Politics and Investing Don’t Mix
When it comes to your investment portfolio, should you ignore the noise coming out of the White House? Or should we be making changes? What does Trump mean for your investments?
Here are the most common questions I’ve faced on this topic in recent months and my answers:
No. 1. How will Trump affect the economy and the stock market?
We start with an overlooked truth: Presidents, regardless of party, get too much credit for when things go right and too much blame when they go wrong.
The president is but one part of the government, which accounts for less than a quarter of the economy, though obviously it has a huge impact on markets and the broader economy through foreign policy, regulations, tax policy and spending.
Yes, Donald Trump can and will affect the economy and the markets. But we should not put all of our focus on the marginal impact of the president while giving short shrift to more important things such as corporate revenue and earnings, the Federal Reserve, interest rates, inflation, congressional spending, employment, retail sales, Supreme Court decisions, and, of course, valuations.
Like all presidents, if he does good things it will be supportive of the markets; if he commits major errors – such as starting a trade war or gets the U.S. into a serious shooting war – it will be detrimental.
No. 2. Why is the market rallying when some predicted stocks would fall if Trump were elected?
One explanation for the market’s post-election enthusiasm for Trump was based on expectations of tax reform, tax cuts, infrastructure spending and deregulation. However, that was a post-hoc narrative. The simple fact that markets in Germany, France and Japan rose more than in the U.S. since the election suggests that something else is at work.
My explanation is that the global recovery from the financial crisis continues apace, slowly repairing and rebuilding from that event. If you insist on singling out an explanation for why global markets are rising, look no further than the robust recovery in corporate earnings, especially in Europe.
As for forecasts of a Trump crash, that – like mostothers – was simply wrong – at least so far.
No. 3. How can you say politics doesn’t matter to markets?
Let me be precise: Politics can and occasionally does matter to markets – especially in the short term – but just much less than many people assume.
If I told you the president was going to be impeached, and the markets will continue to power higher for a few years, you might think I was batty. But that is what happened when Bill Clinton was impeached in 1998. The next year, the Standard & Poor’s 500 Index rose more than 21 percent, and the Nasdaq Composite Index gained more than 85 percent. Yes, it would all end badly the next year, but the impeachment was irrelevant to the dot-com bubble popping.
So too was the accusation that President Barack Obama was a Kenyan-born Marxist who was hell-bent on “Killing the Dow”. When he left office early last year, the Dow was about 15,000 points and nearly 300% higher than the day he took office.
And when President George W. Bush introduced unfunded tax cuts, many economists assumed that the deficit would balloon, inflation would soar, and jobs would be wiped out. Two of those three things never happened, and the market rose 94 percent.
If you let your political ideology get in the way of your investing decisions, the results are never pretty.
No. 4. The Trump news flow is overwhelming. What should we do?
I think we all hoped that once the election was over, we could go back to our normal lives without the incessant parade of campaign news.
No such luck.
Investors need a way to sequester the noisy news flow out of the White House. It is too easy to let the relentless and disturbing headlines throw off well-designed long-term financial plans. Investors must read the news, but not let it interfere with thinking clearly.
Look, let’s be honest about the commander-in-chief: He is the world’s leading Twitter troll, a man whose main goal is to interrupt your thinking, misquote and insult other people, engage in rhetorical sleight of hand, and impugn the integrity of those trying to do honest work. What all trolls want is a reaction, something Trump has achieved to great success.
The first rule for sanity on the internet is “Do not feed the trolls”. No one can really ignore the president of the United States, but it’s probably best to view much of what he says or tweets as minor background noise.
No. 5. You keep saying not to worry about who is president; but surely you do worry about him, right?
Yes, as a citizen I do worry about the president’s rampant prevarications and the degraded culture he has created.
The search for facts and reliable information is the bedrock of modern civilization and well-functioning markets. Agnotology (culturally constructed ignorance) is dangerous and worrisome. Exaggeration is one thing. Living in an alternate universe is another. I have no interest in returning to the dark ages before the Enlightenment. However, that seems to be the direction in which we’re headed, and some people seem to think it will make them the most money.
It likely won’t, and now more than ever, truth remains the best disinfectant.
No. 6. But I’m really worried about the increased polarization of social media, the propagation of “alternative facts”, increased tribalism, a decline in civil discourse and the resulting damage being done to our institutions and our democracy. What should I do?
First, listen dispassionately. One of the reasons I engage on social media is to seek out people who disagree with me. If they can make an intelligent argument about another point of view, it is time well spent. I used to think that 140 characters cannot possibly enough to have an intelligent discussion. While that may still be the case for some topics, for the most part, I now believe that if you cannot express it in 140 characters, you are on a rant. And by all means, there’s the right time for long form analysis; given that you have read up to this point, I presume you agree.
Let me quote from a Financial Times article that, in my assessment, goes to the core of human behavior:
“We humans are social creatures. Given a choice between being right on a partisan question (abortion, guns, globalization, climate change) and having mistaken views that our friends and neighbors support, we would rather be wrong and stay in the tribe. ... in surveys of views on climate change: college-educated Republicans and Democrats are further apart on the topic than those who are less educated.”
Second, strive to keep an open mind and genuine curiosity. Aside from the hot button issues listed, I would add to that many of our democratic institutions have been vilified for partisan purposes: The FBI, the CIA, the judiciary, and the Federal Reserve. It’s easy to self-select social media friends, select internet sites or cable news channels that reinforce our biases and deepest fears. Fear can lead to ignorance and conspiratorial thinking. This media can be manipulated to exploit a person’s political views in order to instill fear and sell grand conspiracy theories. Fear and ignorance can destroy our democratic institutions in the face of conspiratorial boogey men such as the current Breitbart, Alex Jones/InfoWars and Fox News narrative of an evil “Deep State” that will take away our freedoms. Much of this panders to the fears of the “browning of America” and stokes anger among the intellectually disabled while masquerading as alternative news.
... the evidence suggests that curious people are less subject to the temptations of partisanship. When the national conversation becomes polarized, we need to encourage curiosity about how things work rather than them-and-us tribalism.
I'm here to tell you, politics and investing don't mix.
This is a statement that rocks one of our most fundamental and most cherished beliefs. Like many of you, I too have very strong political convictions that affect how I see the world. Whether you sit on the left or on the right, I have some bad news: Your politics can kill you in the markets.
As a student of investment theory, I’ve learned that understanding behavioral psychology, statistics, cognitive biases, history, data analysis, mathematics, brain physiology, even evolution can help us make better investing decisions. Indeed, these are all key to learning precisely what not to do. While making good decisions can help your portfolio, avoiding bad ones is even more important.
We humans make all the same mistakes, over and over again. It's how we are wired, the net result of evolution. That flight-or-fight response might have helped your ancestors deal with hungry saber-toothed tigers and territorial Cro-Magnons, but it drives investors to make costly emotional decisions.
And it's no surprise. It's akin to brain damage.
To neurophysiologists, who research cognitive functions, the emotionally driven appear to suffer from cognitive deficits that mimic certain types of brain injuries. Not just partisan political junkies, but ardent sports fans, the devout, even hobbyists. Anyone with an intense emotional interest in a subject loses the ability to observe it objectively: You selectively perceive events. You ignore data and facts that disagree with your main philosophy. Even your memory works to fool you, as you selectively retain what you believe in, and subtly mask any memories that might conflict.
Studies have shown that we are actually biased in our visual perception – literally, how we see the world – because of our belief systems.
This cognitive bias is not an occasional problem – it is a systematic source of errors. It's not you, it's just how you are built. And it is the reason most people are terrible investors.
How does this play out in the world of investing? Let me share two examples. I don't pick favorites: Both Democrats and Republicans are implicated.
Back in 2003, the dot-com crash had about run its course. From the peak of the market in March 2000 to the March 2003 trough, the Nasdaq had gotten crushed, losing 78 percent of its value. Yes, Seventy Eight Percent!
As Federal Reserve chief Alan Greenspan took rates down to 1 percent, the Bush administration passed $1 trillion in tax cuts. As someone else once said about the stock market, "Give me a trillion dollars, and I'll throw you one hell of a party."
Yet many of my Democrat friends on Wall Street – fund managers, traders and analysts – were highly critical of the tax cuts. At the time, I heard all the reasons why they were so bad: They were deficit-busters, unlikely to create jobs, giveaways to the wealthy.
While those critiques may have been true, they were also irrelevant to equities. As armchair policy wonks obsessed over these issues, they missed the bigger picture: Liquidity is a major factor in how the economy and stock markets perform. Trillions of dollars in fresh cash was very likely to goose equities higher. (Sound familiar?) Indeed, the impact of the tax cuts did just that. Combined with Greenspan's ultra-low rates, you had the makings of a cyclical bull market rally. From 2003 to 2007, the Standard & Poor's 500-stock index – the usual benchmark for equities – gained 100 percent.
And my politically active friends on the left missed most of it.
Fast-forward six years to the credit crisis in 2008. The S&P 500 had fallen 58 percent. By March 2009, op-eds in the Wall Street Journal were already blaming the crash on President Obama (took office two months earlier).
But conditions were forming that would hasten the end of the sell-off. Markets were deeply oversold. Once again, the Fed chair was cutting rates – this time, it was Ben Bernanke, and he took rates down to zero. In a panic, Congress forced the accounting rule-making body to be more accommodative to the banking sector. FASB 157, as it is known, ended mark-to-market accounting – essentially allowing banks to hide their bad loans.
All these factors suggested that a substantial rally from the market lows was coming. Historically, average gains in post-crash bounce-backs were 70 percent. The easy money to the downside had been made, and it was time to stop betting that the markets were heading south. If history held true, we were looking at the mother of all bear market rallies.
By that March, I was explaining this to clients. But the greatest pushback this time around came from across the political spectrum. My GOP family and friends were lamenting the occupant of the White House. I heard things like "Obama is a Kenyan, a Muslim, a Socialist. He is going to kill business."
What followed was the single most intense six-year rally in Wall Street history. By the end of the Obama administration, the US stock market had more than tripled!
And some of my politically active friends on the right missed most of it.
Remember, the cycle of booms and busts are surprisingly regular occurrences. What some people call a "100-year flood" actually happens far more frequently – since 1929, there have been 18 crashes.
It's just as important that an investor participate in the cyclical bull markets, capturing the rally as well. All things considered, missing the downside and catching the upside makes for a pretty decent investment strategy. If only…
You need not be a mathematical wizard to learn this lesson. When you are in the polling booth, vote however you like; But when you are reviewing your investing options, it is best to do so with a cold, dispassionate eye and stick with a well-designed investment plan designed for both good times and bad.
Whatever fears you have based on the current state of our politics, you are not alone. These fears and the risks involved are already baked into market prices.
There are many variables that drive market prices. US government policy is but one of dozens of factors.
Your portfolio is constructed like a well-built car. It is 60% engines (for growth), 20% brakes (for safety) and 20% seat belts and air bags (for crash protection). Like your car, your investment portfolio is designed to get you to your chosen destination, as quickly, efficiently and safely as possible. Don’t let politics interfere with the job its designed to do.
Credit to Alex Merk, President and CIO of Merk Investments for many of the words and ideas included in this month’s blog.