I wish I had a dollar for every time I heard the word “uncertain” over the past few days. If we included synonyms, this could be a windfall. At least I didn’t propose a drinking game involving the term – that would be downright dangerous!
Any experienced market participant knows that uncertainty is inherent to markets. Investors and traders are constantly attempting to balance risk and reward, and risk is, of course, another way to express uncertainty. We can try to mitigate risk, either by moving to safer investments or hedging exposures, but we can’t fully eliminate it. Even assets with guaranteed nominal returns, like T-bills or CDs, risk losing purchasing power in real terms. Nothing in life is guaranteed (except, of course, death and taxes).
The concept of uncertainty came up quite often for me last night. I had dinner with a group of friends, some of whom have vast financial markets experience, others who make their livings in a variety of other fields. We do this monthly, and while it is a purely social gathering (and part of our never-ending quest to find the best steaks in NYC), comments about markets and politics occasionally intrude amidst the preferred discussion topics of sports and comedies.
On our way to the restaurant, I shared a car that included a bond portfolio manager and a senior hedge fund executive, both of whom retired early after successful careers. I was hoping to glean some clarity about the path forward, and they were hoping to get some from me. Perhaps we might have come to a better conclusion if we’d hit more traffic, but our trip went more smoothly than we’d planned (congestion pricing seemed to be working), and instead we bemoaned the difficulty of navigating the current environment. The consensus was that the murky environment meant that diversification and portfolio risk management were as important as ever.
Amongst those who later joined us at dinner was an experienced merger arbitrageur. He was glad that some of his key positions were coming to successful conclusions, but he bemoaned the lack of deals in the pipeline. His conversations with other dealmakers and bankers implied that they are having immense trouble determining which combinations might make sense, given the uncertainty that companies themselves are reckoning with. I asked whether there could be some extra risk regarding private equity, considering that their positions are rarely marked to market and that the IPO pipeline, which seemed ready to open, has slammed shut. That risk was not dismissed, but it seems to be a back burner issue right now.
The comments about corporate uncertainty have been echoed frequently during the current earnings season. During earnings calls, we all listen eagerly for a company’s guidance, knowing full well that those offering it are doing their best to bring clarity to their investors based upon their assessments of the risks and rewards that face their businesses. Unfortunately, the ever-shifting tariff situation makes it quite difficult even for seasoned managers to offer clarity. A wide range of companies, including Pepsi (PEP), IBM, Chipotle (CMG), Southwest Air (LUV), Unilever (UL, ULVR) and Canon (7751), referenced the uncertain environment in their earnings calls. Some, like PEP and IBM, are getting hit hard this morning, but some of the others, like CMG and LUV, are not. That is a testament to the resilience of investor sentiment.
Remember, when sentiment gets bad enough, there is no place to go but up. That appears to be the message of the markets over the past three days, and it is causing traders to embrace risk once again. The broader question is whether that can persist once the oversold conditions dissipate. While this week’s rallies have moved stocks in the direction that most people favor, they have still pushed markets to a degree that would have been highly abnormal just a few months ago. “Socially acceptable volatility” is still volatility. Don’t forget that market volatility reflects uncertainty, and neither is in short supply right now.