2016 Election Aftermath

Models are a fixture in the investment management business. We use models to determine reasonable values for stocks, or to determine the impact of a business investment today on cash flows in the future. Models help us check our biases and give us something concrete around which to plan. Often models are wrong, but the smart investor doesn’t throw out the model when this happens. Instead, she recognizes it as an opportunity to adjust the model to account for previously unknown factors.

As Donald Trump’s election last night became more likely, we learned that futures contracts for the Dow Jones Industrial Average were plunging – at one point indicating an opening loss of almost 800 points, or a 4.4% drop. That’s severe; not October 2008 severe, or post 9/11 severe, but bad. By the time I had woken up this morning, reports were for a 2% drop, or about 360 points. While driving my oldest daughter to school, news reports were for a 200-point decline, or -1.1%. 20 minutes into the day’s trading session, the Dow was up 41 points, or + 0.22%. During the afternoon, the Dow added 200 points and stood 1,000 points (5.6%) above the overnight level.

The first point to make is that political models, like financial models, are routinely wrong. At 6:00 p.m. on election night, The New York Times was modeling an 80% likelihood that Hillary Clinton would win. If they’re smart, the people who designed that model aren’t throwing out the idea of modeling, but are making needed changes.

A second point, one more germane to investors, is that the initial volatility in stock markets following shocking events isn’t predictive of the impact of long-term economic policies on asset values. Instead, it’s a recognition the financial models which were based on certain political outcomes were wrong, and because of this, consensus about asset values in the near term needs to be reestablished. But models and the markets they drive are dynamic, and over the next several hours and days, investors will adapt to new political realities, adjust their financial models, and volatility will very likely subside.

Fortunately, in this case, U.S. stock prices had pared their losses by the time the markets opened. Investors who were inclined to react in fear to a Trump election were saved from themselves by timing: the market had 9 or 10 hours to adjust to the new reality. But that’s not always the case: markets took a few days to adjust to the Brexit decision in June. No doubt some people lost a great deal of money by reacting too quickly and fearfully, selling into the short-run uncertainty.

Famed value investor Benjamin Graham once said, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” By this, Graham meant to distinguish the “noise” of impetuous trading and re-calibrating models from the clear benefits of free-enterprise, which accrue to investors who take the long view.  Our advice is to follow Graham: stick with your discipline and tune out the noise as best you can. You’ll come out the other side with more money, and more peace of mind if you do.