Wednesday, November 10, 2010

Kiss Your Assets Goodbye When Certainty Reigns: Barry Ritholtz - Bloomberg.com


My friend Bob Quinn brought this article to my attention. I think it makes a number of good points.

As the author indicates, everything is always uncertain in the markets, otherwise there wouldn't be a market. While this sounds obvious, I have been constantly surprised when I go to an analyst's meeting, and someone says, "Well, I am going to start getting aggressive once the uncertainty goes away." And, of course, once the "uncertainty" leaves, prices usually move to the level that reflects the new information.

Charlie Munger has been Warren Buffett's investment partner for nearly 50 years, so knows a little bit about investing money. One of Munger's heroes is Ben Franklin. Franklin used to say that he did not feel qualified to comment on a subject unless he could state his opponent's point of view better than his opponent could. It seems to be true in investing as well: if we can figure out why someone is selling a particular stock, for example, we can also try to determine why their point of view might be wrong.

Here's an excerpt from Bloomberg:

“The markets hate uncertainty.”

If you wandered anywhere near a television in advance of the midterm elections, the Federal Open Market Committee meeting or October’s employment report, that cliche was unavoidable. It was the pundits’ preferred proverb.

Wall Street has a sweet tooth for such investing maxims. They infect the trading community like influenza in December. Repeat mindless dictums ad nauseum, and they soon become the accepted wisdom.

The problem with these supposed truisms is they are no more accurate than the flip of a coin. A closer look at this uncertainty meme reveals it to be a false-ism -- one of those emotionally appealing phrases that ping around trading desks. The lack of evidence supporting their premise seems to matter very little.

To recognize how meaningless these statements are, consider the opposite: Could markets function without uncertainty? It takes only a little thought to realize that markets actually thrive on doubt, imperfect information and a lack of consensus.

Uncertainty drives the market’s price-discovery mechanism. Investing requires there to be differences of opinion. When there is broad agreement as to an asset’s fair value, trading volume falls. Without any uncertainty, who would take the opposite side of your trade?

History teaches that whenever the opposite occurs -- when certainty overwhelms uncertainty -- the herd tends to be wrong. In rare instances, when there is a near-total lack of uncertainty in the market, the outcome is usually a spectacular disaster.


Kiss Your Assets Goodbye When Certainty Reigns: Barry Ritholtz - Bloomberg.com