Stocks & Storms, Humans & Hurricanes

"There are some things you learn best in calm, and some in storm." ~ Willa Sibert Cather

The storm is here.  What do I do?  This is a dangerous question -- not because of its prudence -- but because of it's timing... 

The prudent action to take as the storm approaches, arrives and passes is the action that should have been taken long before the storm was just a tropical depression forming off the west coast of Africa -- it is a process or strategy formed before the onset of complacency or fear -- it is your plan. 

Decisions made during the calm are more likely to bring favorable results than those made during the storm.  Creating a process while unaffected by emotion effectively removes you (and your damaging emotions) from the given decision at the given moment of necessity.

"Don't let your special character and values, the secret that you know and no one else does, the truth -- don't let that get swallowed up by the great chewing complacency." ~ Aesop

Time breeds complacency in the minds of fools: Eventually, the same human flaws will lure us into believing that "everything is OK" just before things turn for the worse.  As more time passes from the previous "big storm," the danger for harm increases.  Consider the lack of action in the days before and following Hurricane Katrina:  It was 1969 that Hurricane Camille, a category 5 storm, battered the New Orleans and Mississippi coasts.  The knowledge of how to evacuate was certainly present during Katrina.  But 36 years of compounding complacency was also present -- and the devestating aftermath and human tragedy followed...

"If you spend your whole life waiting for the storm, you'll never enjoy the sunshine." ~ Morris West

Just as complacency results in under-reaction, fear tends to the opposite results.  This hurricane season, only 3 years since Katrina, the pro-action and preparedness for Hurricane Gustav was tremendous and, quite arguably, bordering on over-reaction.  It was the kind of action that should have been present during Katrina.  Going forward, however, complacency will build again as every storm with no major impact comes and goes... until the next big storm arrives...

Does this behavior sound familiar?  There is no mistake that investor behavior is no different than that of behavior (or lack thereof) during hurricane season -- it is not just particular to stocks or storms -- it encompasses all human behavior.

"Perception is strong and sight weak. In strategy it is important to see distant things as if they were close and to take a distanced view of close things." ~ Miyamoto Musashi

Our perception, or how we see things, often and to our detriment, becomes our reality. Something incredibly large can appear quite small when it is far away and vice versa. Where we can get ourselves into trouble is when our perception gives us a false sense of reality.  Knowing this about ourselves enables us to plan or strategize accordingly...

Is it prudent to evacuate 200 miles inland several days prior to a projected Category 1 storm?  Probably not.  Is it wise to jump out of stocks at the first sign of market weakness?  Probably not.  Should we evacuate a storm while it is upon us?  Probably not.  Should we jump back in the market when we perceive prices to be at a bottom?  Probably not.

So, what is the right decision? 

I will not pretend to know the answer to this question.  Prediction is a fool's game.  The most prudent behavior is that of consistency of action in all environments.  And like the weather, the very nature of financial markets is that its behavior is not possible to predict with consistent accuracy; however, it is possible to control our own behavior.

"Human misery must somewhere have a stop: there is no wind that always blows a storm." ~ Euripides

While there is a right time for almost any given action, thousands of years of human behavior tells us that we will react (or not) based largely upon the proximity of the last big storm.  Do we know which action or reaction is right at the right time?  No.  Can we prudently form a process or strategy that will largely eliminate the wrong reaction at precisely the wrong time?  Yes.

Storms come and go.  We know this.  The exact arrival time and location, intensity, and longevity, however, are nearly impossible to know in advance, even with modern technology.  By the time these crucial items are known in absolute terms, the storm has already come and gone. This is why it is not logical to try for pinpoint accuracy in a forecast or even concern ourselves with the small storms but to look at the big picture of probabilities and strategically plan ahead for the big storms.

"The little reed, bending to the force of the wind, soon stood upright again when the storm had passed over." ~ Aesop

The objective is to survive the storm -- to predicit our own behavior and act accordingly -- not to predict the behavior of the storm and make mistakes accordingly.  How we weather the storm is dependent on our actions before it arrives -- not on our actions and reactions during and after the storm. Otherwise, we are susceptible to over-reaction or under-reaction -- either of which may be harmful to some degree.

Hurricanes and financial markets are cyclical.  We know storms and economic and market cycles will come and go.  We have detailed knowledge of those that have passed but our practical knowledge of those storms to come ends there...

Knowledge of our self, however, always has room for expansion...

Related Posts:

Quiet In The Storm

The Storm of Irrational Exuberance

Weekend Wisdom: Perspective on Perception

Comments

[Next Gen Politics]

Great article. One question though. What do we do to prepare for a storm we have never seen,(i.e. global warming). We are in a stage of complacency of epic proportions when it comes to global warming. Like the frog that slowly boils without jumping out of the pot as Al Gore would say.
Again, great article. Keep up the great posts.

Jerame Clough
-Next Gen Politics

[The Financial Philosopher]

Jerame:

The "storm" of global warming is beyond my expertise. With that said, it does provide an interesting example that parallel's the financial aspects of risk management.

For example, most agree that global warming is a threat but there is an idealogical line drawn between those who believe it is "man-made" and those who believe it is a "natural" or "cyclical" phenomenon.

Personally, I do not pretend to "know" with certainty either side is correct. Instead, I ascribe to the philosophy found in the wisdom of "Pascal's Wager."

Blaise Pascal's idea of "risk management" pertained to the existence of God:

"Belief is a wise wager. Granted that faith cannot be proved, what harm will come to you if you gamble on its truth and it proves false? If you gain, you gain all; if you lose, you lose nothing. Wager, then, without hesitation, that He exists." ~ Blaise Pascal

Of course, if you "wager" that God does NOT exist and you are wrong, then you lose everything...

Pascal's Wager, in my humble opinion, is an exercise in the inter-related aspects of risk, uncertainty and consequences.

I try not to get political, but the current administration used this logic with going to war with Iraq. The risks were uncertain (no "smoking gun") but the consequences in failing to act were potentially high.

The disconnect, however, is that this logic is not used by the same administration with global warming. The risk of global warming, arguably, is uncertain but the consequences in failing to act, if it is a man-made phenomenon, are potentially high or even "epic" as you said...

If we wager that global warming exists and we are correct, we gain all. If we are not correct, we lose nothing (except what we have wagered, some well-spent resources) but stand to gain a better place to live.

If we wager that global warming does NOT exist and are NOT correct, then we lose all...

As you may agree, Pascal's Wager works in religion, investing, insurance, war, global warming or any risk management application.

What do you think?

Thanks for provoking thought, once again, Jerame.

For more on Pascal's Wager, please visit my previous blog post, called "Finding God in Behavioral Finance:"

http://financialphilosopher.typepad.com/thefinancialphilosopher/2007/10/finding-god-in-.html

[Next Gen Politics]

That is a great response. I am familure with Pascal, but have never thought about connecting his wager to global warming. I will of course argue that the Bush administration "used this logic with going to war with Iraq. The risks were uncertain (no "smoking gun") but the consequences in failing to act were potentially high."

As we have seen with subsequent evidence, this was never about WMD in Iraq, and terrorists were never welcome in Sadam's Iraq. Enough with the Politics. You are right to connect Pascal's logical thought experiment to global warming. It's a perfect analogy.

Anyway, great post. Keep up the good work. You always leave me thinking. Great site!

Jerame Clough
-Next Gen Politics

[jimcos42]

Two comments:

1. I live in the San Andreas (as well as several other potentially dangerous) fault zones. Is earthquake prep a commonly discussed theme of popular contingency planning? I'm afraid not. Complacency, big time.

2. I wish people would use the term "climate change" rather than "global warming." CC has been around since Day One of planet Earth. GW-- natural or man-made-- is a sub-set of CC. A more dispassionate, less politicized treatment would better serve all and help us make a better bet.

[The Financial Philosopher]

jimcos42:

Both of your points speak to complacency with regard that humans tend towards laziness in their thinking and behaviors (the path of least resistance) as well as their language:

1. Preparation for the eventual and inevitable catastrophic event of major earthquake is a great example. In Charleston, SC, I live near the third largest fault in the country. We have not had a "major" earthquake in 222 years but are "due" for another big one at any time...

2. The use of language and attaching certain terms, such as Global Warming, to a natural phenonema that may or may not be within our control, when another term, such as Climate Change, may be a more useful and more dispassionate term, is also a form of laziness. We tend to accept terms that are commonly used without stopping to think of their meaning or if another term would better serve the particular object of definition and even the greater good...

"Man acts as though he were the shaper and master of language, while in fact language remains the master of man." ~ Martin Heidegger

Thanks for the thoughts, as always...

Kent @ The Financial Philosopher