Despite the record-breaking highs in the S&P 500, Dow Jones industrial average and Nasdaq indexes on Friday, not everyone on Wall Street is convinced that the surge will last, and some are urging caution.

“We see major risks looming, particularly around tax and trade policy” and “a significant risk of an uncertainty shock,” writes Ethan Harris, chief global economist at Bank of America Merrill Lynch in his latest Liquid Insight commentary. “We recommend caution until the policy fog dissipates.”

Andrew Adams, research associate at Raymond James, is “a bit skeptical” about the stock market rally near term despite the breakout above 2,300 for the S&P 500 on Thursday. “The upside still feels limited without some sort of pullback, and there are some other red flags under the surface that may suggest this recent action is already nearing exhaustion.”

On tax policy, Harris is concerned about proposals to eliminate the business tax deduction for interest payments, the immediate expensing of capital investment rather than depreciation over time and border adjustment of taxes. 

Under a border adjustment tax policy, companies that import raw materials could no longer deduct the cost of those imports from their taxable income, while companies that export would not be taxed on the revenue earned from those exports.

(Related on ThinkAdvisor: Trump Inaugural Speech Ignites Fear of Trade War)

Major changes in trade policy, however, are “perhaps the biggest source of uncertainty,” writes Harris.

“Anything that stymies a U.S. company’s ability to do business abroad would not be good considering 44% of S&P 500 revenues come from overseas,” writes Jeffrey Saut, chief investment strategist at Raymond James, referencing J.P. Morgan. “With an economy nearing full employment, too, there is a chance the expected stimulus measures may have limited impact on GDP growth while increasing inflation, which could force the Federal Reserve to raise rates more quickly than the market wants.”

According to Harris at Bank of America Merrill Lynch, withdrawal from NAFTA — the U.S. trade agreement with Canada and Mexico —  would not only weaken the Mexican economy, but also strengthen the U.S. dollar and delay hiring and investment by companies that rely on NAFTA supply chains. Canada and Mexico are the second and third largest trading partners of the U.S. China is number one.

Tariffs and other trade barriers imposed on imports from China, which the Trump White House has threatened, would harm U.S. metal products, machinery and equipment, auto parts and chemicals manufacturers, according to Harris. “The concern is that it will take time for supply chains to develop new suppliers and China could respond with its own tariff or nontariff barriers.”

(Related on ThinkAdvisor: Wall Street Execs Raise Concerns About Trump’s Immigration Crackdown)

Other policy changes could also affect U.S. companies and the economy, according to Harris. Stricter enforcement of immigration policy, which is already underway, would create uncertainty for farming, and the restaurant and construction industries, which all rely heavily on undocumented immigrants.

Changes in Obamacare could affect health care providers and insurance companies as well as patients.

Two measures of uncertainty have already risen, according to Harris: the uncertainty measure in the NFIB survey of small businesses, which climbed to its highest reading in the survey’s history in December, and the Economic Policy Uncertainty Index which has moved higher while the VIX remains near historical lows. Usually the VIX moves along with the uncertainty index, but only half as much.

Not since the Great Recession has there been “so much near-term uncertainty around the U.S. economy,” writes Harris. Until that uncertainty abates and policy changes become more moderate than have been proposed, he recommends a “wait and see approach.”

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