Should Investors Care Who Wins The Election?

I was having lunch last week with a client.  We were talking about the typical kind of commentary that investment firms tend to write – particularly the blather about what the upcoming election means (or doesn’t mean) regarding investing and investment strategy.  Then he said something like, “You should write something - it would be interesting.”

At the risk of my own blather – I’m going to take him up on his suggestion.  For what it’s worth, below are my thoughts on today’s election.

Despite the fact that making big bets specifically on the outcome of any event is a low odds proposition, deep down we are all John Paulson wannabes (Paulson made billions betting the ranch on the failure of the subprime mortgage market).  Big wins like Paulson’s are exciting and make for great stories.  Less interesting, but perhaps more important is that Paulson’s record since his big score is dismal.  

Nobel laureate Daniel Kahneman provides valuable insight of what to do when faced with what we think is a critical choice.  He suggests that before making any decision, to consider the base case.  That is, given the historical data, what is the most likely outcome?  Headlines, commentary, our own (and our friends’) opinions are powerful influences over our perceptions.  Having a base case helps ground our decision-making.  The base case of what happens after elections is mostly inconclusive.   

Whoever becomes President may be a meaningful investment factor, but it isn’t meaningful enough to suggest any kind of drastic investment stance (à la Paulson).  The base case is that markets mostly muddle through events and often respond in a totally counter-intuitive fashion.  While some of us may think that a Trump victory would be a disaster for the market – many of us thought the same thing in late 2012 about the impact of the fiscal cliff.  But when the fiscal-cliff actualized the market rose 30% over the next twelve months.  

As I was thinking of this question, I thought of some important lessons I learned from two well-known statisticians:  Nate Silver (politics) and Theo Epstein (baseball).  Silver came to prominence in 2008 when he accurately predicted the presidential winner in 49 out of 50 states and every single Senate race, following it up with a best-selling book (The Signal and the Noise), and today has the “go-to” website for the current election (www.538.com). 
 

Epstein’s accomplishment is even more remarkable:  he assembled the 2004 Boston Red Sox team that ended the 86 year old curse of the bambino by winning The World Series, and then repeated the feat with the Chicago Cubs this year – ending their 108 year drought.  The irony is - while his feat seems so improbable, it was achieved by maintaining a laser focus on probabilities.
 

The commonality between baseball, politics and investing is that they are all data rich.  Data rich enterprises lend themselves very well to statistical analysis and probabilistic thinking.  Epstein’s goal was to find the best combination of players based upon the data –and then wait.
  

Nate Silver gets his edge by continually updating his view of the world as the facts on the ground change.  His success at political prediction is grounded in his willingness to let the facts form his opinions.  A dispassionate view of the present is the most effective way to have clarity about the future.  

Finally, I think it’s worth repeating that the news cycle and the investment cycle are not connected, at least not in any kind of simple deterministic manner.  In terms of news – it is next to impossible to keep our attention on more than one, perhaps two major stories at any one time.  But risk doesn’t have that limitation – and we ignore that distinction at our peril.

The implications of a Clinton victory or a Trump victory are not insignificant.  But they are a small part of a larger web of investment risks and opportunities whose dynamics are the focus my regular attention.  There will be plenty of time to evaluate, prioritize and monitor the implications of the policies and/or personality of whoever becomes President – we just need to stay present and dispassionate enough to see them, even if the news (and our attention) is directed elsewhere.

How Should We Respond to a Low Return World?

"Investors need to consider the possibility that in a world where guaranteed returns are historically low, and where traditional sources of future return appear to offer, at best, well below average prospects – there may not be an investment solution.  Like a business, the financial part of life is all about revenues vs. expenses.  Investors hold all the cards on the issue of expenses.  And in today’s environment a meaningful segment of individuals are facing a reality that they did not anticipate:  Their investments may not provide enough of a return, and the single most valuable investment strategy at their disposal, the one that will make the difference between living within or above their means – is their ability and/or willingness to reduce their expenses."

- An excerpt from my latest column at ThinkAdvisor.

Indexing wins. Now what?

The point everyone in the active/passive debate appears to be missing, is that the issue at hand is not whether active is better than passive. That has been settled. The real issue at hand is nothing more than the basic calculus of every investment choice we have to confront. Is what I’m gaining from the decision I’m about to make more valuable and important to me than what I’m losing? If I do this, what's the most likely worst-case outcome — and could I live with it if it happens?

Like moths we are instinctively drawn to the light of what's working. But light can blind as well as inform. The demise of indexing, if and when it actualizes, will not be the result of some internal weakness or flaw in its infrastructure; it will be because we overused it, abused it and expected far too much from it.

Excerpted from my latest column at ThinkAdvisor.

Is Valeant just the tip of the Iceberg?

"Most commentary portrays Valeant as an outlier: an extreme case of predatory pricing, excess leverage, creative, perhaps even fraudulent, accounting and who-knows-what-else. Led by heartless, unprincipled and amoral executives who discovered an opportunity they could exploit for very large profits, they were ultimately done in by their own greed.

"On the other hand, if we consider the nature of what passes for normal business practices in the health care world, Valeant might be just the tip of the iceberg: one of many health care companies that appear to be more concerned with their profits than their customers’ well-being."

 Excerpted from my latest column at ThinkAdvisor.

What you see may not be what you get

"What we think of as reality is actually inference, based on a mental model known as a schema. Schemas are enormously useful frameworks for organizing, categorizing and finding relationships between things in a world that, without them, would be complete confusion. So schemas have enormous utility — but they are not reality.

"For centuries, illusionists have exploited (to their benefit and our entertainment) the simple belief that what we see with our eyes is real. That issue has been a subject of ongoing interest within psychology; a brief video demonstrates the McGurk Effect, a simple but powerful reminder how easy it is to separate perception from reality. (To find the video, enter the words “McGurk Effect BBC Horizon” in any search engine or directly in YouTube.)

"Why is this so important? Because investing occurs at the intersection of perception and behavior: how we see the world and how we respond to it. The obstacles to achieving clear perception and sensible behavior are robust and plentiful, external and internal, learned and instinctive. Overcoming them is not easy."

An excerpt from my latest column at ThinkAdvisor.

How do we generate an investment "edge?"

"Angry Investor: 'So, Mike Burry, a guy who gets his hair cut at Supercuts and doesn't wear shoes, knows more than Alan Greenspan and Hank Paulson?!'

"Burry: 'Yeah. Doctor Mike Burry. Yes. He does.'

"Any choice you make, someone else smarter and more experienced than you has come to the opposite conclusion and is on the other side of the trade. It doesn't matter whether you pick your own stocks, buy focused mutual funds, or hold indexed ETFs. It requires a generous amount of chutzpah to conclude that what you’re doing makes perfect sense while holding that the chairman of the Federal Reserve and the secretary of the Treasury don't know as much as we think they do — the brilliant point of that exchange from 'The Big Short.' "

From my latest column at ThinkAdvisor.