"When the mind is in a state of uncertainty, the smallest impulse directs it to either side." Publius Terentius Afer, better known as Terence (c. 185BC - 159BC)
It is important for the prudent investor to understand there is a difference between risk and uncertainty. Risk is quantifiable and can be priced into the value of a security. Uncertainty is not quantifiable, mostly misunderstood, and, well, not certain. There is no doubt, however, that uncertainty is no friend to the stock market. What's more, when risk is perceived to be lower, investors tend to assume more of it, making themselves more vulnerable to uncertainty. "Herd mentality" tends to enhance this, as we saw this week in Pamplona Spain with the "running of the bulls" as well as the running of the stock market bulls this week...
After commenting on lurking uncertainty earlier in the week, more events unfolded that arguably increase the potential for dangerous levels of uncertainty next year. For those who believe stocks to be a discounting mechanism, the current earnings season will mark a shift to earnings expectations for 2008 where the bulls are certain to run into many hurdles:
- Wall Street got smacked this week then rebounded to record highs. Will the psychological level of 14,000 on the Dow add to enthusiasm for stocks or will it fuel the flames of uncertainty?
- The worst retail sales in 2 years could be signaling that consumers are slowing their spending.
- There is increasing uncertainty over interest rates, which are unlikely to fall any time soon.
- Higher oil prices appear inevitable as $80 per barrel looms.
- Is Al-Qaeda strength back to pre-911 level?
Other big picture issues are sure to compound the uncertainty level:
- As 2008 elections draw closer, more Republican dissenters on Iraq policy are likely to shift their bias to a troop draw-down/redeployment/withdrawal for next year...
- Research shows that the third year (2007) of a presidential term is always positive while uncertainty peaks in the months leading up to the election (2008).
- The first and second years (2009, 2010) of a presidential term are typically losers, especially for the riskiest of stocks.
- With no incumbent President or Vice President running, the uncertainty over an entirely new White House administration should prove a challenge to the equity markets.
- On a totally different note, the oldest of the largest segment of the U.S. population, the "baby boom" generation turns 62 in 2008. Will they begin to draw down stock positions as they begin to retire or in anticipation of retirement? Will their own uncertainties regarding their retirement be compounded by all of the other uncertainties already piling up?
The nature of stocks, and the risk and uncertainties attached, is one of randomness. The only thing the prudent investor knows for sure is that there is nothing that can be known for sure. Since the beginning of time, humans have attempted to define uncertainties and to control things that are not controllable. We can define risk and even control it to varying degree; however, uncertainty must be respected, accepted and, most importantly, expected. Otherwise, the focus centered on controlling the risk will make us lose sight of the inevitable uncertainty lurking around the corner...
TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a 'fee-only' Registered Investment Adviser firm located in Mt. Pleasant, SC.
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