A perception that the economy is improving—or deteriorating—can affect investment decisions in a way that can impair investment returns. (UBS)

1. Remember, it’s still early

Despite a persistently low public approval rating, President Joe Biden has reiterated his intent to seek his party’s nomination again. Registered Democrats appear ambivalent about a second Biden term, and, as a recent CNN poll suggested, two-thirds of voters who lean Democratic would prefer a different nominee due to concerns about the president’s age and health. However, a quixotic challenge by Robert F. Kennedy Jr. has failed to gain much traction. So, barring deterioration in the president’s health, Biden is well positioned to receive the nomination next summer.

The Republican Party faces a choice: whether to nominate a former chief executive whose own low approval rating rivals the sitting president’s, or to seek a new nominee. Donald Trump holds a commanding lead in the polls, but it is still too early to conclude he will receive his party’s nomination. Second acts in politics are fairly common, but only one former president—Grover Cleveland—managed to win back the presidency after a previous defeat.

Much will depend on the initial contests, beginning in Iowa on 15 January. The Iowa caucus has a distinctly unimpressive record of predicting the eventual Republican nominee, but a second-place performance by a dark-horse candidate can alter the momentum heading into the succeeding primaries. Those contests are still months away and will be affected by more immediate issues being debated in Congress this autumn.

2. Take the early polling data with a grain of salt
The polling industry was subjected to severe criticism after failing to predict the palpable surge in support for Donald Trump in 2016. A variety of explanations were offered, including the concept of the “shy Trump voter” who provided pollsters with expected but misleading answers to leading questions. Critics also cited the prevalence of respondents who “leaned Democratic” and the practical challenges imposed by the use of mobile phones.

Recent academic research has unearthed another perplexing problem with survey data. In the absence of a financial incentive or another inducement to reply frankly to questions from pollsters, respondents are more inclined to provide answers that correspond to their own personal biases. The risk is particularly acute when questions about economics are preceded by questions about politics.

With few exceptions, national polls should be treated with particular skepticism. In the US, we elect presidents based on electoral votes. A Democrat running up the margin of victory in Oregon, or a Republican doing so in Oklahoma, is less impactful than winning a swing state by the narrowest of margins.

3. Beware partisan bias, which can distort investment decisions
The notion that political affiliation has a direct impact on one’s level of optimism regarding the future direction of the economy is supported by ample academic research. Individuals generally have a more positive assessment of current economic conditions when the White House is occupied by a president of the party they support. The partisan bias exerts significant influence on survey measures of economic expectations, and this bias appears to be increasing substantially over time.

A perception that the economy is improving—or deteriorating—can affect investment decisions in a way that can impair investment returns. Investors who share an affiliation with the political party in office are more likely to believe that financial assets are undervalued and respond accordingly by increasing their allocation to equities. Conversely, investors disappointed with the outcome of an election often adopt a risk-off strategy and take refuge in fixed income securities. While that type of impulse may be less costly when yields are high, as they are today, it runs the risk of distorting longer-term asset allocations.

Professional money managers are also susceptible to this type of confirmation bias. Mutual fund managers appear more likely to allocate assets to firms managed by individuals with a similar party affiliation, and demonstrate greater partisan bias in their asset allocation decisions when the political party they support holds power. Hedge fund managers that are on record as having donated to Democratic candidates in the 2008 election outperformed their GOP-donating peers in the months following the ballot. Eight years later, Republican households were more likely to increase their exposure to investments poised to benefit from economic growth following Trump’s election, thereby improving returns.

Separating one’s own political beliefs from longer-term asset allocation is the overriding lesson from these examples. The American economy is remarkably resilient. While individual fiscal and regulatory policies can affect the performance of individual asset classes in the short run, longer-term portfolio construction is best treated as an apolitical exercise.

4. Take the spitefulness of presidential elections in stride
The upcoming election has the potential to be among the most acrimonious on record. There is no love lost between the two leading candidates, and our political parties vehemently disagree on fundamental fiscal, regulatory, and social policies. Take comfort in the fact that incendiary speech is nothing new to US politics. John Adams was called a “repulsive pedant” and “hideous hermaphrodite” by Thomas Jefferson’s campaign. The Adams campaign responded in kind, calling Jefferson a “godless atheist” and circulating a rumor that he had died during the campaign. The severity of personal attacks has ebbed and flowed in the succeeding two centuries. Adams and Jefferson ultimately reconciled, so there is always hope for a kinder and gentler reconciliation of our political differences.

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