Dealing with a Small Sample Size

One of the main difficulties in navigating financial markets is that significant influential factors don't necessarily happen that often. The closest thing to Covid was the Spanish Flu of 1918. Financial markets were quite different back then, and that's only one "similar" instance which was more than 100 years ago.

Statistics and science rely on testing to try and prove or disprove theories. And you want to test as much as possible to get a lot of data to support your conclusion. So, ideally, your "sample size" should be large. But that is an inherent problem when it comes to financial markets. Conditions are always changing, and even recurring events, like recessions, still don't happen THAT often.

So what do you do?

Quite honestly, the best you can, because the stakes can be high. In the 2008-2009 Great Financial Crisis, many people saw their 401k turn into a "201k" within months as the bulk of that -50%+ downturn happened quickly. Maybe that's not a big deal to a 25 year old, but it could be a huge deal for 65 year old. (obviously noting the "could be" here)

And statistically, you probably wouldn't have thought such a decline was possible since less than 10 years earlier we had a -50% decline with the Internet Bubble crash. I mean declines of that magnitude are pretty rare looking back historically, right?

So the LACK of large sample sizes of macroeconomic events make forecasting and planning challenging to say the least. Still, I believe there are some "universal truths" within the world of financial markets that can at least help guide us in various ways - supply/demand, valuation, economic activity trends, etc.

The goal is to gather as much of this kind of data as we can to help us make the best decisions we can. For example, The Beige Book is a report published by the Fed reflecting aggregated economic activity from all the various regions. It's published 8x a year to give us a pulse of what's going on outside of our own little bubble.

It's slipping below the 0.0 bound and also suggests a recession is coming. Ok, well, this is consistent with many other reliable indicators such as the LEI decline, the inverted yield curve, and rising unemployment.

And while the magnitude of the recession may be harder to gauge, the evidence continues to grow that the recession is still coming. Later than we all expected, but coming none the less.