Foster Group

"The problem, of course, is essentially one of human emotion. We are essentially somewhere between Armageddon and  Nirvana"
David Rosenberg, Chief Economist at Gluskin Sheff as cited in Bloomberg Businessweek, June 20, 2010

Things are certainly uncertain! 

I don't know about you, but everyday the "news" seems to provide less clarity about the future and what to expect than the day before.  Whether we're talking health care policy, tax rates, soundness in the world banking system, employment, housing, oil spills, where LeBron James will play basketball (Miami) what we mean by "financial regulatory reform"... well, you get the picture.  It's a little like Iowa weather, if you don't like it, just stick around for a day or two, I'm sure it will change!

A few weeks ago, I penned a short article about how in times of great disruption there is potential great opportunity.  As we've experienced the return of greater intra-day volatility to stock markets (May and June daily volatility in the S&P 500 was double what we experienced in March and April) I believe we can see that this disruption has created a "hangover" called uncertainty.  Our uncertainty is expressed through wild swings in market indices from day to day, or even within the same trading day.  Every little bit of information is parsed and pored over to see if it holds the key to the return of economic growth or is the harbinger of ultimate financial disaster.

Of course the truth (as we all know in our more sane moments) is that the world is a very complex place and no single piece of monthly financial data is going to save or sink our economic ship.  But we're led to feel like it may, because that's the nature of our news cycle, which reflects and plays to our human nature as well.  We want more certainty, even if it's negative because then we will KNOW what's going to happen next and we'll KNOW what to do.

But, as an investor, don't we really need some uncertainty?  When an outcome is certain (or very close to certain) there is little risk present.  If you purchase a 30-day Treasury Bill, you'll be paid very little interest.  Why?  Because no one (well, at least very few people) expect the US Government to default on its debt in the next 30 days.  Where there is very little risk (uncertainty), there is very little potential return.

However, if you're buying shares of BP right now, the success of your investment five years from now is far less certain.  The Gulf oil spill could bankrupt the company in claims and litigation.  Or the problem leak could be plugged in July or early August, and in eighteen months BP could be back to paying dividends and making relatively large profits.  So, what will happen?  It's uncertain and that uncertainty means the range of possible outcomes is very wide.  This also explains why BP's stock price has fallen so far, so fast.  Investors are unwilling to pay a high price for taking on such risk, such uncertainty. 

If BP returns to financial strength, those brave souls who are buying the stock today will be rewarded generously.  If it goes into bankruptcy, those same brave souls may be called "foolish" for making such a bet.  In either event, it's the uncertainty that presents the opportunity.

On a larger scale, this is what investors are faced with in terms of general stock market investing.  Instead of an oil spill affecting one company, we've had a financial crisis affecting many companies and countries.  So, the question is, five or ten years from now will we look back and see a cleaner Gulf of Mexico as well as a clearer economic environment?  History supports the idea that we'll find solutions to problems like the ones we are facing today, whether oil spills or economic disruption.  When will we find the solutions?  That's entirely uncertain.  And therein lies the opportunity!