Investment pragmatism – lessons from the weather report

We all pay heed to the weather. The singer-songwriter Paul Simon put it this way in The Only Living Boy in New York:

“I can gather all the news I need on the weather report.”

Paul Simon has a point. Meteorological data informs many of our decisions.

Farmers depend on weather forecasts to plan harvests. Electricity grid operators study them to assess how much energy will be available from wind and solar farms. Pilots and sailors rely on them to transport passengers safely across the globe. In everyday life, they influence what we eat, where we travel, how we dress, and so on.

Behind weather reports lie large data banks feeding everything from sophisticated forecasting models for industry and agriculture to the summary maps on our mobile phones.

But weather models and maps have limitations. They can miss relevant context. Their accuracy is short term. And, they can go awry as the weather presenter Michael Fish found out in October 1987. In his now infamous words:

“Earlier on today, apparently, a woman rang the BBC and said she’d heard there was a hurricane on the way. Well, if you’re watching, don’t worry, there isn’t.”

The rest, as they say, is history. Hurricane winds damaged three million UK homes.

What about the ‘financial weather’? What might help us when considering new investments or re-evaluating existing ones, while avoiding unnecessary noise?

An obvious place to start is the daily stock and bond market data on billions of global transactions, used for everything from intricate financial forecasting and valuation models to simpler sense checks summarized in indices, again available on our mobiles.

However, unlike the weather, investment decisions have horizons that often stretch to decades. A country invests in new electricity infrastructure; a company buys a new machine; an individual purchases a house. The time dimension complicates things.

The economist J.M. Keynes argued that our knowledge of long-run fundamentals, even a decade ahead, is limited and sometimes non-existent. As he put it:

“If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing.” (Keynes uses ‘yield’ here to mean ‘future profits’).

Were he alive today, no doubt AI would also appear on that list. Some imagine unstoppable progress in the technology to superintelligence in a matter of years. However, an earlier golden age of AI ended abruptly in the 1970s.

Disruptive ideas percolate reality in unpredictable ways.

Faced with deep uncertainty, investors cannot calculate future returns at all easily. Keynes argued that, instead, investors follow a ‘convention’ – we assume that the existing state of affairs will broadly continue, unless there is good reason to think otherwise. Current market prices, the data output of those myriad transactions already mentioned, underpin our degree of investment confidence in an unknowable future.

There is an important subtlety in ‘confidence investing’. We have moved from forecasting long-term cash flows and intrinsic value to a game of Musical Chairs (the metaphor is from Keynes’ General Theory).  

Of course, the secret is not to be left unseated when the music stops.

Easier said than done. A convention based on mass psychology can be a fickle friend. The lyrics of another famous singer-songwriter, Don Henley, spring to mind:

“In a New York minute, everything can change.”

The vagaries of the collective psyche – the wisdom and madness of crowds – even caught out Sir Issac Newton, as the South Sea Bubble burst:

“I can calculate the motion of heavenly bodies, but not the madness of people.”

So, back to stock and bond data. Their value lies as inputs for a barometer of current investor confidence. In this specific sense, weather forecasting and the stock market outlook do have something in common.

When average investor confidence is steady (think of a stable pressure system), investing on the implicit assumption that the future will unfold along current lines is just about as good as it gets. Good is not great, but it is a lot better than nothing.

So, a data-focused approach to investment, be it rooted in complex AI models or simpler tracker funds that mirror market indices, has much to recommend it.

But when the confidence needle wobbles, or different pointers (say bonds and equities) give contradictory signals, it is a time for active human pragmatism to take the helm. In such cases, the weather analogy would normally advise battening down the hatches and preparing a different course.

In today’s volatile financial markets, the implication is we can do worse than remember the theory of Keynes, and the experience of Sir Issac Newton.

The first law of motion in financial markets is they are driven by animal spirits – avoid hubris and stay close to a chair. 

Additional Reading:

Simon and Garfunkel: The Only Living Boy in New York.

Don Henley: New York Minute.

J.M Keynes: The General Theory of Employment, Interest and Money. Chapter 12.