The Australian sharemarket is forecast to rise this year at its fastest pace since 2013, boosted by a recovery in Australian company earnings.
Bank of America Merrill Lynch expects the S&P;/ASX200 index to reach 6100 by the end of 2017, a rise of around 9 per cent from current levels, with the growth fuelled by higher corporate earnings.
Companies across key sectors are on track for an "earnings bonanza" in 2017 on the back of cost-cutting, exposure to the US economy, commodities demand from China and state and household spending on construction, according to BoA Merrill Lynch analyst Sameer Chopra.
Company earnings guidance usually "starts high, ends low," he says. But that downward guidance revision didn't happen at the end of 2016.
"Instead, we've seen earnings revised upwards. And this trend is quite good across energy, financials, materials, consumer staples … it's quite widespread."
At company shareholder meetings between September to October last year, 76 per cent of ASX200 companies reaffirmed their earlier earnings forecasts, while just 10 per cent downgraded their expected earnings.
Mr Chopra says that, according to the bank's analysis, companies are still at the early to middle stages of significant cost-cutting programs.
"One of the big drivers of earnings recoveries in companies has been the extent to which they can pull out costs. Companies that went early have pulled out a lot. So that's generated a lot of interest."
Companies exposed to the US stand to benefit from tax reform, which new president Donald Trump has indicated as a priority. These include many industrial and healthcare stocks.
The materials and energy sector will also see earnings buoyed by higher commodity spot prices, including iron ore, which is currently around 35 per cent above the bank's forecast. While the high price was unexpected, it is supported by Chinese demand, as well as supply-side reforms, which mean high commodity prices are "likely to continue to be supportive for Australian producers".
In addition, a significant pipeline of housing and building approvals should see construction activity continue strongly during 2017, while state governments are expected to spend between 2-3 per cent of their GDP on infrastructure in 2017-18.
Downside risks
The analyst has identified two main risks to the rosy earnings picture. The first of these is rising bond yields. Australian government bond yields rose in the second half of 2016, and should they continue that trajectory, this could see a sell-off of some "bond proxy" equity sectors, such as infrastructure, property, telecommunication and utilities companies. Mr Chopra estimates a 50 basis point rise in bond yields could see an 80 point drag on the ASX200.
The second factor is continued housing affordability stress, which could leave households highly vulnerable to any rise in interest rates.
While stringent lending standards do not make the possibility of a US-style housing meltdown a likely outcome, any rise in interest rates could have an impact on household consumption, which would weaken domestic demand. Due to this risk, the investment bank is underweight on consumer discretionary stocks.