Investors locally and globally are enjoying a Goldilocks moment. Share prices are buoyant and markets are collectively expressing the view that the global economy is "not too hot, and not too cold". Not hot enough to spur sharp interest rate rises and stimulus withdrawal and not cold enough to spiral into recession and crises. One of the key investment challenges this year is deciding how long conditions can remain "just right".

The recent data from the US is unambiguous. The economy is clearly improving.

Growth in China defied the "hard landing" sceptics in 2016, coming in at 6.7 per cent. In other words, two of the three major engines of the global economy are in sound shape. Europe remains a concern, both as an anchor dragging on the global economy and as a source of systemic risk, but there are no signs of deterioration from current low expectations.

This means the outlook for the global economy, and the bobbing cork that is the Australian economy, is modestly positive. However significant risks remain.

The election of Donald Trump to the US presidency and the perception that his populist policies will boost the US economy is dominating market thinking ahead of the inauguration ceremony on January 20. Monetary conditions are highly accommodative, despite the interest rate increases from the US Federal Reserve.

Monetary stimulus

The Bank of Japan and the European Central Bank are keeping markets awash with cash, supporting global asset prices, and the Fed appears nowhere near withdrawing the $US3 trillion-plus it has pumped into the economy largely through purchases of Treasury bonds and mortgage-backed securities.

Given the underpinning of the largest monetary expansion in history and an improving global growth outlook, it's hardly surprising that share prices are rising. In countries such as Australia and Germany the major indices are at better levels than at any time in 2016. In Britain and the US, sharemarkets are at record highs.

Even so, investors seem to be ignoring some significant headwinds in the form of slow European growth, unstable Italian banks, Chinese credit fears, trade wars and currency moves, among others.

Can it last?

The answer is yes and no. The combination of the US Federal Reserve withdrawing money from the economy and an already fragile sentiment will potentially lead to further bouts of volatility. Although asset prices could rise, the path is likely to be jagged as investor sentiment swings.

This volatility increases difficulty for those unprepared. Calm patches could be followed by violent moves.

Sleeping dragon

Furthermore, a sleeping dragon in the form of inflation is stirring.

Concerns about inflation are centred on the lack of it. However in the US, annual core inflation readings are at 2.1 per cent, above the Fed's 2 per cent target. Unemployment is well down on post global financial crisis highs, underemployment is dropping and average weekly earnings growth hit 2.9 per cent for the year to December. The trend is clear. If the newly elected President and Congress administer an economic sugar hit, bottlenecks could quickly appear. Acceleration in wages growth from current levels would quickly feed into an inflation burst. This could force the Fed's hand on interest rates, and make current estimates of two 0.25 per cent rate hikes this year look dangerously conservative.

The worst case scenario is inflation breaking out and productivity growth remaining moribund. Stagflation is still quite low on most economists' list of risks – but a further uptick in inflation could change perspectives quickly.

Opportunities close to home

The rhetoric from Trump Tower is short on detail for any stimulus plans, or anything other than a southern border wall. Many commentators are cautious about the outlook for the Asia Pacific region given the potential for a President Trump-inspired trade war. Risk awareness is important, but few are focusing on the potential gains for the region. China's pivot to Asia over the past decade could mean many are overestimating the strength of the US position in these negotiations. After all, the major economy with the strongest growth is China, not the US.

The defensive positioning of Asia Pacific markets, including Australia, contrasts with US exuberance. As a result, Asia Pacific markets could see a sustained period of outperformance. Lower currencies and the potential for further falls against a strengthening US dollar add to the argument for an overweight position in Asia Pacific equities.

In addition, anything less than an out and out trade war should see the recent improvement in commodity prices continue. This should lend further support to stock markets that have a significant resources component. In a world of opportunities, sometimes the best investments are close to home.

Michael McCarthy is chief market strategist at CMC Markets.