Beware of Predictions and Remember the Boy/Girl Scout Motto

As I write this, the “massive” snow storm of “historic” proportions that was predicted to hit New York City and the Mid-Atlantic on January 26-27 turned out to be almost a non-event.  Meteorologists were actually apologizing for missing the forecast by such a large degree. (Boston and western Massachusetts is another matter.)

Sometimes we are surprised when something unexpected happens—like a 50% drop in the price of oil over 6 months.  Sometimes we are surprised when the expected does not happen—like rising interest rates or a huge blizzard. Sometimes, we don’t know what to expect because one group is predicting one thing, and another group is predicting another.

Today, we are seeing a pretty big (almost 2%) drop in domestic US markets. Mostly because those that claimed corporate earnings would NOT be hurt by a decline in oil prices and a rising dollar were wrong. Those that claim that markets cannot fall as long as interest rates stay low will probably also be proven wrong.

As an economist and investment manager, I am not in the business of making predictions but rather indentifying possibilities and assigning a range of probabilities to each.  The difference between assigning probabilities and making predictions is very subtle and often mis-understood.   But, that difference is essentially the difference between:   Making Predictions and Being Prepared.

Making predictions is a form of fortune telling and acting on those predictions by placing bets is gambling.   Identifying possibilities and assessing probabilities is the process of making Preparations.

Managing your investments with wisdom is best described by the Boy/Girl Scout Motto: Be Prepared.

I have long been warning that there are many different possible outcomes to the present economic trajectory, and there is little historic precedent from which to learn with one notable exception:

Markets go up and down in cycles.  There are short term ups and downs, but generally there are longer term 6-10 year cycles.  We have had 6 years of upward trend which is now quite “long in the tooth”.  And, there are parts of the markets that appear a bit over-valued. The probability of a substantial market decline, particularly in US stocks and bonds is now a significant risk.  Such declines seldom send an advance warning—they just grind lower over time and then begin to recover over time. The complicated process often takes one to three years and each sector of the market may tend to take a different path.

Keep in mind that the probability of a temporary decline does NOT justify selling good investments, and jumping out of the market to avoid a decline. Then jumping back in later. That would require you to be a fortune teller to be successful.  It is a fool’s errand.

For the retired investor this means that a prudent course of action is to be sure that there are sufficient liquid assets available to cover living expenses so that longer term investment holdings would not need to be liquidated after a temporary decline in value. 

  

In closing, I like to compare risk management to the decisions of a ship Captain of a large passenger liner running the North Atlantic.  One knows that there are icebergs.  Is the proper course of action running full speed ahead in the dark?  Or, should caution be the order of the day?

The Captain of the Titanic would have been a hero if he had set the new speed record for the crossing.  I am sure that many would have criticized the more cautious Captains of other ships that ran slower that ill fated evening but for the Titanic’s tragic sinking.  There will be times that Being Prepared may not produce the best short term outcome.  But, it provides the best probability of actually arriving at your destination. (Keep that in mind when the S&P500 outperforms your portfolio for one year or your bond portfolio does better than your stocks.)

As investors, we should always remember that our time horizon is 5, 10 years or longer. Investing is not like planting tomatoes in your garden---it is more like planting fruit trees in an orchard or like planting and maintaining a vineyard.

Be Diversified, Be Patient and Be Prepared.

  

P.S.  Happy that we did not get much snow in Central PA and Northern MD last night. But, my 48" snowblower is at the ready for our rather long driveway and Carol and I are prepared for whatever snow is sent our way.