The Iowa Debacle's Timeless Lesson for Investors

Editors’ Note: Our political analysis is intentionally non-partisan. We favor no political party or candidate in any country and assess political developments solely for their potential economic or investment impact.

Three days after Iowans caucused for their Democratic presidential candidates of choice, we still don’t know the results. A preliminary tally shows former South Bend Mayor Pete Buttigieg and Vermont Senator Bernie Sanders tied with 11 delegates each, Massachusetts Senator Elizabeth Warren claiming 5, and the remaining 14 waiting for a home. But after several days of chaos and reports of inconsistencies and errors, Democratic National Committee Chair Tom Perez has called for party officials to “recanvass” or double-check every caucus worksheet by hand. As we write, it is unclear whether the state committee will do so. On the surface, this saga isn’t terribly relevant for investors. The Democratic nominee was impossible to predict before this comedy of errors began, and it will remain so for weeks after it is finished, given the wide-open field. But how we got here is, in our view, a shining example in the dangers of letting partisan bias influence your investment decision making.

For those who haven’t followed the nitty gritty, this mess started when a smartphone app failed. The app, created by a little-known firm called Shadow, Inc., was supposed to be a streamlined way for precincts to count and deliver results, speeding the reporting and tabulating process so the public could get the results quicker. But as newly launched apps are wont to do, it crashed, forcing most districts to phone in their results, which overwhelmed understaffed hotlines. While some suspected hackers were behind the glitch, the Democratic Party cited “coding issues,” and an NBC report highlighted evidence that the app was rushed and poorly beta tested. People naturally wondered how this happened and why other alternatives—existing apps or better-known developers—weren’t used. It didn’t take much digging for reporters to discover what seems like a probable answer: Shadow is affiliated with Acronym, a progressive nonprofit that has a political action committee and heavy ties to the Democratic Party.

Recode ran an excellent piece recounting the history, and if you like inside baseball, you will enjoy it. In short, two veterans of Hillary Clinton’s campaign founded a company called Groundbase, whose main product was a texting platform for political campaigns. That failed when users rejected it for being slow and clunky, leaving it at risk of bankruptcy. In stepped Acronym, founded in 2017 by a Democratic Party insider. Acronym infused a boatload of cash into Groundbase, whose name changed to Shadow, and in early 2019 Acronym’s CEO touted this as an acquisition.

Now, it is not abnormal for political insiders to start businesses in other industries. What is a little abnormal is for a political party to give a Tech company a contract to develop an app and then not publicly disclose the app maker—which is what happened. The world didn’t find out until Tuesday that Shadow, Inc. was the developer. This raises a few questions about the procurement process, as several (including this great New York Times op-ed) have noted. Did the Iowa Democratic Party hold a competitive bidding process? Did it solicit proposals and demos from several developers, including those with no political ties? Or did state party official ring up their buddies and award the contract based on loyalty? The Iowa Democratic Party claims the secrecy was necessary to throw hackers off the scent. But it also raises questions about how big a role bias played. Circumstantial evidence says it was big, but that isn’t infallible.

Still, for illustrative purposes, let us pretend the circumstantial evidence is right, and that this was a case of a political party giving a key contract to political buddies and getting less-than-desirable results. This would be an extreme example of something a lot of investors do regularly: letting political preferences drive their decision making. Here are some actions that fall under this umbrella:

• Presuming a given politician is “good” for stocks simply because they like their stated agenda
• Presuming certain companies will do well—or poorly—under a certain administration
• Presuming the market will tank because the candidate you disliked won
• Weeding out entire sectors for political reasons (e.g., Energy and the environment, Consumer Discretionary and labor conditions at factories in developing countries, Health Care and prescription drug prices, Financials and high credit card interest rates and overdraft fees, Real Estate and gentrification, and many more)
• Buying Wall Street products or lists of stocks geared toward this-or-that candidate winning

The problem with all of this? It blocks out critical thinking and more meaningful variables. For example, many investors perceive the Republican Party as business-friendly. But a Republican president signed Sarbanes-Oxley, prolonging the bear market that accompanied the Tech Bubble’s implosion and making it costly and difficult for companies to go public even now. On the flipside, many investors see the Democratic Party as anti-business. But a Democratic president quietly allowed shale oil production to flourish and undid some of Sarb-Ox’s restraints for smaller companies. If you left stocks because Barack Obama got elected, you missed out. The same holds if you sold because Donald Trump won in 2016. Stocks are party-blind. If you bring your political opinions to your portfolio, you shut out more meaningful things. 

On an individual company level, avoiding some firms because of select political or social motivations is probably fine. But carried too far, this could increase risk and reduce return. Make sure you keep sector diversity in mind—avoiding many firms that all fit one category can add to risk. It could amount to avoiding or greatly underweighting an entire sector. That not only opens the door to the risk of it outperforming and hurting your relative return, it could mean you aren’t sufficiently diversified. After all, money you don’t put in one sector must go somewhere else, potentially driving too heavy of a weight.

Wall Street traditionally hasn’t done much to help control political bias. We are already seeing articles and advertisements touting Wall Street portfolios and products allegedly geared for either a Republican or Democratic victory. Buyer beware: These are merely marketing ploys designed to prey on bias. Buying them presumes the banks designing these approaches have great insights into which campaign promises a candidate keeps and can enact. They are also generally pretty surface-level. For example, many of these products hinge on notions like a Democratic win bolstering green energy—while a GOP win would help fossil fuels. Yet these presume politicians have a far greater influence over returns than they really do. Look no further than coal. It slumped under Democratic President Barack Obama. Ditto under President Trump, despite his campaign promises to save it. The reason why: Coal’s real problem, as we wrote years ago, is market forces. The politics of the person winning the White House doesn’t change them.

When you turn off political bias, it becomes easier to think critically about investment decisions. You can more clearly assess the gap between prevailing sentiment and what is likely to happen. You can weigh some of the more outlandish claims about what this, that or the other candidate means for the economy and stocks. You can focus on all sectors’ return prospects, rather than applying a political funnel. You can objectively weigh individual companies’ business decisions and their potential downstream impacts. You can narrow your focus to risk and return and leave feelings out of it. It won’t guarantee better results, just as a competitive bidding process for the caucus app wouldn’t have guaranteed we knew the results Monday night. But in our view, it gives you a much sounder starting place and higher likelihood of success.