What does Trump’s re-election mean for the markets? In this episode, Ben and Mark explore The Presidential Puzzle, a phenomenon revealing that equity risk premiums have historically been higher under Democratic presidencies than Republican ones. With Trump returning to office as the 47th U.S. president, they examine how voter risk aversion shapes political outcomes and market expectations, offering surprising insights into this intriguing connection between politics and investing. They also delve into market timing pitfalls, the importance of diversification, and how financial advisors can help investors navigate emotionally charged decisions. To wrap up, Ben and Mark reflect on listener perspectives and explore the intriguing future of Bitcoin in finance. Tune in to learn what Trump’s win means for expected stock returns and more!

Key Points From This Episode:

(0:00:18) Mark and Ben’s experiences at the Physician Financial Independence Conference.

(0:06:53) Republicans vs. Democrats: What the election results mean for the stock market.

(0:09:09) The Presidential Puzzle and how belief informs asset choices among voters.

(0:15:12) How risk aversion and the economy impact election outcomes and expected returns.

(0:20:08) What investors should and should not do with this information.

(0:24:38) The dangers of making financial decisions based on emotional predictions.

(0:30:02) Unpacking the relationship between global risk aversion and U.S. presidencies.

(0:31:20) Our aftershow segment: digging into recent reviews, the podcast topic puzzle, Ben’s recent trip to Boston, and Bitcoin.

Read the Transcript

Ben Felix: This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer at PWL capital, and Mark McGrath, Associate Portfolio Manager at PWL Capital.

Mark McGrath: What are you smiling about?

Ben Felix: You bugged me about not saying that last time.

Mark McGrath: Yeah, I was going to ask, is that the first time you said it? Because it threw me off.

Ben Felix: It is the first time I said it. I'd be very deliberate about making sure I got my own title right.

Mark McGrath: It feels good?

Ben Felix: I guess so.

Mark McGrath: Good for you. Episode 333. It's going to be a good one. Ben, you and I were at the conference together on November 2nd.

Ben Felix: Yeah.

Mark McGrath: We got invited to the Physician Financial Independence Conference for separate reasons. You did a talk with Dr. Mark Soth, the Looney Doctor. You did a live episode recording of Money Scope.

Ben Felix: Yeah, that's right.

Mark McGrath: How did to go?

Ben Felix: I think it was good. I mean, for someone who's listened to the whole series of Money Scope, it was nothing new. The intention was to do a summary of main points. Although we did structure it based on questions from the audience. We got pre-questions and we used existing Money Scope content to answer all those questions. But it's a pretty good overview of the Money Scope content so far. And I think it is currently published as an episode on the Money Scope channel.

Mark McGrath: Nice. For those who don't know, there's a group of – I don't know what their membership is up to. But it's north of 30,000 physicians and their family members across Canada that are part of a Facebook group. And they go by PFI or Physician Financial Independence. And the entire impetus for this is to become better DIY investors, DIY planners. They're very, very big on things like index investing and fee-only planning and that type of thing. Lots of great people. A lot of my clients who are physicians are part of that group as well. And so, they'll always ask me, "Oh, we saw a post about this. What do you think?" It's a great group.

My talk was a bit different. Because I've worked with physicians historically, I was asked to do the 10 most common mistakes that physicians make with their money. And as I was writing this out, it ended up being 12 mistakes. There's probably some overlap between the two, but I did that. I think it went really, really well. What was interesting is that I had a number of physicians reach out to me after the conference inquiring about PWL services, which was surprising to me just given the audience are largely do-it-yourselfers. The intention of this group was to take back control finances. And so, it was just interesting to me to see some of them actually wanting to go out and get advice.

And I think I kind of predicted this. I didn't say it. In my own head, I predicted this. But I was actually at MD Management when this happened, when the MD was sold to Scotiabank. And I remember just the general feeling from a lot of my clients was they weren't happy about it. And I believe that was the genesis of this PFI group. But I know my clients pretty well and a lot of them who are leaving to kind of take things into their own hands. I thought, some people are very capable and will do a great job of that. And there was a handful of people that I knew, I was like, "I don't think this is the right move for you, but sure enough." And in my head, I was like, "You know what? I think this pendulum at some point will probably swing back the other way."

A lot of people are really excited about it. They're encouraged. They're going to go and try and do it themselves and probably realize at some point that they bit off a bit more than they can chew and are going to go back and seek advice through some channels. I suspect maybe that's why people are reaching out. But it went really well and enjoyed it and got some really great feedback.

Ben Felix: That's really interesting. When you talk to these people who are capable DIY investors or could be capable DIY investors, what are the reasons they're getting you for why they want to talk?

Mark McGrath: Yeah, and it's interesting too because I've got a couple of meetings still coming up, but the few that I've talked to already are like, "They're doing a great job." All the basic fundamental things that we would usually want to look at ourselves for our clients, they're doing great. Portfolio is fully invested in one of the one-stop ETFs, globally diversified. They've got a corporation set up in some cases. They're funding their RRSPs, their TFSAs. They've got term life insurance. They've got disability insurance. They've got their wills, their powers of attorney. They've got the basics really, really well dialed in, which is not always the case when clients are coming to us often. It's because they don't have all of these components lined up properly. But the few that I've talked to have done a really, really good job. I think that group has done a very good job of laying out those basics and people are following that.

And it's the same just outside of this group with people that come to us. I think a lot of people just get to a point in their career, whether it's because of family, demands from the career itself, or just a lack of interest and energy to put into personal finance, they go, "Okay, this is great. But you know what? I'm just going to pay somebody to outsource a lot of this thinking for me." There's just so many financial decisions that people make. And I always tell my clients, "You're going to make thousands of financial decisions in your lifetime and our job is to be the first point of contact for all of these. And we're not going to always have the answer, but we can get you the answer and we can help you think through a lot of the decisions and the trade-offs."

A lot of them are huge fans of the podcast. Fans of your YouTube, Ben. Fans of my Twitter. They're following us and implementing a lot of the stuff we're talking about already. And I think they just get to a point where they're like, "That's a lot of work. My time is just better spent somewhere else."

Ben Felix: I get that, man. In my life, my capacity to do anything outside of doing my job, I spend a lot of time doing that. It's not a, whatever, 40-hour a week or whatever it's supposed to be. Even when I'm not working, I'm listening to podcasts or thinking about stuff, whatever. And I've got kids and kids activities, and then just maintaining a house, which is a job in itself. If someone asked me to do something outside of that, I don't have any time. I totally get why people that could do this, they have the skills to do it, wouldn't want to do it because it's time consuming.

Mark McGrath: You have to stay on top of things. And we had the big proposals for tax changes and stuff. Just to stay on top of the external environment, it's a lot of work. New decisions come up all the time. And you can be really, really well set up and then something changes immediately in your life, or externally, or in the markets, or in tax legislation, or whatever and throws everything out the window and you just need another set of eyes.

We're basically on retainer for our clients. Obviously, we've talked about this before, but there's different advice models. And some people want the retainer model. And some businesses and families want retainer models for legal advice or for that model, I think, for our clients. And others just need ad hoc pay-as-you-go type services. It really just depends, I think, on where people are at.

I think the other big thing, and I've mentioned this before as well, is the liability that comes with it. If you're the head of a household, as your portfolio grows and as things get more complex, I find that people tend to be concerned that they're making decisions with larger dollar amounts for their families. And if they do make a mistake, it's them that's going to be responsible for it. And some people might find that to be okay. But others don't want that to interfere with their relationships with their family and don't want to have to regret that if they do make a mistake.

Ben Felix: Makes sense. Super interesting to hear about people at a pretty DIY-focused conference wanting to talk to a wealth management firm, but not surprising for the reasons you just described there.

Mark McGrath: We covered that on a previous episode too, why people hire advisors.

Ben Felix: Yeah, true. We did a whole episode on that.

Mark McGrath: And the type of people that do, I think you said that there's a higher proportion or at least the average financial literacy level of people who tend to hire advisors is usually higher than those who don't.

Ben Felix: That's right. More financially literate people are more likely to seek out advice and to seek out professional advice as opposed to, whatever, a social media influencer, or a family member, or friend.

Mark McGrath: But you are a social media influencer, Ben.

Ben Felix: That gets complicated, doesn't it? It's an interesting discussion to start. In the rest of the episode, though, we are going to talk about the presidential puzzle, Trump's win and expected stock returns. And then we've got a bunch of reviews and some contrasting reviews, which is fun to talk about because there was one pretty negative one. And then I think more overwhelmingly positive of reviews than we've ever had in a single two-week period where we collect reviews. We'll talk with that in the after-show.

All right. Good to go to the episode?

Mark McGrath: Good to go.

***

Ben Felix: All right. Welcome to episode 333, talking about the presidential puzzle, Trump's win, and what does it mean for expected stock returns? It's a pretty fun topic.

Mark McGrath: We're recording on November 20th. And I don't know that you were going to cover this explicitly. Apologies if you were. But we saw, as soon as the election was finished, markets just went on an absolute moonshot. And as of today, I think they're back to where we were pre-election, are they not?

Ben Felix: There's a paper that I looked at on this that the theory is because Republicans tend to enact favorable tax changes for corporations. There tends to be a bump in asset prices after Republicans are voted in. It's a relatively small effect though, much smaller than the effect that we're going to talk about in the episode.

Okay, Donald Trump obviously won the 2024 US Presidential Election. And he's now set to become the 47th president of the United States. This is rather interesting stuff, but I think he's the only non-consecutive two-term president ever. Someone might tell me I'm wrong on that, but I'm pretty sure I read that.

Now, the interesting thing is that this Republican victory likely contains information about expected stock returns, but it's probably not the information that people expect to hear. I mentioned Republicans being relatively business-friendly. And I think people often assume that Republicans are good for the stock market. And they're not bad for the stock market. And the causality is really interesting. And we'll talk more about that. But the interesting empirical fact that makes this whole discussion interesting is that the historical equity risk premium, going back to 1927, has been much higher, much higher under Democratic than Republican presidents. That's the presidential puzzle.

And there's one big paper, I think, in the Journal of Finance that identified this, and then Ľuboš Pástor later had a paper that confirmed the same thing out of sample, and they put some theory to it, which is what we're going to talk about. And I think because there's this theory behind it, and if you look at the way the world looks today, it looks a lot like what this theory would predict, I think it has just interesting implications for expected stock returns.

Now, the other thing I think is really interesting here is that everyone's going to have a different opinion on what the election results mean for the stock market. Politics are so polarized at the moment in the United States and in Canada too. But in the United States, each side of the political spectrum in the US seems to think that the other side is completely brain-dead.

Mark McGrath: It's gone to the point where it's an insult to call somebody a member of the other party, like stupid Dems, or stupid Liberals, or whatever. And everybody just puts you in an identity box based on your politics.

Ben Felix: Yeah, there's so much identity wrapped up in this stuff. And so, a Democrat might think, "Well, Trump's going to crash the stock market," and a Republican might think that Trump's going to be super good for the stock market. Everyone's got their own opinion. But the problem with this is that everyone's got their own opinion based on their individual model of the world, based on how they see it through their own lens as a Democrat or a Republican. This is separate from the presidential puzzle, but it's still super interesting and it ties back.

There's this 2020 paper, ‘Belief Disagreement and Portfolio Choice’. And they find that households likely to be Republican, likely to be based on their geographic area and what proportion of people in that area vote Republican. They increase the equity share and market bait of their portfolios following the 2016 presidential election when Trump won. And likely Democrats in the same way, they've rebalanced into safe assets. Trump wins, Republicans take more equity risk, increase their equity beta, Democrats rebalance into safe assets. Fascinating.

Mark McGrath: That alone is super interesting. That just shows how disparate the viewpoints are amongst those two groups.

Ben Felix: And how important it is to have an objective view of this stuff? This is a paper by Antoinette Schoar at MIT. We discussed it with her in episode 310 if people want more details on that paper. They control for multiple factors to rule out non-belief-based explanations for that observation. And they conclude that the behaviour is driven by investors interpreting public information using different models of the world.

It's obvious when you think about it because of what we just talked about, like as an insult to call somebody a Democrat if you're a Republican. It's so polarized. It's kind of obvious that people would have such different beliefs about what factual events mean. Democrat households in 2016, they believed Trump was going to crash the market, and they went to cash, or they reduced their equity exposure. Republican households believed Trump was going to send the stock market on a rocket ship, and they increased their allocation to stocks.

But the problem, obviously, is that individual beliefs, they can't all be right. Individual beliefs are not a great model for how the world actually works. And making decisions on that basis can lead to errors. This is where the more robust model that explains the presidential puzzle I think gets pretty interesting.

Again, the empirical fact to start is that the vast majority of the historical US equity risk premium has been delivered under Democratic presidents. One important distinction that I'm going to make later, but I'll make it now as well, is that we're talking about the equity risk premium. That's the return of stocks over the return of three-month treasury bills, not equity returns. Those things are sort of related, but they're distinct. We're talking about the equity risk premium here, and I'll come back to that later.

This is a 2020 paper in the Journal of Political Economy by Ľuboš Pástor. It goes up to 2015. I looked at that after that just to see how it fits with the model. We'll talk about that in a second. And we did discuss this paper with Ľuboš Pástor in episode 124 if people want to go back and listen to that one.

The headline empirical result from the paper, and this is the crazy data point, is that from 1927 to 2015, the average market return in excess of three-month treasury bills under Democratic presidents is 10.7% per year. And under Republicans, it is negative 0.2% per year.

Mark McGrath: That's so big.

Ben Felix: Literally, all of the equity risk premium over that period came under Democratic leadership.

Mark McGrath: That's wild.

Ben Felix: Crazy. I mean, I think that's surprising to people. I know it was surprising to me the first time I read that when we were preparing to talk to Ľuboš back then.

Mark McGrath: Well, not only that, but you see all these posts on social media and people writing articles about how it doesn't really matter who's in power when it comes to market returns. And maybe over the long run, that ends up being true, but there's obviously a difference.

Ben Felix: Well, I'm going to say something like that later too, because stock turns in absolute terms as opposed to the equity risk premium have been positive most of the time on average through both presidential parties. But still, this empirical fact is important. Hence, theoretical explanation, I think, is the really interesting part. I'm going to get there in just a second though.

That return difference, the difference in the equity risk premium of around 11% is obviously economically significant. It's also statistically significant. They look at that in the paper. Now, stock returns on the most recent Republican, which is Trump and Democratic, which was Biden, presidential terms, do not fit with the model. Go and look back at all the historical presidential terms that are in the model. They're not all perfect. It's just, on average, this is what it looks like.

The equity risk premium under Trump was an annualized 14.4% and it was 9.12% so far, under Biden, ending October 2024. No model is perfect, obviously. We can't use a model even if it's a good one to predict the future every time. And I'm going to come back to just that idea a little bit later. When I include those data, as a Bayesian would do to update their beliefs, in the larger data set back in 1927, the overall results stayed directionally the same, where the average equity risk premium under Democratic presidents far exceeds that of under Republicans.

Updated to October 2024, from 1927 to October 2024, I get an equity risk premium of 10.29% annualized on average when the president is a Democrat and 2.23% when they're a Republican. Still a massive difference. Just not quite as big. The first time this was identified was in a 2003 paper. That's the Journal of Finance paper that I mentioned earlier titled ‘The Presidential Puzzle: Political Cycles and the Stock Market’. And then Pástor in the 2020 paper finds that it persists out of sample. In their out-of-sample period, it fits perfectly. There was a big return difference or equity risk premium difference again.

Now, here's the interesting part. The tempting explanation is that the different economic policies of the two parties explain the difference. I mean, that's the polarizing political explanation is like, "Well, Democrats are better for the stock market."

Mark McGrath: Well, that seems obvious. What else could it be?

Ben Felix: And it's a classic case of causation versus correlation, or correlation not being causation. The causal relationship is the really interesting part. Now, of course, markets don't really work that way. If economic policies really had that much of an effect, the expected effect of those policies get quickly reflected into asset prices. And we wouldn't expect these big persistent return differences.

That explanation, the policy explanation would imply that investors persistently misprice stocks by failing to anticipate the expected policy effects, and then they get surprised by, "Wow, that was so much better than we expected." But the simpler explanation that Pástor offers in ‘Political Cycles and Stock Returns’ is that Democrats tend to get elected when expected future stock returns are higher and Republicans tend to get elected when they're lower.

Mark McGrath: Does that also mean the market's generally lower, or down, or cheaper, I guess?

Ben Felix: Yeah. I'll talk a little bit about that. One of the reasons that could happen, that expected returns could be higher, is that investors' risk aversion, it varies over time depending on what's happening around them. Risk aversion is probably high during an economic crisis, as one example. When risk aversion is high, investors demand more compensation for risk, which on average, over a long period of time, is going to play out as higher realized returns.

Now, how this relates back to politics, and this part, this is a really interesting part of the paper, is that when risk aversion is high, like during an economic crisis, voters are more likely to elect a Democratic president because they demand more social insurance, which Democratic leadership tends to provide. And that when risk aversion is low, like during a booming economy, or a booming stock market, or both, voters are more likely to elect a Republican president because they want to take more business risk.

Mark McGrath: It does tie into policy to a degree then, in that they're reacting to external events like what's going on in the economy and the markets in order to make decisions about the policies that they want to vote for, and that has an impact on markets.

Ben Felix: Yes. But instead of policies causing the stock market to perform a certain way, risk aversion causes certain policies to be favoured and causes expect stock returns to vary. The causal direction is the key to the paper here and I think what makes it interesting. The result is what we see, that when Democrats get elected, risk aversion tends to be higher, which leads to higher expected stock returns under Democratic leadership. And when Republicans are elected, risk aversion is lower, leading to lower expected returns under Republicans.

Now, an important thing is that in this model, Democratic presidents, they're not the ones causing high expected stock returns. I guess we're doing what we just talked about. But high risk aversion causes both democratic presidents to get elected and expected stock returns to be high at around the same time. And then it's a similar story under Republicans just in the opposite direction, I guess. They don't cause stock returns to be low under their leadership, but low risk aversion tends to result in Republican presidents getting elected and expected stock returns to be low at the same time.

Now, in the paper, they go back through history and they just look at how does this idea – they do some other interesting stuff to confirm that risk aversion does tend to be high when Democrats are elected separate from the stock market. They look at other measures of risk aversion, but they also just go back through past elections and how does the model look? They look at November 1932, amidst the Great Depression, Republican Herbert Hoover lost the election to Democrat Franklin Roosevelt. Kennedy gets elected during the 1960-61 recession. Carter gets elected after the 1973-75 recession, a Democrat Clinton, Democrat, after the 1990-91 recession. November 2008, of course, in the depths of the great financial crisis, Obama beats McCain. And then in 2020, everyone remembers this one more recently, Democrat Biden beats Republican Trump as the US and everybody else is dealing with COVID-19. That one wasn't in the paper, but it's a pretty obvious one to add.

And then in 2024, I mean, this is where I think it's just so interesting to see how well the model maps to what we see happening, the US economy looks objectively great. US stock prices are nearing all-time highs, and Republican Trump beats Democrat Harris. You couldn't make this up. It just seems so perfect relative to what they describe as their model. They look overall, they look at the data of when the transitions from Republican to Democrat happen, and they find that they tend to be preceded by this, to your point earlier, Mark. They tend to be preceded by low market returns, low GDP growth, and high volatility.

I mentioned this a minute ago. They look at the time series of four proxies for risk aversion, and they find that they indicate that risk aversion tends to start out high and then decline over the course of a democratic presidency. And those are measures of risk aversion that are not directly related to the stock market or they're not derived from the stock market, I guess.

Another interesting thing is that that change in risk aversion contributes to such a large gap between returns under Democrats and Republicans. Because as risk aversion revert to the mean after a Democrat is elected, expected returns are falling, but that's also causing stock prices to increase over that term. And fitting with this model, Trump is likely going to be inheriting a stock market with incredibly high valuations, which I would say suggests low-risk aversion in the market right now. Again, that fits with the model. Republicans are most likely to get elected when risk aversion is at its lowest, which is often at the peak of the business cycle. And so, it's not surprising – and they observe this in the paper. It's not surprising that they observe a downturn shortly after Republicans take office. That's not a surprising thing to see. There does tend to be that little bump that I mentioned from maybe favourable tax policy expectations, but there's often a decline after they take office.

Another thing the model predicts is a larger gap in the early years of presidential terms, which is exactly what we see in the data. In the 1927 to 2015 data series from the paper, the gap in returns is by far the largest in the early years of presidencies. I think this model is pretty relevant today because the U.S. economy is doing well. Stock prices in the U.S. are high, which I guess suggests risk version is low and that expected returns are low.

Vanguard and PWL and, I mean, anybody that creates expected return assumptions, everybody's expecting U.S. stock returns to be relatively low going forward because valuations are so high. I've got some notes in the tax and it's worth mentioning. Basically, there is a little bump from potentially favorable tax policy, but it's dwarfed by this presidential puzzle. It's not even close in magnitude. That's the main idea. Now, what you should actually do with this information, it's interesting.

Mark McGrath: Short US stocks is what you're saying.

Ben Felix: Well, so this is the thing. If we did this episode, or if you listened to Ľuboš Pástor's episode where he describes this model back in episode 124, whenever that was, I think it was around the time Trump was getting elected. I think we talked about that. But if you'd listened to the model back then and said, "Okay, well, I'm going to do that. I'm going to act on that information." As we mentioned, the returns under Trump, his first term, were incredible. And they've been great under Biden too, but not as great. 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 are 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. But 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. That's the 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. It'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.

Mark McGrath: Don't short U.S. stocks is what you're saying?

Ben Felix: 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. I think that's an issue. Even 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. What if I'm wrong? What if there aren't overturned premiums? Well, it's not really that bad. But if you shorten U.S. stocks and you're wrong, you get destroyed. Or if you exit the US market, we could have had the same conversation five years ago or something. Valuations are super high, blah-blah-blah. And then the U.S. 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. And 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 U.S. stocks just as much as I don't think I'd be shorting them. 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 raining.

If we step back and look objectively at the empirical data, there is this puzzle. The puzzle's there. The equity risk premium has been much higher under Democratic presidents than Republican presidents likely due, based on the Pástor paper, to time-varying risk aversion, causing expected stock returns to be high when Democrats are elected and then low when Republicans are elected.

While 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, overtime, markets have just gone up. And they've gone up whether it was a Democrat or a Republican in power.

Yes, there was more equity risk premium under one part than the other, but you can't time that and expect returns are positive no matter what. 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 Schoar, that shows it in such an interesting way. But you can't let your individual beliefs cloud your judgment.

One point actually on the Antoinette Schoar 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. And that can be done either with an automated investment product like an asset allocation fund or through a professional financial advisor. They find in the paper that both of those things reduce this belief-based action on portfolios. All right, that's it.

Mark McGrath: 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 had this exact problem with the client in 2016 when Trump was elected. The physician household, they had about – I think it was just shy of $5 million invested. It was quite a bit, but they were 90% fixed income. Very conservative investors. They were probably in their late 50s, I think maybe early 60s. Gearing up for retirement. So 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. They had about 10% total exposure to global equity and only about somewhere around 4% in U.S. stocks, 4% of their portfolio in U.S. 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. And 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, then 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. Fine, let's do it. 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 – 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. You're talking 13 months, 14 months between the time she sold and between the time I left. I don't know what the eventual outcome was. But 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 time frame. The opportunity cost was massive. And going for the full four years of that particular term, 2016 to 2020, the S&P 500 in U.S. dollar terms was up 80%. 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.

Ben Felix: Oh man, we had 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 blown. Maybe this time because he's already been there, but this time is even crazier 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. Because 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.

Mark McGrath: 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. So I'm going to wait and wait and wait."

Ben Felix: And people never want to get in after the crash. They wait until it recovers.

Mark McGrath: 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? Your handcuffed. Your paralyzed. When do you get back in? Even if you got it right on the cell, 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 your right or whether it goes up. It becomes emotionally and psychologically very difficult to time it back in.

Ben Felix: Yeah, 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 U.S. 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 U.S. stocks or that you should short U.S. stocks because those have, I would argue, greater risks.

But 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. I think – we'll see. I've said similar stuff at various points in the last 10 years and the U.S. market has kept going up.

Mark McGrath: You've been wrong before, Ben? Is that what you're saying?

Ben Felix: I've been wrong so many times on that one anyway.

Mark McGrath: That's a good point. You're not doing anything with your portfolio with this information, are you?

Ben Felix: No. No. Not at all. I don't see how you reasonably could. There'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 Pástor model of 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 frame over that period.

Mark McGrath: Well, if it was a perfect model, then there'd be no difference. It could be arbitraged anyway. It can't be a perfect predictable model.

Ben Felix: That's true. If it was a perfect model, it would just be reality. And reality would adapt to itself. I don't know.

Mark McGrath: Really interesting. You should do the same thing with the Canadian data if you can at some point. Obviously, the U.S. is the big market.

Ben Felix: You know what? I had it in my notes. I guess I must have 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 U.S. political parties as a proxy for global risk aversion. And they just argued that the U.S. is such a big player economically around the world that it's probably a reasonable to assume that there's a relationship between global risk aversion and U.S. presidencies.

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.

Mark McGrath: Interesting. People in foreign countries, the returns – all eyes are on the US, basically for foreign investors. That is really interesting.

Ben Felix: They do test it in other countries just for robustness of their model, and they find the same effect is there, which is, I think, pretty interesting.

Mark McGrath: It would still be interesting to see it with Canadian politics. But I wonder if Canadian politics largely follow U.S. politics. If we were more right or left-wing leaders at the same time as the U.S. talking it loudly. Curious.

Ben Felix: I have no intelligent comments on that. I'd be interested too, for sure. All right. Should we go to the after-show?

Mark McGrath: Indeed. Let's go.

***

Mark McGrath: Have you watched any interesting content recently, Ben?

Ben Felix: Nope.

Mark McGrath: Okay, I'm glad I asked.

Ben Felix: Someone left a comment. I don't know where it was. Or 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 any recent things and I say no.

Mark McGrath: Well, I mean, you mentioned it earlier. It's the same as me, I read, but I don't have time for – although my kids have been sick, my wife's been sick. We've been watching movies and stuff, and having movie nights. And as my son calls them super nights, which are lazy nights and late nights. Lazy nights are like movie nights, or order pizza or whatever. Late nights is when he gets to stay up past his bedtime. We started giving him like one day a week. And when we do both, it's called a super night. We've caught up on some shows and stuff, but it's all kid 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 is like my favourite. And somehow genetically downloaded that to him. He's just obsessed with scaring himself. We caught up on a bunch of family movies with Halloween themes and that kind of stuff.

Ben Felix: That's super funny. We did our first episode with me not being there.

Mark McGrath: That was the first one, eh?

Ben Felix: First ever, yeah.

Mark McGrath: I loved it. It was great, actually. Just me and Cameron. Just two guys having some fun. The imposter syndrome was a lot lower. I wasn't worried about sounding like an idiot in front of Ben Felix. It was pretty nice.

Ben Felix: Oh, man. So funny. All right. I mentioned in the introduction that we got a bunch of recent reviews. Let's rip through those. I'm actually going to start with someone reduced their review from a five star to a two star. And they said, "Lately, not as great. Not as captivating." Maybe it's because there haven't been any Benjamin and Cameron only podcast lately. If it ain't broke ...

Now, the reason I'm interested in just the dispersion of reviews here is that there's 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 overwhelmingly positive about the recent content.

Mark McGrath: I think people tune in for different reasons. And we've talked about this too. 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. We 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. 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. People loved that one. 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."

Ben Felix: 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 wonder, 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."

Mark McGrath: That was great.

Ben Felix: It's crazy.

Mark McGrath: I mean, I think as long as you keep pulling off that hairstyle, we're not going to lose any listeners. So I'm not too worried about the negative reviews.

Ben Felix: I told you before we started recording that you look like an AI avatar of yourself because your beard is so perfect.

Mark McGrath: 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."

Ben Felix: Oh, man. Shall we rip through these reviews?

Mark McGrath: Sure.

Ben Felix: This this is ededed. 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 listened to episode 329 about RESPs, which is very relevant to me. Wish 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.

Mark McGrath: Nice. Another nod to the RESP episode. This is from Glen in Ottawa, "On your recent RESP episode, I really appreciated Dan's candid insights about how RESPs are not meeting the goals they were intended for." As you mentioned, Ben, his little soapbox segment at the end was very well reviewed. Glenn goes on to say, "Hoping lower income families fund higher education and his suggestions for improvements. I hope people with influence in government are taking note." Thanks, Glen.

Ben Felix: Danielramckenzie. 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."

Mark McGrath: See? That's what I mean. 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.

Ben Felix: Can I tell you a secret, Mark? It goes over my head too.

Mark McGrath: Okay. Makes me feel a lot better. The next one is from Fish. "I learned a ton from the Rational Reminder. The co-hosts are incredibly knowledgeable and bring in 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."

Ben Felix: 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? Oh, I don't know if that's going to be a good idea." And 90 % of the time, everyone's like, "Oh, I love that."

Mark McGrath: 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, "Oh, I should post that. 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 thought into it, but then you craft a thread over two days and do a bunch of research and crickets. You never really know.

Ben Felix: That's the worst.

Mark McGrath: You just got to throw it out there and let people tell you what they like.

Ben Felix: That happens to me all the time. And 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. They say, "Great team. Wonderful seeing the team grow. A shout-out to Mark. Great sense of humour."

Mark McGrath: Thank you.

Ben Felix: "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 – you just said no one says anything nice about you.

Mark McGrath: Well, it's funny because, behind the scenes, you'll always post reviews and comments that you get on YouTube and everything and you post them in our teams chat. And usually, you post the negative stuff. I was joking with Ben the other day, I'm like, "Oh, okay. I quit. I'm going to go dust off the resume and apply to Starbucks." 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 is all about Dan's a great addition. I'm like, "Hey, what about me, guys? I'm still here." I'm largely joking. I appreciate you throwing in that nod.

Ben Felix: I posted one that was pretty savage. I don't remember what it was, but it's the one that you're talking about.

Mark McGrath: I don't remember what it was. I tuned it out. I blocked that part of my life out after you posted it.

Ben Felix: Wise. I won't try and find it.

Mark McGrath: No. But thank you to jls3249. I appreciate you.

Ben Felix: 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. Justin's super busy crushing portfolio management financial planning. But we'll have him on for sure at some point.

Mark McGrath: 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 blogging 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 Snksquirrel on Apple Podcasts.

Ben Felix: Very nice.

Mark McGrath: Very nice indeed.

Ben Felix: I don't know if I have anything else. I did go to Boston. I think we said that. Do you guys maybe say that when I was –

Mark McGrath: Well, we recorded while you were in Boston. 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?

Ben Felix: 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.

Mark McGrath: Very cool.

Ben Felix: 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. It 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.

McGrath: Did you get to play at all? Just pickup ball or something while you were there?

Ben Felix: No. During the season, that'd be tough. I think if I went in the summer, they do a lot of pickup just to stay in shape. I don't know if they're allowed to practice in the NCAA in the summer with a coach in the gym. Yeah, if I went in the summer, I could try. I'd probably just get wrecked though at this point. I don't know.

Mark McGrath: Yeah, you're out of practice?

Ben Felix: No. 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.

Mark McGrath: Do you dunk on people though? Like, otherwise? It didn't happen this time, but do you like dunk on people and then yell in their face and stuff?

Ben Felix: 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.

Mark McGrath: 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. Okay.

Ben Felix: No. I mean, I'm playing immensely. All the guys are 30s and 40s. It's not a whole lot of dunking going on there.

Mark McGrath: No. Fair enough.

Ben Felix: Anyway, I think that's it. Anything else?

Mark McGrath: No. There's a Bitcoin meetup in my small town of Squamish next week. I might try to go.

Ben Felix: I've been invited many times to the Ottawa Bitcoin meet up. I'll probably go at some point. I'd be interested to see the folks that go out to this.

Mark McGrath: Obviously, I think it's one of the first ones in Squamish where I live. 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. One of the speakers reached out and said, "Oh, you should come. We're doing a meet-up in Squamish. You should come and check it out." I was like, "Yeah, you know what? I should do that."

Ben Felix: Yeah. No. That'd be fun.

Mark McGrath: Yeah, we'll see.

Ben Felix: I'll do the Ottawa one at some point. Bitcoin's 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 out of power like Trump and Musk who can will that world into place.

Mark McGrath: Totally. 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. It'll be interesting to see the spread of his Bitcoin policy around as well.

Ben Felix: It will be interesting. It's also going to be interesting to see what happens with micro strategy.

Mark McGrath: Yeah. Have you listened to Saylor talk about Bitcoin?

Ben Felix: Yeah. He's different. I'm not sure, man.

Mark McGrath: He's different, for sure. He'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.

Ben Felix: I don't doubt that he's brilliant, but he has very different perspectives.

Mark McGrath: 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 Keynesian view of economics. And if you do subscribe to that view, then everything makes sense. But if you don't, then what?

Ben Felix: But that view can come into and out of favor. You know what I mean? If the U.S. starts going through massive deregulation and whatever other stuff they're planning on doing, that could favor crypto.

Mark McGrath: And 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 now?

Ben Felix: I don't know, man. Regulations exist for a reason. Regulations are written in blood.

Mark McGrath: And if it's safer, then should you – no, I don't know. I don't get too deep down the rabbit hole.

Ben Felix: 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 if people find us just chatting about crypto interesting or not.

Mark McGrath: 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 talk 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. 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. But yeah, I think people would be interested in our views on it. I mean, you guys have 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.

Ben Felix: The politics of Bitcoin are very specific. I'll say that.

Mark McGrath: Cool. Anything else?

Ben Felix: I think that's good. As always, let us know what you think of the episode. Leave us some more reviews if you hate the show now or if you love it. Let us know.

Mark McGrath: Only the good reviews. Only good reviews, please. Thank you. If you don't like the show, you can email us.

Ben Felix: You 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.

Mark McGrath: Exactly.

Ben Felix: I don't think we ever really feel listened but hate the show, especially at this point in the episode.

Mark McGrath: Yeah, there's some selection bias.

Ben Felix: If you're still listening right now and you hate this show, you got to reconsider your life.

Mark McGrath: Yeah, that's on you, not on us, I guess.

Ben Felix: All right. We're just being idiots now. Let's shut it down.

Mark McGrath: All right. See you next time.

Is there an error in the transcript? Let us know! Email us at info@rationalreminder.ca.

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Participate in our Community Discussion about this Episode:

https://community.rationalreminder.ca/t/episode-333-the-presidential-puzzle-trumps-win-and-expected-stock-returns-discussion-thread/33405

Papers From Today’s Episode:

‘Belief Disagreement and Portfolio Choice’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3934061

‘Political Cycles and Stock Returns’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2920401

‘The Presidential Puzzle: Political Cycles and the Stock Market’ — https://www.jstor.org/stable/3648176

Links From Today’s Episode:

Meet with PWL Capital — https://calendly.com/d/3vm-t2j-h3p

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582

Rational Reminder Website — https://rationalreminder.ca/ 

Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/

Rational Reminder on X — https://x.com/RationalRemind

Rational Reminder on TikTok — www.tiktok.com/@rationalreminder

Rational Reminder on YouTube — https://www.youtube.com/channel/

Rational Reminder Email — info@rationalreminder.ca

Benjamin Felix — https://pwlcapital.com/our-team/

Benjamin on X — https://x.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/

Cameron Passmore — https://pwlcapital.com/our-team/

Cameron on X — https://x.com/CameronPassmore

Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/

Mark McGrath on LinkedIn — https://www.linkedin.com/in/markmcgrathcfp/

Mark McGrath on X — https://x.com/MarkMcGrathCFP