This big contradiction has everyone in the stock market at odds

The stock market (^GSPC) continues to make new all-time highs. The popular explanation behind this move is President Donald Trump’s promise of tax cuts and deregulation, which would more than offset the negatives coming from protectionist trade rhetoric.

However, Wall Street’s stock market analysts haven’t yet revised up their 2017 earnings forecasts for this bullish policy outlook. In fact, analysts have actually been reducing their forecasts for earnings since the election of Trump.

This contradiction between rising stock prices fueled by Trump optimism and deteriorating expectations for earnings exacerbated by Trump skepticism have pushed stock market valuations to frightening levels.

So, what’s happening?

Everyone except the stock market analysts are bullish

Goldman Sachs analysts recently reviewed the first quarter earnings announcements and analyst calls of S&P 500 companies, and they identified four major trends in sentiment: 1) “Managements are optimistic about potential corporate tax reform, but are concerned about the controversial border-adjusted tax;” 2) “Hopes for widespread deregulation and improved regulatory clarity are increasing confidence among some management teams;” 3) “Managers of industrial firms are enthusiastic about potential infrastructure spending and a possible end to the defense sequester;” and 4) “Management views are mixed on whether President Trump’s trade proposals will be constructive or will lead to damaging retaliation from US trade partners.”

Those first three positive trends appear to be overwhelming the one negative trend. And it’s reflected by an elevated level of optimism among managements, literally.

All of this optimism about the future has driven stock prices higher, which would make sense as stocks are a discounting mechanism.

So, why are analysts holding back?

The fact is none of Trump’s business-friendly policies have actually been signed into law. Furthermore, anything that does get enacted is unlikely to have a material impact for a little while.

“The new US Administration and Republican majority in Congress have very audacious plans on reforming US taxation, but the likelihood that much of this will pass by midyear seems low to us,” JPMorgan’s Jan Loeys said on Friday. “Deregulation similarly will take quite some time before it has a real impact. Hence, while creating upside, we do not think these will show up soon in the data or earnings.”

“We are approaching the point of maximum optimism regarding policy initiatives,” Goldman Sachs’ David Kostin said. “Our US Economics team expects a tax reform package may not pass until late 2017 or early 2018. Even so, the tailwind to corporate earnings from tax reform will be constrained by the unwillingness of certain Congressional Republicans to significantly expand the federal budget deficit.”

“Positive revisions to aggregate S&P 500 EPS estimates are rare – during the last 33 years, consensus EPS estimates have been revised upward from their starting point just six times,” Kostin observed.

And so, history repeats as analysts cut their forecasts for earnings across the board.

“It is not unusual for estimates to move lower for a given year during the first calendar quarter,” Credit Suisse’s Lori Calvasina said. “But if this trend persists, it is likely to present a challenge for equity markets given extremely high valuations and expectations for upward revisions this year.”

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