Ah, the hypocrisy of investors ... or should I say the ignorance? Maybe both. Remember back in June when Britain voted "Yes" on Brexit? Stocks tanked along with the British pound. Britain had just voted to leave the EU and everyone deemed it to be a disaster.
When you think about it the EU is basically one big, giant trade agreement. It's a free trade zone. When Britain decided to leave, the bears were telling us how leaving that zone and going back to old, World Trade Organization trading rules, would be the end of the British economy. Stocks got slammed and the pound lost 15% of its value.
Now along comes Donald Trump who is promising to renegotiate or pull out of trade deals, impose hefty tariffs where necessary and curtail immigration. In other words, basically do the same or even more extreme things than were promised in Bexit. So what are the markets doing? They are celebrating. We are making new records in the stock averages and the dollar is vaulting to 13-year highs.
Here's what I am saying: The Brexit selloff in both the pound and global stock markets was unwarranted. (Stocks have reversed that, but not the pound.) And the enthusiasm toward the so-called "Trump effect" is unwarranted, too, at least for now.
Full disclosure: I voted for Trump and I think his economic ideas are good. I've written and dissected them here on Real Money in several articles in the past. However, I am reserving judgment until I see what the final, Congressionally-passed, signed-into-law policies and legislation will be.
All this year I was telling you to buy stocks. I was telling you that when everyone else -- the whole entire world -- was bearish. January, March, May, June and more recently in the swoon leading up to the election I was telling you that the pessimism was unwarranted. Furthermore, I said that the fiscal flows (federal spending) were solid and the economy would be okay.
Remember guys like Druckenmiller, Soros, Gundlach? They were all bearish back in May and said things like, "sell everything." The Ira Sohn conference. The SALT Conference. Nothing but deep, deep pessimism flowing out of both of those things earlier this year. I mocked them.
Now, however, bullish sentiment has surged. In the last two weeks bullish sentiment as tracked by the American Association of Individual Investors' Weekly Survey, has shot up by 20%. For the first time this year it is above its historical average. Meanwhile, the neutrals have fallen and so have the bears.
You can see it in futures open interest, too. Back in June the net combined position of asset managers, leveraged money and small speculators in the E-mini contract was short, 200,000 contracts. Now that combined position is net long by nearly 100,000 contracts.
In June they were selling when they should have been buying and now they are buying when, I think, they should probably be selling.
I am still bullish on the market longer-term. However, I think now that with lots of people getting very bullish it's a good idea to hedge one's bets. There's another thing, too, and it's the main thing that I look at. The fiscal flows are struggling to stay above last year. Government spending has been hurt by severe Medicare cuts that were part of September's budget deal. Were it not for that I would have confidently predicted a rise of 15% in the S&P 500 in 2017. Now we'll have to see. It will all depend on Trump and Congress.
Finally, the CME Group's Fedwatch Tool is currently showing 100.2% probability of a rate hike at the Dec. 14 meeting. While I have explained many times why I don't view rate hikes as negative for the economy and stocks, I do think that there will be a short-term negative effect on the market when the Fed does in fact raise rates next month
I would hope to see that translate into a nice shakeout in stocks and the removal of the bullish sentiment that has built up. Then, once Trump is inaugurated and we get to see what policies are proposed and passed, we can develop a bullish strategy for the market.