All those wasted hours of analysis.
The investment industry has produced countless pages of content on the US election; who would win, how markets would respond, how to protect against risk and generate returns… The consensus was that the result would be hard to call, but that a Clinton win was most likely. There was greater certainty that a Trump win would mean “risk off” while a Clinton win would mean a “relief rally.”
We don’t want to write another piece on the folly of forecasting; if this argument is new to you we have discussed it here, as have so many others. In short, we know that human beings spend large amounts of time being surprised about events, and struggle to learn from being wrong. The real problem for most of us is that we fail to acknowledge that when we say “human beings,” that includes each of us.
Pollsters and the consensus
In the days and weeks before the US presidential election there was an acknowledgement that the polls were showing that the candidates had similar levels of support, with Clinton marginally ahead.
Nate Silver, who has a better track record than many, acknowledged that “there’s a wide range of outcomes and most of them come up Clinton”. This is a nuanced argument, with significant caveats that raise profound questions on how we think about probability (what does a 70% chance of a Clinton victory really mean?). That many chose to take poll data at face value only reflects our innate desire for simplicity and certainty. The election result does not discredit polls and pollsters, only those who use them incorrectly.
For many market commentators, the experience of Brexit had led to a more cautious interpretation of polls, but the consensus was still that the Democrats would win. Moreover, the subsequent reaction of market commentary suggests that the Trump victory was a bigger surprise to many than their pre-election rhetoric would have suggested (despite the usual temptation to declare that: “I had a feeling he was going to win.”)
The price response
The conventional wisdom had been that news of a Trump presidency would be bad news for markets. Prior to the vote, some forecasters had gone as far as saying that Mr Trump’s presidency would “likely cause the stock market to crash and plunge the world into recession”. Of course that could still happen in the future. The point is that we just don’t know. We only know that the initial risk-off phase lasted a matter of hours before being reversed, in some assets.
The immediate market reaction was indeed “risk off”. Market participants remembered the Brexit playbook. The US Dollar weakened, bonds rallied, equities sold off. But this knee-jerk reaction only lasted a few hours. This is perhaps best seen in the behaviour of the Japanese Yen; it would have required impressive timing to capture the Trump effect.
Asian markets closed down on 9th November, but soon after that, sentiment had switched. The dollar was recovering, bonds started to sell off and developed market equities were rallying. The Mexican Peso continued to weaken, as did many emerging market assets.
Meanwhile, for the US economy, commentary had switched from the negative impact on growth from Trump’s protectionist stance, to focussing on the boost to growth arising from infrastructure spending and deregulation. Financial stocks seemed to like the steeper yield curve, industrials liked the prospects for growth and pharma/biotech stocks reacted to the removal of price curbs that would have been in place under a Clinton administration. Bond markets were no longer a safe-haven asset, as investors began to worry about higher interest rates and inflation.
Many use terms like “risk off behaviour” and “safe havens” without specifying any further. Most of us employ a rule of thumb based on our own experience, and normally refer to assets like Treasuries, gold and the Japanese yen as beneficiaries in “risk off environments.” This has not been the case so far.
This is a reminder that the safest assets should be the ones we are most confident in delivering a positive return over our investment horizon, not those which we expect others to buy at certain times.
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” ― John Kenneth Galbraith
It’s uncomfortable to admit that we don’t know much about the future, but it is essential. Whether it is about politics, economics or financial market developments, the conclusion is similar. Events such as the US election and its aftermath should serve as reminders of this, but humans are wired to ignore the lesson. Instead of taking our repeated surprises as signs that maybe the forecasting game isn’t for us, we quickly forget just how surprised we were and get back to making new forecasts.
Amid all the noise about how Trump’s team will be constructed, what he will be able to do in terms of policy, how the Fed will react, whether populism is a global phenomenon and the impact on countries outside the US, it is worth pausing for breath and remembering that we are likely to continue to be surprised. Looking back at what we used to believe is important to this.
For example, look at the change in US thirty year Treasuries. Yields have risen to one year highs. We can attribute recent moves to the election news, although bond yields had already begun to rise from the lows in July in reaction to stronger global growth news, including Chinese growth. But what is more important is how investors (and ourselves) have changed their outlook. In January and February, when yields were at 2%, the consensus was for global recession and the risk-reducing properties of bonds in a portfolio seemed self-evident. Why should this have changed? Were markets wrong then, or wrong now?
Looking back at our own changing beliefs about issues such as these is a far more useful process for investors than seeking ever more news on Trump’s political team. However, it is far more uncomfortable and lends less opportunity to talk knowledgeably at investment conferences, to generate likes on Twitter, or to impress at dinner parties. Humans seem unlikely to ever lose this desire for status and certainty, and so for investors willing to look through this and focus on what really matters, there should always be opportunities.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.