The biggest threat to investor optimism in 2017

With the Dow Jones industrials clocking a 13.4 percent gain in 2016 and the S&P 500 racking up nearly 10 percent, Wall Street ended an otherwise much-maligned year on an optimistic note. But as veteran investors know, the good cheer can dissipate on a dime, and analysts cite the very factors lifting stocks as key to their potential unraveling. 

Equities rose to records in the wake of Donald Trump’s victory in the November presidential election as investors bet on sectors expected to benefit from reduced regulation, increased federal spending and lower corporate tax rates. 

Yet the stock market -- an iffy gauge at best of predicting what’s ahead -- may be set up for a fall if the anticipated legislative action falters. 

One large danger is the unknown -- equities always react poorly to uncertainty. “One major risk is that Trump has continued to push for some of the nationalist, isolationist and government interventionist measures that he had advocated for as a campaigner,” wrote economist Gregory Daco, head of U.S. macroeconomics at Oxford Economics in a late December note. “This raises the risk of a trial and error presidency.”

Jim Russell, principal and portfolio manager at investment advisory firm Bahl & Gaynor, noted that investors have been responding to many of the proposals that the president-elect is bringing to Washington, including lower tax rates on corporations and individuals, less regulation and a large spending package. 

“The risk is the market is up, to some extent, believing all or most of these concepts will be passed in their entirety, which leaves the market vulnerable” should that not prove to be the case, Russell told CBS MoneyWatch.

Nick Raich, CEO at research firm Earnings Scout, said the danger to stock prices rests on whether Trump’s policies and their impact on future profits actually play out as the current Wall Street sentiment envisions. The mood could prove at odds with corporate bottom lines, said Raich, who noted that fourth-quarter 2016, first-quarter 2017, fiscal-year 2017 and fiscal-year 2018 S&P 500 earnings-per-share estimates have all gone lower in the 40-plus days that followed election night.

Humberto Garcia, chairman of Leumi Investment Services’ investment committee, said the most immediate threat to the market is that “the new administration’s two-toned flag of tax cuts and deregulation could meet with resistance if they cannot overcome the counterveiling forces of trade retaliation and a strong dollar.” He added: “Also, any big public infrastructure spend could hit a snag in recalcitrant congressional deficit hawks.”

The market also isn’t currently pricing in campaign rhetoric pointing to a U.S. trade policy potentially at odds with other global practices and views. 

“What worries us most is trade policy,” said Janet Engels, director of the Royal Bank of Canada’s portfolio advisory group. “If a trade war were to erupt, it would be bad for the economy and for markets.”

Russell also viewed protectionist trade policy as a negative, saying the U.S. runs the risk of getting into “a mode where the next president choses to slap a lot of tariffs on our imports, or exports, because these companies are not following his prescribed rule set.” 

The robust dollar and higher interest rates could also come into play in undermining Wall Street. “A stronger U.S. dollar comes with higher interest rates and higher inflation and slows multinationals earnings growth,” said Russell in outlining one potential scenario. 

If goods produced outside the U.S. were taxed as they enter the country, it would jack up the price of apparel, 98 percent of which is produced outside the U.S., Bahl & Gaynor’s Russell noted. “Unless companies want to take a lower margin,” he said, “that would be problematic, and one cause of inflation.”