The Dow Jones Industrial Average has closed at an all-time high 15 times since Donald Trump was elected president.
According to Jonathan Golub, chief equity strategist at RBC Capital Markets, there are two ways that this streak of record-setting market days can continue.
For one thing, the current trends are based on expectations of Trump policies. Golub said that the surge in positive data on inflation and consumer sentiments must continue.
“Inflation expectations and interest rates bottomed in July and have inflected higher since the election,” wrote Golub in a note to clients on Tuesday. “A tight labour market and an increase in consumer and business optimism should fuel this trend higher.”
Most likely, this means that both hard data — for instance, actual consumer spending and retail sales rather than just confidence surveys — and meaningful policy statements have to materialise in order to keep up the enthusiasm for stocks.
The second is a bit more qualitative. Golub said that investors have to maintain their view that Trump’s policies are a positive for the economy, instead of possibly running things too hot.
“At some point, however, rising yields will be interpreted negatively, with the Fed more likely to become engaged, shortening the business cycle,” said Golub. “The response of stocks and the tone of market leadership should provide real-time signals on the rally’s health.”
Right now, stock investors view increasing bond yields and inflation expectations as a symptom of further US economic growth. If that sentiment shifts and investors start to think the Fed may be aggressive dealing with inflation getting above their 2% target, that could snuff out the Trump rally.
Additionally, Golub said that while price-to-earnings multiples (P/E) make stocks look expensive by historical standards, this is because analyst projections are falling behind the news, not because stocks are going too high. From Golub’s note (emphasis added):
“Analysts tend to be cautious in adjusting estimates following breaking news, acting only after ascertaining company-specific impacts. Investors, by contrast, are quicker to respond to incomplete information. This dynamic is playing out post-election, with stocks sharply higher while estimates remain largely unchanged. This timing difference creates the false impression that valuations are stretched, and should correct as analysts catch up to the market.”
Put another way, since more P/E ratios use the forward expectations from analysts for company earnings, the foot dragging is making stocks look pricier than they really are. Once analysts get around to revising their expectations, the P/E ratio will come down as earnings are revised upwards, making the “Trump rally” look more sustainable.