Weather - Chatham Financial

An especially bitter New England winter led humorous writer Charles Dudley Warner, a contemporary and friend of Mark Twain’s, to quip that “everybody talks about the weather but nobody seems to do anything about it.” Doubtless Warner would have appreciated the efforts of Russia’s Atmospheric Technologies Agency, reputedly ordered by President Putin to prevent rain during the 2003 St. Petersburg summit, to create a sunny perimeter fifty kilometers around the city center by bursting clouds with dry ice. At last somebody was doing something about the weather!

Yet while the vast majority of us lack the military resources or budgetary authority to produce eternal sunshine above our heads, we all benefit from the forecasts offered up by meteorologists to help us plan correctly. Those in the United States Deep South, directly in the path of potentially devastating hurricanes each year, have increasingly come to rely on the predictions of two Colorado State scientists, William Gray and Phil Klotzbach. Over the past twenty years, their December quantitative hurricane forecast has been must-reading for those in the high-risk hurricane strike zone.

Not anymore. Starting this December, Gray and Klotzbach will provide a qualitative discussion of seasonal hurricane activity, but no more quantitative predictions. Said the scientists on December 7th: “We are discontinuing our early December quantitative hurricane forecast … our early December Atlantic basin seasonal hurricane forecasts of the last 20 years have not shown real-time forecast skill.” In plain language, these predictions – which may have influenced the dollar value of hurricane insurance Southerners purchased for the last several decades – did not forecast hurricanes correctly!

To consider the topic further, we took a look at the last twelve months of unemployment rate releases published on a major market data provider. In each instance, around 75-80 firms offered a forecast for the unemployment rate, producing a median value and an actual value to one-tenth of a percentage point. For seven of these twelve months, at most five firms called the correct unemployment rate; in the four months where the unemployment rate moved by at least 0.2%, there was one correct call out of 318 total forecasts! What’s amazing is that this all happened without a lot of forecast dispersion; after all, the standard deviation on the forecasts was only 0.1%.

Notably, the highest rates of “successful forecasts” occurred with the August and September unemployment rates, where the unemployment rate … didn’t move at all from the previous month! The lowest rates of success (i.e. zero correct predictions) occurred in all three months where the unemployment rate moved by more than 0.2%. In other words, successful forecasting was most directly tied to the rate’s not moving from one month to the next. This would be like a weatherman who always predicted that tomorrow’s weather would be just like today’s; he would always get it right except on days when a new front blew in and changed atmospheric conditions. This would be the exact time when you’d want a weatherman to warn you to prepare for changing weather.

So were there any experts who stood out for forecasting acumen, a kind of Al Roker for financial predictions? There were four months where the rate barely moved (if at all) and the economists were generally aligned in accuracy, but during the remaining eight months, no forecaster predicted correctly more than twice. If this same trend persists over the next nineteen years, will some economists elect to discontinue making economic predictions based on the absence of real-time forecast skill?

We can’t wrap up this discussion without drawing one quick parallel – while the protagonists in this tale spent the last 20 years predicting, Chatham has spent the last 20 years not predicting but rather preparing: preparing our clients to manage risk in a variety of potential interest rate, currency, and commodity price scenarios. Robert Redford said it well: “When did Noah build the ark? Before the flood!” So give us a call – even if it’s just to talk about the weather!