In the aftermath of the election and Brexit, market participants have raised a familiar question, “There is so much uncertainty. Should we simply sell everything until things become ‘a bit clearer’?” This question isn’t unique to this election or Brexit. The same question was asked in the last five years (and every year before that) in 2011 (downgrade of the US debt rating, contagion in Europe), 2012 (fiscal cliff debate, US Election), 2013 (government shutdown, debt ceiling standoff, QE taper, sequester), 2014 (emerging markets currency crisis, Russia’s annexation of Crimea), and in 2015 (oil prices, Swiss currency cap removal, Chinese currency devaluation).
Uncertainty is always present. In habitual routines of life, people don't think about the ever-present uncertainty until a non-routine event reminds them of it. Uncertainty was present on November 11, 1963, the day before JFK’s assassination. It was present on December 6, 1941, before Pearl Harbor, it was present on October 17, 1987, the day before the stock market fell 23% in a one day, and also on September 10, 2001. It was also present the day before Brexit and before the recent election. All of the factors contributing to these developments were present. Market participants simply didn’t ‘feel’ uncertain as they had assigned a low probability to such events and they had been right in the past. Then a seminal event forced recognition of the fact that we do not truly ever know the future.
Further, it is often an event perceived as negative which reminds people that the future is always unclear. An uncertainty which positively breaks our way doesn’t cause our stomachs to drop. As an example, if GDP and corporate earnings rise terrifically, and stocks go up 40% many people would be happy. But that positive surprise does not invite the same level of gut sinking induced by stocks falling 40%, even though both occurrences deviate from expectations. The human brain seems to be wired this way. Thus, in the aftermath of something seen as negative, feelings of uncertainty are much stronger. In fact, one is least likely to consider ‘uncertainty’ when the going is very good.
Since uncertainty is always present, it is no more (or less) important to consider uncertainty now than at any other time. However, to respond to uncertainty does not require heroic forecasting ability or towering intelligence. In fact, I do not know of any one person who forecasted all of the above events. Even if someone had seen them coming and sold all of their investments, they would have paid a huge opportunity cost as the market today stands higher than at the time of all of those events. So predictions were not only difficult but unnecessary and totally unproductive.
The solution, in my view, is to quit forecasting and to accept that the world is always uncertain. The way to protect oneself is to fight the always-present uncertainty with an always present margin-of safety (buying a $1 for 50 cents rather than 98 cents). Margin of safety is the real protection against uncertainty. A margin of safety serves as a shock absorber for investments. That is not to say that prices of investments couldn’t temporarily go down. But a permanent loss of capital is avoided with a sufficient margin of safety. If we consistently buy with a margin of safety and stick to areas that we understand, then prosperity truly is around the corner.
To be sure, if particular policies of a new administration or new agreements drafted by Britain have any bearing on a particular company, they need to be considered in its valuation. But I’m advocating against a large scale shuffling (buying or selling) of equities based on some feelings regarding the unknown. It is better to simply buy when a security is available with an adequate margin of safety and sell when warranted by valuation or management factors.
I will conclude with an example. In 2006, MasterCard went public and anyone could purchase the stock for a split-adjusted price of $4.6. All of the attractive aspects of MasterCard's business are well known so I won’t repeat them here. Let’s say a prescient investor had seen the great financial crisis coming and avoided purchasing the stock which was reasonably priced in 2006. Such an investor paid a truly huge opportunity cost. Even at its recession lows, MasterCard stock was more than triple its 2006 price. As of this writing, it stands at a whopping 23 times its price in 2006 for a compounded annual total return (including dividends) of about 35.2%, compares to 7.5% for the S&P 500. This is despite all of that ‘uncertainty’ of the intervening 10 years!
