Fair winds and following seas

For thousands of years people attempted to predict the weather, with limited success.

A rich folklore developed around various methods of forecasting, including the color of the sky, or the behavior of animals, or even aching joints in the elderly.1 In a few places and under certain conditions these could loosely be relied on. But their broader predictive value was low, and these forecasts had limited ability to see beyond the next weather system.

Humans remained at the mercy of wind and rain when going about their daily routines, farming, or traveling. Voyages by ship were especially precarious, as seas could easily be deadly for vessels caught unaware by storms.

This all changed in a meaningful way on August 1, 1861, when the British Meteorological Office issued its first official forecast, covering the weather two days out for selected cities across the U.K. and on the nearby continent. So began the practice of systematic predictions shared with the general public, providing the ability to plan outdoor activities and subtly influencing the rhythms of commerce.

This innovation was the culmination of years of scientific experimentation, particularly the development of the barometer, first developed in the 1600s. Over time scientists realized that drops in air pressure were associated with impending storms. As the technology improved, they were able to structure and formalize their measurements in ways that made them reliable enough for important decisions.

When dealing with weather, changes in air pressure were one of the most important examples of something called a leading indicator. Such signals provide an early glimpse into events that are yet to happen. A barometer would fall in advance of approaching storm fronts and behave in the opposite fashion when milder weather was coming.

Meteorologists gradually expanded their scope and incorporated other metrics, to the point that forecasts are now globally available, constantly updated, and taken for granted as a seamless part of life. The average person can tailor their plans to the sun or rain giving little thought to the massive effort that made it possible.2

The amount of information used in computing forecasts has grown exponentially, and the underlying models are continuously being refined. Finding additional leading indicators that point to specific changes gives meteorologists better ways to see the future.

They aren’t the only ones whose livelihood depends on them.

Who wants to be a billionaire

Much of the investment management industry—hedge funds, venture capitalists, and the like—functions through the ability to make accurate predictions for what a company will be worth, or how the wider economy will perform, or how some political action will ripple across markets. Thousands of specialized, highly-trained finance professionals3 scour the data trying to figure out which nuggets can serve as leading indicators of what will come.4

They played a key role in 1992 when Britain was moving towards greater financial integration with the rest of the European Union. Part of this process included a political decision to peg the value of the pound to the German mark, in an ill-fated attempt to ensure greater harmonization between the different economies that made up the trading bloc.5

There were fundamental instabilities in this arrangement, which a prescient investor named George Soros latched onto. He recognized that the nature of the British and German economies made a currency link highly tenuous and bet a massive sum of money to back this view. The leading indicators of unemployment, economic growth, trade, etc., pointed to a future where Britain and Germany would diverge and breach the fixed currency range.

His team shifted billions of pounds in anticipation of its imminent collapse. The British central bank tried valiantly to maintain the regime, but traders around the world smelled blood in the water, reinforcing his bet and only hastening the inevitable collapse of the policy. After expending vast reserves and fiddling with interest rates the government caved, letting the exchange rate fluctuate.

When the dust settled a few months later, Soros had banked somewhere north of a billion dollars, making this one of the most profitable trades in history and in the process vaulting him to global prominence.6

Figuring out leading indicators and acting on them can make or break a strategy, or a fortune.

Leading or lagging

Some signals can only be observed and interpreted in real-time or in retrospect. Certain indicators operate during the phenomenon they point to—think measurements of temperature, or statistics tracking active users, or the vital signs of a patient. All show what is happening right now, giving these the label of coincident indicators. Like the gauges on a dashboard, they show current performance.

A third category encompasses lagging indicators, which point to something that has happened in the past. Patient outcomes post-surgery, corporate profitability, agricultural yields—all come after the fact to reveal the quality of the actions that preceded them. Although they serve as an important feedback mechanism, unlike with leading indicators the things they reference can no longer be directly influenced.

keep spinning on this cycle

Whatever your environment, correctly sorting the three kinds of indicators is essential for tuning the decisions you make. The framework can apply to multiple areas of analysis, big and small.

  • To pick up on the weather analogy, apply the idea to something as simple as rain: the presence of clouds is leading, unfurled umbrellas are coincident, puddles are lagging.
  • Use it to assess your personal finances: your performance reviews at work could be leading, a paycheck is coincident, and your bank account balance is lagging.
  • Look through a wider lens and determine what these indicators would be for something like housing markets: construction permits (leading), sale prices (coincident), population changes (lagging).

Untangling cause and effect is not always so straightforward, especially since lagging indicators of one phenomenon can be the leading indicator of the next. Each separate piece of information can be zoomed into further, revealing further nested layers of cause and effect to unpack. Lagging outcomes can also help refine the ways you see the world, providing sharper ways of identifying more subtle leading indicators.

For example, the ramifications of Britain’s disastrous 1992 experience seem to reverberate in 2019. So was the Brexit vote that has roiled politics in the European Union for the past few years a result of past decisions, or a sign of things to come? It could be either (or both) depending on the problem you are trying to solve. Getting the diagnosis right is critical for tailoring the appropriate policy responses, whichever side you take.7

Even if they are not as complex as the weather, similar phenomena permeate your work. Tease out which result from past actions that you can learn from but not change, and which are predictive and can be met with appropriate action. The difference can be extremely significant.

References

The birth of the weather forecast, BBC News

The Trade of the Century: When George Soros Broke the British Pound, Priceonomics

  1. One such method was even mentioned by Jesus 2,000 years ago, when he noted that the redness of the sky was used as a predictor for stormy weather by the scholars of the time. This is due to refraction of sunlight on clouds, captured in the more recent proverb “Red sky at night, sailor’s delight. Red sky in morning, sailor’s warning.” ↩
  2. The staggering mathematical complexity of forecasting means weather bureaus invest in some of the most powerful supercomputers in the world. Even then the results are not nearly as accurate as some would like, leading to the irate local television viewer putting the hapless weatherman on blast. ↩
  3. Often finance bros, these can be recognized by their corporate-branded fleeces and the jocular manner that belies the haggard look in their eyes. ↩
  4. More importantly, they want to identify and act on these before anyone else does, because information that is commonly known is no longer actionable, at least if you want to make a killing. ↩
  5. Also an attempt to import some of that legendary Teutonic stability to what was a shakier British economy. ↩
  6. Keen observers will note that this money did not materialize from the ether and was in fact provided in a circuitous way by British taxpayers, who vented their frustration on the politicians who presided over the policy, hastening their electoral decline. ↩
  7. If nothing else the ongoing drama has introduced those non-Brits among us to the spectacle that is parliamentary debate in the House of Commons, complete with bellows for “order” issuing from its speaker, to whom members ritually bow, and the queen’s ceremonial mace, this last feature being extra foreign to Americans, what with the royal overthrow that got the country started. ↩