Climate Versus The Weather

A few days back, I was looking out the window and it was pouring. So, like most people, I pulled out my phone to check the weather and it gave me a seven-day forecast. However, what the forecast didn’t tell me was what the weather would look like one, three, or five years from now. That’s the basic difference between weather and climate. Weather describes short-term conditions and climate describes a longer-range weather pattern. As Mark Twain said, “Climate is what we expect, weather is what we get”.  Our expectation of what the climate will be over the long-term has a high likelihood of being correct because there are many years of data and science behind it. On the other hand, if you only look at today’s weather and ignore the climate, there is no way to predict based on today’s rain what will happen in the future. This is very similar to how the stock market works.

Looking at the market today and using that information to predict what will happen in the future is like looking at the weather on any given day to make long-term predictions; it doesn’t work.  It may seem that the market and the economy are disjointed right now and that would allow for a reliable prediction to be made, but that isn’t so. There are many instances when a prediction based on short-term events seems to make perfect sense, but then the market decides to behave in a completely different fashion. Like the climate, stock market prices reflect what will happen long-term and not short-term.  For example, it’s very normal to see the stock market go up long before an economic crisis has passed.

A great example of this happened a relatively short time ago.  In March of 2009 the stock markets bottomed mid-month. They then shot straight up and continued to rise the rest of the year and many years after. However, if you looked at the “weather” when the market started its upswing, you would have seen unemployment, home foreclosures, store closures, and empty parking lots. When the market was moving up in 2009 it was predicting the climate, not the current weather. You can see in this chart below the unemployment rate and stock market were increasing at the same time!

I can hear you saying, “But this time is different!” Of course, it’s different, it always is. Every time we have an economic downturn, it’s always for a different and unique reason. If it weren’t different, then it wouldn’t happen; we’d prevent it! Every time there is an economic contraction, the “weather” looks really bad and it seems there is no light at the end of the tunnel. However, we always get through it and some new product, industry or sheer human grit and perseverance pulls us though.

Like you, I also listen to the “pundits” in the media who may seem so convincing with their predictions.  The problem with economic and stock market forecasting is that their assumptions are linear and biased by recent events. That means if things are going well, the average forecast will be, “Blue skies ahead!”  If things are bad, then the forecast is, “Watch out below!” The reality is that it’s not linear, it’s always somewhere in between.  It’s not linear; therefore, forecasting is a guess, not an accurate science. That’s why study after study has shown forecasts are right a little under 50% of the time. This is why we don’t believe in timing the market.

So, if the forecasting is not reliable, what should we do? Well, we do a bit of everything. There are models out there saying the U.S. dollar will decline due to spending. If that were to happen, we should have non-dollar denominated assets (international equity). Some models say the stock markets will drop and see another bottom again, which is why we have bonds to protect us and use for rebalancing back into stocks.  What about inflation? Good news, we have U.S. treasury inflation protection securities and hard assets like real estate to help us. This should sound familiar . . . this is diversification!  Nobel Prize-winning economist Harry Markowitz, the founder of modern financial theory, said in the 1950’s that “diversification is the only free lunch in investing.” Seventy years later, after many recessions and crises, it still holds true and is the reason Bluerock stands by that method of investing.

Of course, it’s natural to feel anxiety about markets. We are human and we feel it, too! However, an investment process based on science, data and long-term predictability will serve us all well. As always, we are here to answer any of your questions and help assess your short-term liquidity and long-term goals.