In these times of (ahem) “political uncertainty”, I am reminded of an observation that the incomparable Don Ezra made at a Russell conference a few years ago.
He noted the difference between two basic forms of risk: market (or investment) risk and political risk. He went on to observe: “Those of us making up this audience today live with market risk. We’re familiar with it. We understand it and cope with it. It doesn’t terrify us. For us, political risk is probably much less manageable and predictable.” Today, I think we can safely delete the “probably” from that sentence.
But not everybody lives in our world. Don described being a delegate at a White House Conference on Aging: “Most of the delegates there work directly with the elderly and the poor. What I learned from them is they know nothing about markets. Markets terrify them. They fear losing everything to a force that they don’t understand and can’t control. In contrast, they understand the political process very well.”
So, in each case, the familiar risk is unwelcome but bearable. It is the unfamiliar that terrifies.
And that is why the current market environment—dominated as it is by political considerations—is so uncomfortable for markets. It’s not just that political risk cannot be squeezed into a probability distribution (after all, market risk cannot be either—even though we like to act as if it can). It’s that it forces investors to work with the unfamiliar, where they cannot even kid themselves they know the odds.
The twist in this tale is that the unfamiliar can, over time, become familiar. If political wrestling becomes the norm, will markets become less terrified of it? Are we even seeing a little bit of that happening this time around: if there is last-minute brinksmanship over the debt ceiling, is it possible that markets will react less strongly than they did a year ago, simply because they feel like they’ve been here before? And would they be right to be less scared this time around or not? Those are tough questions to answer.
Meanwhile, for Russell’s formal analysis of the current situation, our take as of October 1 is available and as that gets updated, you’ll be able to see it on our Research page or if you are a client, login to ClientLINK.