There’s nothing new about uncertainty

Back in fall 2010, one of those absurd memes began circulating in think tanks, on the Internet and around trading desks regarding the impact of uncertainty. “Oh no!” declared pundits. “The economy cannot recover so long as it is racked with uncertainty.”

Not coincidentally, the first go-round was right before the midterm elections in the United States. The “uncertainty trope” is back again, and — what a surprising coincidence! — during another election year.

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Indeed, Google Trends reveals that there is a pattern to the media use of the term “uncertainty.” It starts high in the beginning of the year, as media outlets trot out their year-in-preview pieces. It hits its nadir over the summer as families vacation and the latest fun and sun articles are de rigueur. It ramps up to a distinct peak in October and November, just as voters head to the polls in state, local and federal elections. In a fairly evenly divided country, there is surely uncertainty about election contests. Then it bottoms out around the holidays. While you may not know what you are getting for Christmas, Google’s not high on “uncertainty” either.

Uncertainty has become a news media darling since 2008. The recession, credit crisis and market collapse drive lots of interest in the idea.

It does not take much deep thought to recognize the utter nonsense of this. Anyone complaining about a lack of certainty — in policy, in the economy, in markets or even the weather — simply reveals how little they understand about all of these things.

From the investor’s perspective, markets require uncertainty to function. Indeed, they thrive on doubt, imperfect information and a lack of consensus. Uncertainty drives the market’s price-discovery mechanism. Investing requires differences of opinion, for when there is broad agreement about an asset’s fair value, trading volume falls.

Without uncertainty, who would take the opposite side of your trade?

History teaches us that whenever the opposite occurs — when groupthink and consensus overwhelm doubt — the herd tends to be embarrassingly wrong. In those rare instances when there is a near-total lack of uncertainty in the market, the outcome usually is a spectacular disaster.

Think of the false certainty surrounding the peak of the dot-com bubble (profits don’t matter!), or the nadir in March 2009 (the abyss awaits!) to validate just how true this is.

Indeed, during the dot-com era, everyone knew that profits no longer mattered — it was all about eyeballs and clicks! With uncertainty banished, an epic crash followed.

After that implosion, the pendulum swung to the opposite extreme. There were lots of profitable, debt-free tech companies trading for less than book value. I recall that the stock of MicroMuse, a former high-flying telecom that had traded for more than $200 at its peak, was trading at $1.43. That was less than the $2-a-share cash it had on its debt-free balance sheets and far below its $3 book value. Investors had become certain that a dollar was worth only 75 cents. (IBM eventually bought MicroMuse for more than $10 a share).