There is a difference between uncertainty and risk. Risk can be measured, it can be mitigated or hedged, while uncertainty is just that, and you can’t do anything with it. The cross-currents in our economic and market environment have been overwhelming. And contradictions, inconsistencies, partial understanding, have been a greater cause behind escalating volatility and downward index swings, than any discrete element such as Greece or financial regulation. That is to say, uncertainty rather than risk – whether we are in the midst of a bull market correction or in a new bear market – has led to the “de-risking” to which many refer, and the sentiment is foremost one of no confidence.
This is not mere semantics. While risk management can be contained to portfolio and investing style, befuddlement may spread into the real economy. Uncertainty may cause the loan officer, unable to quantify the downside, to stop lending. Confusion (and fear) could make consumer spending slow down. Diminished forecasting ability may cause the business manager to not hire. The list of examples goes on, and the result could be self-fulfilling.
If one were to try to pinpoint the root of this possible condition, the element that increasingly comes back, in my opinion, is “manipulation.” I don’t use the term in the legal or regulatory sense, but more as it relates to public relations. While public relations may be intended to boost confidence, or calm fears, it can trigger distrust when it is inconsistent, flies too much in the face of data, (let alone common sense), and when statements seem excessively orchestrated. In this case, public relations can feed skepticism, which is more akin to uncertainty than it is to risk. Some illustrative highlights:
Fitch downgraded Spain two notches, from AAA to AA+, with a “stable outlook,” a few weeks after S&P downgraded Spain only one notch, from AA+ to AA, and maintained its outlook negative. Moody’s, weirdly enough, still has Spain rated Aaa. Knowing what we now know – in the post sub-prime debacle – about the rating agency system and its imperfections and pressures, what are we to make of such divergence and its timing? What are we to assume, if anything, about Fitch releasing its statement in the mid-afternoon of a Friday prior to a long holiday weekend, when many traders have already tuned out? These questions and others have been rightly asked by analysts and journalists, and underscore the skepticism to which inconsistency and too much orchestration can lead. When every Fed governor in the land, plus the OECD, are vehement in asserting that the economy is sprouting in the U.S. and elsewhere, what are we to make of the newly released ECRI index update, putting us back where we were last August?
I throw this hodgepodge of examples together purposely, to highlight the undercurrents and demonstrate the confusion, because such variety of contrary signals can now be observed on a daily basis. More often than not, there is an element of announcement, assertion, declaration, on one hand, and economic reality on the other. The two sometimes coincide, and sometimes not, and there may or may not be an agenda. If, however, the purpose is one of public relations, as mentioned – to boost confidence, to diminish fear, manage turmoil, and give capital markets the push that may be necessary as the stimulant effects of 2009 begin to wane – the results could in fact be the reverse.
More than anything, what boosts confidence and diminishes fear is credibility. When this is jeopardized, when risk is replaced with uncertainty and analytic confidence with befuddlement, the resulting volatility can be a dangerous scenario.
