Things can change quickly.
Yesterday afternoon was beautiful, sunny, and warm. It almost felt like summer. It was a great day for mowing the lawn, maybe planting some flowers, and catching some delightful rays of sunshine. Appropriate outside attire included shorts and a T-shirt.
Just a single hour later it was cold, windy, and felt like March. Maybe you even had a passing thought about the wind chill index. Appropriate outside attire included long pants, long sleeve shirt, and a warm jacket.
The National Weather Service coined the phrase pneumonia front in the 1960s. To meet pneumonia level, a cold front must drop the temperature at least 16 degrees within one hour. This usually only happens in spring when a stiff northeast breeze pushes air across the chilly waters of Lake Michigan. With no wind resistance at the surface, the cold front picks up speed as it pushes down the lakefront – leading to a rapid and drastic change in temperature.
The weather forecasters predicted yesterday’s pneumonia front days in advance. Forecasts allow you to prepare for such a rapid change. You can plan appropriate attire. You can properly sequence your outside activities for the day. When the great cold gust arrives, you can confidently say to yourself “I knew this would happen.”
However, if you purposefully and diligently avoided all weather conversations, weather forecasts, and weather apps for the last few days, the great cold gust may have been a very unexpected and unpleasant surprise. You may have been caught with inadequate clothing or ill-timed outside activities.
The financial markets also have pneumonia fronts, except they are called bear markets. Instead of 16-degree drops, bear markets are defined by 20% drops. Instead of only occurring in the spring and being predicted days in advance, bear markets can occur at any time of the year. Instead of using chilled Lake Michigan water to create a temperature plunge, bear markets use traders’ chilled attitude toward the future to temporarily erase optimism.
The unpredictable timing of bear markets can be frustrating. If the weather forecasters predicted a pneumonia front every single day of the year but they only occurred once or twice a year, you would become desensitized to the forecast and ignore all of the pneumonia front predictions. When the predicted pneumonia front arrived, you would be just as unprepared as if you had never heard the forecast.
Our risk-based approach to portfolio construction means that we are always prepared for a bear market to start every day. There are literally years between bear markets even though we are prepared every day. The real danger in this approach is not the eventual bear market, but that we become desensitized to the risk in times of euphoria and lose our preparedness at exactly the wrong time.
While a pneumonia front will not give you pneumonia, a bear market can cause financial illness if you are forced to sell long-term assets at sale prices. Assets that are sold have no chance of seeing their value rebound with the next warm front.
To those who expected the pneumonia front yesterday and prepared for it, congratulations on meeting expectations. To those that would like to be prepared for whatever comes next in the financial markets, take this opportunity to meet with one of our advisors now.
Quote of the week: Shane Parrish: “Those that seem prepared in hindsight often seem boring or less efficient in the moment.”
Graphic from Fox Weather on YouTube
