Notes, Views, and the Occasional Provocation November / December 2016 

As a species, we’ve seemingly come a long way from the days when we explained natural phenomena like earthquakes and volcanic eruptions in anthropomorphic terms as battles between the gods. But the way investors view and talk about the stock markets today puts this view to the test.

As the article below discusses, when it comes to investing, talk is more than just talk and metaphors matter more than we think.

I hope the year is ending well for you and that you navigate the upcoming holidays with as much ease as possible.

Best regards,

Milo Benningfield

A Rally, Yes, But a Trump Rally?
How investors talk about the market influences their expectations for what will happen next and makes them place their bets accordingly. more

BFA Media Quotes
Recent media quotes. more

A Rally, Yes, But a Trump Rally?
Stock prices were supposed to fall if Donald Trump won the presidential election on November 8th. Respected economics professors predicted a 10% market decline under a Trump victory. On election night, the futures markets appeared to corroborate their work, with Dow futures falling 750 points, or over 4%, as it became apparent Trump would win. Caught in the shock of the moment, Nobel economics laureate Paul Krugman, blogging for The New York Times, wrote that the markets might “never” recover and “[w]e are very probably looking at a global recession, with no end in sight.”

Instead, during the four weeks since the election, stocks have soared. Global stocks are up 3.7%, U.S. stocks more than 5% in what is now being called the Trump rally.1 In recent days, The New York Times has advised “How To Play the Trump Stock Market Rally.” Meanwhile, CNN reported in “The Trump Rally: It’s Stunning and It’s Broad:”

[A]bout every part of the market is getting a Trump bump. Nearly three-quarters of the stocks in the S&P 500 are up since November 8. What’s more, about half of those winners have gained at least 10%.

So now, along with Trump hotels and casinos, Trump offices, and Trump steaks, even the market has been branded. But is it really a “Trump” rally?

Those saying yes cite Trump’s pro-growth measures like infrastructure spending, tax cuts and less regulation as drivers of the surprise market rally. Banks, energy producers, and infrastructure companies like Caterpillar are positioned to benefit under Trump’s proposals, so, the theory goes, investors value them more now than before the election. Plus, when Trump speaks, market sectors move, as when biotech stocks fell after he talked about reining in drug prices.

No, say others, the rally is a garden-variety “honeymoon rally” that often occurs after presidential elections, when the markets are relieved to be unburdened of the uncertainty leading up to them. Moreover, the forces behind the rally were already at work before the election: improved labor markets; recovered energy prices; positive earnings reports. Whoever entered the White House would receive the benefit of an improved economy under Obama.

As long as stocks rise, does it even matter what we call this rally? After all, the markets themselves are probably indifferent to any label.

Yes, but we’re not. How we talk about the markets influences our perceptions and expectations about what comes next and thus our financial judgments.

This was the fascinating conclusion in a 2005 paper titled “Metaphors and the Market: Consequences and Preconditions of Agent and Object Metaphors in Stock Market Commentary” by Columbia Business School professor Michael Morris and his co-authors. Metaphors are what “ordinary people use when making sense of abstract events in more concrete, familiar terms.”

Since the global securities markets are one of the world’s great abstractions, “certain kinds of metaphors, such as those that anthropomorphize the market, occur across several languages and cultures.” Humans draw these metaphors from animals and inanimate objects, and we see both types at work in describing market price movements: animals – “the Dow fought its way upward”; “the S&P dove like a hawk”; objects – “the Nasdaq dropped off a cliff.”

These metaphors may make the markets seem more accessible and more familiar, but they also lead us astray. In an interview, Professor Morris noted:

Our minds are not wired to understand random systems, so we often impose patterns where they may not exist. In sports, expressions like "hot hand" in basketball or "hot bat" in baseball convey the notion that a player's chance of success is greater after an immediately prior hit than after an immediately prior miss, a belief that persists even though extensive scientific research has found little or no basis for it. Our study suggests that agent-metaphors foster a similar (and equally dubious) expectation of continuity in the stock market.

“And that expectation,” he adds, “can affect people’s buy and sell decisions.”

What expectation does an anthropomorphic Trump rally create in investors today? It likely depends on what an investor thinks of Trump himself. As Cicero warned in Shakespeare’s Julius Caesar, “Men may construe things, after their fashion, clean from the purpose of the things themselves.” Or put in more modern terms: “Still, a man hears what he wants to hear. And disregards the rest.” (Simon & Garfunkle, “The Boxer”)

It’s easy to imagine pro-Trump investors acknowledging inevitable bumps ahead, but expecting the markets to rise in coming years, as Trump makes good on his promises of deregulation, lower taxes, and infrastructure spending. Their motto: “America, open for business again.”

On the opposite side of the aisle, a “Trump rally” means a period of suspended disbelief before reality sets in, markets crash, and prolonged economic instability ensues. Their motto: “What did you expect?”

It’s impossible to know who will be right about the Trump market going forward, and market history provides both good news and bad news.

Exhibit 1 shows the growth of one dollar invested in the S&P 500 Index over nine decades and fifteen presidencies from Coolidge to Obama:

Exhibit 1. Growth of a Dollar Invested in the S&P 500, January 1926–June 2016

Source: Dimensional Fund Advisors

The bad news: there’s no obvious pattern for how the markets perform based on who holds the Oval Office.

The good news: over the long run, the market has provided substantial returns regardless of who controlled the executive branch.

One implication, substantiated by other studies, is that ultimately the president exerts little actual control over the economy. Instead, presidents inherit economies built by their predecessors, and their ability to change the trajectory of that economy is hemmed by a variety of factors, not the least luck regarding what surprises occur on their watch.

Naming the recent market surge a Trump rally is good marketing, but a distraction from the business of investing. Today’s Trump bump could be tomorrow’s Trump slump in the blink of an eye. But for investors willing to stay focused on the things they can control and let the other things take care of themselves, the markets can be a proven, if sometimes dubitable friend on the road to financial prosperity.

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BFA Media Quotes
Bloomberg News, November 22, 2016

Milo was quoted in an article by Ben Steverman, “Financial Planners Play Therapist to Paralyzed Liberals,” which discussed investor reactions to the presidential election in liberal cities. Milo noted, among other things, that people in San Francisco “felt like somebody had died,” but needed to resist trying to outguess the markets based on these emotions.

Thank you for reading. Please look for our next newsletter in February.

Best regards,

Milo Benningfield

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1 Global stocks represented by MSCI World Index, U.S. stocks by the S&P 500 Index.

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