Why is US Elections Important to Investors?

The US Midterm Elections are just about to be finalised. I believe at this time of writing the Republican has the Senate while the Democrats has the House, and of course Donald Trump is still the President. However, the part of the elections that interests me the most is not the results of the elections but the predictions that were made about the elections.

Take a look at a few here and here.

Back in 2016, most pundits gave Hillary Clinton a much higher chance of winning. A famous prediction website, FiveThirtyEight.com, even gave Hillary Clinton a 71% chances of winning the presidency.

In fact, this is not the first time we see such “unexpected” results. See here for a compilation. And some even blamed the data collected for the error.

What is the Problem?

There are a few problems actually.

Source: The New York Times

First, 85% is NOT 100%.

When a forecast such as “Hillary has a 85% chance of winning” is announced, most of us will immediately think in absolute terms. Either 0% or 100%. Since 85% is more than 50% (random), most will consider 85% as a sure-win. Therefore, when Donald Trump won the elections back in 2016, the public immediately denounced those forecasts as poor prediction and inaccurate. Some even considered Donald Trump’s victory as a “black swan event”

However, we need to take a step back and consider what is 85% chance? Take a different scenario, if a doctor informs a patient that he has a 85% chance of dying in a surgery, should we be surprised if he survived? No, because there was a 15% chance of survival based on past history, which means 15 out of every 100 patients managed to survive the surgery. Not zero.

Therefore, we should not surprised when Donald Trump won with a 15% chance. He “survived the surgery”. His victory is less probable than Hillary’s 85% chance of losing, but definitely not impossible.

Even after multiple changes, they were still off (Source: projects.fivethirtyeight.com)

Second, the World is Messy.

The US elections is a complicated affair, candidates have to go through rounds of selections before becoming the nominee to run the face. It is like a flow model that gives even an engineer like me a headache.

Yet, there are people out there who are more than willing to make predictions at the very early stage of the elections. Unsurprisingly, many of them ended up to be way off.

Why do people like to make predictions? or maybe, Why do people even want to make predictions in the first place?

Because humans crave Certainty. Our minds are hardwired to think in patterns and create certainty. This desire for certainty is mostly useful. For example, when we throw a ball into the sky, we expect it to fall back down. When we hear a rattle in the bush, we expect a snake to emerge. When we farm the land, we expect a harvest. Without certainty, we will be paralysed and not able to make decisions in our life.

However, the danger arises when we continue to seek certainty when the situation is complicated, uncertain and unpredictable. The more complicated the situation is, the higher the desire to “see a pattern” and “find that certainty”. And often at the cost of sacrificing “rational thinking”

So while the rational thing to do is recognising the complexity, and acknowledging our limitations when faced with a very complicated affair such as US elections. People turn to pundits who make bold claims and take a chance for certainty instead.

What has it got to do with Investing?

First, Understanding the Odds.

When we make an investment, we are obviously favouring a certain outcome such as the stock will rise. However, we often forget that while we favour an outcome, there is some odds at play here. Even if you invest in the top notch company in the world at a very undervalued price, there is still a chance that the stock price will fall further.

Just ask Warren Buffet. After he purchased American Express shares at a rock bottom price in 1960, he thought he bought it at a real deal. However, the stock price continued to fall.

“It was not expected to happen but I am not surprised that it did.”

While I could not confirmed if the statement above was indeed made by Buffett, but if he did, it shows you that he understood the odds. He knew that his odds of being right for buying AMEX shares at those prices were very high, but he was not surprised that the prices continue to fall. He held on to the shares, and this became the pivotal point of his career, as AMEX shares soar through the roof in the years to come.

Second, Admit What You Don’t Understand and Find Out What You Do Understand.

The stock market is like the US elections. It is very complicated as a whole. Many factors affect the movement of the markets.

In 2016, after Donald Trump won the elections, the Wall street pundits predicted that the market will drop in reaction because no one expected him to win. However, the stock market went to hit new highs. Interestingly, the Wall street pundits came out the next day to “blame” the market for reacting irrationally, and began justifying why their predictions were off.

As an investor, you need to understand one important fact. The market is neither rational or irrational, the market is the market. You need to respect that. The only one that can be rational or irrational is…. You!

So for me as an investor of my own money and others’s money, I choose to admit that I don’t fully understand how the market work. While I do understand the business and market cycles, I admit that I cannot predict the movement of the market accurately. Especially in the short term.

So what do I understand about the stock market? I understand the businesses in the stock market. I understand what makes a great business and what makes a mediocre business. With that, I choose to actively invest in those great business and just wait patiently for the market to realise the value of those great businesses too. When that happens, I will be able to profit from it. Simple!

With the US elections almost over, lets continue to find great businesses to invest in!

See you soon!

Investing Always,

Pete

Please refer to the disclaimer here