What can we learn from hurricanes and heatwaves?

Woman dancing in a field with an umbrella

How often do we read about futurologists, economists, or even weather forecasters who got their predictions wrong? They tend to be forgotten. There is always an exception, for instance Michael Fish who, on the evening of 15 October 1987, calmly told a BBC viewer who had heard a hurricane was on the way, “…if you’re watching, don’t worry, there isn’t!”. That was a couple of hours before all hell broke loose in the home counties.

Because those who get it right are in the minority, they can achieve notoriety. Back in 1976 Arthur C Clarke predicted satellites, google, skype calls and a whole host of other 21st century technologies. He’s been getting a lot of air time recently because of it.

The financial crisis in 2008 wasn’t predicted by economists. In November of that year, at a visit to the London School of Economics, the Queen asked the simple question, “Why did nobody see it coming”. She didn’t receive a very convincing answer. The bursting dot com bubble in 2000/2001 was equally not predicted.  It’s easy to look back and say that stock market valuations were too high, but that certainly hasn’t always been the case in the lead up to big stock market corrections.

Since 1926, there have been 11 occasions when the S&P 500 has experienced a drop in value of more than 20% – an average of once every 8 or 9 years. When that happens, many years of growth can be wiped out, and your school maths will tell you that a drop of 20% needs a gain of 25% just to get back to the starting point.

Drops like that will happen again; we can be sure of that. No-one can genuinely predict where, when or why, but it will happen. And by the time the signs are visible, it’s already too late to change investment strategy.

So, the obvious question is, how should an investment portfolio be structured to get the right balance between enjoying the good times, and protecting against the bad times? The answer is through diversification, by investing in areas which tend to perform differently at different times. A diversified portfolio won’t be the best performer when markets are booming – you would need to be fully invested in equities to achieve the top spot. But, when waters get choppy, a well-diversified portfolio should provide an element of protection.

At NOW: Pensions, we don’t pretend to be able to predict the future – we’ve seen too many highly respected people get it wrong over the years. What we can do though, is manage a portfolio that should deliver good long term returns regardless of the weather. We’ll leave it to others to predict hurricanes and heatwaves.

Rob Booth, Director of Investment & Product Development, NOW: Pensions