For stock markets, the short-term and long-term outcomes of the “Trump trade” won’t necessarily be the same.
So far, President-elect Donald Trump’s victory Tuesday has been positively received by investors, as was the case in 2016. The S&P 500 rose 2.5% to a record close Wednesday, buoyed by Trump’s stated intentions to, among other tax cuts, take the corporate-tax rate from 21% to 15% for companies that manufacture in the U.S.
In 2018, after Trump’s first round of tax reductions came into effect, the S&P 500’s earnings-per-share, or EPS, jumped by 21%, compared with an 11% increase the previous year.
Much might depend on whether the Republicans win majority control in the House, but some Wall Street analysts think a new wave of tax cuts could boost EPS somewhere between 5% and 10%.
As it turns out, the shot in the arm might come at just the right time to rescue a stock market that was starting to get ahead of itself.
Most S&P 500 companies have already reported third-quarter earnings, and 75% of them have done better than analysts were expecting, according to FactSet, which is in line with the 10-year average. EPS are now expected to be 9.6% higher in 2024 than the previous year.
Cracks are nevertheless starting to appear. For one, the S&P 500 has been able to surprise the upside because forecasters had downgraded their projections by 3.6% since the end of the second quarter. This is more than the median of the past decade, which is 3.3%.
More important, many executives have been warning that profit growth might be weaker than analysts expect in the fourth quarter, as well as in 2025. Among the 62 members of the S&P 500 that have provided guidance for the October-to-December period, 42 of them—that is, 68%—have given a midpoint estimate for earnings-per-share that is below what Wall Street was expecting before the start of the reporting season, according to FactSet.
This is a smaller percentage of negative guidance than firms were issuing at the start of the year, but is firmly above five-year and 10-year averages of 58% and 62%, respectively. It marks a retrenchment from the optimistic guidance provided for the second and third quarters of this year.
Consumer-oriented companies, such as flooring manufacturer Mohawk Industries, hotel chain Hilton and cruise operators Carnival and Royal Caribbean, are behind many of the disappointing outlooks. Admittedly, they are all exposed to the one-off impact of hurricanes, but they also have cited weaker demand.
Analysts are counting on artificial-intelligence-themed stocks to keep leading the S&P 500. This comes with risks: As Apple’s slow sales for the iPhone 16 show, big AI investments could take time to pay off, putting pressure on megacorporations to cut back their vast investment budgets.
To be sure, Trump is inheriting an economy that seems in good health, stripping out weather events and the strike by Boeing machinists. But more cautious guidance does suggest that equities are increasingly priced to perfection.
“Analysts and corporate managements are dealing with the reality that converting solid economic growth into the accelerating expectations priced into profit estimates is hard,” warned Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, in a report to clients this week.
Indeed, forecasts for the next 12 months show the S&P 500’s net profit margin rising significantly above 13%, which is a record. Based on trailing 12-month earnings, however, it is possible that they have already peaked somewhere in the vicinity of 12%. As a result, the gap between backward-looking and forward-looking price-to-earnings ratios is the largest ever outside of the dot-com bubble and pandemic rebound of late 2020 and 2021. Stocks might be even more expensive than they appear, unless earnings growth reaccelerates.
Trump’s fiscal policies make this scenario more likely. Budget deficits have been the main source of widening profit margins over the past few years, and his proposed tax cuts and spending increases could take the deficit from above 5% of GDP—already a record outside of wars, pandemics and recessions—to between 7.7% and 12.2% in 2035, according to estimates by the bipartisan Committee for a Responsible Federal Budget.
Still, while the 2017 tax cuts did mechanically boost earnings for investors, they didn’t lead companies to significantly increase capital investments, which calls into question whether such policies generate permanent productivity benefits.
That uncertainty speaks to a broader problem with the “Trump trade”: While some of his policies have an immediate benefit for investors, the potential downsides of others—namely, his proposed tariffs of perhaps a 10% across-the-board levy on trading partners, plus a 60% tariff on China—are longer-term and harder to measure.
His first round of protectionist measures contributed to a global manufacturing recession in 2019, which drove EPS to fall 0.5% for the S&P 500, and 16% for the “industrials” subsector. The impact might be starker this time, particularly if other nations retaliate strongly. Yet vast uncertainty clouds what the final shape of the tariffs will be, or which products could be excluded.
The stock market may be looking at a clearer road immediately ahead. The final destination, though, has gotten harder to ascertain.
Write to Jon Sindreu at jon.sindreu@wsj.com
