October 3, 2016

Dear Investor:

This carnival of an election has most everyone worried, disillusioned or confused. At least with an actual carnival, the nausea induced by the roller coaster comes after some pleasing thrills and chills. No such fun here.

An intuitive (and, at first blush, attractive) idea is to sidestep the stock market fallout of a possible Trump victory by selling everything and then buying back after November eighth. But (not quite) as perilous as a Trump presidency is the act of trying to time the markets around the election.

My usual list of reasons against market timing will sound like a very broken record to the many of you who’ve been long-time clients. These include the staggering adverse tax consequences of selling everything (except in retirement accounts), the transaction costs, and the bid-ask spreads of selling multiple positions. Keep in mind: those are high costs that can never be recovered, unlike an election-induced dip in the market, which is typically short-lived.

But the main reason market timing is so unlikely to work is because it’s an intuitive strategy. Counter-intuition, not intuition, is far more likely to be rewarded by the market. The reason for this is the complex nature of the markets themselves. The stock market is an efficient discounting mechanism which systematically prices in concerns about the presidential election in real time. History shows that it is very difficult (if not impossible) to gain any advantage by timing the market around a well-advertised macro event such as an election. In other words, any advantage Trump gains in the polls immediately translates into risk premia and stock prices. In fact, the general uncertainty is already weighing on asset prices at this moment. To the extent that this uncertainty gets aggravated by Trump’s strength in the polls, asset prices immediately reflect it.

Just watch the Mexican peso’s daily gyrations to see this dynamic in action. The peso adjusts instantly to the market’s opinion of Trump’s chances, plunging when Clinton has a bad day. Unlike the stock market, the peso is a useful laboratory because its motion has been seized upon by traders as a direct proxy for the election results. In essence, the peso has become as direct a derivative as you can use to speculate on the election. The stock market is reacting too—but buffeted as it is by so many macro factors, the picture becomes muddled. The peso shows this immediate and isolated effect in action.

This, in short, is why trading so rarely works: the market can outguess the trader at every turn. As the saying goes, the market exists to humiliate the maximum number of traders the maximum number of times.

That’s why I eschew market timing and avoid trades based on macro concerns. In doing so, I follow the time-tested discipline of Warren Buffett and other value investors by striving to buy quality assets trading at a discount to their intrinsic value—assets which are so cheap they should appreciate over time, no matter which economic or political event derails them in the short-term.

That said, I’ve been doing a lot of trimming of overvalued positions in client accounts recently, especially where I can do so in the most tax-sensitive way, and particularly in conservative accounts. But I am making this decision agnostic to any well-advertised macro concerns, be it the US election or the virtual insolvency of Deutsche Bank. I am doing it because many assets, such as domestic stocks and consumer staples stocks, have become richly valued and because certain asset classes, such as European equities, have become outright overvalued. And most of all, because the individual risk profile of each account is what should always dictate its equity exposure, regardless of the macro concern of the day.

No doubt a Trump win would be very bad for markets (and for humans), but timing any sell-off profitably is much more difficult than it appears.

If you’d like me to trim your stock exposure based purely on election considerations, please call. I warn you: I will do it, but only after boring you to tears with a sermon on the steep risks, potential opportunity costs, and other disadvantages to such an approach.

With best wishes for the coming quarter.