We recently came across a survey from the asset manager Blackrock that reported the vast majority of investors are fleeing to cash ahead of this year’s general election. Specifically, “three-quarters of Americans believe the election will have a bigger impact on their finances than the election in 2008.”[i]
This comes as no surprise as it is common to see the flight to cash during times of extreme uncertainty, but history has shown that the stock market during national elections behaves no different than any other month or year. We recently published an article from Dimensional Fund Advisors highlighting the zero correlation between presidential elections and market performance. Nonetheless, many investors continue to engage in trying to predict the future and end up re-pricing risk for the buy and hold investors to take advantage of.
Let’s start with something we can all agree on, which is nobody can actually predict the market with both a high degree of accuracy and consistency. The world is just too chaotic and markets are too efficient (not perfectly efficient). Next, let’s address that the little known fact that market timing, stock picking, manager picking, or style picking is an attempt to predict the future. Someone believes they can predict the future movement of a particular stock, asset class, manager, or style and broadcasts it out to the world as if they are the next financial prophet.
More often than not, most of these individuals end up doing no better than a “fair coin” in their ability to call the market, and the coin doesn’t cost you an arm and a leg for its service. You can find the historical track record of some well-known “prophets” here.
The only reliable crystal ball that we have is the “price” being indicated by a particular market. This price is constantly adjusting based on participants’ estimates of future profits of capitalism around the world as well as preferences for risk so that they can expect to pay a “fair” price for a “fair return.” If all of a sudden investors believed that the world is a riskier place to do business than it was before (inflation, slow growth, war, etc.), then they would sell. Prices would decrease in order to accommodate the additional uncertainty, keeping the expected return essentially constant. The long term buy and hold investor is receiving the benefit of knowing that the pricing mechanism that is the basic function of markets is constantly adjusting prices so they can expect a positive “fair” return based on the amount of risk they are taking.
A common response to this line of thinking is that, “this time is different.” The overall mood of our country is different or the stakes are higher or there is more of a divide than ever before. Whatever “reason” we come up with in our mind, realize that it is being driven purely by emotion and not logic. The ability for prices to adjust to risk preferences has not changed. How information is disseminated to the masses has not changed. Investors are still expected to receive a positive return for whatever outcome comes out of this year’s election.
Lastly, it is important to remember that markets have a history of being tested and coming out on top. Two world wars, multiple conflicts, depressions, recessions, bouts of hyperinflation, have all happened in the past and markets have always prevailed.
As much as it would make for wonderful news, this year’s election will have almost zero long term impact on markets. Expectations about the future have already been imbedded into the “price” and investors are expected to be compensated accordingly.
About the Authors
Tom Allen is an Accredited Investment Fiduciary (AIF®), Certified Cash Balance Consultant (CBC) and a Chartered Financial Analyst (CFA®) Level III Candidate. Tom received his Bachelor of Science in Management Science as well as his Bachelor of Art in Philosophy from the University of California, San Diego.
Mark Hebner - Founder, Index Fund Advisors, Inc.
Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.