E-Trade Survey Shows Retail Investors Are Optimistic

Stocks rallied on Wednesday as good earnings reports helped the market regain momentum after Tuesday’s reversal. That means we can continue our discussion on how overly optimistic some investors have become. The table below shows an E-Trade of survey of retail investors. Some of the responses are remarkable. 9% of investors think stocks will rise at least 15% this quarter. That’s over 60% in annualized gains. I don’t see how anyone can think that through and decide it’s the most likely scenario. That type of bullishness is associated with bull market peaks, not troughs. Bull markets are built on skepticism and bear markets are built on complacency. In total, 77% thought stocks would rally in Q1 and 9% thought they would fall. Therefore, a 0.1% decline is considered to have the same likelihood as a 15% increase. This was the most euphoria ever expressed in this survey.

Although the bulls have been correct so far, there aren’t many more bears that can switch over to becoming bulls to drive the market much higher. One oddity with this survey is 68% said they were bullish and 32% said they were bearish. This means 9% of the people said they were bearish and think stocks will go up in Q1. Even the bears think stocks will go up! The other part of the survey is about monetary policy. 66% think the economy is strong enough for a rate hike in Q1 and 9% think it’s not strong enough. This makes sense because the Fed will likely raise rates in March.

Investors were then asked if markets outside of America appeal to them. 62% were positive on international markets and 14% were negative. Currently, U.S. stocks are much more expensive that international equities, so it makes sense, for the long term, to buy stocks abroad. However, just because these E-Trade investors like international markets doesn’t mean they are increasing their weight in them. I wouldn’t assume they are increasing their international weight since they are even more bullish on U.S. stocks.

The final survey question we’ll review is in the chart below. As you can see, the sectors retail investors are most bullish on are energy, tech, and financials. It’s interesting to see investors bearish on consumer discretionary when the consumer is very strong. The main reasons are probably that Amazon is taking share from retailers and that there has been weakness in restaurant sales. America might have too many restaurants per capita just like it has too many brick and mortar stores. One sector I disagree with retail investors on is telecom. That sector will be helped the most by the tax cut. Even though it is defensive in nature which is bad in a euphoric environment, I still like to own companies that have a positive catalyst.

Government Shutdown Updates

Since stocks were affected by the potential government shutdown on Tuesday, it’s worth following the story to its fruition even though equities ignored the story on Wednesday (clearly, I was wrong in my forecast that stocks would be down every day until a deal was struck). The House leaders in the GOP are putting together a new continuing resolution which will last until February 16th. This will be the 4th stopgap measure in a row if it passes. I think it will be the last one as Congress is getting restless, especially the defense hawks who don’t want military spending to be threatened by a government shutdown.

If this short-term measure passes, it means the next few weeks of discussions will get more heated. The continuing resolution includes a 6-year extension of the children’s health insurance program (CHIP), a 5-year delay of the medical device tax, and a 1 or 2-year delay of the health insurance tax and the Cadillac tax which is a tax on high-cost healthcare plans. The deadline for the deferred action for childhood arrivals program (DACA) is March 5th. There are about 800,000 people who will be affected by this. Congress appears to be negotiating on DACA and border security separately from this short-term measure.

The latest update on this story is that the White House is supporting the near term spending deal, but Senator Lindsey Graham is against it. Graham said there have been too many short-term measures. He wants the government to operate on a regular yearly budget to keep the military from being affected by negotiations every month or two. On the DACA issue, he said, “To think you're going to get a budget deal without dealing with DACA is pretty naïve." The GOP will need 10 Democratic Senators to support the bill if McCain isn’t ready to vote on it because of health reasons and Lindsey Graham opposes it. The PredictIt betting market has a 25% chance of a shutdown. I think the odds are higher than that. We’ll get the answer in 1 or 2 days.

This issue is a catch-22 for me because I don’t see why stocks selloff on the chance of a government shutdown since they are temporary nuisances. I think the Congressional GOP will break from the White House in supporting a DACA reform measure to keep the government running for the rest of the year when the February negotiations heat up. That being said, if stocks sold off on Tuesday because of the chance of a government shutdown, it doesn’t make sense for them to go up on Wednesday since the odds haven’t changed. If investors care about a shutdown, we could see a sharp decline on Thursday or Friday if it becomes clear there won’t be a resolution.

Conclusion

The stock market is sometimes disorienting. One day it focuses on the risk of a government shutdown, the next day it ignores the risk and focuses on earnings. I’m conflicted on where stocks are headed in the next couple weeks. On the one hand, stocks have rallied too much too fast as the CNN fear and greed index is at 81/100. On the other hand, stocks should be going up since earnings are strong. Long-term returns look challenging, but investors focusing on the next 12 months should be ecstatic because of the latest earnings reports.