One of the keys to successful investing is dealing with uncertainty. How do markets react when a big unknown event looms? If fear and doubt prevail, what opportunities are there for stocks? As Fisher Investments’ founder and Executive Chairman Ken Fisher has long expressed, high and rising uncertainty adds temporary headwinds for stocks because it discourages risk-taking. But the flip side—falling uncertainty—is often positive for stocks, even if the exact outcome might seem less than ideal.
While companies always deal with some degree of uncertainty, heightened uncertainty likely discourages risk-taking and investment. The more variables and unknowns they have to account for, the less easily they can plan for the future. When unknowns multiply and uncertainty is high, companies have a harder time planning and investing. If a change is forthcoming and the result unknown—inherently unpredictable—companies are stuck in limbo. The best they can do is plan for contingencies, taking strategic action when certain outcomes become more likely. Until the uncertainty clears, they are flatfooted—frozen in place.
Management is less likely to pour resources into a time-intensive and costly endeavor (e.g., build a new factory) that doesn’t pay out for years if the rules are unclear or could change. Put yourself in a business owner’s shoes. Say your product is a hit and you want to expand globally. Where do you locate a new production line? It may make sense to put a plant in your fastest growing end market. But what if there is a forthcoming election and one of the leading candidates advocates strict foreign investment policies that might make a new facility prohibitively expensive? Would you go ahead or wait for the election results? Firms likely take fewer risks when their future is unclear. Then, capital expenditure tends to slow or fall and growth can stall. Investors may also delay decisions until they get clarity, slowing market returns. Look no further than the uncertainties surrounding Brexit.
In turn, we think falling uncertainty is beneficial. In Ken Fisher (Trades, Portfolio)’s 2006 investment book "The Only Three Questions That Count," he explains: “When headlines are most dour and your friends and colleagues are bemoaning how terrible things are, you can be confident they will feel better later and sentiment will improve.” As time goes on, developments play out and head towards resolution. The result is falling uncertainty. This gives businesses the information they need to determine which long-term plans to launch. How did the election go? Is the winner pressing ahead with campaign pledges favoring domestic industries at foreign investors’ expense? Will their legislature go along? Forward-looking markets don’t necessarily wait for clarity to arrive—glimmers of probable futures will do. As odds form, investors can start assessing likely scenarios and have a better idea of what they will be dealing with—and they can plan accordingly.
Politics offer lots of examples, in our view. Two recent ones: The U.S. and French presidential elections. America’s 2016 presidential race drove a whirlwind of uncertainty. A stock market correction (sharp, sentiment-driven drop of around 10% to 20%) coincided with the chaotic Republican primary, as investors tried to reconcile Donald Trump’s outsider status, blusters and radical campaign pledges with his status atop party polling. But the correction ended in mid-February as he started winning primaries. Stocks improved throughout the spring and summer as he became the presumptive nominee. That doesn’t mean Trump was bullish. Rather, we think it demonstrates the benefits of falling uncertainty. Stocks knew what they would be dealing with.
Volatility resurged during the campaign’s home stretch, as state-by-state polling indicated the race was too close to call. But once the votes were in, and it became apparent Trump would be a president with only a narrow Republican Senate majority—including several senators who had spoken out against his campaign pledges—stocks again rose as the extent of the forthcoming intraparty gridlock became apparent. The rally was well underway by the time he took office and started hitting a wall with the separation of powers and a GOP Congress that didn’t fully back him.
Half a year after Trump’s election, France also seemed to many to be on a course-altering trajectory for its May 2017 election as rising populism gripped Europe and raised political uncertainty. Stocks fell in the run-up to the first round, which saw anti-euro nationalist Marine Le Pen take first place, upstart centrist Emmanuel Macron—a former finance minister—take second and all traditional parties shut out of the run off. Investors particularly feared Le Pen taking the country in a nationalist direction and potentially out of the euro, with devastating economic consequences. But soon it became apparent Macron had the edge in the decisive head-to-head second round, as supporters of other, ousted centrists threw their weight behind him. That raised the likelihood of a pro-euro, non-radical government. Accordingly, French stocks began rising well before the second round took place and cemented Macron’s win.
Getting the perfect outcome is secondary to falling uncertainty itself. This is something Ken Fisher (Trades, Portfolio) has stressed a lot lately, especially as it pertains to Brexit. A change may present uncertainty—an obstacle unfavorable for business—but once it becomes a known factor, companies can start planning for it and find ways to mitigate the impact.
Whether a particular development is better or worse for companies isn’t as relevant for markets as knowing the lay of the land—at least for the next few years or thereabouts. 2010’s Affordable Care Act (ACA)—America’s biggest health care reform in a generation—stirred strong feelings and stoked widespread uncertainty. It weighed on health care stocks especially, which underperformed for the better part of two years in the lead-up to—and aftermath of—its passage. The rancorous debate and numerous iterations before the ACA became law, and its rocky rollout and legal challenges afterward, didn’t help the sector’s outlook. But then a funny thing happened. In mid-2011, health care stopped lagging. The Supreme Court affirmed the ACA’s constitutionality in 2012 and Obama’s re-election seemed to establish its permanency. By 2013, health care stocks were outperforming. Business—and investors—had adapted to the new legal landscape.
Future uncertainty is a constant for business. But how much, and whether it is rising or falling, varies. That has a huge impact on markets and economies, as it affects businesses’ and investors’ ability to assess the future. This is something Ken Fisher (Trades, Portfolio) has observed throughout his long career: Investors should consider business leaders’ ability to cope and plan for obstacles when they consider major, potentially disruptive events.
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