This 'Year of the Underdog' could be leading markets into a funk for no real reason

Photo: chasing his tail by Lil Sheperd © 2016, Flickr, licensed under Creative Commons Attribution 2.0 License.

Markets are in a bit of a funk right now because traders and investors fear the uncertainty that a Trump presidency would bring to the White House and the impact that would have on the US economy, tariffs, trade deals, currency policy, engagement with allies and foes, trade deals… the list goes on.

It’s a reasonable fear because even after so many months of campaigning, Trump’s maverick approach to the election, to his opponents, and what he says about policy, leaves markets with little understanding of what a Trump presidency would look like.

While the polls have certainly tightened, and because who is actually in the lead is still inside the statistical margin of error, the election genuinely appears too close to call.

But there is a real chance that the fears of markets across the globe are misplaced because 2016 has seen so many “surprises” and traders are betting that Trump is just the next shoe to drop in this remarkable year of upsets.

Just this morning I received an email from someone who should know better, a friend with a Master in Psychology, saying “the underdog pattern continues – Leicester City, Chicago Cubs….Trump?”

I wrote back: “You psychologists would call that an availability bias, I think.”

I’ll get to his response to that a little later. But it got me thinking. Is the fear of a Trump presidency just being fed by the strange year we have had in 2016 when underdogs have continually upset the status quo?

But is there really any correlation between victories of outsiders across multiple football codes, the breaking of a 108-year baseball hoodoo, the victory of a rank outsider in a horse race, and the outcome of the US presidential election?

Of course there is not.

But behavioural psychologists, economists, and finance types will tell you that humans look for patterns and are also prone to the “availability heuristic” (bias of mental short-cut).

Writing in his best-selling book Thinking Fast and Slow, Daniel Kahneman, the father of behavioural finance and economics, says (emphasis added):

The availability heuristic helps explain why some issues are highly salient in the public’s mind while others are neglected. People tend to assess the relative importance of issues by the ease with which they are retrieved from memory – and this is largely determined by the extent of coverage in the media. Frequently mentioned topics populate the mind even as others slip away from awareness.

In that definition you can see why markets are extrapolating the high profile success of sporting outsiders into a correlation with Brexit and the chance of a Trump victory.

But you can also see in that definition why Trump’s repetitive name-calling and slogans for his opponents get traction with his supporters.

But the polls say the race has tightened to the extent that the outcome is too close to call. And traders are worried about the uncertainty, as I noted before.

So the availability bias points them straight to the market funk that occurred after Brexit and it also points them to the political sentiment that drove Brexit and arguably the rise of Trump and Bernie Sanders.

Which brings me back to my psychologist friend. He told me the commentariat is “completely misreading the public hostility in all countries” to the policies and prescriptions that appear to favour the elites and wealthy over the majority of the population.

That inequality is the strongest political and social force on the planet right now, and it’s something I’ve written about recently.

So maybe Donald Trump is riding that wave and will become the next President of the United States.

And while I think traders are mistakenly extrapolating outsider sporting success into the political sphere right now, I also know the availability bias means if Trump does win, fear of another Brexit market funk will magnify that outcome materially as everyone runs to the safety of cash while the dust settles.

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