Trump stock market rally: Likely to keep going in 2017

Donald Trump is Time's Person of the Year
Donald Trump is Time's Person of the Year

Donald Trump has been very good for the stock market so far.

Expect the "Trump rally" to keep going in 2017. At least that's what major Wall Street banks predict for U.S. stocks next year.

They are betting that Trump and the Republican-led Congress will get the job done and cut taxes and regulations.

"Corporate tax cuts could easily add 5% to 7% to profits annually going forward," writes Jonathan Golub, chief equity strategist at RBC Capital Markets. He projects U.S. stocks will soar 10% from where they are now.

Business and consumers seem more optimistic. If that translates into more spending at stores and on new equipment, Golub argues that it will be an even bigger boost to the economy and profits.

The S&P 500, a key index of American stocks, is currently sitting at about 2,270. It's up over 11% this year, well above the historic average (and far better than most experts projected).

Here's a rundown of S&P 500 forecasts for next year from some big banks:

Royal Bank of Canada (RY): 2,500 (+10% from current levels)
Deutsche Bank (DB): 2,350 (+3.5%)
Citigroup (C): 2,325 (+2%)
Bank of America (BAC): 2,300 (+1%)
Goldman Sachs (GS): 2,300 (+1%)

At first glance, many of these projections look low, but most were made a week ago -- when the S&P 500 was barely at 2,200. The market has risen rapidly since, but experts say they're still bullish.

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The bullish case

"We think this rally can continue for the next six to 12 months," says Katie Nixon, chief investment officer at Northern Trust Wealth Management. There's been a "fundamental improvement" in earnings and the economy.

Savita Subramanian, head of U.S. equity strategy at Bank of America Merrill Lynch agrees that there's a chance the bullish case will play out and the market will end 2017 at a high of 2,700 -- almost a 20% jump from where the market is trading now.

To get there -- or anywhere close -- Subramanian argues the market needs two things: euphoria (investors buying stocks and ditching bonds) and the Trump administration delivering on policy.

"We need to have some clarity [from Washington] in first couple of quarters. We've penciled in tax reform package," says Subramanian.

But she worries the market has already priced in tax cuts AND a big infrastructure spending bill. Infrastructure already looks in doubt as some Republicans balk at so much spending that would add to the already large ($19 trillion) debt. That's why her team has priced in a much more conservative gain of just 2,300 for the S&P 500 next year -- for now.

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Watch out for inflation

Goldman Sachs, which now has four alums in key posts in Trump's transition team and cabinet, forecasts the market will jump in the first quarter as investor continue to bank on high "hopes" for action. They see the U.S. markets easily hitting 2,400.

"But less-than-expected tax cuts combined with higher inflation and interest rates will limit both upward EPS revisions and P/E multiple expansion," the bank writes, which is why it only predicts a small uptick in the S&P 500 by the end of 2017.

While there's a lot of focus on the Trump team, the bigger wild card may turn out to be inflation next year. There are already signs it's picking up, especially American worker wages.

"Joe 6 pack gets a raise," said a recent Bank of America report.

Some inflation is a good sign that economy is picking up again, but like just about everything in life, the ideal is to get inflation in moderation.

"Margins are high and they will come under pressure from rising labor costs and the stronger dollar," warns Russell Investments, an asset management firm. It's telling investors to stay diversified, even though bonds don't look so great.

If inflation gets out of control, the Federal Reserve will have to hike interest rates quickly and the second-longest bull market in U.S. history could stall, if not end.

"The post-election optimism driving markets in late 2016 could quickly change," says Russell Investments, which predicts the S&P 500 will end the year at a mere 2,100. In other words, a negative return year.

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