The Cost of Certainty

A common theme throughout my time as a financial advisor is being asked the question, “How will today’s news event impact the stock market (and therefore my account)?”  Every few weeks, there is a new topic of conversation, but the question is essentially the same.  Then, every four years, the question is exactly the same as four years prior, “What is the impact of the presidential election on the stock market?” 

In a divided country where many people define themselves as a person by the politicians they support, it can be very difficult to set those feelings aside and make calm, reasoned decisions about our portfolio.  However, the real truth is that outcomes like elections, interest rates, and geopolitical tensions are both hard to predict and even harder to know how they will be received by the entire world of investors.  Let me give you an example.

When the 2016 presidential election rolled around, there were two things about which almost everyone was certain: Hillary Clinton would win, but if, by some quirk of fate, Donald Trump were to win, the stock market would collapse. The least certain pundits said Clinton was 80% likely to win, and the estimates of her probability of victory ranged upward from there.

And yet, Trump won, and the stock market rose more than 30% over the next 14 months. The response of most forecasters was to tweak their models and promise to do better next time. Mine was to say, “If that’s not enough to convince you that (a) we don’t know what’s going to happen and (b) we don’t know how the markets will react to what actually does happen, I don’t know what is.”

Sometimes things go as people expected, and they conclude that they knew what was going to happen. And sometimes events diverge from people’s expectations, and they say they would have been right if only some unexpected event hadn’t transpired. But, in either case, the chance for the unexpected – and thus for forecasting error – was present. In the latter instance, the unexpected materialized, and in the former, it didn’t. But that doesn’t say anything about the likelihood of the unexpected taking place.

Some investors may believe that one political party holds within their power the ability to move the economy and shareholder value forward while the other will use every resource at their disposal to slow down and even reverse this progress.  If you subscribe to that belief, I invite you to study the chart below.  It shows the path of the S&P 500 since 1948 on top of the periods of time when the White House was occupied by either a Democrat or a Republican.

If you are able to see a pattern that I haven’t found, you may be tempted to only invest when your preferred party is in power and leave your long-term investments in cash when they are not.  The Schwab Center for Financial Research ran the numbers on this little experiment going back to January 1961.  If a politically conservative investor started with $10,000 and only held stocks during Republican administrations, by the end of 2023, their portfolio would have grown to $102,293. 

If a liberal investor did the same during Democratic administrations, their portfolio would be at $500,476.  The Democrat would be victorious, right? Not so fast.  If a third investor held onto their portfolio during all presidencies, that individual would end up with $5,119,520, ten times the amount of the Democrat-only investor and 50 times the amount of the Republican-only investor.  As the late Charles Munger, business partner to Warren Buffett, often said, “The first rule of compounding is to never interrupt it unnecessarily.”

As humans, we desire certainty, but sometimes we look for certainty where none is to be found. Economist Howard Marks recently wrote, “There simply is no place for certainty in fields that are influenced by psychological fluctuations, irrationality, and randomness. Politics and economics are two such fields, and investing is another.”  

We are fortunate to live in a free land where we all get to be involved in choosing our local, state, and national leaders.  We should take that right and responsibility seriously.  But when we turn our attention to our lifetime financial plans, we would be better served to check our politics at the door.  Presidents and their policies come and go.  That pendulum swings back and forth.  Through it all, great companies continue to serve their customers, increase their earnings, and raise their dividends over time.  That’s what we are investing in.  Everything else is just noise.  Telling ourselves that “this time is different” is simply another way of throwing out all perspective gained from centuries of documented human history.