What a boring world it would be if the future was entirely predictable.
We would have no need for fancy statistical models aimed at forecasting
the future direction of share prices; nor would it be possible to make
extraordinary profits by making forecasts that were more accurate than
others. Economists, statisticians, market analysts and even astrologers
would need to rethink their careers in a predictable world. However,
uncertainty is a fact of life. Not only financial markets, but the
entire universe is built around uncertainty.
Too much uncertainty though, is not a good thing. How can you make progress in life, if you cannot draw upon previous experiences and patterns to make an informed decision that is likely to lead to the best possible outcome? While I’m not the world’s best cook, I know that if I follow my favourite recipe for chocolate cake I’m likely to end up with something that is at least edible, if not delicious. That’s because I’ve used that recipe dozens of times before and it has never let me down. Similarly, in financial markets, making observations about the way markets have behaved previously in similar conditions should enable you to take the right actions and to reasonably predict the outcome. The high degree of volatility is evidence that the level of uncertainty is so high that buy/sell decisions have become more of a gamble than a rational process.
It’s not only share markets that are affected. The Government’s Deposit Guarantee Scheme introduced on 12 October has increased uncertainty in fixed interest markets. While it is reassuring to know that bank and certain non-bank deposits are now guaranteed, many questions now remain unanswered. What effect will this have on deposit interest rates? Will there be interest rate differentials between banks and non-banks where both are covered by the guarantee? What effect will there be on non-guaranteed fixed interest investments such as corporate bonds? Government intervention in markets usually results in distortions of some kind and it may be some time before we see the full effect of the Government’s actions.
So what should a prudent investor do? It really depends on your appetite for risk. If you are a conservative investor, or you are focused on short term returns, your best course of action may well be to play it safe with guaranteed deposits until the level of uncertainty is reduced. If you don’t mind risk, or you are focused on long term returns, then the high level of uncertainty may offer opportunities to take quick action on market anomalies, that is, where investments are selling for less than their fundamental value or offering higher than normal returns in relation to risk.
Harking back to astrologers, my horoscope this morning says: ‘If we are not careful, we start to think that we are here on this earth to wear the right clothes, eat the right food and worry about the Credit Crunch. That's not what it's all about. We are here to celebrate the magic and mystery of the Creation. We are here to experience deep gratitude for the precious gift of life; to enjoy every moment to the full and to do justice to the incredible force of compassion and invention that has put us here.’ In other words, let’s stop worrying and start living.