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Monday, October 19, 2020

Don't Bet On Your Politics


Whatever your political beliefs, no matter how confident you are in them, do not invest according to those beliefs. You will lose money. The reason for this is that the political opinion becomes the ideological basis for an economic theory which, because it is based on an opinion, is by definition biased and leads to wrong conclusions. This is true whether you are on the right, on the left, or somewhere in between; it also applies if you identify yourself as far away from that spectrum entirely.

In short, political bias is an investment bias that can and does lead people astray; to demonstrate the risks of this way of thinking, I want to highlight two very bad mistakes I have seen in my time active in equity markets, and how the political biases of these mistakes resulted in massive underperformance.

The Mistake on the Right

The best example of this at play was in 2008. At the time, libertarian thinkers believed that quantitative easing would lead to hyperinflation that would wreck the U.S. economy throughout the 2010s. The theory behind this argument is that an increase in the monetary base would cause hyperinflation, and the only proper response was austerity and leaving the market to sort itself out. This theory was based on the political belief that markets have a natural, healthy force guiding them and that intervention is bad.

Some of the people who spouted this nonsense were highly respected. Bryan Caplan remains a revered economics blogger and thinker, despite sounding like a crackpot at the time. This blog post has not aged well:

Normatively, I still favored the privatization of money. … Bernanke and company ignored their own research, got predictably bad results, and pleaded impotence. Instead of playing the voice of reason, they acted like they'd believed in bailouts and fiscal stimulus all along. I expected better. I was wrong."

None of this is true or even remotely accurate; not only did Bernanke follow his research quite well (and learned significantly from Japan's lost decade), but he also used a monetary stimulus program that worked somewhat well to help the economy recover - and would have worked better had it been bigger. So successful was QE that the Federal Reserve's decisive response to COVID-19 by offering liquidity, opening loan programs, and other actions has become applauded by serious thinkers on the left and right, and dismissed only by a very tiny crackpot minority.

Caplan gets it very wrong because of his libertarian bias; fine, professors get things wrong all the time (it seems to be a favorite pastime of the cohort if not part of the job description). But what's really worrisome is if you invest according to this political view.

Unfortunately, many people have made this mistake in the past, and bizarrely, the people helping them lose money have had long high-profile careers. Peter Schiff warned of hyperinflation in 2009; he was wrong. That didn't stop him from urging investors to buy gold; while this worked for a couple of years, thanks to a broader delusion and the market's ignorance about the impact of QE on the market, it's been a terrible investment since.

The reason is simple: that hyperinflation never came.

Not only did inflation stay below 3% over the decade, but the average rate of CPI growth underperformed the long-run average. Gold underperformed even long-term Treasury bonds over the decade, because that libertarian-view of market intervention causing an apocalypse was silly and wrong.

That hasn't stopped people from buying Schiff's mutual funds (and underperforming at best, or losing money at worst); the guy has even guested on Joe Rogan several times, making predictions that never came true. Meanwhile, investors who listen to him are poorer as a result.

So the libertarian ideology, whether it has moral or logical principles that are superior to other ideologies or not, was clearly a bad guide for making an investment decision. Libertarians may be right when they say, as Caplan did, that the Fed's acts "set a long list of dangerous precedents, and pushed the U.S. and the world down the road to serfdom." You can believe that, and think this underperformance is temporary and one day the chickens will come home to roost.

How long will you wait? 20 years? 50 years? In the long run, we're all dead, and do you want to be poorer and right? If a sense of moral superiority matters to you more than money, maybe you should just donate everything you own.

The Mistake on the Left

The mistake on the left is equally easy to demonstrate and dismiss, and it all comes down to Donald Trump. Your feelings of the man and his followers can be whatever they are, but if you invest according to those feelings you're going to make a mistake.

I had friends call me shortly after the election and ask if they should sell everything due to Trump's surprise victory. I obviously laughed, but at the time it was a serious position. Check out this Politico article titled "Economists: A Trump win would tank the markets." Of course, that didn't happen.

Immediately after Trump's victory the market went up, because politics and markets aren't connected in the way some people think they are. The media should have known this; the clickbait-addicted pundits warned just a few months before Trump's victory that another ideological event was on the cusp of destroying the world. Namely, Brexit.

While Brexit did cause a short-term blip in markets as seen above, markets recovered in two weeks' time, and in the longer-term chart above that short-term period is unnoticeable.

Of course, well-meaning liberals investing on their conscience would have sold both after Trump's victory and again following Brexit. If they read through from their convictions to the conclusion that the world is about to turn into an apocalyptic nightmare, they would have missed out on these returns.

Furthermore, as we have seen from 2020, an actual global catastrophe like the pandemic has a very different implication for financial markets than what seems most plausible. This is the problem with investing according to your political beliefs: it can blind you to the subtle and counter-intuitive implications of the facts and cause you to underperform as a result.

So What Should I Do?

If you want my advice, being less political is a good idea; you'll be happier, healthier, and have more friends. But if a strong political belief is very important to you, the better course of action would be to ignore your political beliefs when investing.

The stock market is a mechanism whereby the market can price the value of future earnings (and sales). There's very little politics involved, and when people invest according to their beliefs and not based on the fundamentals of sales and earnings, that becomes a market opportunity for someone to profit off that politically biased person buying or selling. Your best course of action should be to logically analyze the value of a business, the growth (or lack thereof) of the market in which that business operates, the quality of management and the potential effectiveness of their strategy, and whether the market has overestimated or underestimated the value of those things.

Of course, that takes a lot of time, energy, and work, which is why you're probably better off just buying a high quality closed-end fund managed by people who spend their time doing just that

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