Investors and Political Pundits Fooled by Randomness

Everyone Knew Trump Would Win All Along
People fool themselves into thinking that things turned out just as they expected. But the world doesn’t work that way.
Bloomberg, November 11, 2016

The issue of hindsight bias and fooling ourselves about what we think knew a priori haunts investors constantly. We are reminded of this by those who claim they saw the financial meltdown coming. Despite the lack of proof, they remain convinced they knew what was about to happen all along.

These folks are fooling themselves. Due to several cognitive features of the human brain they are convinced of this and other untrue things. Of course, everyone knew Apple was going to be huge, too. Or Amazon or Google or Facebook.

This is a feature, not a bug. Your brain seeks to make sense of a world filled with random events. These coping mechanisms are useful when confronting meaningless chaos. Existential nihilism doesn’t really lend itself to perpetuation of the species.

If you want to see an example of how outcomes affect narratives — how we craft stories after the fact to conform with what we now know — look no further than the U.S. presidential election. I discussed the lessons for investors of hindsight bias and changing narratives, but the sea of headlines making wild sweeping generalizations is even more stunning then I expected.

Most of them are examples of hindsight bias: broad after-the-fact insights that assume victory by one side was predestined.

But was this outcome inevitable?

Allow me to show you just how random the outcome of elections can be. In this case, let’s think (as unpleasant as it may be) about Carlos Danger, the online name that disgraced former congressman Anthony Weiner allegedly used to send racy texts and photos to women and underage girls. He is the estranged husband of Hillary Clinton’s closest aide, Huma Abedin.

Why do I suggest this is a random event?

• Weiner sent hundreds or thousands of texts and photos to women;

• Some of those went to underage girls;

• Some of those girls didn’t delete the photos;

• Some of the undeleted pictures were discovered by their parents;

• Some of those parents turned the pictures over to local authorities;

• Some of the local authorities forwarded them to the FBI;

And some of those texts were brought to the attention of FBI Director James Comey, who just 11 days before the election said he was reconsidering the agency’s probe of Hillary Clinton’s use of a private e-mail server while she served as secretary of state. Some of the e-mails from Clinton’s private server ended up a computer Weiner shared with Abedin. Could Comey’s announcement have changed the outcome of the election?

Now, I don’t care what you think of either candidate, or that Clinton shouldn’t have been using a private server in the first place (I agree with you) or that it was wrong for Comey to insert the FBI into the campaign 11 days before election day (I agree with you, too).

What I want to point out is how random that timing was. This could have happened months earlier and been forgotten and overtaken by other events. Or it could have surfaced after the election. Or maybe not happen at all. Who really knows? But it occurred at precisely the moment in time to potentially affect the election. All but the most rabid partisans must admit the truly random nature of this event.

It all seems, at some level, to make sense after the fact. But no one, of course, knows how complex events will play out in advance. There are only probabilities, and presidential elections that occur every four years provide only a small sample set that is subject to error.

Investors should take note.

Originally: Everyone Knew Trump Would Win All Along