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Wall Street theory is you didn’t need Trump to revive earnings

President Donald Trump announces Lt. Gen. H.R. McMaster as his next National Security Adviser, at the Mar-a-Lago resort in Palm Beach, Fla., Feb. 20, 2017.

AL DRAGO/NYT

The 2017 stock market: a celebration of Donald Trump's presidential promises, or the byproduct of influences that predate his election? A cohort of Wall Street strategists is leaning toward the latter.

Yes stocks started gaining hours after his victory, and yes they've rarely slowed down since as gauges of business sentiment boomed. But one pillar of the rally has been strengthening for months with little help from the executive branch.

It's corporate earnings, which after an 18-month meltdown are starting to climb with the robustness that marked the bull market's first six years. Presidential inducements are fine, but to some Wall Street bulls they're not the reason S&P 500 Index income is poised to rise more than any time since 2010.

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"It's clear that this reflationary process was already under way before Trump," wrote Jonathan Golub, chief equity strategist for RBC Capital Markets, in a note last week. "While stock prices jerked forward in the days following the election, the broader trend is better explained by other forces."

Nobody is saying Mr. Trump's proposals haven't helped. But according to Golub, the creation of 2.25 million new jobs in the last year is squeezing wages higher and shows signs of boosting the economy, with each 1-per-cent expansion in gross domestic product translating into a 2 1/2-percentage point increase in S&P 500 sales. Golub sees S&P 500 earnings rising to $128 a share this year from $115 in 2016.

Overall, equity analysts surveyed by Bloomberg predict S&P 500 companies will earn $130.70 in 2017, up 12 per cent from last year and a turnaround from the profit declines suffered in 2015 and 2016. Rebounding since March, the forecasts reflect the views of thousands of individual stock analysts who don't usually incorporate political rhetoric into their predictions, according to Alan Gayle of Ridgeworth Investments.

"Companies took a lot of self-help measures in order to restore profitability within the existing economic upswing, which is a key reason the markets had some momentum going into the election," Mr. Gayle, a senior strategist at Atlanta-based Ridgeworth, which oversees about $40-billion, said by phone. "That's what analysts are looking at, since it's difficult to base estimates on any policy outcome."

The 10-per-cent rally since the November election reflects not so much expectations Mr. Trump will spend on infrastructure and cut taxes, but an improving labor market that's created a "wealth effect that's worked its way into the economy," says Bill Schultz who oversees $1.2 billion as chief investment officer of McQueen, Ball & Associates Inc.

Data showed employers added the most jobs in four months in January. In addition, fewer Americans than forecast filed applications for unemployment benefits last week. Meanwhile, consumers and small businesses are more bullish on the prospects for economic growth than any time since 2004.

The earnings recovery was no surprise to Mr. Gayle, who says he expected to see profits pick up regardless of who won the election. To him, the key fact was how companies withstood the five-quarter profit pullback ending mid-2016, the longest such stretch since the start of the bull market.

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"We went through a profit recession without a lot of layoffs, and without a lot of major plant closures," he said. "That tells me businesses are still running very lean, and that we're starting to rebuild inventories."

The S&P 500 will rise with without any policy assistance, says Binky Chadha, the Deutsche Bank AG chief global strategist with Wall Street's most bullish year-end price target.

"The post election Trump rally has not reflected expectations of policy changes or stimulus," a group of Deutsche Bank strategists led by Chadha wrote in a Feb. 17 client note. "It in fact followed the typical trajectory around close presidential elections, pricing out the uncertainty risk premium rather than pricing in policy changes or stimulus."

According to JPMorgan Chase & Co. strategists, S&P 500 earnings will rise enough to justify the rally without any help from Trump. The benchmark will see 7 to 8-per-cent earnings upside largely driven by the "positive base effects from commodity linked sectors and normalization of the U.S. and global business cycles," they wrote. If he turns on the spigot, even better.

Data from Leuthold Group LLC shows the S&P 500's trailing 12-month EPS is smack in the middle of an 80-year trend channel -- nothing exotic going on. That may mean there's room left for earnings to rise, although they did fail to reach the upper band of its range even with net profit margins at an all-time high in the third quarter of 2014, the firm wrote in a Feb. 7 note.

Investors will now turn their attention to any tax reform details Trump may provide on Feb. 28, when he addresses a joint session of Congress for the first time. He's expected to present his budget goals and potentially outline plans to cut taxes. The speech is not a traditional State of the Union address, though it will have all the policy gravitas of that event.

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"Trump's speech is likely to be the starting line for analysts to start putting a sharp pencil to their estimates," said Mr. Gayle.

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