Much has been said and written about the surprising results of Brexit vote in UK and Trump win in US Elections, their causes, and implications. However, there is an obvious and important lesson for those managing investments that has not received much attention.

The unexpected wins for Brexit in the June EU referendum in UK, and for Donald Trump and the republicans in November elections in US, and what these results mean for the economy and markets, have undergone a lot of discussions. These are very important and relevant topics. However, the implications of those wins are not the focus of this article. Rather, the focus is on examining the events from the perspective of investment managers, whose investment decisions are shaped by views formed from the information, opinions, and forecasts they receive from the media and the experts. The focus here is on the fact that in two of probably the most consequential events of the year, almost the entire world reached the wrong conclusion, and yet there was readily available information that would have pointed anyone, who took a slightly deeper look at the data rather than simply accepting the wide consensus view, to a better conclusion, or at least, not as certain a wrong conclusion.

BREXIT Vote

On 23 June 2016, the United Kingdom voters defied the polling experts, betting odds and much of the political establishment, and surprised the world by voting 52% to 48% in favor of leaving the European Union. Most people had gone to sleep believing Remain win was a foregone conclusion. The surprise roiled the markets – within an hour of the announcement of the result, the Pound lost 10% of its value, US Treasury yields were down 30-35 basis points, and Gold price was up by $73.

Before the vote, the opinions polls were close, with Remain slightly ahead[i].

With lack of clarity from polling results that were veering all over the place, markets were focused on probabilities derived from betting markets. Betting odds are assumed to convey the “wisdom of the crowds” and take into account a greater range of factors than the snapshot a poll will offer. The evening of the referendum, bookmakers (including U.K. bookmaker William Hill PLC and British bookmaker Paddy Power, part of Betfair Group PLC) placed the chances of a “Leave” vote at 10% or less. By Thursday night as the polls closed, Betfair was predicting a 94% chance the U.K. would vote to stay, and the pound reached its highest levels of the year against the dollar.

There was information out there from bookmakers that would have questioned the conclusion based on odds from them. But it seems like almost no one was looking for them as the opinion had been formed and consensus reached already.

Reports on June (ii) quoted spokesperson for the betting shop Ladbrokes saying that over 80% of the number of bets outside London were in favor of Brexit, even though Ladbrokes’ odds were in favor of Remain. Similarly, British bookmaker Paddy Power, part of Betfair Group PLC, said its odds skewed in favor of a vote to remain due to large bets. Graham Sharpe, a spokesman for William Hill, said 71% of bets placed with the firm are on a “Brexit — British exit — outcome, but 73% of all the money bet with the company is on the remain camp prevailing

Clearly fewer larger bets were skewing the odds in favor of Remain even though majority of bets were for Exit. Unlike a market were the size of purchases is important, in a poll or referendum, one person gets just one vote. Ladbroke publicly talked about the data before the vote and after the vote explained why the betting markets got EU Referendum results so wrong[iii] in a blog. If most of the cash went on Remain, as it did, bookies had to follow the money and make Remain the favorites. And the bookies all agreed that while three-quarters of the £40 million (not a very big amount in the scheme of things) eventually gambled on the referendum was placed on Remain, when it came to counting individual flutters, bets on Leave far outnumbered punts on staying in the EU.

Very few market observers focused on this data (“Something Strange Emerges When Looking Behind The “Brexit” Bookie Odds”[iv]) before the vote, even though the stakes were high. People knew big market moves were likely if Leave side won. One hedge fund manager reportedly made £110 million[v] by betting Britain would vote for Brexit and the pound would tumble. George Soros correctly predicted[vi] possible 15% decline in value of Pound if Brexit won, but even he is reported to have had a long bet on Pound.

Trump Victory in US Elections

As polls were coming to a close on November 8, the prevailing view in the media was a victory for Hillary Clinton and a loss for Republicans. As counting began, within a few hours, it started becoming clear that all of the polls, predictions, and political pundits’ views were simply wrong. Just as in the case of Brexit vote, most everyone had reached the wrong conclusion. The surprise was evident in markets – the Dow Jones Industrial Index futures went into a freefall around 8 PM, quickly falling 900 points or about 4%. What is remarkable is that the forecasters got it wrong even after the Brexit experience and with so many comparing US situation to Britain!

Just as in case of Brexit vote, people have analyzed the causes for the surprise result – the socio-economic factors, the failure of polling techniques, etc. Much has been said and written since then (“5 surprising lessons from Trump’s astonishing win”[vii], “Five key lessons from Donald Trump’s surprising victory”[viii], “Election Experts Puzzled Over Surprise Trump Victory”[ix], “Trump tells Wisconsin: Victory was a surprise”[x]).

Before the election results were out, the widely-followed FiveThirtyEight forecast[xi] gave a 71.4% chance to Hillary win, TheUpshot in New York Times gave her an 84% chance[xii], and betting site Paddy Power gave her a 4/11 odds or 73.3% chance[xiii].

The actual polls were much closer. NYTimes.com summarized various polls[xiv]:

On the face of it, though the difference was only 3 points, almost 9 out of 10 polls indicated a Clinton win. However, if you looked at the details, that could lead you to question that as a foregone conclusion. For example, below is the result of the Bloomberg poll results published on Nov 7. Clinton was ahead of Trump by 3%, but interestingly 4% were listed as “Don’t want to tell.” If one thought about whether Hillary or Trump supporters were more likely to hide their support, and noted the +-3.5% margin of error, the 70-80% probability of Hillary win might have seemed questionable, since even though 9 out of 10 polls showed her winning, each one was highly uncertain (granted that the predictions from experts were not based on simply looking at the polls like that but incorporating the electoral college math).

Just like Brexit, there were signs that the majority did not pay attention to: “The clearest sign yet that the US election will be like Brexit”[xv], “Why Brexit could be a warning for American voters, Trump and Clinton”[xvi].

These two cases of a view held by the vast majority being wrong is not an isolated phenomenon either. And they do not always get corrected quickly. The Great Credit Crisis was caused by the almost universal belief that US house prices could not go down or could not go down everywhere at the same time! The huge successes of the few who questioned that belief[i] and did their own work have been chronicled in article, books, and movies.

The incorrect views are also not necessarily always those ignoring risks. In 2008 and 2009, majority of investors in mortgage area had the view that commercial mortgage sector was going to be similar to subprime and AAA CMBS were going to take huge losses. Unlike subprime AAAs, CMBS AAAs have not taken losses and are trading above Par, but it was very hard to convince people to buy those bonds when they were trading at 50-60% of Par.

Lessons for Investors from Brexit Vote and Trump Victory  

The almost universal consensus views were wrong in both of these major events. The data that did not support the conclusion was there and available – just one google search away. Yet, it seems like most people did not look for it, or pay attention to it. The Efficient Market Hypothesis tells us that the market prices always incorporate all available information. Yet, despite the free, easy, and abundant availability of information to everyone, that was not true in both of these highly consequential events that had the attention of almost everyone. One obvious point for investment managers to keep in mind is that those who dig into details, look for relevant data, and draw their own conclusions can still add significant value to the investment process.

It is also useful to examine why were the beliefs so universal and so one-sided? Several factors played into it. How information flows from the source to its consumers is one of the factors[1]. One feature of that flow of information today is that it gets repeated several times. Once a statement is made, an announcement is released to press, a blog is published, or a tweet is sent, it gets picked up by multiple sources, repeated on other news channels, republished on other blogs, or retweeted. One somewhat comic example that illustrates the point is a clip showing news anchors from different TV stations all repeating the same phrase[xvii].Consumers of information hear and see the same thing from multiple sources, even though it all may have originated at a single point. Reading and hearing the same thing from multiple sources makes it more believable. The more people start believing it, the more they repeat it[2], and pretty soon everyone has the same view, and people stop questioning it or even looking for data that might show a different conclusion.

For some time, the economy has benefited from the recent technological advances in internet and web space, and the resulting free information available to all, which has contributed to higher productivity. But now, that phenomenon may have reached the stage of diminishing or negative marginal returns. Too much information coming in tends to cause people to focus just on the headlines and less on digging in to details, or questioning something that looks like everyone in the world agrees on. A seeming consensus from everyone makes people less likely to spend time questioning it. Even though the information exists and is easily and freely available, we may not make any attempt to look for it because we believe we already have it. Those who ask if the consensus is an informed view based on full analysis will look for more data.

Another factor is blurring of lines between journalism and entertainment/editorial/commentary. News-type shows often are influenced by personal or corporate views of those presenting the news, or are highly correlated to their own biases. There is also a blurring between facts, opinions and conclusions, with all often presented or perceived as facts.[3]Combine those with the fact that most people prefer certainty (easier to think about) over uncertainty, and it is easy to see how a wrong consensus view is possible.

While looking out for biases in others, we also need to be aware of our own biases. With all the choices of information, we chose who we listen to and who we ignore. On social-media, which is becoming an a larger part of news consumed, we are linked to people who are generally of same views as us.

A more recent phenomenon adding to the negative marginal returns from information availability is the rise of fake news stories that are put out and spread by people as pranks, or to generate advertisement revenue, or to promote their own agendas by misleading others. These can be inconsequential to serious at times. One recent example[xviii] is the nuclear threat against Israel by the Pakistani Defense Minister[xix] after reading a fake news story. Another incident[xx] involved firing a gun in a Washington pizzeria by someone after reading a false claim online[xxi] about that pizzeria.

From a perspective of longer-term investment opportunities, my view is that we may be reaching a point where the pendulum will slowly start swinging back from the zillions of free sites to paid sources of information, where people can be sure that the information has been vetted before reporting. Maybe the large traditional news organizations will have a more profitable future after all.

My most important take-away  is a simple reminder to ourselves, as investment managers for our own portfolio or for clients’ portfolios, that despite what Efficient Markets Hypothesis tells us, we can add significant value by thinking independently, questioning consensus views, working intelligently (making an effort to look for details beyond just the headlines), and considering biases – in our sources of the information, and our own.

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[1] I have used the term Information Momentum to describe the concept. See Using Information Momentum to Understand Markets & Economy (https://marketsandeconomy.wordpress.com/2014/08/03/using-information-momentum-to-understand-markets-economy/).  Everyone seems to form the same opinion at the same time. However, sometimes those opinions can be wrong.

[2] Web and internet make it very easy for anyone to repeat and reach a very wide audience.

[3] Howard marks makes some great points in the Latest memo from Howard Marks: Expert Opinion (https://www.oaktreecapital.com/insights/howard-marks-memos).

[i] https://today.yougov.com/news/2016/06/22/final-eve-vote-brexit-poll-remain-leads-two/

[ii] http://www.businessinsider.com/most-gamblers-think-brexit-will-happen-but-odds-still-favour-remain-2016-6

[iii] http://news.ladbrokes.com/politics/british-politics/why-did-betting-markets-get-the-eu-referendum-result-so-wrong.html

[iv] http://www.zerohedge.com/news/2016-06-22/something-strange-emerges-when-looking-behind-brexit-bookie-odds

[v] http://www.dailymail.co.uk/news/article-3666800/Harrow-educated-hedge-fund-manager-won-110MILLION-betting-Britain-vote-Brexit-pound-tumble.html

[vi] http://fortune.com/2016/06/20/soros-brexit-pound/

[vii] http://www.cnn.com/2016/11/09/politics/donald-trump-wins-biggest-surprises/

[viii] https://www.washingtonpost.com/news/monkey-cage/wp/2016/11/09/five-key-lessons-from-donald-trumps-surprising-victory/?utm_term=.5b56c825a927

[ix] http://www.voanews.com/a/election-experts-puzzled-over-donald-trump-surprise-victory/3589558.html

[x] http://www.politico.com/story/2016/12/donald-trump-wisconsin-232605

[xi] https://projects.fivethirtyeight.com/2016-election-forecast/

[xii] http://www.nytimes.com/interactive/2016/upshot/presidential-polls-forecast.html

[xiii] http://blog.paddypower.com/politics/2016/11/02/early-payout-has-paddy-sweating-as-trumps-odds-continue-to-improve/

[xiv] http://www.nytimes.com/interactive/2016/us/elections/polls.html

[xv] https://www.indy100.com/article/brexit-donald-trump-us-election-2016-7386096

[xvi] http://www.cnbc.com/2016/09/20/why-brexit-could-be-a-warning-for-american-voters-trump-and-clinton.html

[xvii] https://www.youtube.com/watch?v=PStpvviPgxk

[xviii] http://www.huffingtonpost.com/entry/pakistan-nuclear-israel-fake-news_us_585f2e8ae4b0de3a08f58fb6

[xix] http://www.nytimes.com/2016/12/24/world/asia/pakistan-israel-khawaja-asif-fake-news-nuclear.html

[xx] https://www.washingtonpost.com/opinions/pizzagate-shows-how-fake-news-hurts-real-people/2016/11/25/d9ee0590-b0f9-11e6-840f-e3ebab6bcdd3_story.html?utm_term=.9a7f77e036ca

[xxi] http://www.nytimes.com/2016/12/05/business/media/comet-ping-pong-pizza-shooting-fake-news-consequences.html?_r=0