More Uncertainty Ahead?

“The future is messy and the past is neat. It’s always like that.” – Seth Godin

Check out this CNN Money headline from earlier this week:

What’s Congress going to do now? Will there be a war in the Middle East? Is there going to be another government shutdown? Where will the next black swan come from?

Sound familiar?

The financial media loves to discuss uncertainty. Scare tactics always seem to suck viewers in. Financial news programs love to bring on market experts to try to guess what will happen next. It’s much easier to discuss how uncertain things are currently than to suggest that the future is always uncertain.

Uncertainty about the future always seems much worse right now than it was in the past. Then after some time passes, it’s easy to think that past events were much easier to predict than they actually were.

Of course stocks were a great buy at the bottom.

It was obvious the market was going to crash.

It’s easy to see that Google was a great buy at the IPO price.

The ability to look back on the past and assume it was nice and neat is our hindsight bias in action. Here’s Daniel Kahnemen on this subject:

“Hindsight bias makes surprises vanish. People distort and misremember what they formerly believed. Our sense of how uncertain the world really is never fully develops, because after something happens, we greatly increase our judgment of how likely it was to happen.”

That’s why the past always seems so obvious while the future seems so scary.

While we do stand at a precarious moment what with central bank intervention around the globe, stocks at all-time highs, interest rates near all-time lows, high unemployment and dysfunctional politicians, this is actually how the world works.

It’s not going to be easy this time because it never is. Investors have always been faced with uncertainty. The reason that you are able to earn higher returns on risky investments is because there is always an uncertainty premium that you must be willing to accept.

Investors dislike uncertainty because it is impossible to measure.  There are plenty of ways investors measure risk through mathematical formulas and such for things like volatility, risk-adjusted returns and probability distributions.  But you can’t put a number on uncertainty.

That’s why I favor risk management over risk measurement.

It’s how you react to uncertainty will determine how successful you are at building wealth.

You can either (a) try to constantly forecast what you think is going to happen next and make your decisions based on those low probability short-term forecasts or (b) make your decisions based on a historical context by thinking long-term and avoiding the guessing game of what will happen tomorrow, next week or next month.

I like my chances much better with option (b).

The only certainty you will find in the markets is a lack of certainty.

Source:
Uh-oh! Investors face more uncertainty (CNNMoney)