Wall Street thinks stocks will rise, but what could go wrong?
NEW YORK/SAN FRANCISCO (Reuters) – Wall Street’s rally could be derailed by renewed worries about President-elect Donald Trump’s policies, a resurgent dollar or potential wild-card events such as cyber attacks or a trade war, investors say as they look to 2017.
Stocks are at record highs on optimism Trump will boost the economy, and strategists in a recent Reuters poll expect more gains this year.
But they also worry about what could derail the market as a surprising 2016 wraps up and an uncertain 2017 awaits.
Here are some potential roadblocks to more gains:
TRUMP FALLS SHORT
Many strategists’ top worry is that Trump’s efforts to boost the US economy will be diluted or delayed by a Republican-controlled Congress reluctant to widen the budget deficit.
Trump’s promises to ease regulations, cut taxes and boost infrastructure spending have spurred sharp gains in shares of banks, health-care and construction-related companies.
“As bold as people think these policy changes are going to be, maybe they get watered down,” warned Bob Doll, chief equity strategist at Nuveen Asset Management in Princeton, New Jersey.
TRUMP AND TRADE
Underscoring investor worries about Trump’s threats to renegotiate trade deals, retail shares fell 3.5% on December 22 on reports he is considering import tariffs as high as 10%.
A day earlier, Trump named Peter Navarro, an economist who has urged a hard line on trade with China, to head a newly formed White House National Trade Council.
Tariffs on goods from countries such as China and Mexico would bump up costs on imported goods for US consumers.
THE DOLLAR CRIMPS EARNINGS
Further strength in the dollar, which has gained nearly 5% since the election, could hobble sales of US multinationals.
“Companies are saying, You know, we’ve got this higher dollar that’s making our business overseas a little more difficult,” Doll said.
A yearlong US profit recession has just ended, but earnings growth needs to pick up or stocks will get too expensive. The S&P 500 is now trading at nearly 18 times forward earnings versus a long-term average of about 15, Thomson Reuters data shows.
THE FED GETS REALLY AGGRESSIVE
Stocks racked up big losses earlier in December after the Fed signaled three rate hikes are likely in 2017. While a stronger economy boosts stocks, higher rates can hit spending.
“One risk would be the Fed being a little overzealous and maybe bringing rates up quicker than what makes sense,” said Daniel Morgan, a portfolio manager at Synovus Trust in Atlanta, Georgia.
POPULISTS DEAL BODY BLOW TO EU
Antiestablishment candidates are on strong footings ahead of spring elections in the Netherlands and France, and victories for them could strike a critical blow to a European Union already weakened by Britain’s vote to leave.
Ahead of the Netherlands election in March, surveys point to strong gains for the euroskeptic Freedom Party. In France, far-right National Front leader Marine Le Pen’s popularity recently reached 27% ahead of a May election.
“There is still an overwhelming lack of recognition of the power of populist movements,” Commonwealth Financial Network chief investment officer Brad McMillan said.
TOO HAPPY FOR THEIR OWN GOOD?
Stocks closed the year amid some of the highest readings of bullish sentiment in nearly two years, and that can mean tough sledding ahead.
Citigroup’s US equity strategy team’s Panic/Euphoria Model shows that when investors are euphoric, stock prices are lower 12 months later more than 70% of the time, with a median decline of 12.6%. Citi’s model is not yet in euphoria territory, but it has shot much higher since the election.
Meanwhile, the American Association of Individual Investors’ final weekly sentiment survey of 2016, which is a component of the Citi model, showed investor bullishness holding near its highest level since January 2015.
By contrast, about a year ago bearish sentiment was prevalent as commodity prices dived and China’s market gyrations roiled investors around the world. US stocks had their worst start to a year ever, but 12 months later the S&P has delivered a 12.5% total return.
EXCESSIVE LEVERAGE
US stocks are owned with a near-record level of borrowed funds, often the quickest money to leave at the earliest signs of weakness.
Data from the New York Stock Exchange showed debt balances in margin accounts at the end of November stood at $500.4 billion, just 1.3% below the record level of $507.2b. in April 2015. It has risen by nearly 15% from February’s trough.
After each of the last three major peaks in margin debt balances – March 2000, July 2007 and April 2015 – the market was lower a year later.
CHINA’S CURRENCY KEEPS FALLING
Chinese policy makers are wrestling with growing debt and property bubbles, while the yuan currency is near eight-year lows. Last year, fears of crisis in China’s financial markets sparked a global sell-off.
As well as threatening to impose tariffs on China, Trump could formally label Beijing a currency manipulator.
“There is a chance for politics and economics and finance to intersect in a potentially disruptive way,” said Commonwealth Financial’s McMillan.
CYBER ATTACKS
Allegations of hacking by Russia ahead of the presidential election, along with breaches at Yahoo, have heightened fears among investors of future, larger-scale attacks that could harm the economy.
“I haven’t placed a trade with an actual broker in five years,” said Jake Dollarhide, chief executive officer of Longbow Asset Management in Tulsa, Oklahoma. “Cybersecurity and attacks on our way of life and our way of doing business are certainly something to keep in mind.”