Volatility and Uncertainty

Volatility and Uncertainty

Bubbles are built on uninformative social signals ("don't miss out, jump on the bandwagon begfore it's too late") rather than private ones (don't like these valuations one bit). Bubbles develop in assets that are uncertain, such as railways,  emerging markets and tech stocks...and cryptocurrencies and tech stocks again perhaps.

Big moves in volatility can hurt shares. Investors struggle to estimate future probabilities of a share price falling. Uncertainty rises. And as investors abhor uncertainty, shares will fall to price in an uncertainty premium. Following a bout of volatility, shares can reach a floor, providing better returns to the investor willing to take on uncertainty.

High volatility of volatility can lead to good returns. For example, the VIX was very volatile in the 2H 2008 paving the way for big rises in shares in 1H2009. This will not necessarily happen this time around. Having said that, prices can rise or fall during periods of reduced uncertainty premium.

It seems that we have been sleepwalking for too long in a haze of low uncertainty premium. We need to adjust to the return of volatility and uncertainty, especially the lurking unknown probabilities in the shadows. The known probabilities of risk have shifted and our portfolios reflect this.