Is the Trump effect over?

It’s perhaps inevitable that 10½ months into Donald J. Trump’s presidency we would pause to consider whether the Trump Effect has begun to wane. As Trump’s first year in office enters its final stretch, advisers should be prepared to answer client questions in this regard.

It’s probably premature to downgrade this “bump-and-shudder” hold on the markets to a fleeting dynamic, but it’s true the “Trump Rally” and “Trump Agenda” have begun to appear more vulnerable. The markets, it seems, have been pricing in more than just talk of a pro-growth agenda.

We’ve seen defense stocks surge to all-time highs with Trump’s anti-North Korea rhetoric, and Puerto Rico’s bonds dive with his suggestion the hurricane-damaged island’s debt would be wiped out. Most recently, we saw the market stumble as former national security adviser Michael Flynn pleaded guilty to lying to the FBI, and the Dow Jones Industrial Average break the 24,000 mark on news of growing support for the GOP tax plan.

There’s no reason to think these short-term jolts won’t continue. The bigger question is, why do we fixate on them? The volatility is well-suited for professional traders, but can also serve as a distraction for buy-and-hold investors whose portfolios are constructed based on long-term horizons.

(More: Tax reform will boost food, chemicals, rail stocks. Technology? Not so much.)

Although the bull market is in need of repose, it does shows signs it will continue to thrive in 2018. But in the same way we wouldn’t credit a yacht with beautiful weather as it sails into clear waters and sunny skies, we think it would make little sense to attribute the continued upward trajectory of the bull market to Trump.

PULLBACK TIME?

The markets are showing signs they may be a bit ahead of themselves. Bull markets average four 3% pullbacks per year, but we haven’t experienced a pullback of 3% or greater for 13 months. Hope for a new tax code could be contributing to this streak, but would likely be minimal given no legislation has yet been signed.

That’s not to say that Trump’s tax plan didn’t generate optimism that contributed to the market’s momentum—or that a failure to pass one couldn’t trigger a selloff—but that the true drivers of the economy remain earnings, revenue and global economic growth rates.

Continued strong earnings growth could sustain the bull market. S&P 500 earnings are now expected to grow 19.84% year-over-year (YOY) compared to an estimate of 18.98% as of Dec. 5, 2016. Other possible drivers include accelerating global economic growth and median revenue growth improving at all capitalization levels YOY. The absence of any substantial bubbles and a lack of volatility could also help sustain a bull run, as the end of bull markets tend to be characterized by big swings.

(More: As cash flows to companies after tax reform, here’s how to invest.)

A market selloff of 5% to 10%, on the other hand, could be triggered by the taking of gains as next year begins. It also could be set off by geopolitical or domestic developments involving North Korea, interest rates, or tax reform, for example.

FED WATCH

With this in mind, advisers and their clients might be better served keeping an eye on Trump’s Federal Reserve chair nominee Jerome Powell, and a continued transition to more hawkish rate actions, with the unwinding of the central bank’s balance sheet possibly shifting market rates higher.

Advisers should also watch trends in emerging markets. The U.S. is about two years ahead of the rest of the world in our globally synchronized monetary stimulus meted out by central banks. That means other countries experiencing the recovery the U.S. has already seen now have economic growth accelerating at a faster pace.

We believe advisers and investors shouldn’t ignore Trump, but they should be aware of the scope of his influence. The Trump Effect comes in short-term spurts, but we believe sticking firmly to a buy, hold and rebalance strategy is still the best approach to position portfolios to meet long-term objectives.

Mike Boyle, CFA, is a senior vice president of Advisors Asset Management.