Why does the stock market hate uncertainty so much? Uncertainty limits the market’s ability perform its core function, which is to put a price tag on each stock.
Take the example of the Japanese nuclear situation, particularly the way it was presented last week. How could an investor put a price tag on a stock if the odds of a nuclear meltdown in the third largest economy of the world were as high as it appeared then.
One could do a similar scenario analysis for the Middle East. It is not clear at this stage how the situation in this key region will unfold over the coming weeks and months. What if the coalition’s air campaign does not unseat the Libyan regime? Can the Saudis maintain their domestic stability even as regimes in neighboring Yemen and Bahrain appear vulnerable? These are hardly academic questions. They have a direct bearing on the price of oil and, as a result, on our economic outlook.
In the long run, stock prices should reflect the underlying fundamentals of those companies. The mother milk of stocks, as they say, is earnings. Not just current earnings, but the outlook for earnings. But the relationship between the stock’s price and its fundamentals breaks down in times of uncertainty. While the typical investor flees at the first sight of uncertainty, savvy ones are looking for just such opportunities. We have seen this time and time again, including last week.
The market’s collective nervousness appears to have eased in the last few days as the Japanese nuclear situation has stabilized. But there is no shortage of clouds on the horizon. It will not be long before anxieties return for one reason or another. Investors who don’t get swept up by the fear and emotion of the moment come out ahead of the pack.