One of the more banal and annoying statements we hear whenever share prices fall is that ‘markets hate uncertainty’. It gives the impression that the stock market would be fine if only things weren’t so uncertain.
The market deals in uncertainty. It is a discounting mechanism, constantly looking into the future, which is of course unknown.
True, in the past decade or so the Fed and other major central banks have tried to take uncertainty out of the equation by becoming the lender and buyer of first, last, and any resort.
The perception is that risk is lower. Things are not so uncertain because the market knows (or thinks it knows) that there will always be a rescue, a bailout, a helping hand.
But then something happens…a small and tragic event morphs into something much more significant.
On 17 December, a fruit vendor in Tunisia burned himself in protest of police harassment. This sparked a countrywide uprising, which has now spread to Egypt and other parts of the Middle East.
You can keep a lid on a simmering pot but once it starts to boil, the lid falls off. Egypt is beginning to boil. A one million-person march is planned for Tuesday. The aim is the overthrow of President Mubarak and his 30-year reign.
What comes next is anyone’s guess. The trajectory of Middle Eastern politics is impossible to predict. Uncertainty has emerged from the shadows.
The equity market isn’t too perturbed just yet. But the oil market is nervous. Brent crude is now trading just over $100 per barrel. Could the fragile Kingdom of Saudi Arabia be next to experience widespread unrest? Oil might just be preparing for that chance.
Emerging market bulls take note. Easy money policy in the west has caused agricultural prices (wheat, corn, rice, cotton etc) to spike and poor countries to revolt against these price rises. Now, with oil breaching US$100 and set to move higher, energy prices will bite into what little incomes are left over.
The last time we experienced food and energy price riots was in 2008 when commodity prices peaked. We are probably close to a similar inflection point.
If we are, no one seems to be taking much notice, not in the equity market anyway. After experiencing a one-day panic (uncertainty) on Friday, Wall Street has shaken off its Middle Eastern blues and is back in rally mode. Faith in ‘the Bernak’ is supreme.
The Aussie market is doing it tougher though. ‘The Steven’ isn’t as accommodating as the Bernak. Aside from resources, the rest of the economy is struggling along in near recessionary conditions.
But that’s not stopping the market moving grudgingly higher. After all, nearly all the experts are certain that share prices will on average finish the year anywhere between 10-20 per cent higher than what they started.
There’s no such thing as uncertainty when highly paid investment strategists need to impart their early-in-the-year ‘wisdom’ on the investment masses. Their jobs depend on it. What’s surprising though is that so many investors lap it up, year after year.
Dylan Grice, a strategist at Societe Generale provides a nice antidote to market groupthink and certainty of opinion. In a recent note to clients, he comes out and says what everyone in the industry knows, but is too scared or full of hubris to say:
At this time of the year we’re supposed to give our predictions for what’s in store for the year ahead. The problem is I don’t have any. Not because making forecasts is difficult. It isn’t. It’s just pointless.
Instead, I suggest getting in touch with our inner Kevin Keegan, the hapless former England football manager who, facing the sack after a bad run of results famously lamented “I know what’s around the corner, I just don’t know where the corner is.”
The more people construct portfolios on the assumption that they can see the future, the greater the opportunity for those building portfolios which are robust to the reality that we can’t.
And this classic:
In financial markets, craziness creates opportunity. It affects only prices, not values. And one of the craziest afflictions I know of is our faith in our ability to see the future. Indeed, there isn’t even an appropriate opposite to the word ‘foresight’ in the English language. So I’m going to make one up. And rather than build a portfolio based on the pretence we have foresight, let’s explore some ideas for building one that is robust to our foreblindness.
Events in Egypt this week are stark proof that we have no idea what lies ahead.
In the investment game, you would do well to think like George Costanza from Seinfeld. That is, as a way to get ahead, do the opposite of what your instincts tell you.
While nothing much worked for George, with discipline such an approach can work for you. When there is perceived certainty in markets, when you feel most comfortable with your investments, there is little to no value. Stocks are no longer cheap.
But when an event triggers the realisation that uncertainty is the norm, hubris swings to humility. Prices come down and value emerges for those brave enough to buy.
Here’s to uncertainty.
For Markets and Money Australia