The Trump trade may be causing markets to be overvalued, which could lead to potential problems.

• High expectations exist that tariffs will not result in unfavorable consequences, the 2017 tax cuts will be renewed, and deregulation will stimulate trading on Wall Street and decrease energy costs.
• There are concerns in some corners that the market may be experiencing premature gains, which could result in negative consequences in the future.
• While the stock market may still experience gains before the end of the year, we are not pursuing trends aggressively into 2025, according to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

For weeks, investors have been actively raising prices in anticipation of President-elect Donald Trump's actions upon taking office.

The 2017 tax cuts are expected to be renewed, accompanied by others, and deregulation will spur dealmaking on Wall Street and lead to lower energy prices, while potential tariffs are not expected to cause adverse outcomes.

What if they're incorrect?

The anticipated course of lower taxes, less regulation, and spending on energy and other initiatives has led to a run in which the major averages have posted solid gains, while prices for gold, silver, and cryptocurrencies have also rallied. Specifically, the S&P 500 has increased by approximately 3% over the past month, with bets accelerating that Trump would win.

There are concerns in some corners that the market may experience negative consequences if it continues to pull forward gains now, particularly if Trump initiatives lead to both growth and inflation, as some economists predict.

"The markets were booming before the election and are now experiencing a post-election surge, fueled by optimism, lower taxes, and the pro-business stance of the new administration," said Holly Newman Kroft, managing director at Neuberger Berman Private Wealth, on CNBC. "The market must now weigh the benefits of the administration's pro-growth stance against the risk of higher inflation."

Although inflation was not a concern when Trump first took office in 2017, it is now, despite the fact that it has decreased towards the Federal Reserve's 2% 12-month goal. The core consumer price index reading for October, which excludes food and energy costs, came in at a 3.3% annual rate on Wednesday, significantly higher than the Fed's desired target.

A global trade war could result from Trump's plan to impose 10% tariffs on imported goods, even though it may not directly cause price increases.

It's also a different policy environment from then.

Trump presidency — then and now

Inflation was under control when Trump took office in 2016, and the Fed's main policy rate was close to zero. Currently, the rate is within the target range of 4.5%-4.75%, which is a restrictive level as central bank policymakers try to balance easing inflation with concerns about a weakening labor market.

While the stock market may still experience gains before the end of the year, we are not pursuing trends aggressively into 2025, according to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

"Trump entered 2016 amid tailwinds related to an economy finally emerging from six years of secular stagnation with fed funds at zero, according to Shalett in a note. While markets may be discounting policy certainty based on a monolithic view, our experience suggests that the current Trump policy agenda entails risks and contradictions that put a premium on sequencing and execution, even with strong congressional backing."

Even if Trump's full goals are achieved, the timing of their implementation is uncertain.

Strategists such as Kroft and Shalett believe that the investing implications are significant, though not necessarily negative.

Although she exercised caution, Shalett stated that Morgan Stanley does not plan to significantly alter its asset allocation recommendations and instead advises clients to avoid taking on excessive risk while maintaining a balanced and diversified portfolio.

Kroft recommends diversification and focusing on higher-quality names instead of chasing momentum. For example, she stated that Neuberger Berman is underweight in high-yield bonds and emerging market debt while taking an overweight position in small caps, which have performed well since the Trump victory.

The Fed question

If economic growth and inflation increase due to Trump's agenda, it may alter policy decisions.

Recently, futures markets have adjusted their predictions for the pace of interest rate cuts in the upcoming year, anticipating that the federal funds rate will settle within a range of 3.75%-4%, which is approximately 0.5 percentage points higher than what was previously expected.

Trump advocated for lower interest rates and criticized the Fed for raising them during his previous tenure when the economy was struggling.

Although uncertainty may be a cause for concern, it could also be beneficial.

According to research on economic uncertainty, markets are inversely correlated, meaning that more uncertainty has resulted in higher stock prices, as stated by market veteran Jim Paulsen.

According to Paulsen, a former chief strategist for Wells Fargo, when economic policy concerns are as extreme as they are today, the negative fallout from excessive worries about the future direction of monetary and fiscal policies is more than offset by support from a large Wall of Worry.

The Trump rally has shown some slowing in the past two days, but there may be near-term volatility.

"In an interview, Paulsen stated that he believes the market is not as far ahead of itself as people think and that the current situation is just a normal ebb and flow of the market. He added that they are prepared for an ebb at some point."