Forecasting vs Investing

Forecasts for the day and year
Image by pasja1000 from Pixabay

Everyone has stories about the inaccuracies of weather forecasting. 10% chance of rain this weekend turns into a scene from Noah’s Ark. Having no clue what would be the weather for Halloween made picking a costume feel like a death sentence by sweat or snowstorm. Weather forecasting was unreliable and widely mocked.

 

A recently published study in the Journal of Science found that “a modern five-day forecast is as accurate as a one-day forecast was in 1980.” Between the 80’s and now, technology and science has greatly bolstered our weather forecasting capabilities.

 

Still, asked to predict what the weather will be on April 20, 2021 would be an estimate at best. A more accurate and valuable estimate would be to forecast what the average weather will be over the month of April. Moreover, how many people really need to spend their time forecasting weather for a specific date compared to the weather for that week or month?

 

Similar to weather, the financial markets have day-to-day volatility and noise that becomes muted over longer-terms. In fact, the timespans for reliable forecasts need to be even longer because there are more variables at play. In addition to consumer surveys, global central bank decisions and geopolitical noise, we have stock market operations, such as a large buyer or index reconstitution, that can affect the temporary pricing of securities. Over the long-term, these noises fade and give way to the drivers of security pricing—improving company operations, increased demand, efficiencies and access to new markets.

 

Once we tune out the financial media noise and begin to expand the timeframe of investment returns, you gain greater comfort in return expectations. The worst stock calendar year return of a painful -39% morphs into a worst 5-year return of a manageable -3%.

 

The oscillations in returns are further dampened when we include 50% or more in bonds, which is common for most established investors. A 50% stock and 50% bond portfolio had a worst calendar year return of -15%. Expanding the timeframes to 5 and 10-year periods, the worst annual returns are 1% and 2% respectively.

Returns are not smoothed by extending the time period, but they do begin to have a sort of normalcy and predictability to them. The surprising May high of 90-degrees is normalized by the next week of 65-degree highs. The stock market reactions to Brexit are cancelled out by improving company profits and global GDP growth.

 

While it’s the job of the National Weather Service to determine short-term weather patterns and forecasts, an investor must expand their time horizon to match their extended goals. Short-term market forecasts are only applicable for individuals trying to squeeze out the last of stock or bond returns from their portfolio.

 

When investor goals are defined, we can gain greater comfort in return expectations. Today’s investor is fortunate in being able to have clarity in long-term returns that match their long-term goals. All the while, we recognize that it’s the job of an advisor to help our clients remember this fact when there are talking heads shouting on tv and weathermen standing in Gail wind hurricanes.

 

After all, a weatherman standing in a hurricane doesn’t change tomorrow’s weather. However, a panicked business reporter standing on the floor of the New York Stock Exchange can cause uninformed investors to make rash decisions.

 

Sources:

https://science.sciencemag.org/content/363/6425/342