How Not to Do It

Climate Change3

On Monday, the United Nations’ Intergovernmental Panel on Climate Change issued an important report on climate change. From the report: “Impacts from recent climate-related extremes, such as heat waves, droughts, floods, cyclones, and wildfires, reveal significant vulnerability and exposure of some ecosystems and many human systems to current climate variability.” Moreover, for “countries at all levels of development, these impacts are consistent with a significant lack of preparedness for current climate variability in some sectors.” In other words, climate change is a big problem and we’re ignoring it. That’s important stuff, if not exactly news.

John Tamny of Forbes (already notorious for an appearance on The Daily Show — video herevehemently disagrees. His article explaining why provides a veritable treasure trove of examples of how not to do investment analysis, or analysis of any sort for that matter.

Tamny’s specific attack relates to a documentary from Vice shown on HBO (summarized here) focusing on the melting of Greenland’s ice cap. NASA’s Gavin Schmidt, in an interview with Vice’s Shane Smith, made the non-controversial assertion (at least among scientists) that there is a climate crisis, that it is “man-made” and that climate change is “well ahead of the worst case scenario” predicted by some of the world’s top scientists. Tamny asks a good question: “Scary stuff, but is it true?” Tamny claims that the answer is “no” (my own viewpoint is outlined here; NASA provides the key data here). Let’s take a look at his analysis.

Tamny begins with a caveat that ought to be a huge, waving red flag to discerning readers. “It should be said up front that [my] analysis of Smith and Schmidt’s alarmism will be wholly free of science, as I’m not a scientist” (a fact he will go on to demonstrate).

It should be axiomatic that scientific arguments need to be rebutted scientifically. Despite political and ideological conflicts about climate change, the science is well settled. James Lawrence Powell 2013piechartbyred2updated his previous research (see here and here) by reviewing peer-reviewed articles on climate change in scientific journals over the period from November 12, 2012 through December 31, 2013. Consistent with the earlier research, he found 2,258 articles, written by a total of 9,136 authors. Only one article, by a single author in the Herald of the Russian Academy of Sciences, rejected the idea of man-made global warming. All other published academic papers agree on the nature of the problem (if not on how to go about solving it).

Accordingly, virtually no scientists even seek to provide scientific evidence so as to argue that climate change either isn’t happening or isn’t man-made. That is significant because scientists make names for themselves most effectively by challenging conventional wisdom, showing how other scientists are wrong, providing evidence of an alternative reality, and publishing their finding in the scientific literature. Such critiques happen all the time in the scientific world in a wide range of contexts. That is how science is done and how careers are made. That (essentially) nobody is trying to do that with respect to climate change is remarkably good reason to believe that there is no such scientific argument to be made.

To be sure, it is at least theoretically possible that the thousands of scientists whose articles were surveyed by Dr. Lawrence have given up career gain and notoriety in order to perpetuate an enormous global conspiracy to deceive the public about climate change toward some unknown end. It’s also possible that the entire scientific community is simply wrong. But the only way legitimately to make the sort of case that Tamny wants to make is to provide substantive scientific evidence.

Like Tamny, I’m no scientist either. So, unless I’m shown very good scientific reasons not to, I provisionally accept the scientific consensus (on climate change, modern medicine, the use of cell phones, that Apollo 11 really landed on the moon, etc.). Until research is done and published that contradicts what science is currently telling us, there is no reason even to pay attention to the political and ideological windbaggery trying to pose as something like science.

Despite his denials (remember, he claimed that his criticism would “be wholly free of science”), Tamny can’t resist trying to make a scientific point. He argues that ice cap melting in Greenland is irrelevant to rising ocean levels: “just fill a cup with ice and water, and watch the ice melt. The level of water in the cup will logically remain the same…”. His point about the cup and the ice is correct (without saying so, he’s referring to Archimedes’ principle), but it is utterly irrelevant and thus terribly misleading. The reason Greenland is important is that the ice cap there is on land, meaning that its melting will indeed increase sea levels. Five minutes with a search engine and Tamny could have figured that out. Oops. But, of course, Tamny’s argument is science and fact-free.

Tamny then moves on to his supposed point. Again, he offers no basis to attack the science directly. What purported arguments does he offer to attack the science indirectly?

“But I can look at market signals like anyone else can, and they reflect a catastrophe-free future that supports the view of global-warming ‘deniers.'”

What he characterizes as “market signals” is really just Tamny’s recognition that climate change hasn’t stopped investment in coastal areas: “What else would explain all the investment that continues to migrate toward the world’s coastal cities despite the fact that their days are allegedly numbered?”

Not surprisingly, the markets themselves offer a straightforward answer: we tend to be remarkably short-sighted. The latest Dalbar QAIB data shows that over the past 20 years, the average equity investor has suffered an aggregate underperformance of nearly 50 percent while the average fixed income investor has suffered an aggregate underperformance of nearly 85 percent. Morningstar’s research reveals the same general problem in that individual investors underperform the average fund’s return by an average of 2.5 percentage points annually. Ironically, Forbes has reported on this problem, though perhaps Tawny hasn’t read about it. We find it extremely difficult to “stay the course” and thus make foolish and short-sighted mistakes.

Everybody who tries to lose weight or get in shape in order to improve his or her long-term health knows how hard it can be for us to think long-term. Other examples of our general short-sightedness are legion. For example, roughly 70 percent of people turning age 65 can expect to use some form of long-term care during their lives but only about 10 percent purchase long-term care insurance. At the federal level (and in many states), we have an enormous debt and deficit problem, but are unwilling to forego significant governmental spending today in order to deal with it. At the state and local levels, our pension systems are woefully underfunded, but we aren’t willing to make the tough current decisions necessary to deal with the problem. Here in California, despite severe earthquake risk in many areas, real estate prices remain exceedingly high (does that mean there’s no earthquake risk?). You get the point.

Sea level is now rising at a rate of 3.16mm per year. That means that it will take about seven-and-a-half years for sea level to rise one inch. So we’re talking about a very long-term problem. Despite meaningful more near-term problems, New York will not be underwater in my lifetime. Despite the enormity of the problem, we can readily think that it won’t really be a problem anytime soon or that American ingenuity — which is indeed fantastic — will come up with a solution in time. For most of us, lunch is a long-range plan. Is it really so hard to fathom why folks on both coasts aren’t heading for the lifeboats just yet?

Tamny’s other key problem is his insistence on seeing the markets through an ideological lens, which is always a mistake.

“Yes, market signals strongly suggest we’re a nation of global warming deniers, so while it’s possible that the markets are very dumb, what’s more likely is that they’re a great deal smarter than Smith, Maher and the warming-infused portion of the scientific community promising a climate catastrophe.”

Seeing the market, as Tamny does, as “known best for pricing all information” reflects an ideological commitment that people who trade the markets and have their own money on the line every day recognize as a crock. One cardinal investment sin is our tendency to favor ideology over evidence. You don’t need to be a Keynesian to agree with Keynes when he noted that the markets can stay irrational longer than you can remain solvent. Remember Pets.com, Webvans, eToys? The market makes lots of mistakes (even if taking advantage of them is extremely hard).

In 2005, three Fed economists proposed that the alleged “Great Moderation” was on account of the success of financial innovation. Similarly, Robert E. Lucas Jr., the Nobel Prize-winning University of Chicago economist, opened his presidential address to the American Economic Association in 2003 by proclaiming that macroeconomics “has succeeded: Its central problem of depression prevention has been solved.” In other words, the markets are essentially self-regulating purveyors of truth.

Nonsense. Remember, the market (at least in the nearer-term) is much more a voting machine than a weighing machine. Anyone relying on “market signals” alone would have been buying tech stocks on margin in 1999 and have been buying as many houses as possible using no-doc loans in 2007. We have a long-term problem: we tend to ignore the long-term.

So, I’ll leave it to you: is the market being smart or dumb about the long-term risks of tobacco based upon the market performance below?

Tobacco Index

As early as 1930, German researchers found a strong correlation between cancer and smoking. Eight years later, Dr. Raymond Pearl of Johns Hopkins University reported that smokers do not live as long as non-smokers. By 1944, the American Cancer Society began to warn about possible ill effects of smoking, although it admitted that “no definite evidence exists” linking smoking and lung cancer. After Reader’s Digest published “Cancer by the Carton” in 1952, detailing the dangers of smoking, the tobacco industry began its dreadful disinformation campaign. Significantly, Big Tobacco didn’t offer contradictory evidence (as there was none). Instead, it constantly and consistently attacked the existing science as flawed, incomplete and contradictory. It insisted that the link between smoking and cancer was insufficiently proven. Sound familiar?

The tobacco industry has been seemingly under siege since the mid-1960s, when the Surgeon General published a massive study called “Smoking and Health.” Yet despite warnings, restrictions and criticisms more direct and ominous at every point, the “market signals” (see the performance of Alteria — what was Philip Morris — below, for example) have been consistently strong throughout that entire time and remain incredibly strong today.

MO Performance Source: Morningstar

MO Performance
Source: Morningstar

As opposed to the indirect links Tamny features, one market segment has a direct link to the risks of climate change. In the comments section to his piece, Tamny claims that “[i]nsurance is a market, and it’s merely a measure of risk. There’s no evidence that this market things [sic] a catastrophe is coming.” Even if what Tamny says here were true, it would be largely irrelevant because insurance companies primarily care about the next year, not the next 100 years, because they mostly sell policies one year at a time. Even so, Tamny hasn’t done his homework in this regard either. As reported by The New York Times, insurers have “no doubts on climate change.” And if any market should offer us a good signal about climate change, it would be insurance.

“Our business depends on us being neutral. We simply try to make the best possible assessment of risk today, with no vested interest,” says Robert Muir-Wood, the chief scientist of Risk Management Solutions, a company that creates software models to allow insurance companies to calculate risk. And RMS has indeed altered its current models on account of climate change. “Basically, after the 2004 and 2005 [hurricane]seasons, we determined that it was unsafe to simply assume that historical averages still applied,” he says. “We’ve since seen that today’s activity has changed in other particular areas as well—with extreme rainfall events, such as the recent flooding in Boulder, Colorado, and with heat waves in certain parts of the world.” Muir-Wood notes that “[i]n the past, when making these assessments, we looked to history. But in fact, we’ve now realized that that’s no longer a safe assumption — we can see, with certain phenomena in certain parts of the world, that the activity today is not simply the average of history.”

The insurance industry was the first major business sector to acknowledge the effects of climate change and to seek to deal with that risk in a systematic fashion. Last June, the Geneva Association, an insurance industry research group, released a report outlining the evidence of climate change and describing the new challenges insurance companies will face as it progresses. “In the non-stationary environment caused by ocean warming, traditional approaches, which are solely based on analyzing historical data, increasingly fail to estimate today’s hazard probabilities,” it stated. “A paradigm shift from historic to predictive risk assessment methods is necessary.”

A group of leading insurers from North America, Europe and southern Africa has formed ClimateWise, which seeks to raise awareness about the economic risks associated with climate change. A Lloyd’s of London executive makes the same general point here. In January, the National Association of Insurance Commissioners issued a report recognizing the reality and potential impact of climate change and noted the risk disclosures that are now necessary as a consequence. Karen Clark & Co., an insurance risk-assessment consultant, predicts that top hurricane wind speeds could increase up to 5 percent because of climate change. The Reinsurance Association of America – a trade association for property and casualty reinsurers that operate in the U.S. — has consistently warned about the potential effects of climate change (see here too).

Just two weeks before SuperStorm Sandy slammed onto the Jersey shore last year, German reinsurance giant Munich Re issued a major report entitled Severe Weather in North America, in which it linked the risks of severe weather events to human-caused, or anthropogenic, climate change: “In the long-term, anthropogenic climate change is believed to be a significant loss driver. […] It particularly affects formation of heatwaves, droughts, thunderstorms and — in the long run — tropical cyclone intensity.” Allianz actively lobbies for worldwide, binding carbon emission targets and has designed various insurance products to deal with climate change risk, such as catastrophe bonds and micro-insurance. Swiss Re also has a product line that is explicitly geared toward climate-change risks. The Hartford is consistently on record with its concerns about the issue.

Interestingly, Muir-Wood — who is knee-deep in the data pretty much all the time — even contradicts Tamny’s specific point about oceanfront property. “I personally wouldn’t invest in beachfront property anymore,” he says, noting the steady increase in sea level we’re expecting to see worldwide in the coming century, on top of more extreme storms. “And if you’re thinking about it, I’d calculate quite carefully how far back you’d have to be in the event of a hurricane.”

Market signals indeed.

9 thoughts on “How Not to Do It

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  4. “It insisted that the link between smoking and cancer was insufficiently proven. Sound familiar?” Yes, very familiar. It sounds like people who say the climate deniers have insufficiently proven their case. Isn’t that funny?

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