From Charles Roth: Market gains since Trump’s election are starting to look fragile, undercut by friction between the U.S. president’s pro-growth reform proposals and his mercantilist and anti-immigration stances.

In the wake of Donald Trump’s November electoral victory, investors focused on his pro-growth agenda of tax reform, deregulation and infrastructure spending, not on his protectionist and anti-immigrant rhetoric. U.S. equities jumped 5%, catapulting the S&P 500 Index to a 12% return in 2016. Fueling investor optimism, of course, was Republican retention of Capitol Hill, which should pave the way for the market-friendly policy initiatives and, hopefully, a long-awaited investment cycle that supports U.S. growth and corporate earnings. There’s not much margin for error, though, with the bluechip index trading at eye-watering valuations, making index gains more challenging and losses less so.

If investors had assumed that Trump and his mainly business- and military-populated cabinet would thoughtfully sequence priorities to improve the chances for doubling economic growth to 4% from the anemic 2% pace of the last eight years, what they got was a needless spat with a good neighbor about who will pay for a wall, and a poorly drafted executive order on immigration. With understatement, House Speaker Paul Ryan said of the temporary ban on U.S. entry from seven majority-Muslim countries, “regrettably, the rollout was confusing.” No doubt, given the initial inclusion of green card holders and special visa recipients such as interpreters who had worked with U.S. forces in those countries. Although none was as sweeping as Trump’s order, his five immediate predecessors in the Oval Office all used the same authority at one time or another, without sparking widespread protests at home or abroad. Trump gets the news cycle, however, shifting the focus to financial sector deregulation with new directives Friday.

The real difficulty for investors trying to model outcomes for asset prices is two-fold, and neither can be easily plugged into a spread sheet. First, his pro-growth agenda may be offset by his anti-growth “America First” proclivities—mainly his mercantilist view of international trade and his nationalism. Second, Trump’s approach to pushing his economic and political initiatives is abrasive, prompting many Democrats, who in the wake of the election seemed warily open to working with the new administration, into opposition mode and some Republicans in Congress and the Senate may tire of undertaking damage control.

Trump will need legislative support for the reforms that are crucial for spurring growth—the tax system overhaul, infrastructure spending, and meaningful fixes (rather than tinkering at the margins) of Dodd Frank and Obamacare. We’ve also witnessed consternation from his conversations with, or comments on, leaders from Mexico to Australia to Germany, close trading partners or allies that the U.S. will need to manage the regional hegemonic designs of China and Iran, not to mention Russia. On the other hand, Trump has executive authority to act unilaterally on the initiatives that are inimical to growth—pulling out of prospective trade deals and threatening punitive tariffs on imports from countries he accuses of “stealing” U.S. jobs and restricting immigration. As Thornburg’s Ben Kirby notes, “the positive things he can’t do alone, but the negative things he can.”

The threat of trade retaliation in the case of punitive U.S. tariffs is real. In a November 13, 2016, op-ed, The Global Times, a subsidiary publication of the People’s Daily, the Communist Party of China’s main publication and the country’s biggest newspaper group, warned that “China will take a tit-for-tat approach to any punitive U.S. tariffs, adding that “a batch of Boeing orders will be replaced by Airbus (and) U.S. auto and iPhone sales in China will suffer a setback, and U.S. soybean and maize imports will be halted.” The threat should be taken seriously. Shortly after former President Barack Obama took office, he announced a tariff on imported Chinese tires, and China retaliated with tariffs on U.S. chicken and automotive product imports.

In the aftermath of the election, we recommended that investors watch what he does, not what he says. We still think that’s the right approach. So far, Trump’s not been “nearly as disruptive or damaging” as the left-leaning media make him out to be, Kirby notes. Trump’s largely market-friendly cabinet may get him to refine, not damage, trade relations with China, Mexico, et al; to prioritize and sequence reforms judiciously; and to work wisely with, not antagonize, allies. Investors are watching.

The S&P 500 Index essentially treaded water over Trump’s second week in the Oval Office, holding on to its 2.5% gain over the first five weeks of 2017. The bond market, too, is in a holding pattern after the U.S. Treasury 10-year yield jumped from around 1.85% at the time of his election to around 2.6% in mid-December, having since drifted down to around 2.45%. The benchmark yield could keep declining, and the S&P 500, which at a trailing price/earnings ratio of nearly 21x is four multiple points above its long-run average, could slip, if the high-beta Trump doesn’t deliver on his growth promises. The dollar may already be reflecting the risks. The U.S. Dollar Index (DXY) gained around 4.4% from Trump’s election to the end of the year. But since the start of 2017, it’s shed about 2.3%, giving up more than half its post-election bounce.

The currency volatility may in part be driven by the leading tax reform proposal—a border-adjusted tax that would apply a 20% tax on U.S. imports, exempt exports from the levy but apply the same 20% tax on domestically produced goods consumed at home. The proposal in theory should strengthen the dollar, alleviating the hit to importers such as retailers. But with Trump and his trade advisor, economics professor Peter Navarro, harshly charging trading partners with pushing currency devaluations to gain unfair trade advantages, while suggesting that the dollar is “too strong,” the contradictions become apparent.

The friction between his pro-growth agenda and his trade and immigration restrictions may also begin to weigh more heavily on stocks and bonds, especially if he moves on the latter agenda before the economy-boosting overhauls are implemented. Deregulation is clearly making progress. But the market advances that Trump has celebrated will likely be tenuous until it’s clear that the growth agenda is his main focus.

The SPDR Dow Jones Industrial Average ETF (NYSE:DIA) was trading at $200.48 per share on Wednesday afternoon, down $0.1 (-0.05%). Year-to-date, DIA has gained 1.50%, versus a 2.48% rise in the benchmark S&P 500 index during the same period.

DIA currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #6 of 76 ETFs in the Large Cap Value ETFs category.

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This article is brought to you courtesy of Thornburg Investment Management.

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