A few years ago, I had the privilege and the pleasure of addressing the cadets in the finance program at West Point. The topic of my talk was “Signal Interpretation” and I wanted to help the cadets understand how to differentiate between information-rich signal and distracting noise. I used many examples from my career as an investor to illustrate how to think about these matters as well as how to evaluate risk. We also talked a lot about how to identify situations where the market is missing something.

 

Last night, as I was watching the election returns, this was a topic that was on my mind. The polls have been inaccurate for multiple election cycles. So, if the thing that most of us have relied on for the majority of our lives to predict elections is no longer predictive, what can we do? There were ways to track public sentiment in real time without relying on inaccurate and misleading polls.

 

• This prediction market had the advantage of being a way the public could put up real money to bet on an election result. It’s the closest thing to stock market signaling that elections have. The downside is its currently illegal for US citizens to bet on their own elections and the market is relatively thin. Detractors reasonably pointed out that a small number of large bettors were skewing the market. These are both valid concerns, but we should note that while Polymarket betting was volatile, it was directionally correct. Seeing Trump go from being a favorite to an underdog back to a favorite was predictive while the magnitude of the move wasn’t as useful.

 

• President Trump was pro-Bitcoin in his campaigning and showed up at the Bitcoin Conference to ask for their votes. DKI Intern, Alex Petrou, was in the audience and wrote about it for a summer version of the 5 Things. The President Elect talked about establishing a national Bitcoin reserve. On the other side, Vice President Harris avoided the topic, and other prominent Democrats, led by Liz Warren, waged war on Bitcoin and the crypto markets. Evidence has surfaced indicating they may have intentionally killed Silvergate Bank because due to a large number of crypto customers. In the weeks preceding the election, the Polymarket-derived probability of a Trump victory was highly correlated with the price of Bitcoin. Last night, the dollar price of Bitcoin started rising around 7pm when we got the first exit poll results. From 9pm to 11pm, as we started to get election returns indicating the Democrats’ “blue wall” of Midwestern states was crumbling, Bitcoin rose further and faster. (DKI discussed this in our Macro Update distributed last Sunday.)

 

• $DJT. President Trump’s media company is publicly traded under the stock ticker $DJT. That stock was up more than 10% in aftermarket trading. A couple of months ago, someone suggested I consider shorting that stock. Given President Trump’s ability to garner media attention and what I considered the high probability of him regaining office, I declined to short the stock.

 

• Equity Futures Markets: Last Sunday, DKI distributed our Macro Update. In it, I reminded people that futures markets in the US took off in 2016 on election night when it became apparent that President Trump was going to win an upset victory. You could see the same thing happening last night.

 

There were also movements in interest rates, the dollar, and commodity markets that all indicated a likely Trump win. The polls were inaccurate noise (especially the strange one from the weekend that predicted VP Harris winning deep red Iowa by 3 points). The stock market, futures markets, Bitcoin, currency, and betting markets were all telling you the wisdom of the crowd saw a big Trump win. There were multiple ways to predict the outcome if you knew where to look.

 

I’ve mentioned before that I maintain close relationships with many of DKI’s former interns. I was chatting with one of them via text last night, and he demonstrated the kind of agile thinking that I believe will make him a successful investor one day. He participated in one of the prediction markets that is legal for Americans to use and bought Harris to win when she was trading at 33%. He sold his bet when it rose to 47%. He correctly thought Trump would win, but that the probability of that outcome was below 67%.

 

Last night, I was thinking similarly. At one point, bets on Harris were trading at 3% and there were reports that trucks with tens of thousands of ballots were heading for a Philadelphia election site. I thought Trump would win, but remembered going to bed in 2020 believing he had an insurmountable lead. Mail-in ballots delivered a Biden win days later. At 33-1 odds, I would have been willing to put some money up on a late mail-in-fueled upset. The point of all of this is many amateur investors think about the most likely outcome or the preferred outcome. Professionals tend to think in terms of probabilities and risk/reward.

 

One important characteristic of being a good investor is a willingness to admit error. We all get stock picks and market direction wrong at times. Exiting when you have evidence that your thesis is wrong is important no matter how difficult it might be to admit that error. A couple of years ago, all the big investment firms were marketing their 2023 investment preview and predictions. They’re big thought pieces. I ignored the ones that came from firms that didn’t predict the inflation and higher interest rates of 2022. If it’s not predictive, it’s not useful.

 

The same applies in politics. In 2016, when so many believed the big media firms saying Secretary Clinton had the election locked up, I was reading alternative writers who correctly predicted the improbable Trump win. I find a lot of what these people write to be inflammatory and annoying. Yet, I still read their work because they’ve been predictive. There’s nothing wrong with enjoying a book or movie as a fantasy escape. When it comes to real analysis, it’s crucial to face uncomfortable information if it helps you determine what’s going to happen next.

 

We all make mistakes and we’re all subject to errors based on our own biases. The important thing is to self-correct. I have a friend who’s a smart investor, but not affiliated with DKI. Before the Trump/Biden debate, he told me that Biden was mentally sharp and Trump was showing signs of age-related decline. He predicted that Biden was going to run circles around the fading Trump in an intellectual debate. Biden’s performance was so alarming that his party replaced him shortly afterwards. To the best of my knowledge, my friend hasn’t acknowledged that error. I value his opinion on finance, but he’s too biased to be a valued source on political and policy analysis.

 

I recently made an error in a stock where DKI Board Member, Raji Khabbaz, warned me from the start that there was more risk than I thought in the position. When I sold the position, I called him, told him that he had been right from the beginning. Again, we all make mistakes, but an unwillingness to acknowledge them and adjust is dangerous.

 

The key point in all of this is to find predictive sources and be willing to engage with information that makes you uncomfortable or which might convince you the other side is correct.

 

I’m going to break the usual rule around here and delve into politics briefly. There were two stories that resonated with me this election season. One was the story of P’Nut the squirrel. This sweet happy pet had been rescued by someone who saved him as a baby when his mother died. An attempt to release P’Nut into the wild didn’t work so the squirrel became a pet. Seven years later, NY State authorities invaded the man’s home, searched the place, took the squirrel, and then killed it. These were people supposedly there to ensure the welfare of the animal. Normal Americans saw this as a gross overreach of government power. The word that many used was “disgusting”. It was.

 

The other story that grabbed my attention was the heavy-handed closure of an Amish dairy that was selling unpasteurized milk. The Amish tend not to be politically active and mostly want to be left alone. This act spurred them to action. Tens of thousands of Amish citizens registered to vote and took their horses and buggies to the polls. They helped deliver President Trump the biggest prize of the night, a crucial win in Pennsylvania.

 

There are lessons in these two stories for both parties.

 

My condolences to team blue. The country has rejected heavy-handed government in delivering the Presidency (both an electoral and popular vote win), a Senate majority, and a larger House majority (probably) to your opponents. I hope the Democrats reflect on why their policies were so roundly rejected and come back with a better offering next time.

 

My congratulations to team red. You have a clear mandate. I hope you’ll take to heart the lessons of P’Nut the squirrel and the Amish dairy. I hope you’ll use your mandate to lighten the load of government on the people and use your well-earned mandate gently. If you choose to govern in a heavy-handed manner in the coming years, please see the above paragraph because it will likely be about you in four years.

 

Ok – I’m done with the politics now. This piece is intended to be about good decision-making in investing. As promised, whether you’re team blue, team red, generally bored or annoyed with politics, or one of our many non-US subscribers, DKI will be here for you with the intention of making money with you. Together.

 

 

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