The stock market is pricing in flawless results from the GOP in terms of fiscal policy. To analogize, it’s like when the market is expecting a company to beat earnings estimates and raise guidance. If the company meets expectations, the stock falls after hours because it’s priced for perfection. I have a few charts to review which show the market is expecting too much. Next, I’ll go over the GOP’s healthcare plan. Healthcare is the lynchpin to the GOP achieving its fiscal policy objectives. It also works as a signal to tell investors whether the tax code will be overhauled. If the healthcare plan and tax code change don’t get through Congress, I foresee a stock market correction. I also think a token tax cut will occur if nothing major passes to show the voters the politicians got something done.
I’m not a big fan of trusting politicians to justify my investments. It’s not a partisan opinion; I don’t think either party is organized enough to work efficiently. Just because one party wins an election, doesn’t mean passing legislation is easy. Each party has major divisions within them. The idea of both parties’ moderates working together isn’t as likely as it once was as the hostility within the parties has escalated, as you can see from the length of time it’s taken for Trump to get his cabinet appointments approved by the Senate. However, investors have decided to go against logic and trust that fiscal policies will boost the economy as the Fed takes its foot off the pedal. The first chart below shows the TD Ameritrade retail sentiment index. The so called ‘dumb money’ is the most bullish since the index was created in 2010. I think the Dow hitting 20,000 was a psychological catalyst for getting retail investors to put more money to work. They’re more likely to make decisions based on sentiment than professional money managers.
Even though retail investors have been piling into stocks lately, they aren’t alone. Retail investors don’t have enough fire power to push the market up on their own. My point was retail investors tend to get involved toward the end of the cycle. As you can see from the chart below, hedge fund leveraged exposure to U.S. equities is currently higher than the peaks of 2000 and 2007. It will result in a bigger selloff than the last two cycles when this unwinds since the leverage is higher.
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