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The 2020 presidential election shows us yet again why most of us should be buying and holding a stock index fund.
The reason the two are related is that the markets on the whole did a better job than opinion polls in digesting the news prior to the Nov. 3 election and coming up with a realistic forecast. By “markets” I am referring to the markets in general, not just the stock market — including the various predictions and betting markets. What’s true for the elections markets is even truer for how the stock market assimilates all available information about the future profitability of publicly traded corporations — and therefore, why index funds benchmarked to the broad U.S. stock market are so hard to beat.
Consider forecasts about the outcome of the U.S. presidential election. Opinion polls on balance appear to have been wrong about both the odds of a so-called Blue Wave and a Joe Biden victory. The betting markets, in contrast, were far more subdued in their forecasts.
Take Nate Silver of FiveThirtyEight.com, who I consider to be one of the most careful and sophisticated statisticians analyzing the polling data. His final projection prior to the Election (posted at 1:08 AM eastern time on Nov. 3) gave 90% odds to Biden winning. In contrast, the betting markets at that same time gave Biden 64% odds of winning. (These betting market odds are courtesy of Bonus.com, a website that aggregates the odds from Betfair, Betway, Smarkets and PredictIt.)
To be sure, since as of this writing Biden appears to have won the election, one might say that both the polls and the election markets were right. But it’s a mistake to judge predictions in a binary fashion as either all right or all wrong; instead it’s a matter of probabilities. And this election proved to be significantly closer than the polls were implying.
I checked in with Eric Zitzewitz, an economics professor at Dartmouth College, who two decades ago pioneered the use of electronic betting markets to gain insight into the markets’ behavior. In an email, he said that the betting markets got right “the level of uncertainty with the polling… The [betting markets’] odds did not get as far away from 50-50 in response to Biden’s big lead [in the polls] as they would have in earlier years. The [betting] markets anticipated that the pivotal state would be closer than the national popular vote, that polling was a bit biased towards Biden, and, most importantly, that polling accurately has gotten very difficult, and that these difficulties are not fully accounted for in polls’ published margins of error.”
Dan Hopkins, a professor of political science at the University of Pennsylvania, acknowledged these uncertainties when blogging on the FiveThirtyEight.com site after the polls had closed on Election Day. He wrote: “One thing that’s critical to know is that nowadays, response rates to surveys are very low… And it’s really hard to recruit Americans who don’t like politics — which, to be fair, is most people.”
Hopkins continued: “I recently started with a sample of 10,000 Pennsylvania voters who have voted in only one recent election. I then sought out information on their email addresses before using Facebook to try to recruit them to take a survey. Around 1,200 people saw my ad, 48 clicked, 6 completed the survey. Today’s pollsters do innovative work but on a very hard problem.”
Zitzewitz added: “Pollsters’ ability to representatively sample the electorate has declined sharply, even since 2016.”
My hunch is that polling will become even more difficult in coming elections. If so, we may be turning to the betting markets even more than ever to get insight.
Stock market reacts to a Biden victory
Another way in which the markets acquitted themselves well in advance of the election was in assessing President Donald Trump’s claim that the stock market would crash if Biden won. By correlating changes in Biden’s odds in the betting markets with corresponding changes in the S&P 500 SPX, -0.02% , it was clear that the markets did not share Trump’s belief.
It’s not just Monday-morning quarterbacking for me to say this. In late September, for example, upon analyzing the behaviors of the betting markets and the S&P 500 during and immediately following the Sep. 29 Biden-Trump debate, I found no evidence that the market would crash if Biden were to become President. I quoted Professor Zitzewitz saying “One doesn’t see anything in these market movements that suggests the market is terrified of a Biden win.”
As we know now, of course, the stock market soared in the days immediately following Election Day, as Biden’s odds of winning became progressively better. Though the betting markets can’t take credit for predicting this sizable rally, they can take credit for concluding that the market wouldn’t crash.
No contention over index funds
Let me emphasize that I am not saying the betting markets are infallible. They most definitely are not. Sometimes they get things wrong — very wrong. My point is that, over time, they make fewer and smaller errors than do other approaches to predicting the future.
The same goes for the stock market and index funds that are benchmarked to the market. While some advisers and strategies will be able to outperform index funds over certain periods, few are able to repeat their success over time. That’s why index funds are so hard to beat over the long term.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
More: Time to move on? Here’s one investor’s advice on what to do after the election
Plus: Interest rates typically make big moves after an election — why that may not be the case this time
