The Independent Market Observer

Uncertainty Leads to Volatility. Duh!

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jun 25, 2012 9:38:17 AM

and tagged Market Updates, Europe

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Short term, overall market activity is largely random. Unless, that is, there is some overwhelming new information that can, in fact, change the aggregate valuation level. We thought that might happen this morning, with the Supreme Court preparing to rule on Obamacare. As it turns out, we’ll have to wait three more days, until June 28, to find out whether a proposed restructuring of about 18 percent of the U.S. economy is constitutional or not.

To quote our vice president, this is a big #*%!-ing deal. I don’t want to get into the details of the policy: first of all, I’m not qualified, and second of all, I try to stick to facts rather than opinions here. The factual takeaway, though, is that the federal government has asserted a right to restructure nearly a fifth of the economy. Literally everyone’s life will be affected in one way or another.

In the past, I’ve used other examples of how policy now overrides economics in many areas—interest rates, trade relations, government spending and benefit programs—but this is actually the 800-pound gorilla that proves my point. If constitutional, the bill will have immediate economic effects, changing tax rates, corporate policies, and individual lives on an everyday basis. A better example of policy trumping economics is hard to imagine.

None of this is to say that the policy is wrong or mistaken, just that it’s not driven by economics. As I mentioned the other day, the European project (you knew we would get to it eventually) is also a noneconomic endeavor. Major parts of life are inherently noneconomic as well—child-rearing, for example. Normally, when you spend lots of money, you get stuff. With my four-year-old son, I spend money and then get to spend more money!

And I love it. But the fact that noneconomic decision factors are playing a larger role in the economy also makes it much tougher for markets to incorporate information and come up with fair prices. In my opinion, volatility has increased over the past several years as a result. Policy changes and political winds can have outsize economic effects, and the markets have reflected this.

With Europe, with the health care decision, with the pending fiscal cliff and debt ceiling debate rerun, there will be plenty of noneconomic uncertainty on top of the usual economic uncertainty, which is also at an all-time high.

We live in interesting times.

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