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Markets and Reality - Outside View by Asad Dossani

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Markets and Reality
Mar 2, 2017

When Donald Trump speaks, the markets listen. And yesterday, they liked what they heard. Stock markets soared globally. Once again, the US markets made new highs. This should come as no surprise. Since his election, economic expectations have been sky high. From deregulation to tax cuts to infrastructure spending, Trump's plans are likely to boost the economy and hence the stock market.

It's worth repeating an old adage here: Watch what people do, not what they say (or tweet). And herein lies the problem. Since Trump has been in office, there's been almost no progress on Trump's economic plans. Instead, the only major actions he's taken are the travel ban and withdrawing from the TPP. Both of these actions negatively impact the economy.

Why have Trump's economic plans stalled? Because he needs Congress to implement them. And this is where it gets tricky. A large portion of the Republican party is opposed to any policy that increases the budget deficit (e.g. tax cuts, infrastructure spending). A large portion of the Democratic party will block anything Trump proposes.

Put simply, Trump has too many obstacles. The odds his economic plans actually become reality are slim and getting slimmer. With zero progress in month one, months two and beyond don't look promising. At best, he'll manage to pass something heavily watered down.

Of course, the markets think otherwise. They have all but priced in Trump's economic plans. They have priced in higher GDP growth and higher interest rates. And don't get me started on interest rates. The Fed is notorious for talking about rate hikes without actually implementing them.

The evidence points to an overvalued market. A stock market in bubble territory. Other indicators are pointing to this too. The cyclically adjusted PE ratio stands is to 30. This is way above its long-term average. Historically, markets have fallen when PE ratios are at this level.

The US markets may be breaking new records. But that doesn't mean the fundamentals justify it. A reality check is on its way. And for the brave contrarian traders out there, this is a fantastic opportunity.

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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