One of the most commonly repeated bromides on Wall Street today is: “Markets hate uncertainty.” But is this necessarily true?
The basis of this statement (which I believe is a misconception) is the observation that, from the 1980s through the ‘90s, a consistently transparent and accommodative Fed helped keep the markets on a relatively even keel throughout those years by providing investors with the assurance that monetary policy surprises wouldn’t upset the broad market’s rising trend.
There’s no denying that a fair degree of certitude surrounding interest rate and regulatory policy in Washington can provide the markets with a strong tailwind. This is particularly true when rates are low and trending even lower (as was largely true during the halcyon years mentioned above).
But what happens when rates are no longer falling and the Fed isn’t as transparent? When federal government policy is less consistent and predictable?
My answer is that, assuming the market’s liquidity backdrop is still accommodating (as it is now), prevailing uncertainty can actually become an investor’s best friend.
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Consider the context of today’s market backdrop: Geopolitical volatility, along with fiscal and trade policy uncertainties, has dramatically increased in the last six months. What’s more, the stock market was taken aback by the escalation of the tariff war between the U.S. and other countries earlier this year, reacting in the negative way that conventional wisdom would dictate.
Yet despite the continued uncertainties the market has endured in recent months, smart investors are beginning to adjust their expectations accordingly, with many learning to tune out the shrill political noise while focusing instead on market fundamentals.
By the same token, the intermittent waves of geopolitical turmoil we’ve experienced since the April market low have had another benefit (for the bulls). While the major averages have been largely unperturbed by the very latest war-related developments, legions of traders have reacted by building up short positions in numerous individual stocks—particularly ones they think might be vulnerable to bad news.
The predictable result is an unsustainably high buildup of short interest in some sectors, which could serve to fuel short-covering rallies…and such rallies in turn would help keep the market’s forward momentum intact.
While not a direct short interest measure, the CBOE put/call ratio has proven itself a fairly reliable gauge of investor sentiment. An overly bearish (a high ratio, typically above 1.0) signal in this indicator has historically presaged buying opportunities in the market, while an unreasonably bullish reading (a low ratio, typically under 1.0) often precedes or accompanies market bottoms.
As the following chart illustrates, after hitting a major peak—backed by excessive bearish sentiment and coincident with the early April bottom in the S&P 500—the put/call ratio (blue line) collapsed over the following few weeks before reversing higher in late May, while the S&P rallied.
Source: MacroMicro
Since then, the put/call ratio has trended higher as smaller traders are apparently skeptical of the staying power of the broad market rally. There can be little doubt that the latest flare-up in the Middle East contributed to the bearish sentiment, but from a contrarian’s perspective, this will likely prove supportive for stocks (as it has in the recent past).
3 Reasons Uncertainty Should (Mostly) Benefit the Market
Moreover, here are a couple of additional reasons why increasing levels of uncertainty should (mostly) benefit the market, near term:
1. Relentlessly strong gold and silver prices indicate extraordinarily high hedging demand against geopolitical volatility. Such activity normally supports equity strength.
2. The ratio of insider sales-to-buys has tended to be more bullish than bearish in recent months.
3. The recent (and historic) panic-induced reversal in the crude oil prices, from massively up to massively down in just a couple of days, is also supportive of near-term stock market strength—particularly in the tech sector—with such collapses historically prompting higher stock prices (e.g., June 2022 and June 2023).
All told, the prevailing angst on the economic, geopolitical and policy fronts serve as a reminder that, far from reacting emotionally, investors should embrace the uncertainty of the headline-related news/noise and view it for what it really represents: a psychological support for the market and an opportunity to practice contrarian investing principles.
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