The point of maximum uncertainty

In this most unpredictable of years, is today the point of maximum uncertainty? As you read these words, the list of things we don’t yet have an answer to is long and daunting. We don’t know who the next President will be; we don’t know if Brexit will come with a deal or no deal; we don’t know when a vaccine will be found.

All three of these feels like a big gap in our knowledge as we try to make sense of the world and, as investors, attach the right price to it. One of them might be resolved this week (perhaps not, let’s see which way those key marginal states fall tomorrow). One will certainly be clear by the New Year - the timetable for Brexit, if nothing else, is fixed. An effective jab might be a slightly longer wait.

There’s a string of other known and unknown unknowns too, to use Donald Rumsfeld’s misunderstood taxonomy. Earnings season is turning out better than many analysts feared, but it is still early days. The ECB (European Central Bank) is keeping its stimulus powder dry until next month. There is still so much we don’t know about the coronavirus. But one by one, these clouds of uncertainty are going to start lifting from here.

It is often said that markets hate uncertainty. That’s not true. Markets require uncertainty to create the tension between buyers and sellers. But investors certainly dislike the absence of a crystal ball. It’s why the VIX volatility index, Wall Street’s fear gauge, spiked higher last week as shares suffered one of their worst days since the spring. It’s also why the UK stock market has performed so much worse than most of its peers - there is less certainty here than in most places right now.

Humans don’t handle uncertainty well. It induces fear and, as Bertrand Russell said, neither a man nor a crowd nor a nation can be trusted to act humanely or think sanely under the influence of a great fear….to conquer fear is the beginning of wisdom.

Jason Zweig, in his excellent book Your Money and Your Brain, describes an experiment conducted by Daniel Ellsberg, a psychologist who in a subsequent life leaked the Pentagon Papers to the New York Times. He showed participants two urns, telling them that the first, call it Urn A, had 50 red balls and 50 black ones. Urn B, he said, also had 100 balls but the balance of red and black was a secret.

The deal he proposed was that those taking part in the experiment would win $100 if they picked a red ball from either urn. Most people picked from Urn A. No surprise - people prefer odds they understand. He then repeated the offer, but this time the $100 was paid if a black ball was picked from either urn. Guess what - most people picked from Urn A again.

This made no logical sense. If you picked Urn A for the red ball, by definition you thought that Urn B had fewer than 50 red balls and so more than 50 black balls. So why would you not go for it when looking for a black ball. The reason is that Urn B was overflowing with ambiguity. Just like the world and the markets this Monday morning, the day before the Presidential election, with the European diplomats locked in their Brexit tunnel and Covid infections soaring.

The neuroscience of fear is perfectly suited to keeping us alive and well, but less good at helping us make good investment decisions. The speed with which the amygdala fires up our brains at the slightest hint of something new, unexpected or scary is a great survival tool, but the only person who benefits from your reflexive response to fear and uncertainty is your broker.

There are a few ways in which you can modify your behaviour at times like these to avoid being overwhelmed by the unknowns. First, and I hesitate to say this in a newspaper, find the off-switch. Go for a walk, read to your grandchildren, listen to some music. Second, use words to neutralise the power of images. The emotional brain is triggered by pictures, while the more complex nature of language activates your reflective brain. Ask yourself things like this: apart from the price, what else has changed; do the reasons why I bought this investment in the first place still apply? Third, keep an investment diary that tracks not just what you do but how you feel about it. You will start to see a pattern. You make the best investments when you are uncertain and scared. Finally, don’t follow the herd. What everyone else is doing, is usually wrong.

So, applying this contrarian Zen approach to today’s uncertainties, what might we conclude? First, whoever wins the US election, we are likely to see significant fiscal stimulus in 2021, aided and abetted by a supportive Federal Reserve. A big blue sweep implies more spending than a divided government, but it is a matter of degree not direction of travel.

Second, it is in the interests of neither the EU nor a UK government on the back foot to allow fishing rights and hypothetical state aid questions to get in the way of a trade deal. Expect a face-saving fudge.

Third, the widening gap between new infections and Covid-related deaths shows how far we have already come in six months when it comes to living with coronavirus. A vaccine will emerge in due course and the economy will quickly recover.

Finally, companies will adapt as they always have to external changes and threats. With around a quarter of the S&P 500 constituents having reported, around 80pc of companies are beating expectations. Investment analysts are no less prone to over-reacting to uncertainty than the rest of us. Investors hate uncertainty. They shouldn’t.

Tom Stevenson is an investment director at Fidelity International. The views are his own. He tweets at @tomstevenson63.