Tuesday, January 19, 2010

Lessons for Investors from the Massachusetts U.S. Senate Race

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The markets can be thought of as a daily poll showing support from two competing sides - the bulls and the bears. Election day is the date an investor sells. What is really taking place in the markets or a political campaign is never completely clear because there are always conflicting pieces of data. The losing side will be prone to using the mainstream media to bolster their case and they will always have something to work with, even if they have to produce the supporting numbers themselves. Investors need to sift through the numbers to pull out the most relevant ones and ignore the numbers that are questionable or that are just not that important.

The numbers produced by political polls as well as economic figures constantly confuse people. One reason is that both are subject to manipulation. The best rule for helping to sort out what is going on is 'the trend is your friend'. This rule instantly makes clear what is going on in today's Massachusetts Senate race for Ted Kennedy's old seat.  The Democrat, Martha Coakley started out 30 points ahead in the polls in the fall and has dropped to negative numbers in a number of polls taken just before the election.  While the specific numbers for each poll vary, the trend is unmistakable: Coakley in losing ground fast and her Republican opponent Scott Brown is surging. Nevertheless, the media has had a number of articles trying to downplay this story by finding problems with one poll and talking up another poll (which was usually more error prone than the poll being attacked) with somewhat different results. All this is just noise, just like much of investing coverage is.

The handling of the Massachusetts race also highlights a constant problem with investing - starting from preconceived notions. Massachusetts is one of the most Democratic leaning states in the U.S. Ted Kennedy, and President Kennedy before him, held the senate seat being contested for 56 years. It is quite reasonable to think that a Republican could not win this seat and this was indeed the conventional wisdom right up to the week before the election. The early statistical evidence indicating this could happen was ignored because of unwillingness to consider the alternative. Only when the evidence became overwhelming did it get people's attention. There are times when it can be dangerous to think something has to be one way because it has always been that way. Investors need to be alert for these possibilities. The demise of General Motors, Bear Stearns and Enron are good examples of this. Legions of people insisted that General Motors could never go bankrupt, but it did. Right up to the last week of its existence, Bear Stearns had its cheerleaders telling the public that everything was fine with the company. Enron also had it supporters trying to get investors back into the stock almost to the very end.

Just like in politics, a strongly entrenched bull or bear view can always result in a counterattack against the changing status of an investment. In Massachusetts, the Democrats finally realized an impending loss was imminent in the Senate race. Money and political operatives started flooding into the state from Washington, D.C. President Obama himself came to Massachusetts to try to rouse the base in favor of Coakley. Obama's volunteer lists were tapped and phone banks set up across the U.S. to call into Massachusetts to get Coakley voters to the polls. After being promised a big tax break in the health care bill, big labor has bussed in a number of foot soldiers to work the vote on Election Day. The entrenched interests do not give up easily and investors should always keep this in mind. A counter-trend rally is the best stock market analogy and the price movements of the U.S. dollar have similar underpinnings to the reaction counter-reaction that is taking place in Massachusetts politics.

There is also an important lesson on short versus long-term trends in the Brown Coakley race. With the exception of short-term momentum traders, most investors need to keep the long-term trend in mind. One race for the senate in and of itself represents a short-term event. In context it can have much broader implications. A loss for the Democrats in Massachusetts will follow loses in statewide races in Virginia and New Jersey in 2009. These were downplayed by the pundits as being caused by special circumstances. It will much harder to deny a third loss is not part of a bigger trend (although this will indeed happen, expect the excuse machine to be revved up to full power after the election). In the markets, a major sea change appears to be taking place in long-term U.S. interest rates. They are trying to break a three-decade downtrend. It is likely when this takes place it will be explained away by a number of investing pundits.

The implications for the Brown Coakley race in Massachusetts are very significant for U.S. politics going forward. Obama will be severely depowered by a Coakley loss, both in the short and long-term. The Democratic supermajority in the U.S. Senate will be gone. Republicans will be energized in the November elections and are likely to gain a significant number of House and Senate seats. Investors should pay attention to how the markets react the day after the Senate election and to Obama's State of the Union address on January 27th. The market will tell you what it thinks of this turn of events.

Disclosure: Not applicable

NEXT: Big Bank Earnings Contradict Economic Recovery Claims

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

1 comment:

Nona said...

What an interesting, provocative post. Thank you!