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Wall Street could be in for a rude awakening if President Donald Trump's pro-business agenda fails to pass muster.
The buoyant market reflects investors' anticipation for the reforms outlined by Donald Trump on the campaign trail, but Congress will need to turn those promises to cut corporate taxes and slash regulations into actual legislation.
“Much of the rally has been based on expectations of coming fiscal and policy changes — and so far, we’ve been hearing the ‘right’ things being discussed [like] tax reform,” Jennifer Lee, senior economist at BMO Capital Markets, told NBC News. “The slightest change (in the other direction, perhaps) in the wording or the message could cause the market to take a step back.”
Jeremy Glaser, markets editor for Morningstar.com, said the rally has pushed stocks above their value by about 4 percent, on average.
“We really see it being driven by a lot of hope that we’re going to see tax reform, in particular, a rollback of regulation and that there’s going to be some fiscal stimulus coming out of the Trump administration,” he said.
Positive data on metrics like retail sales and inflation have given this rally staying power, said Andy Smith, senior vice president of financial planning at Financial Engines.
“There’s sentiment and then there’s data,” he told NBC News. “When you only have one and not that other, that makes it difficult. But when you have sentiment and economic data that both point in the same direction, that lends more credibility to what we’re seeing.”
To keep the ball rolling, experts say the Trump administration will have to deliver on the President’s campaign-trail promises. Current market trends are baking in the assumption that a unified GOP government will be able to make good on its pledges to corporate America.
“In the past we’ve often seen that things are easier said than done,” Glaser said. “I think that’s one potential risk.”
“I think the Republicans were woefully unprepared for the majorities that they have. Now they’re scrambling to put policies together,” said Mitchell Goldberg, president and CEO of ClientFirst Strategy.
Not a Trump Bump?
It would be a mistake to give Trump sole credit for the market’s current state, said Goldberg. “The rally started before the presidential election,” he said. While the outcome of a unified GOP White House and Congress certainly helped, he said there were other factors at work, some years in the making.
“I don’t think investors appreciate the trillions and trillions of dollars of stock buybacks over the past eight years,” he said. Years of paring costs to the bone also helped.
“Companies have gone on a cost-cutting binge and now that there are pockets of growth all over the world, a slight uptick in revenue has a magnified impact on earnings,” he said.
The flip side is that any hint of bad news could have an outsized impact, said Richard Zeckhauser, a professor of political economy at the Harvard University Kennedy School.
“If we go along and suddenly there’s a realization that maybe this really isn’t going to happen, I would expect that stocks could plunge. The stock market historically is up on most days, but when it goes down, it goes down by more than it goes up.”
Zeckhauser said a belief that corporate tax reductions will happen in a timely manner is critical to sustaining the rally. “It’s hard to get corporations to perform a lot better, but it’s sure easy to increase their profits” by cutting tax rates, he said.
The open question is for how long Wall Street’s patience will hold. Treasury Secretary Steven Mnuchin said earlier this week that Congress was aiming to tackle tax reform before the August recess.
Evidence that tax reform won’t be hammered out this year or that tax cuts are smaller than anticipated could prompt a swift correction.
“The market can wait for some period of time, but it’s not indefinite,” Glaser said. “Given that valuations are high, it’s being priced in that this stuff is going to happen.”