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The Science of Hitting
The Science of Hitting
Articles (531) 

Correctly Predicting the Future – and Losing Money

Some thoughts on the presidential election and what it says about predicting short-term stock market swings

November 21, 2016

In the weeks leading up to the U.S. presidential election, there was a pretty clear pattern in the stock market: Anything good for Hillary Clinton’s chances of winning the presidency was good for equities (broadly speaking). If forced to guess, it’s safe to say most investors (including myself) would have called for a pretty substantial selloff if Donald Trump managed to pull off the upset.

The largest hedge fund in the world, Bridgewater Associates, did just that (from Fortune):

“On Tuesday, Bridgewater Associates sent out a note to its clients predicting that the Dow Jones Industrial Average could plunge nearly 2,000 points in one day if Trump is elected president. That would be the biggest one-day slump in stock market history, by more than double, besting the 777-point plunge that happened on Oct. 29, 2008, at the high of the panic surrounding the financial crisis. The drop would translate into a 10.4% dive and immediately send the stock market into correction territory. And it’s not just U.S. stocks that would collapse. Investment around the rest of the world would crumble as well, according to Bridgewater. The hedge fund predicted that both China and European stock markets could drop by roughly 11% as well.”

Bridgewater certainly wasn’t the only firm predicting major declines on a Trump victory.

The chief equity analyst at Citigroup sent a note to clients on Nov. 4 saying the Standard & Poor's 500 would fall 3% to 5% if Trump was elected president. Research firm Macroeconomic Advisors put the damage at an 8% decline. Economists at The Brookings Institute, with the most drastic prediction I’ve found, estimated a Trump victory could cause the S&P 500 to fall as much as 12%.

On Election Day, the unexpected happened: Trump won. The markets braced for pain with futures plummeting on the news – as was widely predicted. The prognosticators looked good for awhile. But then the losses started to disappear with markets eventually moving into the green. By the time markets closed on Wednesday, the S&P 500 was up more than 1%. For the week of the election (Nov. 7 to Nov. 11), the S&P 500 was up nearly 4%.

Just to take a step back and summarize the chain of events:

  • The market sent a pretty clear signal that a Trump win would be bad news.
  • Trump won.
  • Markets moved sharply higher.

What the heck? How could that possibly happen? I’ve read a few articles from the forecasters mentioned above and I’m not sold by their explanations.

The best answer I've seen comes from Howard Marks (Trades, Portfolio): First, no one really knows what events are going to transpire. And second, no one knows what the market’s reaction to those events will be.

The reaction to the election is another telling example of just how difficult it is to correctly predict short-term movements in the stock market – even if you can correctly predict how events will transpire. (At least when you bet on the horses, you know which outcomes will make you some money.) Over the course of an investment lifetime, I have no idea how an individual investor (or more appropriately, trader) can possibly be successful playing that game.

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (13 votes)

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Comments

idaustin
Idaustin - 2 years ago    Report SPAM

Great comments as always

The Science of Hitting
The Science of Hitting - 2 years ago    Report SPAM

Idaustin - Thanks for the kind words!

Thomas Macpherson
Thomas Macpherson premium member - 2 years ago

Always the problem working through the signal and the noise. Oh...and primates throwing darts at boards. Great article Science. Best - Tom

The Science of Hitting
The Science of Hitting - 2 years ago    Report SPAM

Thanks Tom!

Alex Garcia
Alex Garcia - 2 years ago    Report SPAM

Good commentary. The rally in financials is amazing. Even good ol Berkshire has rallied (major holdings in WFC and AXP)

http://www.projectberkshire.com

The Science of Hitting
The Science of Hitting - 2 years ago    Report SPAM

ProjectBerkshire,

Yep, they've gone up a lot.

Interesting idea on "Project Berkshire" - I look forward to your future articles.

Alex Garcia
Alex Garcia - 2 years ago    Report SPAM

Science,

See any flaws in the project? I always look forward to your articles.

The Science of Hitting
The Science of Hitting - 2 years ago    Report SPAM

ProjectBerkshire,

Nope, I don't see any flaws. As you noted in your first post, might as well share your thoughts on Berkshire versus keeping them private in a notebook. I'll be interested to see the direction you take ProjectBerkshire over time.

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