Weather Vs. Climate

As everyone knows, it’s been quite the winter here in Boston. Believe it of not, we’re still hoping for 2 more inches of snow so we can at least break the all time snowfall record and have something to show for all the trouble! Yesterday, however, is a beautiful sunny day which reminds us that spring is on the way!

I am always looking for good analogies to explain long-term investing and how it differs from speculation. As long term investors, we need to ignore the daily swings of financial markets or we will inevitably make bad decisions. What follows below is an article written by Jim Parker, a Vice President at Dimensional Fund Advisors, where he compares weather and climate as a way to explain long-term investments. Given the weather we’ve had, it seems appropriate to share his thoughts.

FSB

February 27, 2015

Weather vs. Climate

Jim Parker, Vice President

Notice how TV news bulletins put finance next to the weather report? In each, talking heads point at charts and intone about intraday events that are quickly forgotten. Meanwhile, the long-term wealth building story gets overlooked.

Many investors feel that they are not properly informed about the financial world unless they have checked daily, or even hourly, on how the Dow, FTSE, or Nikkei have moved in the intervening period.

In most cases, its a pretty harmless activity. It at least provides a bland conversation starter in fleeting social encounters, just as keeping up to date with tomorrows weather forecasts can fill an awkward silence.

But our very human focus on the day-to-day can often encourage us to make bad decisions that affect our long-term interests.

Thats because while we live moment-to-moment, what often affects us most are imperceptible, gradual changes that occur over many years.

Look at the way markets have begun in 2015, as reflected in daily news headlines from Reuters:

• January 6. Wall St. in Longest Losing Streak in 13 Months

• January 8: Wall St. Jumps for Second Day, Helped by Economic Optimism
• January 14: US Stocks Fall Heavily on Growth Concerns
• January 20: China Seen Posting Weakest Growth in 24 Years
• January 20. UK Stocks Gain on Chinas Growth

Trying to keep up with market sentiment based on news headlines is challenging.

The China GDP story is a good example. The curtain-raisers announced it would be the weakest economic growth number for nearly a quarter century. And, sure enough, it was. But because the result was a fraction higher than what the market had priced, Asian stocks rallied.

As always, markets price expectations for events like this and then move if the outcome varies with what is in the price. It is hard enough for professional investors to keep track, never mind a layperson.

So, from minute to minute, market sentiment shifts in reaction to newsnews about the economy, companies, governments and politics, and the wider world. Prices rise and fall in response to this news, which by definition is unpredictable.

To use an analogy, the market news is like the weather. One day its sunny. The next day it rains. Its unseasonably warm one day but cool the next. The narrower is your frame of reference, the greater is the apparent variability.

Look at Exhibit 1 (in USD terms) above, showing monthly moves in a common barometer of the global share market. All you see are the monthly ups and downsthe regular changes in the weather.

Another way to look at this movement (see Exhibit 2) is to measure the growth of wealth. This way we are less focused on the day-to-day or month-to-month movements and more on how wealth accumulates through time.

For a long-term investor, this is the more important measure because it takes into account cumulative gains. The media, by virtue of its publication schedule, must focus on the short-term. They need a different story every day.

These two ways of looking at the market are like the difference between the weather and the climate. The former changes constantly, the latter more gradually. With long-term investment, its the climate you need to think about.