Episode 333 - The Presidential Puzzle: Trump's Win and Expected Stock Returns

20:23But if you had listened to the model back then and said, okay, well, I'm going to do that. I'm going to act on that information. Trump, as we mentioned, the returns under Trump, his first term were incredible. And they've been great under Biden too, but not as great. So you have to have a lot of confidence in the model, which you probably shouldn't have. You have to have a lot of confidence in it to make asset allocation decisions based on that model. I think there's just too many other variables, other factors that can affect actual outcomes. Over the next 100 years, there's a good chance, I think, that this model is predictive.

20:52But over any individual presidency, I think it's tough. And then the other thing that I mentioned earlier is that this is looking at the equity risk premium. So that's a premium for owning stocks over short-term government bills, in this case, three-month treasury bills. But raw stock returns, if you just look at have stock returns been positive, they've been reliably positive on average under both Democratic and Republican leadership. You're not going to lose money necessarily. I mean, we might have a market crash. I don't know. But we're not saying that on average, you should expect to lose money by staying invested when Republicans are in power.

21:20It's just that the risk of owning stocks has been better compensated while a Democratic president leads the country, but stock returns have been reliably positive no matter what. So don't short US stocks is what you're saying? I don't think so. I don't think you can use this to time the market. I don't think so. I mean, that most recent out of sample period that I did the data for, it proves that point. If we had this paper and we said, okay, we've got this model of data to 2015, let's implement this strategy. I mean, you got wrecked as often happens with back-tested strategies. Yeah. So I think that's an issue.

21:49Even a good model that has been historically successful at explaining differences in returns. It's not a perfect guide for future decision making, especially for something like this. I love the test for a strategy of what happens if I'm wrong. With the dimensional funds that we use, they own the total market. They're slightly tilted towards small cap and value stocks and high profitability stocks relative to the market, but they still are based on market capitalization weights just with some adjustments. So what if I'm wrong? What if there are no return premiums? Well, it's not really that bad.

22:16But if you short U.S. stocks and you're wrong, you get destroyed. Or if you exit the US market, we could have the same conversation five years ago or something. Valuations are super high, blah, blah, blah. And then the US market is just like a rocket. So I think it's really hard to do anything with this information. However, I think in the other direction, it's worth being careful in light of this model. Again, this is just a model. It's not perfectly predictive. You shouldn't probably make major asset allocation changes based on it. But believing that the incredible recent US stock returns are going to persist forever at a time when valuations are high and risk aversion is low.

22:49And this model about presidential elections suggests that, hey, maybe expected stock returns are low right now. I don't know if I'd be going all in on US stocks just as much as I don't think I'd be shorting them. So I think that's another important thing to think about. Diversification is always important. It's like an umbrella and you don't want to have to buy an umbrella after it starts running. So if we step back and look objectively at the empirical data, there is this puzzle. The puzzle is there. The equity risk premium has been much higher under Democratic presidents than Republican presidents, likely due based on the past or paper to time-varying risk aversion, causing expected stock returns to be high when Democrats are elected and then low when Republicans are elected.

23:27While that may make market timing tempting, no model is perfect. And the reality is that while the equity risk premium has varied, average stock returns have been reliably positive through political cycles. There's a great chart that we have, The dimensional fund advisors made, they posted on their website, so we can show that in the video, but it just shows over time markets have just gone up and they've gone up whether it was a Democrat or Republican in power. Yes, there was more equity risk premium under one party than the other, but you can't time that and expect returns are positive no matter what.

23:58So I mean, whatever, you got to stay invested, stay diversified. Politics can get super emotional as we've seen pretty clearly just everywhere. And in that 2020 paper by Antoinette Schor, that shows it in such an interesting way, but you can't let your individual beliefs clad your judgment. One point actually on the Antoinette Shore paper is that they do find that, and they look at this empirically, the best ways to reduce the impact of individual beliefs on investment decisions, the best way is to delegate your portfolio management. That can be done either with an automated investment product, like an asset allocation fund, or through a professional financial advisor.

24:32They find in the paper that both of those things reduce this belief-based to action on portfolios. All right, that's it. I'm sure you guys have too. And everybody who's an advisor listening to this has probably been through these exact conversations with clients, but I have this exact problem with a client in 2016 when Trump was elected. So it was a physician household at about, I think it was just shy of$5 million invested. So it was quite a bit, but they were 90 % fixed income. So very conservative investors. They were probably in their late fifties, I think maybe early sixties. So gearing up for retirement.

25:01So maybe risk aversion was higher for them personally at that time as well, but they were always very, very conservative. Lots of GICs, tons of fixed income. So they had about 10 % total exposure to global equity and only about somewhere around 4 % in US stocks, 4 % of their portfolio in US stocks. And she called me. It was something like two days before the 2016 election. Full on panic, sell everything, Trump's going to win. I'm like, well, hang on, let's back up here. Sure, he might win, but so what? She was convinced that not only was he going to win, but as a result, the market was going to absolutely crater.

25:31And it was a really difficult conversation because on the one hand, you're trying to explain, you don't really have that much exposure. It's 4 % of your portfolio. If it went to zero, you're talking about a 4 % loss. Everything is in super safe investments, GICs and fixed income. But to your point, what if you're wrong? You can predict the event properly and be correct on some binary outcome, but not predict how the market's going to react to that event properly. And that's, of course, exactly what happens. I pleaded with her and I just couldn't win that discussion with her. And I said, you know what, if it's a sleep at night decision and you're more comfortable and knowing, of course, that it was the opportunity cost of her being wrong wasn't that high just because their exposure to stocks in general was relatively low.

26:05It's like, fine, let's do it. So we sold the whole 10 % equity sleeve of her portfolio and went to fixed income with it. And of course she was right, Trump won. And the market just went on an absolute tear. I looked it up yesterday and from the time she made that decision to the time I left that role. So I ended up leaving that role and handing that client off to another advisor. And at that time, she had still not got back into stocks. And this was in January of 2018. So you're talking 13 months, 14 months between the time she sold and between the time I left. So I don't know what the eventual outcome was.

26:32But at least over that 13-month period, she hadn't gotten back into stocks in general and specifically not US stocks. I looked it up yesterday and the S &P 500 was up north of 30 % over that timeframe. So the opportunity cost was massive. And going for the full four years of that particular term, 2016 to 2020, the S &P 500 in US dollar terms was up 80%. So assuming she never got back in, that was the cost of making that irrational decision. And again, their exposure was relatively low. So the upside wasn't huge in dollar terms, but it just goes to show that making emotional decisions around predictions about what markets might do because of some event is a very dangerous way to manage your money.

27:08Oh man, we had to, not so much this time, which is interesting. I don't know why that is, but in 2016, Trump was like, people couldn't even believe that he'd gone in to run for president and he did it and he won and everyone's mind blowing. Maybe this time because he's already been there, but this time is even crazy though. Anyway, we didn't get many calls about it this time, but back then we got a lot of calls from people with the exact same sentiment. This is crazy. The market's going to crash. And of course, like you mentioned, it didn't. I think the other really important point in your story though is that market timing, you don't just have to be right once.

27:36Because even if it had crashed, you have to be right twice. You have to get out at the right time and you have to get back in at the right time. And getting back in, I mean, I've heard stories. I don't have clients that are in this situation, but I've heard stories secondhand from other advisors of clients who got out of the market in the 2000 tech crash and still to this day have not gotten back in. That's just it. And if they were right and it does crash, it's still really, really difficult to get back in because you're at the hard ride edge of this drawdown in the market. You're like, no, it's going lower.

28:01So I'm going to wait and wait and wait. And people never want to get in after the crash. They wait until it recovers. And when it bounces back up, you're like, no, this is a dead cat bounce. It's going to drop again. And then it just keeps going up. And then now what? You're handcuffed. You're paralyzed. When do you get back in? So even if you got it right on the sell, like you said, you have to be right twice. And whether you're right or wrong the first time, it becomes very, very difficult to get back in whether the market does go down and you're right or whether it goes up. It becomes emotionally and psychologically very difficult to time it back in.

28:28Yeah. So I definitely don't want people to interpret the differences in expected returns under different types of political parties in the United States as a suggestion that market timing makes sense. I think we're pretty clear about that. But I think it's just a really interesting point. Probably my biggest practical takeaway from it is continuing to expect that the recent US market performance is going to be, that's just it, that's the future. I think that's a big mistake. And again, I'm not saying that you should not own US stocks or that You should short US stocks because those have, I would argue, greater risks.

28:56But I think the most reasonable way to use that information is in setting your expected return assumptions. Don't assume the US is going to keep returning 10 % a year nominal forever, or it's even higher in recent history. Yeah, so I think we'll see. I've said similar stuff at various points in the last 10 years, and the US market has kept going up. You've been wrong before, Ben? Is that what you're saying? I've been wrong so many times on that one anyway. That's a good point. You're not doing anything with your portfolio with this information, are you? No, no, not at all. I don't see how you reasonably could.

29:28There's too much uncertainty. And the example of 2016 is such a good one where if you got out of the market, even with the past store model of, hey, expected returns are probably low right now. If you got out of the US market, then you got absolutely wrecked. Even if you got back in under Biden, I mean, you still got some positive returns at least, but you missed out on a huge chunk of the equity risk premium over that period. Well, if it was a perfect model, then there'd be no difference. could be arbitrage anyway. So it can't be a perfect, predictable model. That's true. If it was a perfect model, it would just be reality and reality would adapt to itself.

30:00I don't know. Really interesting. You should do the same thing with Canadian data if you can at some point. Obviously the US is the big market, but. You know what? I had it in my notes. I guess I must've taken it out at some point, but I did have it in my notes that they test. Let's see if I can find it real quick. But the thing is they do look at it for other countries, but not for other countries, political parties. they used US political parties as a proxy for global risk aversion. And they just argued that the US is such a big player economically around the world that it's probably reasonable to assume that there's a relationship between global risk aversion and US presidencies.

30:35So they test that. Canada was in there. And I want to say Australia, Germany, maybe the UK. I'll keep seeing if I can find it here. But they do find that there is the same relationship for all the other countries that they look at. Interesting. So people in foreign countries, the returns, all eyes are on the US basically for foreign investors. That is really interesting. So they do test it in other countries just for robustness of their model and they find the same effect as there, which is I think pretty interesting. It would still be interesting to see it with Canadian politics, but I wonder if Canadian politics largely follow US politics, like if we were more right or left-wing leaders at the same time as the US talking out loud, curious.

31:10I have no intelligent comments on that. I'd be interested too, for sure. All right, should we go to the after show? Indeed. Let's go.

31:23Have you watched any interesting content recently, Ben? Nope. Okay, I'm glad I asked. Someone left a comment. I don't know where it was, if it was an email or something, but someone left a comment saying that they absolutely love it when Cameron asks me if I've watched it recently and say no. Well, I mean, you mentioned it earlier. It's the same as me. I read, but I don't have time for it. Although my kids have been sick, my wife's been sick, so we've been watching movies and stuff and have been movie nights. And as my son calls them, super nights, which are lazy nights and late nights. So lazy nights are like movie nights or he ordered pizza or whatever.

31:52Late nights is when he gets to stay up past his bedtime. So we started giving him like one day a week. And when we do both, it's called a super night. So we've caught up on some shows and stuff, but it's all kids stuff. It's Disney and he's big into spooky movies like Halloween. When I was a kid, I loved scary movies and spooky stuff. And Halloween's like my favorite and somehow genetically downloaded that to him. He's just obsessed with scaring himself. So we caught up on a bunch of like family movies with Halloween themes and that kind of stuff. That's super funny. we did our first episode with me not being there that was the first one eh first ever yeah i loved it was great actually just me and cameron just two guys having some fun the imposter syndrome was a lot lower wasn't worried about sounding like an idiot in front of ben felix it was pretty nice oh man so funny all right so i mentioned in the introduction that we got a bunch of recent reviews so let's rip through those i'm actually going to start with someone reduced their review from a five-star to a two-star.

32:46And they said, lately, not as great, not as captivating. Maybe it's because there haven't been any Benjamin and Cameron only podcasts lately. If it ain't broke, dot, dot, dot. Now, the reason I'm interested in just the dispersion of reviews here is that there was that one that was pretty negative and they say they don't like the recent content. And then we got how many more? One, two, three, four, five, six, six other ones that were like overwhelmingly positive about the recent content. I think people tune in for different reasons. And we've talked about this too. I mean, we do stuff like we did today where you've done a deep dive on a particular topic and it's largely you coming back and telling the audience what you found.

33:22We do some Canadian specific financial planning stuff. Obviously the guest episodes are huge and the types of guests we have on are super varied as well. So I think the podcast does a lot and covers a lot of different themes and I'm sure listeners like some things and maybe not others, but then there's others who like the other thing. And so I think it's just hard to please everybody. And if you were listening because you liked this one thing and now we're doing that less, then you're obviously not going to be as happy. But to your point, we'll read these out. But we got a ton of great comments on the RESP episode, the education funds episode we did with Dan as well.

33:49People loved that one. And that was a really specific Canadian financial planning topic. But maybe some people who are foreign listeners are really here for your deep dives, Ben. They're like, man, that's not my stuff. I don't know, man. Dan's soapbox at the end too, a commentary about how the RESP may not be accomplishing its goals. I wondered, is that relevant to people who are trying to make individual financial decisions? And there are so many reviews that were like, I love Dan's soapbox. That was great. It's crazy. I mean, I think as long as you keep pulling off that hairstyle, we're not going to lose any listeners.

34:16So I'm not too worried about the negative reviews. I told you before we started recording that you look like an AI avatar of yourself because your beard is so perfect. Well, I have to keep up. Every comment on your YouTube channel is just like, oh, Ben Felix, he's so dreamy and everything. And I'm like, hey guys, I'm here. Oh man. Should we rip through these reviews? Sure. This is Ed, Ed, Ed from Canada. Keep the Canadian content coming. Been listening for a few years and thoroughly enjoying it. some of Ben's technical dives go over my head, but the common respectful tone keeps me listening. Just listen to episode 329 about RESPs, which is very relevant to me.

34:48Wish I had known those details earlier. Given the variety of topics, to your point, Mark, it seems reasonable to focus on Canadian topics occasionally. I agree. Nice. Another nod to the RESP episode. This is from Glenn in Ottawa. So on your recent RESP episode, I really appreciated Dan's candid insights about how RESPs are not meeting the goals they were intended for. So as you mentioned, Ben, his little Soapbox segment at the end was very well reviewed. Glenn goes on to say, helping lower income families fund higher education and his suggestions for improvements. I hope people with influence in government are taking note.

35:18Thanks, Glenn. Daniel, R.A. McKenzie. They say, great pod. Love the pod sometimes. It's more technical and detailed than I can handle, but that may be more of a reflection on me than the guys. So that's what I mean. Like there's a lot of people I think who are really quantitative focused, Ben, who love your super deep dives and some of the highly intelligent guests we get. And then there's some people, like even me, your stuff goes away over my head most of the time too. so anybody listening feels bad that they don't get some of Ben's stuff, don't worry. I don't get it either. Can I tell you a secret, Mark?

35:43It goes over my head too. Okay, it makes me feel a lot better. So the next one is from Fish. I learned a ton from the Rational Reminder. The co-hosts are incredibly knowledgeable and bring an equally knowledgeable guests with a range of perspectives. I especially enjoyed the recent episode on education savings and Dan's policy analysis of the RESP and its limitations in improving savings of low-income households. More of these critical policy analyses, please. So funny, man. Doing a podcast has taught me so many times that I have no idea what is a good thing to do on a podcast. So many times me and Cameron and you now, obviously, since you joined us, Mark, we talk about, should we try this?

36:16Oh, I don't know if it's going to be a good idea. And like 90 % of the time, everyone's like, oh, I love that. And it's the same with posting on social media too. Usually my throwaway tweets that I'm thinking of as I'm falling asleep, I'm like, gosh, you post some weird time of night or whatever. And you wake up and you're like, oh, that's one of my best performing tweets. And I put zero a thought into it, but then you craft a thread over two days and do a bunch of research and crickets. So you never really know. That's the worst. You just got to throw it out there and let people tell you what they like.

36:39That happens to me all the time, man. Low effort tweets that just blow up. And then I'll take a video script that I've spent three weeks writing, and then I'll condense it down into a tweet thread, and then I'll post it and it's crickets. This is from JLS3249 in Canada. And they say, great team. Wonderful seeing the team grow. A shout out to Mark. Great sense of humor. Thank you. very interesting perspective on topics with great examples coming from his experience with clients and his interactions on social media he spices things up and always happy when he's present on the show that's a pretty good call you just said no one says anything nice about you well it's funny because behind the scenes you'll always post reviews and comments that you get on the youtube and everything you post them in our team's chat and usually you post the negative stuff i was joking with ben the other day my call okay i quit gonna go dust off the resume and apply at starbucks like nobody likes me kind of thing i'm glad that you put this in thank you i'm sure you did it just to appease my sense of defeat because everything's all about Dan's a great addition.

37:30I'm like, hey, what about me guys? I'm still here. I'm largely joking. I appreciate you throwing in that nod. I posted one that was pretty savage. I don't remember what it was, but it's the one that you're talking about. I don't remember what it was. I tuned it out. I blocked that part of my life out after you posted it. Wise. I won't try and find it. No, but thank you to JLS3249. I appreciate you. Oh, I didn't finish reading it. Now that Dan is present, there is just one member missing to complete the dream team? When will Justin Bender finally step in for a segment? We'll have Justin on for sure.

38:00Justin's super busy crushing portfolio management financial planning, but we'll have him on for sure at some point. Nice. Okay. And then another one for the RESP episode. Thank you for the terrific insight into how withdrawals for an RESP could work. Investing and saving has been the easy part, mostly thanks to Dan's terrific couch potato blog and tools early in my investment journey. Looking forward to working with PWL in the future as my retirement withdrawal strategy will need a plan. As always, an excellent podcast for ever increasing and validating my investment knowledge from SNK Squirrel on Apple Podcasts.

38:29Very nice. Very nice indeed. I don't know if I have anything else. I did go to Boston. I think we said that. You guys maybe say that when I was... Well, we recorded while you were in Boston. So we mentioned that you'd been, and I think we mentioned just at a high level why you were there. But yeah, what was that about? It was a great trip. It was one of my teammates, Matt Janning, that I played with at Northeastern, was inducted into the Northeastern Hall of Fame. Very cool. So he's a good buddy of mine, and I figured I'd go support him. And a few of the other guys that we played with were there too.

38:53It was really nice to see some of those guys, see the coaching staff. We caught a game. They lost to Princeton by two, but it was a good game. It's too bad they lost, obviously. Did you get to play at all? Just pick up ball or something while you were there? No. During the season, that'd be tough. I think if I went in the summer, they'd do a lot of pickup just to stay in shape, but I don't think they're allowed to practice in the NCAA in the summer with a coach in the gym. But yeah, if I went in the summer, I could try. I'd probably just get wrecked though at this point. I don't know. Yeah, you're out of practice?

39:19No, I still play a lot. I almost had a huge dunk in my Sunday league last week, but someone hit my arm and I lost the ball. Still went in the basket, but I didn't get to do my huge dunk. Do you dunk on people though? Like otherwise, it didn't happen this time, but you like dunk on people and then like yell in their face and stuff. The last few years I've been good for like maybe one dunk a season. I wouldn't say that I dunk on people. I can dunk. But it's not like the NBA where you're seeing people aggressively dunk on people and you're up there screaming in their face like a caged animal or something.

39:44Okay. No, I mean, I'm playing in the men's league. All the guys are thirties and forties. Not a whole lot of dunking going on there. No, fair enough. Anyway, I think that's it. Anything else? No. There's a Bitcoin meetup in my small town of Squamish next week. I might try to go. I've been invited many times to the Ottawa Bitcoin meetup. I'll probably go at some point. I'd be interested to see the folks that go out to those. Obviously. I think it's one of the first ones in Squamish where I live. And I've been just reading more books about that kind of stuff lately. And I post about it on Twitter from time to time and I've been wrong mostly about stuff.

40:13One of the speakers reached out and she's like, oh, you should come and we're doing a meetup and Squamish should come and check it out. I was like, yeah, you know what? I should do that. Yeah, no, that'd be fun. We'll see. I'll do the auto one at some point. Bitcoin is so interesting, man. One of the things I've been thinking about with Trump and Musk and all that stuff that's happening is Bitcoin's based on a certain political and economic ideology that's ingrained in everything right down to the technology. And those ideologies aren't things that necessarily naturally emerge. You can have someone come into power like Trump and Musk who can will that world into place.

40:45Totally. And the knock-on effects can be significant. If now other countries need to follow suit because they're concerned about falling behind in that particular arena, then they have to step up too. I think since then, somebody in Poland, one of the politicians in Poland started talking about a strategic Bitcoin reserve. So it'll be interesting to see the spread of his Bitcoin policy around as well. It will be interesting. It's also going to be interesting to see what happens with micro strategy. Yeah. Have you listened to Saylor talk about Bitcoin? Yeah, he's different. I don't know, man. He's different for sure.

41:13He's a highly intelligent. He graduated from, I think, MIT, I want to say. I don't follow him closely, but I checked out a couple of his videos. I don't doubt that he's brilliant, but it's very different perspectives. And that's just it. To your point, you need a certain worldview to make sense of that whole technology. And your view on economics has to be different from the standard Canadian view of economics. And if you do subscribe to that view, then everything makes sense. But if you don't, then what? But that view can come into and out of favor. You know what I mean? If the US starts going through massive deregulation and whatever other stuff they're planning on doing that could favor crypto.

41:46And does it become safer as a result? If now we've got countries building strategic reserves, is this a backstop for it or a floor for it? No, I don't know. I don't know, man. Regulations exist for a reason. Regulations are written in blood. And if it's safer, then should you? No, I don't know. I don't get too deep down the rabbit hole, but we might have to learn. That's that old joke about crypto, that it's speed running whatever number of years of economics and finance, relearning all the lessons that have already been learned. Anyway, I don't know. I don't know if people find us just chat about crypto interesting or not but i think they probably do i talk to people about it just in public and on social media and stuff and so i think people are interested the people i talked to are more educated on the topic usually than i am but it's interesting because i used to dunk on it quite a bit and then people are like well have you done your research kind of thing have you done your mandatory 100 hours you're not allowed to talk about bitcoin negatively unless you've done your 100 hours of research because that's how long it takes to understand it no you know i don't really think i have so i went and read up a bunch of books on it and there's some pretty compelling arguments there and i'm just not smart enough to know if it's a good decision or not i own a little bit just as a hedge against my own ignorance kind of thing.

42:43But yeah, I think people would be interested in our views on it. I mean, you guys did a 17-part crypto series that was largely around crypto in general, not specific to Bitcoin. There was a lot of Bitcoin stuff in there, but Bitcoin seems to be its own thing. The politics of Bitcoin are very specific. I'll say that. Cool. Anything else? I think that's good. As always, let us know what you think of the episode. Leave us more reviews. If you hate the show now, or if you love it, let us know. Only the good reviews. Only good reviews, please. Thank you. If you don't like the show, you can email us.

43:11You can tell us you hate the show, but leave a five-star review so that other people can find it because they might not hate it as much. Exactly. I don't think we have very many people that listen to that hate the show, especially at this point in the episode. Yeah, there's some selection bias. If you're still listening right now and you hate this show, you got to reconsider your life. Yeah, that's on you, not on us. All right. We're just being idiots now. Let's shut her down. All right. See you next time.

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