Market

Elections and the Stock Market: Much Ado About Nothing

It’s a presidential election year and with that comes the invariable stock market correlations seeking to predict election results or forecast the market’s direction.  On one hand, the performance of the stock market during the two months leading up to the election has been somewhat of a predictor of who will win the race. On the other hand, we try to predict the direction of the market based on who wins the election. While all of this makes for interesting and fun banter around the water cooler, thoughtful investors would be wise to leave their Ouija boards in the closet and stay focused on their long-term investment strategy.  As much as we would all like to glean even a small amount of investment insight from the election year follies, it would be important to note that the stock market is essentially non-partisan, and Presidents have very little impact on the direction of the markets. 

The Stock Market as an Election Predictor

Admittedly, the stock market has been fairly successful at predicting the results of Presidential elections. Since 1900, the performance of the stock market between July 31 and Election Day has correctly predicted the winner 88 percent of the time. 82% of the time when the market rallied between August and election day, the incumbent as won. 86% of the time when the market declined, the challenger won. That’s 25 out of 28 elections that the stock market has, in effect, selected our President.  That is pretty remarkable on its face, and, if I were a betting person, I would have to consider those to be outstanding odds.

There is some logic behind this relationship, the idea being that a rising stock market is a reflection of the general belief by investors that the economy will be stronger in the months ahead. The gives voters a confidence boost which, in turn, boosts the chances of a win for the sitting President. 

The Election as a Predictor of Market Direction

Each election year I am asked whether a win by either party will be better for the stock market.  My instinctive response is, “I don’t know, and I don’t care.” Of course, I do try to explain in gentler terms that the market forces are much more powerful than any single person, even the President of the United States. With a slowing global economy and the possibility of increasing interest rates the market already has enough to absorb. Although, the uncertainty of who will guide our country for the next eight years is a contributing factor.  All told, there have only been three election years of the last 21 in which the S&P 500 had a negative return. 

Is the Stock Market Pro-Republican or Pro-Democrat?

If we try to apply any logic to this, we would have to surmise that the stock market should perform better with a Republican in office. After all the markets like free-enterprise, lower taxes and less regulation, right?

Try telling that to George W. Bush. The stock market lost 25 percent during his two terms as President. Of course, he had two recessions and two stock market crashes as bookends to his eight years in office.

Conversely, the best stock market performance under a two-term President was none other than Bill Clinton who actually increased taxes. It can be said though, that the stock market performed extremely well under Ronald Reagan albeit for two down years (1st and 7th years of his presidency). But now, we have Barack Obama, under whom taxes and regulations have increased significantly, and the democratic candidates are putting proposals for more tax increases are on the table. Yet, of the last five Presidents, his first-term has seen the biggest four-year return of 46.5 percent. Of course, his first term began just as the stock market hit bottom after the 2008 crash. 

The final tally shows that the best stock market performances in the last 30 years have come under democratic presidents.  Yet, nothing they have done while in office can be remotely linked to the performance of the stock market.  

The Final Analysis:

As those who follow our investment philosophy already know, the markets are random, but they do work regardless of who is in office.  Principled and disciplined long-term investors don’t invest for an election cycle, they invest for a lifetime. Vote your conscience and keep your eye on your target.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.

Comments on the Boston Business Journal's piece "Boston's Economic Forecast: Trouble on the Horizon"

It is easy to forget that newspapers and television live on sensationalism. 

The more sensational the headline, the more newspapers will sell.  Boston Business Journal recently released an article entitled, "Boston's Economic Forecast: Trouble on the Horizon." If their headline was instead, “Ignore the pundits, things are basically OK," they’d probably sell fewer newspapers. 

Our advice when there is “Trouble on the Horizon,” from an investment point of view, is to ignore the headline and look into the premise behind it.  Often, ignoring the hype is the right long term investment decision.

We agree with the sentiment quoted, “A recent report … rated the chances of a 2016 U.S. recession as “reasonably low,” though … economic data pointed to “a somewhat fragile future” for the national economy, as suggested by the weak fourth-quarter GDP”.  There is a possibility of recession (there is always the possibility of recession) but the probability is reasonably low.

As far as Greater Boston, the major industries of education and healthcare are largely impervious to economic downturn.  Financial services, real estate, bio-tech and venture capital may be subject to recessionary pressures, but high talent human capital can often offset cyclical economic forces.  In the longer term, Greater Boston’s attractions as a world class city with world class facilities, universities and hospitals point to further population growth and increased tourism.  As Boston goes, so goes Massachusetts, so we think the Massachusetts economy will continue to grow slowly over time.

With regard to equity markets, past experience helps us to frame our understanding of the future.  For example, the average market correction since December 1949 is -14% with the average correction lasting 120 days.  The average gain following a market correction is 47% (median gain is 32%) lasting an average of 495 days. From peak (July 20, 2015) to trough (February 10, 2016), the S&P 500 was off -12.1% on a total return basis. Since February 10, the S&P 500 has returned + 9.5% through last Friday.  Year to date, the S&P 500 is off -0.5%. (See chart below)

The year began poorly with market fears related to the continued drop in oil prices, slowing growth in China and the strong dollar.  This created uncertainty in the short term which fed negative investor sentiment and poor equity market returns.  We expect continued uncertainty related to the US election, emerging market currencies, the direction of oil and the dollar and liquidity concerns in low-grade segments of the bond market.  However, a good earnings season, lower PE valuation ratios and the long term positive impact of low oil prices may offset these fears in 2016, leading to low single digit equity returns in 2016, albeit with a lot of volatility and uncertainty.

There is uncertainty as to the direction of overseas economies and markets.  When oil prices plunged below $30 to the lowest level in twelve years in February, fears of contagion spread into the energy, materials and financial sectors.  Global deflationary fears are a concern to central bankers with negative interest rates in Japan, Denmark, Switzerland and Sweden.  In the US, the fear is the opposite, that the Fed will raise rates over the next two years.  This divergence in foreign monetary policy from US policy is causing disruption in currency markets.  Add geo-political uncertainty and we get a flight from investment risk.

The major drivers of equity returns are the state of the economy, the actions of the central banks, company fundamentals and valuations.  The US economy is still growing in the low 2%s annually, despite a slowdown in the fourth quarter.  Ex-US central bank actions remain accommodative, which are net positive for stock appreciation and global liquidity. Earnings weakened in the fourth quarter, particularly in the energy sector but most analysts still believe that earnings growth will be forthcoming and thus far in the quarter, company earnings have been at or above estimates.  This leaves us with valuation, or investor sentiment.  At year end, forward PE was at 16.1 times earnings versus the 20-year average of 17.2 times earnings.  Valuations are not stretched at this juncture, but on the other hand, equity risk seems to be increasing which might justify a lower PE. 

While we are not certain of the current direction of markets, we do have confidence that well-diversified portfolios should give us opportunity for gain while limiting exposure to losses.  There is a chance that the market forces evident in January and early February will return and continue a long stretch of negative returns, beginning last August, such as we saw from 2001 to 2003.  Today, the market forces are more positive and being driven by earnings, improved investor sentiment and higher oil process.  Our most likely scenario is that the US equity market recovers to low single digit returns by year end.

- Matthew V. Pierce, Chief Investment Strategist

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest.

How Confirmation Bias Could be Hurting your Investment Performance

Have you made up your mind on just about everything, even before you know what it is? For instance, when you meet someone, is your opinion of the person formed from the first impression? Or, when you hear a political argument from the other side, is your mind opened or closed? Are you able to concede the “good points” the other side make, or do you dismiss the whole argument? We encounter people and ideas every day, and, while most of us would like to think we are open-minded, human nature, being what it is, makes it extremely difficult to discard our preconceived opinions. So, we almost instinctively filter out the information that doesn’t support our preconceived notion or opinion, at least initially. Behavioral psychologists refer to this kind of selective thought process as “confirmation bias.”

What does this have to do with investing? Well, when you consider that our investment choices are usually guided by a thought process, it can mean everything. If that thought process is clouded by confirmation bias, you may be making important, sometimes life-changing, investment decisions with one-sided information, and that can dramatically skew the big picture you need to make fully informed decision. Some of the more costly mistakes investors make can be attributed to confirmation bias which often leads to poor decisions based on incomplete information.

Take, for example, the investor who hears his colleagues bragging about the latest hot stock they all bought which has already doubled in price. No one wants to be left out of the next big thing, but at least this investor has the sense to do some research on his own. As he pours through the reports and surfs the internet for validation of their claims, half of his mind is racing with thoughts of the new car he will buy, as well as the possibility that he will be thought of as a “chump” for not getting in on the deal. Granted, he is allowing greed and fear to creep into the process; however, in doing so, in begins to filter out any information that might raise red flags and, instead, focus on the information that validates the investment. Now, imagine that this investor made that investment at the height of the Dot Com Bubble.

Confirmation bias works subtly, some would say insidiously, inside the minds of investors as they seek nothing more than to make the best possible decisions with their money. Even those who spend as much time analyzing the cons as they do the pros of a given investment, confirmation bias tricks the mind into giving more weight or credence to the pros, if there is already a preconception in favor of it. Or, more overtly, it simply allows us to dismiss or discount information that doesn’t conform to our beliefs. That’s a very dangerous mindset when your money is at stake.

Overcoming Confirmation Bias

Overcoming confirmation bias is not as easy as you might think. It’s one thing to be aware of it and even make a point of dealing with it. However, it’s that same bias that often presents us from taking the necessary steps to avoid it. If you are the president of the United States, let’s say, and your policies seem to always go in the wrong direction as far as the public is concerned. You may convince yourself that you are right and the public is wrong if all you do is surround yourself with people who agree with you. Having the strength and security to include people who have differing viewpoints in your life can cure you of confirmation bias; if you are willing to examine their viewpoints with an open mind.

Overcoming confirmation bias doesn’t mean abandoning your beliefs or even your preconceived opinions; rather it means recognizing how your bias could lead to making bad decisions in any aspect of life.

Being aware of it and recognizing that it could, in fact, cloud your judgment is the first step. Then, in gathering and analyzing information, focus on that which doesn’t conform to your opinion or belief and try to understand why. This might involve inviting those who don’t share your opinion to give you their view without you arguing yours. Just listen and evaluate. The same can be done by reading blogs and articles by people with different views. The most important thing is to work through the thought process more rationally without fighting opposing viewpoints. 

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.

Investors Beware: The Media Noise can be Deafening

Most people would argue that living in a digital world, with instant access to an endless stream of information has made us smarter and more self-empowered than past generations. Investors believe that it has “leveled the playing field”, enabling them to make investment decisions based on the same information once only available to the investment pros. The incessant quest for information has reached such a fever pitch that the media outlets, including the cable channels, print media, and now the blogosphere, are churning out content 24/7, and it still isn’t enough to satiate peoples’ ravenous appetite for information. So, it’s all good? WRONG.

There is a much stronger argument that can be made that, for people in general and investors especially, information overload not only makes it more difficult to make rational decisions, it often leads to behavior that can be harmful, if not devastating to your financial health. While there has obviously been a marked increase in the quantity of information, the quality of the information will always be in question. Where you have quantity without quality, all you really have is “noise.” And for people who really should be listening for legitimate financial advice and relevant information, it can be deafening.

With most of the population wired to the Internet and mobile devices, information has become so ubiquitous that it has become an entitlement for people who take its availability for granted. The media is taking full advantage of that entitlement attitude to layer on as much content as it thinks the public can consume. In order to attract the attention of a pre-occupied public, and therefore the advertising dollars its viewership generates, the information has to be entertaining, pithy, and compelling. To that end, the media has no fear or shame in hyping a story beyond a reasoned reality, in order to make its information more essential.

In the investment arena, stories can’t be compelling, or entertaining, for that matter, unless they are consequential in the short term. In other words, the Facebook IPO, even though it was of little actual consequence to most investors, is a much more compelling story than an essay on the superior, long-term performance of index investing, even though it could benefit the vast majority of investors. The problem is that the information we, as investors, receive is filtered through an “excitability” gauge. Can you imagine an analyst or stock guru spending 20 minutes on CNBC talking about the 5-year growth prospects of the stock market and how a diversified portfolio is your best opportunity to outperform the market? Three-quarters of the audience would switch over to the food channel where they could find much more “consequential” information.

Unfortunately, access to more information and technology has not improved investor performance over the last couple of decades. While we’re not suggesting that you should turn off your cable news or refrain from surfing investment sites, you do need to remind yourself that these sources of information don’t necessarily share your agenda. Gathering information and educating yourself are essential parts of the process, but it should be done in the context of your clearly-defined objectives and a well-conceived financial plan.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.