The financial media is, as I have lamented here previously, largely an endless loop of recycled cliches. Most of them are categorically incorrect, such as a recent favorite, the idea that political gridlock is somehow good for the markets due to inaction from Congress. An even more pervasive concept reared its ugly head again around the time of the mid-term elections, and has actually been present during much of the rally off March 2009 lows. Pundits have harped on the fact that markets hate uncertainty. If talking heads repeat the same foolhardy phrases, they often become the perceived reality for a lot of traders and investors. But just like the idea of gridlock, the evidence just isn’t there to support the idea that markets abhor uncertainty. In fact, it is quite the contrary.
Take a look at periods in the market when there was a high degree of certainty. During the dot-com boom, traders were certain tech stocks, regardless of earnings, would climb endlessly higher. Before the housing bubble burst, investors were certain that their money was safe in real estate. It is this herd mentality that gets a lot of investors in trouble. The best investors, the Warren Buffets and David Teppers of the world, for example, look for heightened opportunity during uncertain times. Both aggressively bought the battered financials in 2009, taking advantage of an overreaction to ‘uncertainty’. As Barry Ritholtz says, “uncertainty drives the market’s price-discovery mechanism.” When the herd becomes fearful and hesitant to buy in the face of uncertainty, that is when you should look to be most aggressive as a long-term investor. From Ritholtz:
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.
Since July, when the Era of Uncertainty began, the Morgan Stanley Cyclical Index — those businesses most closely tied to this uncertain economy — is up 26 percent.
Want some certainty? Go buy yourself Treasuries. You can pick up a very lovely two-year bond yielding 0.41 percent. (Good luck charging two and 20 on that!)
Money has flooded out of equities during this entire rally, with risk-averse investors instead choosing the historically low returns offered by bonds. Each time the market has had even a modest pull-back, bears have called for a double dip or harsh correction. The endless cliche loop from CNBC and others played a part in causing investors to miss out on the buying opportunity of a lifetime in equities over the last two and a half years. Around election time, the topic of uncertainty resurfaced. What the media failed to realize was that this market cared naught which party controlled Congress, and last week turned out to be another opportunity to buy as the herd presumably retreated from longs under the false pretense of ‘uncertainty is bad for the market’.
Uncertainty and risk are still high, but it feels like investors are starting to return to equities after seeing the paltry returns of their fixed income investments relative to stocks. Another manifestation of uncertainty has been the precipitous rise of precious metals. Investors, including myself, have piled into Gold and Silver due to currency uncertainty. People are becoming more and more certain that precious metals will go to infinity, and as that sentiment grows, I will start to become more cautious. We have a long way to before there is any degree of certainty in the currency market, stock market or economy, but be wary of that day. When certainty reigns, that is when bloodbaths take place.
Kiss Your Assets Goodbye If Certainty Reigns
Bloomberg, Nov 9, 2010 9:00 PM ET
*Disclosure: Long SLV and DGP