The Independent Market Observer

2/11/13 – Uncertainty and Snowstorms Roll Back In

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Feb 11, 2013 9:58:33 AM

and tagged Market Updates

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After spending the weekend digging out from the latest “storm of the century,” it feels good to get back to my desk and away from my shovel and snowblower. Hope everyone here in the Northeast made it through with as little pain as possible.

According to my wife, who presumably got it from a reliable source, it was the fifth worst winter storm on record. But then, we’ve had multiple record-setting “hundred-year storms” over the past couple of years, which suggests either that something has changed or that our standards for hundred-year storms are out of whack. Maybe we’ve all been the unknowing beneficiaries of a spell of peaceful weather that’s now ending.

I suspect no one will be surprised when I extend this analysis to the economy and the markets. I’ve written before about how governments and central banks have been able, and willing, to moderate economic declines over the past couple of decades, at the cost of more or less constant deficits and increasing debt—and how that has changed, on both the willingness and the able fronts. The “Great Moderation” in the economic and business cycles, which ran from the mid-1980s to around 2008, coincided rather suspiciously with that same willingness to spend, suggesting that, as governments abdicate the role of economic stabilizer, things will continue to become more volatile going forward.

It doesn’t really matter whether the climate has changed or whether we just had a quiet spell. Storms are coming more frequently and with greater severity. Likewise, it doesn’t really matter whether the Great Moderation was caused by government and central banks, China’s entry into the world economy, or something else, or whether we just got lucky for a couple of decades. What matters is that it seems volatility is back to stay.

What does this mean? First of all, we need to relearn investing lessons from earlier years. Most of us have lived our professional careers in the Great Moderation, and we need to look back to a more volatile era to understand what might happen. Second, we need to consider whether current low levels of volatility are likely to persist and to plan for what might happen if they don’t. Uncertainty extends to all levels. The papers today are full of stories about how companies are uncertain, countries are uncertain, markets are uncertain. We hear great arguments on all sides, how things can get better, or worse. No one knows—or rather, everyone knows, but they all know different things.

Right now, I would argue that the balance of probability is for continued recovery in the U.S. and for markets to continue a slow climb. I do not, however, rule out the possibility of other outcomes. I expect volatility. I expect hundred-year storms. I know they are coming, but I don’t know when.

We had a monster economic storm in 2008–2009, and I certainly hope we don’t see another one any time soon. I also hoped the same thing after Sandy, but here we are with a monster snowstorm. Though it brought much less damage, it was still large and dangerous. Hope alone isn’t a strategy for the weather, and it is not a strategy for the economy. Instead, hope for the best, but prepare for the worst.

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