Don't Oversimplify

Reading the headlines one could conclude that markets are “plummeting” as a reaction to the election last night.   That conclusion would be an oversimplification and generally wrong.

Without taking sides in the political discourse, in my professional role as an “investment economist” I can tell you that today’s market action probably has more to do with Europe than the election in the US.  

After being fixated on our election for the past few days, this morning, traders focused attention on Europe and did not like what they heard---the head of the ECB indicating that inflation was not a risk because the economy in Europe was so bad and likely to be bad for a long time!   Yes, the Dow fell more than 2.5% in the morning, but dollars flowed from Europe and the stock market into US Treasuries. If you don’t have confidence in the leadership of the US government—it is not logical to buy IOU’s from the US government.  At about 11 AM, the DOW began rising steadily.

No doubt, a certain portion of the nearly half of the electorate who voted against the incumbent have sold stocks this morning—sort of a vote of “no-confidence”.   But, in fact, the election has essentially changed nothing—we have the same political situation that we had a week ago, and I would argue, the markets have essentially expected this very outcome. (With one exception—namely that coal and energy stocks had risen in anticipation or hope of a Republican victory and they have fallen back considerably today.)  As I write this, the DOW is essentially close to the August 30, 2012 level. 

Framing (many times influenced by media headlines) is a nasty behavioral bias that pre-disposes humans to certain behaviors—a desire to simplify a very complicated world using certain pre-conceived notions.  Oversimplification is dangerous. Concluding that all rich investors are unhappy with the outcome of the election and are selling their stocks would be wrong.  Data shows that the 10 richest counties in the US voted overwhelmingly for the incumbent—more than 60%!  (My take is that the election results are not related to a struggle of haves against have nots, but rather “traditional” values against secularism.)   

As I have stated, we are in a period of great uncertainty about Europe, China, Middle East Geopolitics, and US Monetary/Fiscal/Tax Policy.  Any of these could and probably will affect markets in the short term. But it is precisely because of this short term uncertainty, stock prices are depressed—providing very good long term opportunity in many cases, for specific investments. In addition, history teaches (since 1950-13 out of 15 quarters following a presidential election) that there is an 86% probability that markets will be higher on 12/31/2012 than they are today.

While there seems to be a lot of risks affecting short term global growth---there is growing evidence, barring any unexpected global shock, that robust global growth is on the longer term horizon. Beware, when robust global growth returns, it will probably bring along it’s pesky friend—inflation.

The only thing that I see that is more dangerous than oversimplifying is paying too much attention to media sources whose main goal is to entertain and to sell advertising rather than to inform.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.