The stock market rally – which many are calling the “Trump rally” – does not come without its risks, according to Bob Doll, senior portfolio manager and chief equity strategist at Nuveen Asset Management.

The S&P 500 Index surged 3.1% last week, according to Morningstar’s data as of Dec. 9. Helping equity markets rally sharply was positive investor sentiment, which remains focused on prospects for better economic growth, tax reform and potential fiscal stimulus in 2017. Despite a drop on Wednesday following the Federal Reserve’s meeting, the S&P 500 seems to have bounced back on Thursday and Friday.

In his weekly investment commentary, Doll explains the recent stock market rally as well as factors that could derail the equity markets.

“The current rally appears to have been primarily triggered by November’s election results and higher prospects for a pro-growth, pro-business legislative agenda,” Doll writes.

Other important contributors fueling the rally include fundamental economic and earnings improvements that emerged over the summer, a not atypical year-end seasonal bounce and investors who may have missed the initial rally adding to positions.

“For now, investors are looking past issues such as potential negatives from the political environment, elevated sentiment, stretched valuations and possible issues associated with Federal Reserve policy,” Doll writes.

Doll believes this broad pro-risk shift will likely continue through year-end and into early 2017.

However, Doll also points out some possible risks that could derail equity markets.

“Although we have a generally positive view toward the economy, earnings and equity markets, we think it is worth pointing out some possible risks given how quickly and how far markets have moved higher over the past month,” Doll writes.

The main risk to equity markets is the surge in government bond yields and the rising value of the U.S. dollar, according to Doll.  

“Higher bond yields could create a drag on equity valuations and a higher dollar could put pressure on corporate earnings,” Doll writes.

If the current advances in yields and the dollar “moderate,” Doll thinks that equity markets will not experience much damage. However, if they continue or accelerate, equity markets may no longer be able to ignore these trends.

Global central bank policy should help buffer higher yields and a stronger dollar. While the Fed raised rates this week, “central bankers will likely move slowly and remain highly attuned to the risks inherent in higher yields and a stronger dollar,” according to Doll.

“[W]e expect any equity market selloff resulting from a possible yield/dollar spike to be short-lived,” Doll writes.

Another potential risk that Doll is watching is possible political negatives from Donald Trump’s presidency, such as escalating geopolitical turmoil, currency wars with China or trends against immigration or globalization. Additionally, investors may become wary of improving sentiment and less attractive valuations.

Doll also points out that positive effects from a new political environment won’t be felt right away. 

“Investors anticipate an economic boost from President-elect Trump’s proposed tax, spending and regulatory plans, but given the complexity in rolling out legislation, the economy may not feel the effects until 2018,” Doll writes.

Despite these risks, Doll thinks, overall, the environment is improving for pro-growth, risk-on areas of the global financial market.

“[W]e think it makes sense to retain overweight positions in equities,” he writes. “Additionally, we think U.S. markets look more attractive than most areas of the world, despite more expensive valuations due to stronger growth prospects.”

— Related on ThinkAdvisor:

Save