Prepare Not Predict

by: Richard A. Anderson

Author Nancy Hatch Woodward once wrote, “Snow brings a special quality with it – the power to stop life as you know it dead in its tracks.” Anyone who lives in the Northeast knows this all too well.

On Thursday, November 15, 2018, the New Jersey/New York area was hit with one of the more notable November snowstorms in history. Parts of Northern New Jersey and New York City received upward of six inches of snow, with some areas getting hit with as much as ten inches.

Six to ten inches is a lot of snow, but we’ve been hit with larger snowfall before. What made this snowstorm so extraordinary was the quickness and ferocity. As late as Wednesday evening, the National Weather Service’s weather models were predicting just two inches of snow. However, by Thursday afternoon the forecasts changed and called for four to eight inches of heavy snow.

This quick and sudden change from light to heavy snow resulted in a nightmare scenario for municipalities across New Jersey and New York. The municipalities were not ready for such heavy snowfall, and as a result, the roads were untreated and quickly covered with snow. This resulted in accidents, road closures, and significant traffic that caused massive delays for drivers across the two states.

In the past few weeks, the New Jersey/New York area has experienced a handful of days of light snowfall. Two in particular stood out to me.

One was Wednesday, February 20th. Forecasts called for anywhere between one and four inches of snow. NJ Governor Phil Murphy went as far as to declare a state of emergency. Many schools prepared by announcing closings and early dismissals in anticipation of the snowfall. Yet, the actual snowfall fell short of expectations. Many areas of the state only received a coating.

The second was last Monday, March 4th. Forecasts called for anywhere between three and nine inches of snow. Many schools in New Jersey prepared by announcing delayed openings and New York City Mayor Bill de Blasio announced New York City public schools would be closed in anticipation of the snowfall. The snowfall was significant on this occasion but was less than expected and ended early enough that morning commutes were only mildly disrupted.

What struck me as odd was that because of the unpreparedness for the November snowstorm that caused such a massive headache for NJ and NY residents, the states overprepared in anticipation of storms that never arrived.

There is a parallel here to investing. Think about the two periods of high stock market volatility in 2018. From January 26th to February 9th, the S&P 500 declined 11.8%. From September 21st to December 26th, the S&P 500 declined 20.2%. During both of these periods, investors moved out of stocks and into safer investments, like cash. Once the stock market calmed and began to recover, investors piled back in to stocks.

The chart below shows the relationship between the return of the S&P 500 and cash positions for Charles Schwab account holders. You can see as the S&P 500 index drops in value, the cash positions increase.

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Investors tend to react to negative returns by increasing their cash positions, which is the opposite of what they should be doing. You want to buy low and sell high, not sell once the market has already gone down and buy back in once it has gone back up.

When it comes to forecasts of snow, many state and municipal officials in the New Jersey/New York area have expressed a “better safe than sorry” mentality after the November debacle. They would rather be overly cautious and overprepared than underprepared.

When it comes to investing, many investors have taken a similar approach. They see predictions and forecasts for future market downturns, and they overreact, expecting that the next downturn is going to be like the last. They move out of “risky” assets like stocks and move into “safer” assets like cash and bonds. However, this creates potential for incorrect predictions that can have a major impact on long-term portfolio value. We think a better approach is to have an all-weather portfolio that is prepared for market downturns. After all, the best portfolio is the one you can stick to.