Contrary to the gravity-defying action of the past six weeks, the stock market can’t go up in a straight line forever.
The Trump rally on Wall Street has sent the Dow skyrocketing 1,600 points and within spitting distance from the 20,000 milestone.
Many market gurus are optimistic about 2017 and stocks could continue to rally for some time. However, the extreme bullishness masks the real risks that lie ahead as President-elect Donald Trump takes office.
Mike LaBella, portfolio manager at QS Investors, said the election has sparked the most market “exuberance” that he’s witnessed in a decade.
“Right now, the market is assuming none of the negative consequences will go into effect. That could make for an ugly 2017 surprise,” said LaBella.
Here are some of the biggest threats for investors to be mindful of as they head into the next year:
Stimulus fails to stimulate: Investors are downright giddy over Trump’s promises to slash taxes and ramp up infrastructure spending on roads, bridges and airports. But there is no guarantee that these stimulus plans will turn into actual legislation in the timing and manner that Wall Street is hoping for, nor that they’ll effectively accelerate the economy.
Sam Stovall, chief investment strategist at CRFA, worries that “hype turns into gripe” as the stimulus plans get bogged down by Republican infighting.
Trade war: For now, Trump’s anti-trade campaign rhetoric — threats to impose tariffs or even rip up NAFTA — is being dismissed as mere negotiating tactics. But, as president, Trump will have the power to turn protectionism into actual policy if he wants to.
There’s also the risk that Trump tariffs lead for a tit-for-tat with major trading partners like Mexico and China or even a destabilizing trade war. Keep in mind that about half of S&P 500 revenues are from overseas. FedEx CEO Fred Smith recently warned that getting out of NAFTA “would be catastrophic for the U.S. economy.”
Global tensions, terrorism: The world is a scary place and the new president is likely to get tested early and often. In just the past few days alone, escalating geopolitical risks were on full display in the deadly terror attack in Germany, the assassination of Russia’s ambassador to Turkey and China’s taking of a U.S. naval drone (and subsequent tweets from Trump).
“There will be some geopolitical event that Trump will have to handle after inauguration. That does create some risk for markets in general,” said Shannon Saccocia, head of asset allocation and portfolio strategy at Boston Private.
Dollar goes on steroids: The U.S. dollar has raced ahead of rival currencies since the election due to the stronger growth outlook and expectations of Federal Reserve rate hikes. It’s nearly at parity against the euro. While that makes it cheaper for Americans to travel abroad, the strong dollar also has negative side effects. That includes making goods sold by U.S. multinationals like Nike more expensive overseas, while at the same time reducing the value of foreign revenue. If the dollar gets too strong, it can act as a powerful brake on profit growth in the S&P 500.
Red-hot stocks overheat: The post-election euphoria has made U.S. stocks more and more expensive. That can’t last forever. Either earnings catch up to rising prices, or markets need to be correct to lower valuations.
Stovall’s research shows that if the bull market ended today, it would be the second most expensive bull market top since World War II based on trailing price-to-earnings ratios. Ironically, Trump himself has warned the stock market is in a “big, fat, ugly bubble” — and that was when stocks were trading at lower prices than today.
Inflation rears its ugly head: Given the nine-year low in the U.S. unemployment rate, it remains an open question whether the U.S. economy even needs the stimulus Trump has promised. Fed chair Janet Yellen recently said fiscal policy is “not obviously needed to provide stimulus to help us get back to full employment.” The fear is that too much government spending causes inflation to rise rapidly, forcing the Fed to raise interest rates so aggressively that it spooks the stock market.
Bond turmoil spreads to stocks: The bond market has tanked since the election due to expectations of more aggressive rate hikes, government spending and inflation. That in turn has sent mortgage rates rising, though they remain historically low. The fear is that borrowing costs rise to levels that hurt growth or that losses in the bond market spark forced selling in the stock market.
Wildcard: Many times investors don’t anticipate what upsets the rally until it’s too late. Other risks to stocks in the coming months include everything from natural disasters and trouble with China’s economic slowdown to attacks by Trump on the independence of the Federal Reserve or other unexpected targets.
