Irene, Investing and Predicting the Worst

Pop Investing explores the intersection of mainstream media and investment practice. It takes discussions from popular culture and applies them to the financial industry in order to better understand investor attitudes and trends.

As the media goes soul-searching for what lead to such great heights of expectation before Hurricane Irene, investors would do well to remember that the same forces apply to the financial markets. In both nature and investing, certain predictions take on a life of their own, only later to rendezvous with reality.

To begin with, some disasters are built to capture our imaginations more than others. When we learn Lower Manhattan might be submerged, we tune in, but when scientists report heavy metals entering our water supply, we tune out. Such “Category 5” disasters as a New York City hurricane may be easy to visualize, but they are no more or less dangerous, or likely to occur, than a host of other, less dramatic doomsday scenarios. Similarly, just as any investor shivers to imagine the chaos that would follow a U.S. default or a collapse of the Euro, certain potential financial crises are more readily accepted into our collective consciousness.

Then there is the media. As anchor Chuck Scarborough at Channel 4 New York said recently, “We're in the news business. We deal in doom.” As soon as it’s no longer a disaster or potential disaster, viewers are going to move on, so news channels have to take an alarmist tone in order to keep viewers glued to the set. And as soon as one crisis is over another must take its place. In the case of mainstream cable viewers, the new “crisis” may be little more than a distraction, but for those seeking long-term investment advice, the impact of an overblown threat can be catastrophic.

Furthermore, in both natural disasters and investing, hysteria tends to feed hysteria. As soon as everyone in your neighborhood begins hoarding water, you have no choice but to join in. Disaster predictions feed on themselves as more and more people talk about them to the point where it’s all anyone can talk about for a while. Just take a look at this chart of searches for “Muni Crisis” soon after Meredith Whitney’s warning on the topic. While investors are no strangers to herd behavior, a dose of real world, shelf-clearing chaos at the supermarket should serve as a reminder of how crowd mentality can stifle rational thought.

Invested interests can also further skew predictions toward the extreme. As soon as Mayor Bloomberg ordered the first-ever mandatory evacuation of New York, it became in his interest to convince the public of the threat’s seriousness. Just so, any hedge fund manager short a company’s stock knows that negative hype is good publicity. It’s not that predictions from invested sources are necessarily wrong, but simply that they will be more prone to swing one way than the other.

Which brings this discussion to a final point. As a tweet by New Yorker editor Ben Greenman wryly stated over the weekend, “It seems like whatever gets near Wall Street gets downgraded.”

The financial industry has indeed earned a reputation for less-than-accurate prediction. Just as weathermen can never say with certainty how powerful a storm will be until it hits, neither can analysts truly forecast the risk of an investment. Yet every day on TV, in articles and at events around the country, someone is trying to predict the next disaster.

On the whole, this is a good thing. The financial industry is forward looking by nature. But while the Weather Channel can at least argue that it readies the public for a worst-case scenario, the case isn’t so clear-cut in the financial industry. Sure, investors would benefit from accurate predictions of the next downturn, but just ask PIMCO’s Bill Gross how easy that can be. In investing, the disaster may just as easily lie in its prediction.

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