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.
Read the whole thing as it is very worthwhile. Ritholz is surely right; it is the times of market certainty – such as right now as a matter of fact – that bother me the most. Right now, investors seem quite sure of a few things:
- Emerging markets: Everybody seems to want to own or wants to tell the CNBC audience that they already own and you should too, something emerging markets. Stocks, bonds; doesn’t matter as long as it can be called emerging markets. The emerging, emerging markets are even sexier.
- Bonds: Government bond funds are the safe and sure bets.
- The US Dollar: The US dollar is doomed and on a one way trip to palookaville.
- Commodities: Because of 3 above, the dollar price of all commodities must rise.
- Quantitative Easing: QE II will proceed as expected and on schedule.
There are reasons why things might not go as expected but these are just guesses:
- Emerging markets: These economies are hot because US monetary policy is causing capital inflows. Their governments are trying to limit inflows through various methods but are mostly unsuccessful. Many of these countries are experiencing inflationary booms. When the inflows stop, so will the booms. When and why that happens, I don’t know.
- Bonds: Long term government bond yields have already started to rise. Assuming QE II is successful in raising inflation expectations, that is not compatible with lower bond yields (higher bond prices). Bond buyers may be irrational but higher inflation will open their eyes.
- The US Dollar: It is obvious that the Obama administration, like the Bush administration, wants a lower dollar. That doesn’t mean they’ll get it. Maybe higher bond yields attracts capital back to the US. Maybe the politicians get their act together and actually enact some decent economic policy. Hey, it’s a long shot but not impossible.
- Commodities: If the dollar doesn’t fall, a lot of money will come out of commodities because that’s the only reason it’s there.
- Quantitative Easing: I’m not convinced it will do anything for real growth even in the short term. The more likely outcome would seem to be inflation of commodity prices. At what point will the Fed pull the plug on QE II? Oil at $100? At what oil price does the drag of higher oil prices put us right back in recession? What does the Fed do then?
QE II has inspired the meme that all asset prices must rise because the dollar must fall and so far that has been a good bet. It isn’t that simple people.