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What Investors Learned From the 2016 Presidential Election

Although it’s year-end, I’m not going to take this opportunity to discuss the historical 2016 investment market performance. We’ll save that for January. Instead I want to comment on one of the most powerful lessons investors can learn from the 2016 presidential election. It is this:

Predicting is NOT investing. (It’s speculating.)

Now, to some supporting statements on that.

A Brief Tutorial on Market Mechanics

First, how does a stock (or bond or REIT fund, etc.) get priced? Academic inquiry has revealed it’s the result of all participating investors’ collective decisions. Based on interpretations of known information, some bet pricing will go down. Some bet it will go up. If there are more “up” bets, supply and demand drive prices up. Vice-versa if the “down” bets dominate.

Every moment, as the news changes, so do investor perceptions, and so does the pricing. Messy? Yes! But also surprisingly efficient … and very hard for any one investor to consistently outmaneuver the market’s mechanisms.

What does this tell us about making near-term predictions? “Success” in this context depends on luck versus skill. That’s because a skillful “bet” would require knowing the unknowable … twice. First, you’d need to know what new information is about to be known. Second, you’d also need to accurately predict how the collective market will react to the unknown news.

What the Experts Didn’t Know About the Election

“But,” you may ask, “wouldn’t someone with more information than me – an “expert”— be up to the challenge of making successful predictions?” Before we explore the question in the context of investing, the recent election provides us with an excellent illustration on the reliability of expert forecasts.

How many political experts predicted who our next President would be in the summer of 2015? I don’t know the exact answer either, but I’m guessing it was only slightly north of zero.

“No fair,” you say. “There were 17 Republican and 4 Democratic candidates. And besides, 18 months isn’t exactly short-term in an election cycle.”

Fine. How many made the correct call after Super Tuesday, 8 months ago, with 3 Republican and 2 Democratic candidates left? Or how about the day before the election when it was effectively a coin-toss? Seriously, with all the data at hand, how hard should it have been for seasoned political pollsters who have dedicated their careers to the craft to predict the outcome by then?

And yet, the polls were largely wrong. To understand how wrong, consider the post-election commentary from statistician Nate Silver, whose predictions were among the closest when he gave Trump slim 29% odds of winning (along with the caveat that nobody really knew for sure). That, compared to several other models predicting single-digit odds for Trump.

“Given the historical accuracy of polling and where each candidate’s support was distributed, the polls showed a race that was both fairly close and highly uncertain,” said Silver, in retrospect. “People mistake having a large volume of polling data for eliminating uncertainty. It doesn’t work that way.”

What the Experts Didn’t Know About Investing

Fine that’s politics. Back to investing. How did the stock market gurus make out predicting what would happen to the markets if Donald Trump won the election? Here are a few examples I saw, among many:

  • “If Donald Trump wins in November, U.S. stocks would fall about 8%, erasing all its gains for the year.” - CNN
  • “Citi predicts possible 5% drop for S&P 500 if Trump wins, warns on recession” - CNBC
  • “A Huge Hedge Fund Says Stocks Will Crash if Donald Trump Wins” … “If Donald Trump wins the election, kiss your 401(k) goodbye.” - Fortune
  • “Simon Johnson, the Massachusetts Institute of Technology economist, posited that Mr. Trump’s presidency would ‘likely cause the stock market to crash and plunge the world into recession.’” – NY Times

What happened in real life? The S&P 500 Index was up 5.5% the first week after the election. As I type this, the markets have continued to rise and the DOW Industrial stock index and NASDAQ recently hit all-time highs. Note that I am NOT predicting one way or the other what may unfold next in the markets. The point is, the experts don’t know any more than I do. They don’t know what we don’t yet know … and none of us knows how the markets will respond to what we don’t yet know.

I’ll offer one more illustration: the Federal Reserve. If anyone could predict what we don’t yet know about interest rates, you would think it would be the agency essentially in charge of adjusting them. This time last year, the Fed predicted four rate hikes in 2016. Instead, they ended up making exactly one, relatively modest hike, two weeks ago. You would have been ill-advised to react to anyone who told you in early 2016 to brace for the “inevitable” increases.

You would be ill-advised to react today.

What We DO Know About Investing

The truth is, many “experts” who are in the business of making market predictions have ulterior motives that don’t include you and your best interests. They know that their predictions easily sway us, susceptible as we are to a potent mix of behavioral biases that we often aren’t even aware are at play. Our biases trick us into believing we can outsmart the market or find someone who can. Whenever one guru disappoints, along comes another with a tantalizing newsletter, exciting show or specialized technique promising a secret to success. And for only $9.99 (plus s&h), you can be in on the action.

Is there any harm in listening to info-entertainment known as stock market predictions? Only if you are one of the very few who can listen to, but completely ignore the urgent calls to action. Unfortunately, you’re probably in the minority if you can do that, so you’re best off avoiding the onslaught.

Case in point: Prior to the November election, BILLIONS of dollars flowed out of equity mutual funds. In the week of October 19th alone, $17 billion left U.S. equity funds. That was the most in one week since 2011. In the meantime, post-election, just after all those funds had flowed into fixed income investments, stocks went up and bonds went down. Way down.

Onward, on an Upbeat Note

To end on a positive note, there’s good news to share. Yes, it’s at least as difficult to play the financial prediction game as it is to correctly call a presidential election … or forecast our DC weather. But fortunately, you don’t have to play to begin with. In fact, you shouldn’t. To participate in the market’s expected long-term returns: save some money, invest it according to your personal goals and risk tolerances, remain patiently disciplined and diversified, and ignore prognosticators with agendas that aren’t your own.

Do all that, and you’ve given yourself the best possible odds for enjoying a …

Happy New Year!

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