May 2022 – Climate Versus Weather
Like many of you, I pay close attention to the weather forecast, especially this time of year. As a trained weather spotter, I stay alert to the beginning of tornado season here in Illinois. Seasonal weather patterns greatly influence the timing of the northernly spring bird migration (which bird lovers like me wait all year for). Wherever we happen to live, it is prudent to check weather conditions before venturing outdoors.
Climate change is, of course, a contentious topic nowadays. As something of a weather aficionado, I’ve noticed many times in casual conversation (and in some news reporting) that a particular recent weather event, such as an intense tornado outbreak, a heat wave, or flooding, gets cited as evidence of climate change. It is clear to me that there is often confusion about the difference between weather and climate. They are definitely not the same thing, and the terms should not be used interchangeably.
In his excellent book Unsettled?, author Steven E. Koonin, the former Under Secretary for Science under the Obama Administration, writes that “a location’s climate is the average of its weather over decades.” He uses this illustration to clarify the difference: “If you are moving from Wisconsin to southern Arizona, knowledge about your new home’s climate tells you to invest in air conditioning for the summers, that it’s probably safe to leave your heavy winter coats behind, and that the water-loving plants that flourish in Madison are unlikely to fare as well in Tucson. But knowledge about the weather tells you that, according to Tuesday’s forecast, you’ll need an umbrella when you arrive on Thursday.” He concludes “Climate is what you expect, weather is what you get.”
Investing is analogous to these meteorological concepts. Longtime readers of this blog are frequently reminded of the importance of keeping a long-term perspective when investing in the capital markets. We invest in the hope that we will capture the returns the market has to offer over the long term, using history as a guide. This is the fruit of economic free enterprise, innovation, entrepreneurship, competition and capitalism, with the resulting wealth creation accruing to the shareholders as a return to putting their capital at risk in businesses of all sorts, large and small. This is akin to climate. It is what we expect to receive.
Weather, on the other hand, is what we actually get on a day-to-day and week-to-week basis. As of this writing, the U.S. stock market is down over 17% year-to-date. Market declines and high volatility, such as we are experiencing today, are like moving to Florida and having to deal with a hurricane: we know they can, and do, happen, but we hope that most of our time there will be more in line with our long-term expectations.
The S&P 500 Index from 1928 through 2021 has averaged about 10% in total return per year (including dividends). You could think of the “climate” for equity returns to be about 10% per year. But how many times over that 94-year period has the annual market return been 10%? Once, in 1993 (the actual return was 9.97%).
The “weather” of volatility and drawdowns happens frequently. The average maximum intra-year drawdown over 94 years is -16.5%. In 59 of those years, losses exceeded 10% and in 24 of those years, losses exceeded 20%.
Here is a table of annual returns and average intra-year drawdowns by decade:
Even with the high occurrence of drawdowns over this time period, the stock market ended the year in the black three out of every four years.
Regular readers will also be familiar with my oft-repeated adage that market volatility and frequent drawdowns (the “weather”) are the price of admission for gaining exposure to long-term expected equity returns (the “climate”). While those future returns may be higher or lower than 10% per year, investors could put capital at risk in much worse things than in a diversified portfolio of U.S. and global shares of well-run, growing companies across many sectors, industries, and geographies.
Your overall portfolio allocation between stocks, bonds, and cash are key drivers of your long-term investment results. Clients who stay the course with their overall portfolio structure, and resist the temptation to sell, in times like these, will be in a better position to achieve their long-term financial goals.
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 Unsettled? What Climate Science Tells Us, What it Doesn’t, and Why it Matters, Steven E. Koonin (BenBella 2021)
 Italics by author.
 I acknowledge Dimensional Fund Advisors for the idea for this blog