Little things happen in a hurricane. Example: When the wind is blowing counterclockwise on the Gulf of Mexico coast, it pushes the waterline away from the shore. Manatees get stranded in the mud (cbsnews.com/news/hurricane-irma-tampa-bay-water-levels-strands-manatees/).
People are more mobile than manatees. One wonders, however, about their relative intelligence. Some people in Tampa walked out, following the receding waterline. What were they thinking? That the water wouldn’t return, and suddenly? Police had to save them from tragedy (tampabay.com/news/weather/hurricanes/hurricane-irma-is-so-strong-its-pulling-water-from-tampa-bays-shores/2336958).
Big things happen, too, like millions of folks without power, fearing tornadoes, storing water, needing food, seeking shelter, finding gasoline. Yes, big things also happen.
So hurricanes become the obsession of lots of people. Even the ardent tennis fans were flipping between the Open and the Weather Channel, if they hadn't lost their electric power.
The news flow intensifies in parallel with storm size and intensity. Manatees ignore news; they can only wait patiently for the return of their normal environment or for rescue by well-meaning bio-citizens.
Modern humans are not designed for patience. Proof is available on blog sites of the power companies busily repairing a wounded system. Social media instantly expands the experience. Some believe it is social media pressure that has changed traditional television and thus added to the intensity.
Behavior patterns of humans are diverse, and each person’s forecast or fear reaction is unique. Has social media fattened the tails of this distribution of human behavior?
Economics teaches that the averaging of those forecasts is likely to generate a more accurate prediction than relying on any single one of them. Yet each of us is motivated by our conclusions – a single data point that is not likely to be the average.
Economics also teaches that mean-reverting tendencies do not guarantee that the variable in question is going to stay at the mean for long. As Irma reminds us, we must acknowledge the volatility of forecasts and of outcomes; failure to do so can be perilous as the Florida Keys now attest.
Irma was a mean-shifting experience for some folks, who will now incorporate the experience into their decision-making. For a while, some people will beef up their preparedness. This pattern of reacting to the most recent event will drive many personal and economic decisions. My colleague, Bob Eisenbeis, wrote about these economics yesterday.
In economics we use models and techniques that adjust for experience, just as weather forecasters update their models in the wake of large hurricanes. Those adjustments will now be made by serious market agents.
Some things don't need models. Only a few walked out onto the Tampa mud flats. Most figured out that this was a bad idea, because they could come up with a reliable prediction on their own that the water would return. They had incorporated life experience in their models. Those who actually walked out in the mud engaged in behavior that psychologists might labor to explain.
In the financial markets we use models. We calculate a mean and a volatility, and we derive estimates distributed by probability. And we attempt to adjust for shocks. We also modify these models for expectations, since human behavior has that behavioral component and people drive financial markets. Remember, the algorithms were all written by humans.
Why do we do this modeling if we know it is imperfect? We do it because we seek something called "price discovery." What is the correct price of something in the marketplace? How and why does it change? How efficient are markets at setting prices?
These are the daily questions we ponder. And when a hurricane allows pensive time, we ponder them with more focus. Wind and rain become boring after a while spent without electricity.
We raised weights in the insurance ETF and some financial ETFs last week. By one estimate insurers were 130% oversold. Hat tip to my colleague Matt McAleer, who follows this daily and diligently.
The Washington hurricane is swirling, too. "Politics makes strange bedfellows," said journalist Charles Dudley Warner more than a century ago. It sure does. Maybe Trumpelosi will dance? Maybe we’ll get a budget and tax reform and infrastructure and repatriation and more.
The sun is out in Sarasota. Cleanup is underway. A lot of folks need help, and those of us who are able to help should do so. Philanthropy is a good and necessary thing. We advise donors to check carefully the governance of the organizations they assist, so as to insure that monies are well spent and assets are well managed.
Life continues. The manatees are back in the water. Irma, farewell. There's more to do.
David R. Kotok
Chairman and Chief Investment Officer
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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
