In These Uncertain Times

I am far from being a long-tenured veteran of the financial services industry. In 2007, when the last big drop in financial markets began, I was studying mechanical engineering on a full athletic scholarship. I have no recollection of worrying about the market; all of my expenses were covered as long as I met my athletic and academic obligations (which I did). As far as I could tell, I had financial certainty in my life. 

How blissfully ignorant was I?

Uncertainty is a constant. It is a constant in general, but it is like a spectator sport in the case of the financial markets. Uncertainty shows up immediately in prices. That can be scary. Humans struggle with the idea that there are more possible outcomes than we can plan for.

Making matters worse is our tendency to focus on recent events while largely ignoring the past. One of the most common themes that I hear from other people is the constant feeling that right now is exceptionally uncertain. 

It’s hard to say whether times are more or less certain now than they have been in the past. As much as we try we can’t measure uncertainty. Nassim Taleb explained it elegantly in Antifragile:

Man-made complex systems tend to develop cascades and runaway chains of reactions that decrease, even eliminate, predictability and cause outsized events. So the modern world may be increasing in technological knowledge, but, paradoxically, it is making things a lot more unpredictable.

An annoying aspect of the Black Swan problem— in fact the central, and largely missed, point —is that the odds of rare events are simply not computable.

A proxy for uncertainty in financial markets might be volatility. It is far from a perfect proxy, but if there is a perception that the future holds more risk, asset prices may drop due to increased discount rates. To see if we are living in exceptionally uncertain times as measured by volatility we can look at the historical standard deviation of the US market by decade.

1926 33.49
1936 21.23
1946 12.83
1956 11.71
1966 16.49
1976 14.84
1986 14.98
1996 16.15
2006 15.35
2016-present 8.98

Data Sources: Data source: Dimensional Returns Web, CRSP

It is clear that market volatility has been relatively stable through time. Each of these decades has seen trade disagreements, political scandals, wars, or recessions. Each day in the past, at the time, felt as uncertain as tomorrow feels today.

Today we have less volatility than past decades. This does not tell us much about current or past uncertainty. What it does tell us is that it might not make sense to expect more or less market volatility based on what we perceive as uncertainty today.

Delaying investing due to the feeling of uncertainty is not rational. Uncertainty is exactly why any investor expects a positive long-term return.

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