10 October 2018

The unknowns of uncertainty

In 2002 when asked about the lack of evidence linking Saddam Hussein to the supply of weapons of mass destruction to terrorist groups, Donald Rumsfeld replied with the now infamous quote, “as we know, there are known knowns; there are things we know we know.


We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns - the ones we don't know we don't know." As well as being an excellent non-answer to the question, it is a helpful way to think about the global economy and investment markets at the moment.

We are constantly being told that the world is currently full of uncertainty, but is that actually the case? Surely life in general is always full of uncertainty, and today is no different. So what can we be certain of? We know that US growth is proving resilient and that interest rates are on an upward trajectory. We know unemployment in the US remains low and that inflation is finally picking up. However, we also know that technological advances are changing consumer behaviour and putting pressure on companies’ abilities to increase prices. We also know that President Trump is a populist who will try and increase GDP growth by any means possible; while at the same time, President Xi Jinping is trying to slow down the rate of China’s economic growth to a more sustainable level. We also know that the US and China are critical to the health of the global economy.

What about the known unknowns, the uncertainty that we hear so much about. For UK investors Brexit lies at the top of the list; for Europeans it has to compete with the Italian government and the fallout from the migrant crisis. Brexit without doubt is a headache, with many possible outcomes, none of which will please everyone. There will be some companies who will benefit and some who will lose out, whatever the outcome. Other known unknowns are the outcome of President Trump’s trade wars, and the policies of the Trump White House in general. While in the UK, alongside Brexit, investors can ponder what impact a socialist government might have on the economy for the first time in over 30 years.

Finally, the unknown unknowns. Current examples of these are by their very nature difficult to identify. One way to think of them is as black swan events, as described by Nicholas Taleb. These are events that are extremely difficult to predict, and whose outcomes have far-reaching consequences that were not foreseeable. The Russian default in 1998, the 9/11 terrorist attacks and the 2008 housing crash, are all examples. It is worth noting that part of the reason that the impact of such events on markets is so great is that they occur when the mindset of investors has already turned negative and the event simply becomes a trigger to act.

As investors, we have to consider how we take into account all these factors. Obviously you could focus on what you can be certain of, which at the moment may be to just buy US stocks. That may prove fruitful in the short term, but it ignores what will happen if the trade war with China pushes inflation up, forcing interest rates to rise to a point where GDP growth is choked off, and the US to enter a recession. And it completely ignores the possibility of an event we cannot predict but which will have a serious impact on the US stock market. At the same time, we cannot prepare for the unknown by merely holding cash waiting for the ‘inevitable’ fall in markets that fails to materialise.

Instead we have to continue to focus on the fundamentals of the companies we invest in and rely on the benefits of diversification. It sounds boring and it may limit some of the potential upside for a portfolio, but it provides protection for when the downturn comes, and means that over time we hopefully have a little more certainty in the strength of our portfolios.


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