| NEW YORK
NEW YORK The latest leg of the relentless rally in U.S. stocks since Donald Trump was elected president has all the hallmarks of being driven more by sentiment than sense, but that doesn't mean the ride is over, although it could well be a bumpier one from here.
The U.S. stock market, which has been hitting new highs almost every day, is more expensive than it has been since 2004. Trump's address on Tuesday to Congress sparked another buying frenzy, as the reset in the president's often bombastic tone to an uncombative stance ignited investor optimism - even though his speech was light on details of waited-for initiatives.
Growing expectations of faster interest rate rises at the Federal Reserve helped fuel the rally, with bank shares leading Wednesday's gains.
The stocks rally since November has been driven by an expectation that Trump's push for deregulation tied to increased infrastructure spending and corporate tax cuts will jolt economic growth - and company earnings.
However, investors caution that the tough job is now to come: pushing promised policy changes through Congress, which has proven less than easy even on issues Republicans agree on such as repealing Obamacare.
"If Trump delivers on some milestones that are relatively meaningful - corporate tax reform, deregulation ... then I think the markets continue to rally, but if none of that happens people start to take risk off the table," said Northern Trust chief investment officer Bob Browne, who is overweight U.S. equities.
Equities are surely richly priced. Since the 12 percent advance on the S&P 500 since the Nov. 8 election, investors are now paying $18 for every $1 in expected earnings over the next 12 months - the highest forward price-to-earnings valuation in 13 years according to Thomson Reuters Datastream.
Still, large investors such as Warren Buffett are optimistic. Buffett told CNBC earlier this week that the U.S. stock market was cheap with interest rates at current levels, although he conceded that U.S. shares could conceivably "go down 20 percent tomorrow."
But Buffett said he was "baffled" about who would buy a 30-year bond at current yields.
Rich valuations are not a sell signal in themselves, since in the later stages of a bull market - which can last years - "corporate earnings are cyclically elevated and the multiple that the market assigns to those earnings is often elevated as well," according to a note from analysts at Bank of America/Merrill Lynch on Wednesday.
The BAML analysts raised their year-end target for the S&P to 2,450, or about 2 percent above the current level, noting that they expect the benchmark to slide below 2,230 at one point before 2018.
Even so, the high expectations on policy execution and the elevated valuation leave stock investors exposed.
"Expectations today are quite optimistic relative to the likelihood of delays, friction and more negative offsets than the market is currently pricing in," wrote the BAML analysts.
The lack of detail on Trump's speech Tuesday regarding tax reform concerned some investors.
Scott Clemons, chief investment strategist at Brown Brothers Harriman in New York, said tax reform got "really, really short airtime" and it appeared to be a "secondary priority."
But Clemons said any market pullback on that front would be short-lived because of the expected strength in corporate earnings.
Earnings for the S&P are expected to rise more than 10 percent over the full year, according to Thomson Reuters I/B/E/S data. But that number has been trending lower. For the current quarter, analysts see earnings rising 10.6 percent, down from an 18 percent estimate in April and a 13.8 percent gain seen in January.
With Trump's speech light on details, the market focused on the growing expectations that the Federal Reserve will hike interest rates sooner and maybe more times this year than previously thought. Investors now see a 65 percent chance that the Fed will move to raise rates later this month, up from 35 percent Tuesday.
But higher rates, which buoyed investor optimism because a March rate hike would signal policymakers' growing confidence in the economy, would be a double-edged sword for equity investors.
The dollar has risen on the view of higher interest rates, with the 100-day average of the dollar index .DXY at its highest since 2003.
Every 5 to 6 percent increase in the dollar results in negative earnings revisions of about 3 percent on the S&P 500, as sales in other currencies are converted to fewer dollars.
Higher rates at the Fed also mean companies spend more on credit. After a period of nearly a decade in which the Fed did not raise rates, increases can creep up in a company's expenses and generate unwanted risk for investors.
Plus there's the added risk of uncertainty over how the Fed will shape its policy in the coming year, as six of the eight permanent-voting positions at the Fed could all have new occupants due to term endings and currently open spots.
"I'm more worried a year from now when we have no idea what the Fed board will look like," said David Kotok, chief investment officer of Cumberland Advisors.
"It means you have a complete unknown about who is going to make the Fed policy and what it will be."
(Additional reporting by Richard Leong and Megan Davies; Editing by Leslie Adler)