Hurricanes Happen

Hurricanes Happen

The rush of wind and patter of rain against the windows greeted us on our recent trip to the coast. Hurricane Ian was out in the ocean and the exact spot of landfall was uncertain. Since evacuations weren’t ordered, we decided to take some reasonable precautions and stay put.

There are two lessons here: First, hurricanes happen, so you have to prepare for them. That might mean boarding up your house, putting away outside furniture, and putting out sandbags to protect low-lying areas. Second, even if you prepare for hurricanes, they still happen. The hurricane doesn’t know that you’ve boarded up your house, it doesn’t know you’ve stashed your outside furniture, or put out sandbags. And it doesn’t care. It’s coming anyway.

These same lessons apply to managing your money. Recessions and bear markets happen. That means you have to prepare for them. You need to diversify your portfolio and stay focused on the long term. But even if you prepare, recessions and bear markets will still happen. The market doesn’t know that you’ve made preparations, and it doesn’t care.

Determining whether or not a hurricane will hit you isn’t an exact science. It’s imprecise and full of uncertainty—a matter of probabilities. Hurricane forecasting focuses on what’s called “the cone of uncertainty”—what’s represented by the white zone in the diagram below. The X marks the current position of the hurricane at sea. The white cone represents the likelihood that the hurricane will be in a given location at a given time. You’ll notice that the further in the future we look—that is, the further away from the X in the white cone we are—the wider the cone is. That’s because the further into the future we look, the less certain we are exactly where the hurricane will be. The closer the time period, the tighter the cone; the further out the hurricane is from you, the wider the range of uncertainty.

Something analogous is true of your financial life. Determining the state of the market or the economy isn’t an exact science; it’s imprecise and full of uncertainty. Financial forecasting is a matter of probabilities. But unlike the cone of uncertainty for hurricanes, the cone of uncertainty for financial markets is inverted: hurricane paths are more predictable the closer the timeframe; investing probabilities are the opposite. Markets in the short term can cover a wide cone of uncertainty, but this cone narrows as you extend the timeframe.

The closer you look into the future, in other words, the less certain you are what direction the market is going to move. You can’t know with any certainty what the market will do in the next few days or even weeks. As you look further out, however, general patterns start to emerge—patterns that have repeated themselves throughout market history. Here are some of them: The average bear market lasts about 11 months and on average represents a 22% decline from the market peak. The average bull market lasts about 55 months with an average increase from the bottom of  71%.

How can these observations help us understand the market right now? We’re in a bear market. Stocks are down. Usually, the bond market is a safe haven when stocks are down. But high inflation wrecks the bond market. That means that bonds are not a safe haven at the moment.

As a result, people seem to have fewer reliable investment options. This year’s market is what I call a “nowhere to hide” market: stocks are down, and bonds don’t provide a dependable alternative because of rising interest rates and inflation.

Sometimes hurricanes happen, and when they do, they can make a mess of things. It works the same way with markets. Sometimes markets are down, and there’s nowhere to hide. Right now is one of those times.

In times like these, you need to keep one thing in mind: hurricanes don’t last forever! Our best clients keep their eyes on the future, and trust the market will bounce back—just like the weather does.

Hurricanes happen. You have to expect them to occur, and prepare. In your financial life, you also can prepare by expecting some challenging markets occasionally. The less that you’re surprised, the lower the chance that you make short-term decisions that might detrimentally impact your future.

If you live in the Southeast, you know that once the hurricane passes, the weather is beautiful! Ready for a real conversation?