pointing towards central banks passing on the baton to governments to undertake fiscal stimulus.”
“I think Trump is the embodiment of this if you like. He is fiscal stimulus turbocharged. If we get fiscal stimulus we get the economic growth that we have been lacking, we get inflation back and that is what has largely driven this rally.”
Performance of index in 2016
Source: FE Analytics
Indeed, since the US presidential election, the US market is up 5.28 per cent while the UK market has risen 4.87 per cent – reaching the aforementioned highs.
However, despite the strong run, the analysts warn that investors should not feel too comfortable at the current highs.
Wealth Club investment director Ben Yearsley said: “You always have to take any kind of Christmas rally with a slight pinch of salt firstly because there’s thin trading and very little news flow.”
“You’ve had the US continuing to hit record highs, you’ve had some decent data out of China which is good, and you’ve had the oil price going up which seems good for economic activity.”
“All those things have been largely positive but it has been on the back of thin trading and little volume so anything decent will move the market.”
“I wouldn’t read too much into it because I think more interesting is what’s going to happen in the next month when trading normalises and volumes pick up again,” he said.
AJ Bell’s Mould agreed: “The beginning to 2016 seemed similarly set fair yet January and February were poor months (and very volatile ones) and it might not take a lot to shake things up this year, given the prevailing buoyant mood, so we would be wary of getting too carried away just yet.”
However, in mid-December he forecast the FTSE 100 to finish 2017 at 7,350 implying a total return of around 10 per cent.
While this looks a bit low after the December surge, he says the dependence on banks, insurers, oils and miners means the index lacks a little in quality of earnings even if the market is looking forward to a healthy improvement in quantity this year.
Meanwhile, Chris Beauchamp, senior market analyst at IG Group, says he too expects to see new highs later in the year, but warns that the near future could be rocky.
“A lot of expectation has been built into this rally and the euphoria should fade in due course. The lesson of 2016, however, is that this bull market is not dead by a long shot and investors should await a correction with ill-disguised glee, as a chance to add to the strong performers.”