We are through both Republican and Democratic National Conventions, so at least we know the candidates’ names if not what they might actually do in office. Now comes the communication contest to see who can effectively persuade the most voters by the end of the day on Tuesday, November 5th.
If this election cycle is anything like previous ones, there will be plenty of hyperbole, vague policy descriptions, big promises about lives being so much better (or worse), and very creative uses of facts, figures, statistics and what Malcolm Gladwell calls, “Revisionist History”!
So, what does this mean for you and me as investors and people with financial goals?
Among other things, it means we’ll need to find ways to keep our wits about us, not panic, and recognize that the media, news, social and otherwise, are out for our attention, not really for our portfolio or financial plan’s best interests.
How do we “Keep Calm Carry On”? One way is to recognize the signs of cognitive bias, the bad thinking that can emerge when we pay too much attention to electioneering rhetoric. If we can step back and ask, “Am I falling into…?” we might just be able to keep a bit calmer and laugh at ourselves, both good practices for decision making.
Nobel Laureate, Richard Thaler, is a pioneer in the field of behavioral economics. On a Freakonomics podcast, host, Steve Dubner, asked Thaler to describe the field in a way that fits on a bumper sticker. Thaler’s response was great, “We don’t think people are dumb. We think the world is hard.”1
Cognitive biases and decision-making errors make the world harder. Here are a few that I think are important to look out for in ourselves and others during the next 3 months.
Thinking Error Number One: Overconfidence
Research finds again and again that human beings tend to be overconfident, especially in their ability to know the future. In an election season, this bias may show up as overconfidence in our ability to predict who will win, what they will do in office, and what the result to the economy and stock market will be. Maybe the best recent example of how this did not pan out well for some was in the 2016 election. Going into Election Day, conventional wisdom and polling had Hillary Clinton defeating Donald Trump at the polls. So, markets expected that result, as well. When it became apparent during the evening of election coverage that perhaps Donald Trump was going to win, stock market futures began to go down, a little and then a lot. The market went from one overconfident prediction, Clinton winning, to a second one, Trump will be bad for stocks. Both were wrong. Clinton lost, and the stock market did very well under Trump, until COVID-19 temporarily upended things in 2020.2
Right now, supporters of both candidates are telling us, with a great deal of confidence, that their person will be good for markets and the economy and the other person will be bad. Here’s where a little history is helpful: Both the US stock market and US economy have done well under Democrats and Republicans. And for the majority of the 2-year election cycles since World War II, Washington has had some form of divided government 61% of the time. Real GDP and market returns, while positive, were less so than when one or the other party was in control. 3
I track seventeen iterations of Washington, D.C. control, depending on which party or combination of the two parties controls the White House, the Senate, and the House Of Representatives. Every two years, during election season, I update the numbers. What I can tell you is that you can find something to use against or in favor of either party. Just looking at Democratic vs. Republican Presidents, you see a 14.8% vs. 9.3% stock market return advantage for Democrats since 1926. Looking at control of Congress, Republicans hold a 15.1% to 12% market return advantage over the same period.4 So, who’s better for the market? It depends on the story you want to tell.
These are just a couple of good examples of figures that don’t lie, but liars, or let’s call them storytellers, often figure.
Thinking Errors 2 & 3: Narrative and confirmation bias
We love stories and, as the saying goes, “the best story wins”. Why does the best story win? It wins because we want a narrative that makes sense of the events happening every day. If we can find a narrative that seems to explain things well, we’ll feel more confident in understanding and predicting the future (back to that overconfidence error).
Confirmation bias makes our narrative bias that much more powerful and potentially harmful. Once we have a story we like, we start looking for evidence to support it. Again, study after study shows that we will give extra weight to facts and figures that confirm our preferred narrative and discount or ignore observations that would conflict with or contradict the story we like best.
For example, if you like the storyline that Democrats are better for the stock market, you’ll point to the advantage Democratic Presidential terms have had in market returns over Republican Presidents. But, you will de-emphasize the statistics showing Republican control of Congress has coincided with higher stock market returns. The reverse is true for the Republican storyline.
What if the real story is that markets do relatively well under all kinds of partisan control iterations? A recent favorite example of this looks at what a hypothetical $10,000 investment in the S&P 500 stock index would have done starting in 1961 (the year I was born) if investing only during years Republicans were in the White House. Of the sixty-two years between 1961 and 2023, the split between Republicans and Democrats is thirty-one years for each. So, there is no advantage in numbers of years. If invested only in the thirty-one years of Republican Presidents, that $10,000 would have grown to $102,293. If invested only in the other thirty-one years of Democratic Presidents in the White House, that $10,000 would have grown to $500,478. That is quite an advantage. But, and this is the most important takeaway, if that $10,000 had been invested for the entire sixty-one years, it would have grown to over $5.1 MILLION dollars.5 The lesson here is that compounding and long-term investment are far more powerful than which party happens to control the White House!!
Beware of falling in love with a story to the extent that you discount or ignore contradictory evidence. Usually, the “real story” is more complicated than we want to admit, and outcomes are far less certain than we hope they will be.
Thinking error number four: Catastrophizing
I find this one is notoriously complementary to the first three when it comes to election seasons. If we are overconfident in our narrative, and screening out facts to the contrary, the narrative of what will happen if the “wrong person” wins leads us to believe that all worst case and imaginable negative outcomes are now highly probable, even when the facts say they are not that likely. I find, in listening to my own thoughts and the words of others, that catastrophic thinking is very often overconfident fear.
Data from 1992 to 2020 shows that stock market volatility as measured by the VIX, an investment options contract which is also called, “The fear gauge,” tends to increase in the months leading up to a Presidential election and then decline afterward when the results are known.6 Combine this tendency with our US media environment (social, cable and traditional news media) which studies show are all now measurably more negative than news media in the rest of the world7 and you have the perfect soil for growing high levels of catastrophizing, of developing an overconfident fear of the very worst things happening.
So, what’s the antidote to all of this? I like this phrase,
“Educated optimism as an antidote for anxious uncertainty”.8
Every two years, when I look at market performance and election outcomes, both my own research and the research of many others, what stands out is the lack of attributable effects that elections have on markets. That’s not to say that elections are not important, but these results seem to indicate just how resilient markets and the US economy really are.
Longtime senior researcher, John Rekenthaler, from Morningstar, recently put it this way:
“My claim is that for equity shareholders, elections do not bring significant change…No matter who wins, the economic underpinnings remain largely intact. And those underpinnings have been very, very good for stock prices for several generations.”
He closes his piece with this,
“There are many reasons to vote in November. The performance of equities is not among them.”9
So, instead of letting these and other cognitive biases and mistakes ruin your mood for what’s left of this summer and the upcoming fall, it is better to be on the lookout for overconfidence, narrative and confirmation bias and catastrophizing in ourselves and others and find some humor in it. Let’s give ourselves a break. Maybe that break needs to include limiting the intake of media, especially some of the partisan cable news networks, like Fox, MSNBC, and social media networks that have already picked up on our biases and have created algorithms to exploit them.
As Nobel winner, Richard Thaler, says, “We don’t think people are dumb. We think the world is hard.” Let’s not make it harder by missing out on reasons for educated optimism.
If you’re anxious and uncertain about how an election or something else could impact your financial life, remember that you are not alone. Connect with your advisor or reach out to Foster Group. We can provide you with support and guidance to help you stay on track. Let’s work together to ensure that your plans can weather any political climate.
1. https://freakonomics.com/podcast/people-arent-dumb-the-world-is-hard-update/
2. YCharts, S&P 500 Total Return 12/30/2016 – 12/31/2020
3. BEA, Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Guide to the Markets – U.S. Data are as of July 22, 2024.
4. S&P 500 Stock Market Index 1926 – 2023, Dimensional Fund Advisors, Wikipedia for President and Congressional majorities 1926 - 2023. Calculations by Foster Group. All data is for calendar years.
5. Schwab Center for Financial Research; Morningstar
6. Avantis, CBOE Volatility Index, 8/1/1992 – 2/28/2021
7. https://freakonomics.com/podcast/why-is-u-s-media-so-negative/
8. Quote attributed to David Booth, Founder Dimensional Fund Advisors
9. https://www.morningstar.com/columns/rekenthaler-report/stock-investors-have-already-won-election