Market Uncertainty

Barry Ritholtz on market uncertainty via Bloomberg. {Excerpt with my highlights. }

“The markets hate uncertainty.”

If you wandered anywhere near a television in advance of the midterm elections, the Federal Open Market Committee meeting or October’s employment report, that cliche was unavoidable... Wall Street has a sweet tooth for such investing maxims.... Repeat mindless dictums ad nauseum, and they soon become the accepted wisdom.

The problem with these supposed truisms is they are no more accurate than the flip of a coin. A closer look at this uncertainty meme reveals it to be a false-ism -- one of those emotionally appealing phrases that ping around trading desks. The lack of evidence supporting their premise seems to matter very little.

To recognize how meaningless these statements are, consider the opposite: Could markets function without uncertainty? It takes only a little thought to realize that markets actually thrive on doubt, imperfect information and a lack of consensus.

Uncertainty drives the market’s price-discovery mechanism. Investing requires there to be differences of opinion. When there is broad agreement as to an asset’s fair value, trading volume falls. Without any uncertainty, who would take the opposite side of your trade?

History teaches that whenever the opposite occurs -- when certainty overwhelms uncertainty -- the herd tends to be wrong. In rare instances, when there is a near-total lack of uncertainty in the market, the outcome is usually a spectacular disaster....

Recall the dot-com era....An epic crash followed. After the Internet implosion, the opposite extreme was operational: Profitable, debt-free tech companies were being traded for less than book value. In a few rare instances, they were being sold for less than cash on hand... There was little uncertainty heading into the March 2009 stock-market lows. Almost everyone was sure the world was falling into the abyss...... How did the consensus work out in that instance?

When we discuss uncertainty, what we are really discussing is risk. All unknown outcomes contain risk, and therein lies the possibility of loss. Risk is inherent in the concept of uncertainty. However, anyone looking for performance must embrace risk, for without it, there can be no reward.

Uncertainty is what makes alpha, or market-beating gains, possible. Smart traders know that uncertainty is where the money is. No uncertainty, no risk; no risk, no possibility of outperformance.....Want some certainty? Go buy yourself Treasuries. You can pick up a very lovely two-year bond yielding 0.41 percent.....

The future, by definition, is unknowable. Investing involves making our best guesses about the value of an asset at some point after this moment in time. There will always be an element of uncertainty involved. We can discount various outcomes, engage in probabilistic analysis, but no one knows for certain what tomorrow will bring.

Those who claim to know fail to understand the most basic workings of markets. We need only consider the track record of Wall Street’s prognosticators to know the truth in this statement.... Pundits may hate uncertainty -- it tends to makes them look foolish -- but markets harbor no such bias. In fact, markets thrive on uncertainty. It is their reason for being.

(Barry Ritholtz, author of the book “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy,” is the chief executive officer of Fusion IQ, and blogs at The Big Picture. The opinions expressed are his own.)

Link:  Kiss Your Assets Goodbye If Certainty Reigns