Who can investors listen to when everybody’s wrong?

THE year 2020 will be remembered for any number of things, including how wrong so many were about so much. From the pandemic to the election, and from the economy to financial markets, prognosticators did a horrible job.

When it comes to Wall Street, it’s easy to see why so few got it right. Coming into the year, not a single strategist had “global pandemic, 1.5 million deaths worldwide, the worst economic downturn since the Great Recession, a 34 percent market crash and subsequent rebound led by a handful of tech stocks” in their 2020 outlooks. But “tail risk” events, whether they be wars, natural disasters or pandemics, regularly upend the even the most logical of forecasters.

There are lessons in the deductive reasoning errors and faulty data analyses, no matter what the field, that can lead even the savviest market participants astray. Let’s consider three examples from the US Presidential election and what they mean for investors.

Beware Coincidence: Money-making “insights” materialise regularly in the firehose of daily market data. Upon closer analysis, most turn out to be a mirage. Determining if these indicators are based on good logic can help an investor avoid losses.

Consider this fact: Since 1928, whenever the S&P 500 Index has risen in the three months prior to a presidential election, the party that controlled the White House won 90% of the time. Julian Emanuel, the chief equity and derivative strategist for BTIG, seized upon this idea in mid-October, saying this and other market data suggest polls may be “underestimating the probability of President Trump getting re-elected.” And he wasn’t the only one to spotlight this datapoint.

In the three months prior to this year’s election, the S&P 500 rose 2.3%. Annualised, that is a gain of more than 9%, which is about average for any given year. Even so, the incumbent lost.

The problem with this indicator is that both variables occur quite frequently: Markets tend to go up most of the time, about three out of every four years, and incumbent presidents tend to win re-election – 33 out of 44 prior to Trump. If both of these outcomes occur about 75% of the time, it is more likely that their simultaneous occurrence is coincidental and not predictive. It is a form of denominator blindness, where analysts use data without context. The six-for-six track record is more likely just a reflection of how common each is. Failing to recognise this leads to a misreading as prescience instead of coincidence.

Don’t Confuse Luck With Skill: Most pollsters failed to accurately predict the 2016 election, but the Trafalgar Group nailed it. Robert Cahaly’s firm had the most accurate polls in seven swing states: Florida, Pennsylvania, Michigan, North Carolina, Ohio, Colorado and Georgia. Trafalgar even accurately predicted the number of Electoral College votes – 306 – that Trump would garner.

Trafalgar’s success led many to take note when Cahaly foresaw another Trump win in 2020. He predicted so-called shy Trump supporters would propel him to an Electoral College victory in the high 270s to low 280s, with wins in North Carolina and Florida as well as in Arizona, Georgia, Michigan, Nevada and Pennsylvania. Cahaly got the first two right and the last five wrong, leading to a Trump loss. —

Bloomberg.