The Big Picture

Some of the election dust has settled, but not all of it. There was a lot of dust kicked up by the stock market, which quickly ran to new all-time highs after the election results showed Donald Trump had scored a decisive victory in the presidential election and that he was likely to have a GOP majority in the House and Senate with which to work.

The GOP majority in the House was confirmed this week, which ended up being a pullback week for a stock market that had pulled forward a lot of good news.

Questions Being Asked

As discussed last week, the stock market's enthusiasm for the election results revolved around its thinking that president-elect Trump will pursue plans to cut taxes and regulations in what has been labeled a pro-growth agenda.

Growth is good. The path to future growth is paved with good intentions, but as we also noted last week, it is always easier to campaign than it is to govern.

President-elect Trump will have Congress on his side -- certainly for the first two years of his administration. The numbers just line up that way, yet the GOP majority in the House will be a slim majority that leaves little room for defection when it comes to passing tax plans.

The current period is a kumbaya period where GOP members all seem to be on board with the president-elect's plans, only the train hasn't left the station.

Eliminating taxes on tips; eliminating taxes on overtime pay; and eliminating taxes on Social Security benefits are promising-sounding campaign proposals that just might get derailed by deficit hawks inside the GOP, who will also be dealing with proposals to lower the corporate tax rate, raise the SALT cap, and extend the reduced personal tax rates from the 2017 Tax Cuts and Jobs Act that expire at the end of 2025.

That possibility wasn't taken into account in the post-election rally. In that rally, everything was possible, if not likely. It was a buy-first-ask-questions-later kind of move. The pullback this week was about questions being asked.

• Did the market get too far ahead of itself in its post-election rally?
• Is inflation going to heat up again -- or at least not make it to the Fed's 2% target?
• How many times will the Fed cut rates, and will the neutral rate be higher than previously thought?
• Why are market rates going up?
• Can president-elect Trump keep the deficit under control and inflation in check with his policy proposals?
• Can NVIDIA (NVDA) live up to investors' sky-high expectations when it reports its earnings results in the coming week?

The Velveteen Estimate

Today, we plan only to tackle the first question: Did the market get too far ahead of itself in its post-election rally?

The answer is yes. It is an easy answer because nothing has happened -- and things won't start happening on the policy front for another few months when the new Congress is sworn in, and president-elect Trump rightfully becomes President Trump again on January 20.

Nonetheless, there is no stopping a forward-looking market when it has its mind made up that good things are in the offing. In this case, it envisioned stronger profit growth with a lower corporate tax rate and less regulation.

How much stronger? Goldman Sachs estimates that the lower corporate tax rate could add 4-5% to S&P 500 earnings growth, but that wouldn't be until 2026. According to FactSet, the current consensus estimate for 2026 S&P 500 earnings is $308.84. A 5% increase would elevate that number to $324.28, which is 19% higher than the current 2025 consensus estimate of $273.46.

What looks better? A P/E multiple of 21.8 or a P/E multiple of 18.1? Here again, it is an easy answer.

A P/E multiple of 18.1 is a lot less demanding than a P/E multiple of 21.8 when stacked against a 10-year average of 18.1. Participants clearly saw a pathway in the inflated 2026 estimate to the market not being "overvalued" like it was on November 4, and they ran with that.

In effect, they pulled forward an earnings estimate that isn't real yet, but because they loved it, they made it real in their mind, justifying the rush to new all-time highs.

Take It Back

Who knows? The Velveteen 2026 earnings estimate could end up being real, but there is a long negotiating row to hoe to get there, and it won't be easier if interest rates remain elevated -- or also move higher into 2026 because of other issues like deficit concerns or inflation heating up.

The October CPI and PPI reports didn't connote some warm and fuzzy inflation feelings with core-CPI up 3.3% year-over-year and core-PPI up 3.1% year-over-year. What they did do is temper the market's rate cut expectations. Those got pulled forward as well.

A month ago, the market expected the target range for the fed funds rate to be 3.25-3.50% following the September 2025 FOMC meeting. Now, it is expected to be 3.75-4.00%, according to the CME FedWatch Tool, so 50-basis points higher than previously envisioned.

Given that, the stock market has taken back some of the rate cut premium in stock prices that had been pulled forward.

What It All Means

The parabolic move following the election wasn't going to be sustained. The market had gotten ahead of itself, all charged up with a powerful mix of liquidity, a fear of missing out on further gains, short-covering activity, and the most upbeat earnings view into 2026 (forget about 2025).

It pulled forward that view, and pulled down the earnings multiple along with it, to rewrite an overvalued narrative that flowed from a market cap-weighted S&P 500 trading at 22.4x forward 12-month earnings at its post-election peak on November 11 -- a 24% premium to the 10-year average.

While there is a difference between campaigning and governing, there is also a difference between proposals and policy.

There isn't a policy agreed to yet that will lower the corporate tax rate or any tax rate. There will be a push for that, but the market pulled forward too much, too soon, when it comes to pricing in tax cuts and rate cuts. Hence, it needed to pullback to let the dust from an overdone, post-election rally settle.

--Patrick J. O'Hare, Briefing.com