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The market rally started without Trump, and could continue without him

As the stock market returns to action from its best session of the year — the Dow Jones Industrial Average closed above 21,000 on Wednesday for the first time and finished off its fastest-ever rise of 1,000 points — most of President Donald J. Trump's big new policy promises are behind schedule, tied up in court or causing his congressional allies to cower from angry constituents who want to save the Affordable Care Act.

Yet some pundits think Trump's agenda of tax cuts and deregulation caused the rally after Trump's Tuesday night speech to Congress.

The Charging Bull sculpture in the Financial District of New York City
Getty Images
The Charging Bull sculpture in the Financial District of New York City

Everyone is looking to Trump — not just Trump himself, who noted the market had added $3 trillion in value since his election during the congressional address — as the stock market's chief motivator. Longtime bull Prof. Jeremy Siegel of Wharton said the speech removed any "thin ice" from the rally.

But the best reasons to think the rally will continue are fairly apolitical. The Dow's last 300-point gain before Wednesday was the day before Trump's election.

For apolitical bulls, the first thing to remember is that the market has been rising for a year now — not just since the election. February 2016 marked the bottom of a market panic over China, and fears of a new European recession, that pushed the S&P 500 down 15 percent since June 2015. Then it rose 16 percent before Trump's election on Nov. 8. The surge that followed last October's market lull began the day before the election, when prediction models put Trump's odds of winning at anywhere from 28 percent to as little as 1 percent.

That was happening because third-quarter macroeconomic data was strengthening, leading to a strong October as well, said Mark Zandi, chief economist at Moody's Analytics. The U.S. economy grew 3.5 percent in the third quarter, which ended September 30, joblessness reached 4.6 percent by November, and especially strong readings on January manufacturing sentiment and construction spending sent first-quarter growth expectations much higher. Growth was also picking up outside the United States. And global stocks have kept pace with S&P 500 gains this year.

At the same time, earnings forecasts for this year were rising, as higher crude-oil prices drove estimates for energy companies to four times' 2016 profits, according to CFRA Research chief strategist Sam Stovall.

"Valuations are at best fairly valued and at worst overvalued." -Sam Stovall, CFRA Research chief strategist

In fact, economic data actually slowed down after the election as stocks kept moving higher, dragging fourth-quarter growth down to a 1.9 percent annual rate and the unemployment rate back up to 4.8 percent, according to government reports. Then it picked up again, with January purchasing-managers surveys that hit Feb. 1 and 2 that showed bullishness, especially in manufacturing, that wasn't fully backed up by the industrial production report Feb. 15, which shaved half a percentage point off the Atlanta Federal Reserve Bank's GDPNow tracking forecast for the first quarter.

Today even the Fed is giving conflicting advice. GDPNow revised downward its projection from 2.4 percent to 1.8 percent annualized growth for the first quarter, after Wednesday's personal-income report fell well short of expectations. The New York Fed's NowCast says growth will come in at a more robust 3.1 percent, but it hasn't been updated in a week. Neither forecast includes any effect from the new administration's policies, which haven't been enacted yet.

To be sure, some specific sectors of the market have performed exceedingly well specifically due to Trump's election. The Financial Select Sector SPDR is up 26 percent since the election, and only 23 percent since what is called the Dimon Bottom in mid-February 2016. That is when JPMorgan CEO Jamie Dimon bought 500,000 of his bank's shares in a vote of confidence. But broader equity markets have rallied strongly, not just since Trump's election, but since mid-February 2016.

Biggest ETFs since Nov. 9

ETF
Return since Nov. 9 (%)
Return since February 2016 bottom (%)
SPDR S&P 500 12 28.6
Vanguard Total Stock Market 12.7 31
iShares MSCI EAFE 6.2 16.9
Vanguard Emerging Markets 3.7 32
PowerShares QQQ 12.2 34

(Source: Google Finance and XTF.com)

Investor sentiment has not been this high since 1987 — two market bubbles ago.

That brings up the most apolitical reason to be skeptical of the rally, according to Sam Stovall, chief market strategist at CFRA Research: Valuation.

Stocks are trading at 18.4 times this year's projected profits. And the market is defying a past pattern of going through at least one 5 percent correction between each thousand-point milestone on the Dow Jones Industrial Average. The Dow made it from 19,000 to 20,000 without a setback, and made it 21,000 on Tuesday.

"Valuations are at best fairly valued and at worst overvalued," Stovall said. "Yet all of the bulls justify their forecasts by saying that tax cuts are not currently included in the 10.8 percent projected rise in S&P 500 earnings for 2017. They surmise that the forecasted gain will double when tax cuts are added in."

David Rubenstein, the co-founder of private equity giant Caryle Group, said Trump's tax cuts are more likely to be a 2018 event than something that gets through Congress this year.

Betting on 2018 in 2017

Prospects for valuations are worsened by the rising likelihood that the Federal Reserve will raise interest rates at least twice this year, and maybe three times, since higher rates historically reduce the premium investors will pay for a given level of corporate earnings. The likelihood that the Fed raises in March has shot up, doubling this week from 33 percent to 66 percent.

One important reason: The Consumer Price Index has risen 2.5 percent in the past year, making more investors conclude the Fed's target for core inflation, which excludes volatile energy and food prices, will soon be reached. That gain wiped out all of the 2016 average increase in hourly compensation, the Labor Department says.

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Politics does play some role in the bear case, just as it has been a part of the bull case since the election. Disorder in the new administration, highlighted by a court fight over Trump's order barring travelers from seven mostly-Muslim countries from entering the U.S., caused delays in proposals Trump had vowed to make in the first days of his term, Goldman Sachs economists Jan Hatzius and Sven Stehn said. The revised order is expected imminently. But the immigration ban chaos already caused Goldman to trim its views of how rapidly any boost in growth may come, and how much it might be offset by trade restrictions.

"Longer term, we still expect a fiscal boost, but the timeline for passage of a fiscal bill has moved into late 2017 or maybe even early 2018," the Goldman team says. "Meanwhile, the downside risks from the more adverse parts of Mr. Trump's agenda remain significant. An increase in the effective tariff rate on imports seems likely and we now assume a somewhat bigger decline in net immigration flows than we did immediately after the election."

Those risks include a replacement for the Affordable Care Act, as well as a corporate tax bill on which retailers like Bentonville, Ark.-based Wal-Mart have faced off with manufacturers, with retailers worried the changes will raise the cost of imported goods. Arkansas Sen. Tom Cotton has criticized other GOP representatives over the border tax idea, saying it would "see working Americans railroaded."

CNBC contributor Larry Kudlow, who is close to Trump and his team, said on Wednesday that the White House is leaning toward the border tax.

At the same time, Wall Street is increasingly skeptical that Trump's plans to boost mostly private-sector infrastructure investment by $1 trillion over 10 years using tax credits would make it through Congress.

"I think the Trump rally is very vulnerable," said Zandi. "It's about corporate tax cuts and lots less regulation. Stock investors are attaching a high probability to both this year. It's almost a done deal in their minds. I doubt it. The odds that the Trump Administration and the Republican Congress get it sufficiently together to pass tax reform and make big regulatory changes are dropping."

The same political chaos has led to the boldest speculation of all about Trump's presidency: it won't last, either because he gets impeached or resigns before his term expires in 2021. While the president held the first rally of his re-election campaign on Feb. 18 in Florida, British betting house Ladbroke's is laying 10-11 odds his administration will end prematurely — the same odds it is offering on Trump serving a full term.

Trump's speech to Congress was judged by both sides of the political divide as his most "presidential" moment, at least in tone, providing relief to the likes of Wharton's Siegel.

But, oddly, the unlikely chance that a Trump term ends early might be even better for stocks, Zandi said. Vice President Mike Pence, who would take over if Trump left, is a fan of tax cuts and deregulation without posing the worries about trade wars that his boss does. "This is interesting. And a reasonable question," Zandi said. "Pence would be an establishment Republicans' dream come true."

It also points to a simple fact, neither all good or all bad, that both bulls and bears need to evaluate: You're dreaming if you think this rally is all about Trump.

By Tim Mullaney, special to CNBC.com