(Bloomberg Gadfly) -- The Trump bubble has sprung a leak. The question is how far it will deflate before it can be mended, or whether it even can. The good news for the market is that reports about the departure of adviser Stephen Bannon from the White House seemed to be something of a patch, but for how long is anybody's guess.
The Dow Jones industrial average at mid-day Friday had fallen about 350 points since President Donald Trump backtracked on an earlier statement condemning the racist groups that marched in Charlottesville, Virginia, last weekend. Business leaders fled his advisory panels en masse until Trump decided to abandon them altogether.
The stock market rally that started with Trump's election victory -- the S&P 500 is still up 14 percent since early November -- was launched on the belief that the president would cut regulations and lower taxes, boosting profits. But the embrace of Trump by investors and, until recently, CEOs, has always flown in the face of his other commerce-averse tendencies including protectionism, borderline warmongering and the aforementioned tolerance of white supremacists.
Along the way, as investors bid up stocks on Trump hopes, another thing happened: Earnings actually improved. They increased nearly 18 percent in the first quarter, according to Bloomberg's adjusted numbers, the biggest jump in profits for S&P 500 companies in years. And that continued in the second quarter, albeit at a slower pace. That has led some to believe that even if Trump doesn't come through with a tax cut, the stock market's recent run-up is justified. That is wishful thinking.
Earnings growth in the third quarter is expected to drop to 6 percent, according to FactSet. Profit growth is expected to rebound to 11 percent next year, but those estimates still include a boost from Trump's tax promises, which are looking increasingly empty. A survey earlier this week from Bank of America showed that fund managers were significantly less optimistic about future earnings increases they they were at the start of the year.
If the market returns to the stock multiple it was trading at before stocks were bid up after the election -- a price-to-earnings ratio based on forward earnings of 17.5 -- and earnings continue at the third-quarter pace, which is generous given that profits are slowing, then the S&P 500 should be trading at 2,275, or about 7 percent lower than where it is today. And that's just if the air comes out of the Trump bubble. If his presidency begins to seem to be a drag on the economy, then the market would fall even more.
The calculus of the Trump trade from the beginning was that the tax-and-regulation-cutting Trump would outweigh the trade-warring one. Already, the Obamacare rollback failure put Trump's pro-business agenda in jeopardy. His response to Charlottesville, and just before that the "locked and loaded" threats to North Korea, seems to be enough for investors to redo that math. Bannon's ouster may only be a temporary recalculation. They'll need to keep their erasers handy.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.