Tutorials

Is Donald Trump a genius? Or should we simply take him at face value?

After Donald Trump’s election, the market gave him the benefit of the doubt. That may have been a mistake. And its unwillingness to change its mind may prove costly. John Stepek explains why confirmation bias is such a dangerous thing.

190603-donald-trump

"When the facts change, I change my mind. What do you do, sir?"

This quote is often attributed to economist John Maynard Keynes. In reality, it's apocryphal (ie, we can't track down an exact source that shows Keynes as having said it).

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

But it's fun, and it sounds exactly like the kind of thing that Keynes, an inveterate smartypants, would have said. So let's stick with it.

Anyway, it's actually a great piece of advice for investors.

Advertisement
Advertisement - Article continues below

But it's something that we find remarkably hard to do.

How confirmation bias creates opportunities for investors

The efficient market hypothesis argues that new information is priced into markets almost instantaneously. And without rehashing all the arguments over market efficiency, I don't think this is far wrong.

We use markets because the "wisdom of crowds" is a decent way to put prices on assets and outcomes. Get 100 people in a room to guess the number of sweeties in a jar, or the weight of a cow, and the aggregate answer will be remarkably close to the truth, even if all of the individual guesses are all over the place. This is why passive investing (tracking an underlying market) works so well.

But there is a very large gap between "decent" and "perfect". That gap represents a space in which some investors can make a lot of money. And one thing that contributes to the size of this gap is our reluctance to adapt to new information that contradicts our existing narratives.

We all believe certain things about the investments we own or are considering. If you own shares in Uber, for example, then you must believe that it's going to move beyond being a minicab-booking app into running a fleet of self-driving cars, or dominating the takeaway delivery sector. (Or maybe you just think that someone else will be stupid enough to buy it from you in a year's time.)

To form this particular view, you had to put some thought into it. You then invested in it. So you've made a decent-sized commitment to this particular worldview.

Advertisement
Advertisement - Article continues below

Constructing a satisfying narrative is hard work. It takes mental effort. And like anything else that takes effort physical or mental we like to find excuses not to do it.

As a result, we are all predisposed to resist processing new information that contradicts our existing views. This is "confirmation bias" the desire to cleave to information that confirms our worldview and it's probably the most pernicious cognitive bias we have. (I cover this in a lot more detail in my book, The Sceptical Investor I'm biased, but if you're new to investing I think you'll find it a useful handbook on how to approach the market).

As well as blinding us to other points of view, it also creates friction in the process of "pricing in" new information. There will always be a tendency to interpret all new information in the framework of the existing narrative, even if it flat-out contradicts it.

So the more leeway involved in the interpretation, the more scope for the market to get it "wrong".

If an individual company issues a profit warning, then like it or not, investors need to change their minds. The facts are generally clear and often brutal. They leave the original story ("this is a successful company") as entirely insupportable. So that information gets priced into the market pretty sharpish.

But when it comes to the "bigger picture", there's a lot more flexibility. Which brings us to the US president, Donald Trump.

Advertisement
Advertisement - Article continues below

The world is definitely not flat

When Trump was elected, markets were very willing to give him the benefit of the doubt. And until very recently, they've continued to do that.

Markets have been so invested in the ideas of globalisation, free-flowing capital, and "convergence" the idea that the "world is flat" (as Thomas Friedman once put it) that they can't bear to do the work involved in changing their minds.

Note also that many in the financial industry are heavily dependent on the "buy and hold forever" model. So the message to clients is "don't worry, markets always go up in the long run, this is just a storm in a teacup". That encourages the creation of arguments to support the status quo, even as it is increasingly challenged.

This is why investors would rather believe that Trump is a player of 3D chess a master strategist and negotiator, bringing his business experience into the rarefied, stuffy halls of government.

A man who understands that expressing his views in barely coherent, often-abusive language, catches his opponents off guard and increases his appeal to people who are fed up with career politicians.

A man who understands that threatening to impose tariffs aggressively will impress his home base and bring his opponents to the negotiating table, where he can strike deals, mano a mano.

Advertisement
Advertisement - Article continues below

The alternative that he's someone with poor impulse control, low self-awareness, and who genuinely believes in protectionism is too worrying to contemplate. And it's also too much cognitive effort to figure out how this would change the "big picture" outlook.

There are signs that this information gap is starting to close. It now looks as though there will be no deal between Trump and China. Then last week, he started on Mexico again. And now this morning, we hear he's been talking about imposing tariffs on Australian aluminium.

Like it or not, times are changing. It starts with tariffs on physical goods. Then you get freedom of movement restrictions. And then capital starts being restricted too.

It'd be nice to think that we won't get there. And maybe we won't. But the rules have changed. We can't take any of the old certainties for granted any more.

We'll be exploring what that means a lot more in both MoneyWeek and Money Morning in the coming weeks and months. But a combination of financial repression (savers being forced to fund their governments by investing in domestic government bonds) and stagflation (prices rising more rapidly than growth as goods become more expensive and harder to come by) seems increasingly likely.

Ouch.

Advertisement

Recommended

Visit/519858/how-long-can-the-good-times-roll
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Visit/517688/the-british-equity-market-is-shrinking
Stock markets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019
Visit/511212/reasons-for-investors-to-be-bearish-but-stick-with-the-stockmarket-bulls
Stock markets

There are lots of reasons to be bearish – but you should stick with the bulls

There are plenty of reasons to be gloomy about the stockmarkets. But the trend remains up, says Dominic Frisby. And you don’t want to bet against the …
17 Jul 2019
Visit/510684/good-news-on-jobs-scares-stockmarkets
Economy

Good news on jobs scares US stockmarkets

June brought the best monthly US jobs growth of the year, but stockmarkets were not best pleased.
11 Jul 2019

Most Popular

Visit/currencies/600665/currency-corner-new-zealand-dollar-kiwi-vs-us-dollar
Currencies

Currency Corner: how is the New Zealand dollar doing against its US counterpart?

The New Zealand dollar has been doing well against the US dollar in recent months, but has started to wobble a little. Is it still a buy? Dominic Fris…
20 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600653/indias-small-and-mid-cap-stocks-are-set-for-big
Share tips

India’s small and mid-cap stocks are set for big gains – here are three to buy now

Each week, a professional investor tells us where he’d put his money. This week: David Cornell of the India Capital Growth Fund highlights three favou…
20 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600636/class-acts-going-cheap-buy-into-europes-best
Share tips

Class acts going cheap: buy into Europe’s best bargains

Value investing appears to be making a comeback, while shares on this side of the Atlantic are more appealing on metrics such as price/earnings ratios…
16 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600641/share-tips-of-the-week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020