The Investment Scientist

Living with uncertainty

Posted on: April 15, 2010

[Guest post by Tom Warburton] Last week a buddy walked into my office distressed over unemployment, the economic malaise, gold prices, the prospect of inflation, government debt, currency fluctuations, trade imbalance and future prospects for the stock market.  He basically covered the waterfront of issues we see on the front page of financial magazines and issues we hear talked about on CNBC.

When my buddy left my office (somewhat soothed – I believe – in the knowledge that his portfolio was positioned to achieve his financial goals without regard to the speculations of Jim Cramer), I found myself thinking about the many obstacles that humans have overcome and the unlikelihood that ‘conditions will last’.

In the words of John Allen Paulos, Professor of Mathematics at Temple University and versatile author with books on a wide range of philosophical topics:

“Uncertainty Is The Only Certainty There Is, And Knowing How To Live With Insecurity Is The Only Security”

Seasoned observers of financial markets and capital market investors know that a predisposition to worry about one thing or another is instinctual. What’s not often apparent is how quickly worries are factored into security prices and how rapidly the narrative changes.

Recent fretting points for investors, in addition to those noted by my buddy, include default risk in southern Europe, the threat of China’s economy over-heating, the dependency of risk assets on government stimulus and the implications of proposed regulatory reforms in the health care and banking industry.

A fair observation for the majority of hot-button financial and economic issues is that “by the time you read about them in newspapers and magazines, the markets have moved onto worrying about something else”.

Greece is an excellent recent example. A search of Bloomberg for the words “Greece and default” yielded nearly 300 news stories in the month of March. The subject of these articles ranged from the “ying” (fears of outright default) to, by the end of the month, the “yang” (news of a strengthening Euro as Greek fears receded).

If one searched Bloomberg for “stimulus”, more than 600 news articles appeared in March, ranging from Brazil’s attempt to lure investors with governmental stimulus (infrastructure spending) to news that Japan’s retail sales were growing at their fastest pace in 13 years, thanks partly to government stimulus.

Today we benefit from, and are sometimes cursed by, rapid global information flows.  Aided by web-based distribution, news is incorporated into security prices almost instantly. A geopolitical development like a bomb blast in a Moscow subway, economic news such as an agreement on a bailout for Greece or company-specific news like a Chinese firm buying Volvo from Ford all find their way into prices before the average person is aware it has occurred.

Is it a surprise to know that investors err by tinkering with their portfolios based on information that is already reflected into securities pricing? Is this like chasing a moving target or trying to catch a falling sword?

No sooner have you pondered, for instance, the implications of Y2K or the SARS virus on your portfolio than the market has decided that this issue is a flash in the pan and has gone onto worrying about something new.

A more useful approach is to accept that markets are extremely efficient at incorporating fresh information into prices and that trying to second guess how the markets will react to today’s news is hazardous to your wealth.

An Australian Financial Advisor developed a useful technique for dealing with queries from clients regarding their portfolios and the capital market implications of whatever issue is currently dominating the financial media headlines:

  • To Be Completely Honest, I Don’t Know What The Implications Are
  • But I Can Tell You This: It Won’t Last.
  • Now Let’s Talk About Your News.

This is a healthy approach to responding to news that’s dominating the markets.  Concern yourself with your personal values, goals, needs, resources and obligations.  Make changes when your personal situation changes and ignore “The Noise”.

The economy, headlines, and governmental policy – well, they are all interesting.  They are topical, they are forever changing.  However, let us remain mindful – they are beyond our control, there is very little we can do about them and, if our portfolios are purposefully constructed, they do not necessitate action on our part.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

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