"Forecasts create the mirage that the future is knowable" (Peter Bernstein)
Certainly, these events have shown that outcomes and market reactions are often unpredictable, despite polls often suggesting otherwise. Nevertheless, investors often position themselves with a definite set of expectations and its degree of certainty, which is mostly unjustified. Therefore, some assets are priced as if the future is predictable from a political, economic, and market behavioral standpoint.
To us, it is not foreseeable to what extent any event has already been discounted in stock prices and to what degree different scenarios are likely to happen; as an example, Hillary Clinton was not only favored to win the US presidential election, but she was also “favored” by the market. As seen by market anticipations leading up to the vote, with increasing “certainty” of Hillary Clinton winning the presidential election, stock prices moved up, while on the flip side, market prices fell as soon as Donald Trump won ground in the polls.
On Monday and Tuesday of election week, markets moved up expecting Hillary Clinton to win. Following the election of Donald Trump, the market’s perception turned on its head and the US market had its best week since 2014.
Even though all three major election results seem to be the opposite of what investors were hoping for, the equity markets closed the year clearly higher than they had started in January.
In 2017 there are again several elections in economically influential countries which could be decisive for the political landscape, the economy, and also to market sentiment. Among others, there will be the Dutch general election in March, the French presidential election in April, and also the German federal election in September. All of the aforementioned events are carrying the possibility of catapulting populist parties into the seats of power. The upcoming elections might offer other surprises, or they might not. We simply do not know what will happen, nor how the market will react on either outcome.
With these observations in mind it is important for us to focus on our strengths and continue to stay a disciplined and prudent value investor. All our efforts are focused on finding undervalued companies which are able to navigate through tough waters. Therefore, political events do not alter our portfolio positions in advance. We do not believe that there is a competitive advantage of predictions to outcomes of certain events, and we have certainly not developed a competitive advantage in doing so.
In general, we do not make predictions about short-term market movements or reactions to political events. Following these events, changes of positions are also rare, unless either valuations of certain segments become more attractive or our portfolio has become too expensive through its outperformance. Typically however, political events increase uncertainty and reduce visibility for short term investors. In these periods, we need to acknowledge that investors are willing to pay a high price for perceived certainty or predictability. As a value investor, this provides us with the opportunity to become more active, seek new bargains, and position ourselves for the mid- to long-term.
Price fluctuations do offer, ceteris paribus, buying and selling opportunities. Principally, like many fellow value investors, we stick to our contrarian mindset and concentrate on the long-term perspective. We focus on companies with superior cash-flow characteristics over an entire cycle and try to discover mispricings, which may occur in times of high uncertainty. Companies have and will adapt to the new environment over time. It is not an option – it is a must for economic survival.
The last year marks a difficult one for many investors and strategies in rapidly changing market environments. We managed to achieve superior investment results and navigate successfully through these tough waters by focusing on our investment process of selecting undervalued companies and refraining from short-term, emotional reactions.
We certainly cannot ignore political decisions and developments. However, our task is to focus on what we believe our competitive advantage is, i.e. selecting undervalued stocks! Short-term timing of market movements or macroeconomic forecasts do not belong into the repertoire of our decision making process. Based on our philosophy we remain committed to value-oriented stock selection.
