Lessons for Investors from Irene

Millions of Americans were affected by Irene, whether it was a hurricane or a tropical storm. The debate, for many, seems to center on whether reporters and forecasters “over-hyped” the strength of the storm as it approached the East Coast. The answers to that debate are not relevant but there is one lesson we can learn from the experience of forecasters as they plotted the probable track and strength of Irene.

At a very basic level, there are two parts to forecasting hurricanes.

The first is performed by computers and this generates a variety of possible tracks and levels of strength. The second is the interpretation of this data and the ultimate selection of the model that generates the most consensus among hurricane forecasters. Obviously, humans are involved I both the design of the software that produces the computer model and the selection of the model they feel most accurately predicts the storm.

Like all hurricanes, Irene, had a wide variety of computer models each producing different tracks and strengths. Forecasters analyzed these models and, with a conservative bias, agreed on a specific probably outcome. I must say I love the name of the probable path of hurricanes. It is called the “Cone of Uncertainty”. I would not be surprised if a bearded author and investment advisor soon creates a similar “cone of uncertainty” for the markets!

Dr. Frank Marks is the head of director of the Atlantic Oceanographic and Meteorological Laboratory’s Hurricane Research Division. For over a decade he has been on a mission to improve the accuracy of hurricane forecasts. Without question, forecasting has improved but it is still not entirely accurate. The lesson for investors is contained in a quote from Dr. Marks in an article by Alan Boyle released yesterday on MSNBC’s website: “Experts review the lessons learned from Hurricane Irene”. Alan asked Dr. Marks why none of the models showed the storm weakening as it moved up the East Coast. “Some of the models did represent it well,” Marks said, but there wasn’t enough confidence in those models to change the storm forecast.

Forecasters had more confidence in other models. Hey, they are human and mistakes are part of the human condition! The key word is “confidence”. According to Dr. Marks, they had an accurate forecast but they did not have as much confidence in it as they did in other models. For investors, confidence is critical but like hurricane forecasters, confidence must be in the “right” model.

I would suggest the only appropriate model for forecasting markets is long, not short, term. Yes, there are many who refer to our time as a new normal and others who say things are different today. They have confidence in this belief, but the evidence things are any different now is a belief without evidence. I believe it is fear that affects both the hurricane forecasters who chose “The Day After Tomorrow” forecast of a storm destroying the NYC metropolitan area over a more accurate model that indicated major flooding of New England.

It is also fear that prevents investors from remaining invested for the long-term. Fear is not a solid foundation for confidence, at least when it comes to confidence in a positive outcome. Have faith and be confident that it was just as hard for people to remain invested in 1933 than it is today. Those that stayed in the markets came out far ahead of those who abandoned stocks or tried to market time their investments.

Speaking of faith, I was inspired by a simple Kentucky Fried Chicken cup filled with water and placed on my deck rail during Irene. I figured it wouldn’t make it for more than a few hours and that it’s fall would let me know the storm was upon us. It survived the entire storm despite sitting on the center of a deck rail on the Eastern and windiest side of the house. Here’s a video from the height of the storm in Virginia Beach. If a flimsy plastic cup can survive Irene without being blown over, you can survive the winds of these markets without moving from your plan!

KFC Cup vs Irene